Ecolab Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Interim financial statements are unaudited and were reviewed, not audited, by PwC.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net sales | $3,462.7 million | $3,317.2 million | $6,624.3 million | $6,414.6 million |
| Operating income | $439.0 million | $412.5 million | $812.3 million | $784.0 million |
| Net income attributable to Ecolab | $296.6 million | $258.4 million | $550.1 million | $489.2 million |
| Diluted EPS | $1.01 | $0.87 | $1.87 | $1.64 |
| Operating cash flow | — | $859.7 million | $874.8 million |
Q2 reported sales increased 4%; fixed-currency sales grew 5%, including 3% volume, 1% pricing and 1% acquisition contribution, partly offset by a 1% currency effect. For the first six months, reported sales increased 3% and fixed-currency sales 4%.
Reported operating income rose 6% in Q2 and 4% year to date. Excluding special items, adjusted operating income was essentially flat in both periods; adjusted fixed-currency operating income grew 1%. Reported operating margin was 12.7% versus 12.4% in Q2 and 12.3% versus 12.2% year to date. Adjusted gross margin declined to 46.7% from 48.0% in Q2 and to 46.6% from 47.7% year to date, mainly due to higher delivered product costs and unfavorable currency hedges; pricing and cost savings partly offset these pressures.
Adjusted diluted EPS, a non-GAAP measure excluding special items and discrete tax effects, increased 5% to $1.13 in Q2 and 4% to $1.93 year to date. Reported diluted EPS increased 16% and 14%, respectively. Lower reported tax rates (21.4% Q2; 19.6% year to date, versus 24.1% in both prior periods) benefited from share-based compensation tax benefits and other discrete items. Management expected those excess tax benefits to affect the full-year 2017 tax rate by approximately 1%–3%.
Segments and material period changes
- Global Industrial: Q2 fixed-currency sales +3%; operating income −4%. Higher input costs, currency hedging effects and business investment weighed on margins.
- Global Institutional: Q2 fixed-currency sales +8%, but +3% acquisition-adjusted; operating income +7%. Anios contributed substantially to reported growth; acquisition-adjusted sales were led by Specialty and Healthcare.
- Global Energy: Q2 fixed-currency sales +4% and acquisition-adjusted +5%; operating income −8%. Well stimulation and downstream gains were offset by production declines and cost pressures. Oil-market activity was recovering gradually from 2016 lows, but remained a source of volatility.
- Other: Q2 fixed-currency sales +6%; operating income −3%, with field investment weighing on margins.
Ecolab acquired European hygiene and disinfection company Anios on February 1, 2017, for $798.3 million total consideration, including repayment of $192.8 million of debt. Anios had approximately $245 million of pre-acquisition annual sales. Its preliminary purchase accounting included $518.1 million of goodwill, which was not expected to be tax-deductible; allocation remained subject to change.
Cash flow, debt and liquidity
Six-month operating cash flow was $859.7 million, down $15.1 million year over year. Investing activities used $1,150.1 million, principally reflecting the Anios acquisition; capital expenditures were $340.2 million. Financing activities provided $226.0 million, including $909.8 million of net commercial paper and notes payable issuance, offset partly by $501.1 million of share repurchases and $222.9 million of dividends. Cash ended the period at $260.7 million, of which $254.7 million was held outside the U.S.
Total debt was $7.68 billion at June 30, 2017, up from $6.85 billion at December 31, 2016; net debt was $7.42 billion. Short-term debt was $1.77 billion, including $918 million of commercial paper and $810.8 million of current maturities. The company reported net debt/EBITDA of 2.6x and net debt/adjusted EBITDA of 2.6x. A $2.0 billion revolving credit facility, expiring December 2019, had no borrowings; commercial paper outstanding totaled $918 million, with a reported average annual rate of 0.9%. Ecolab said it was in covenant compliance and expected operating cash flow and borrowings to fund foreseeable requirements. Current assets were $4.53 billion versus current liabilities of $4.32 billion.
Outlook, unusual items and risks
- Management expected strong operating cash flow to fund foreseeable needs over the next 12 months, including debt repayments, investment, acquisitions, dividends, repurchases and pension contributions. No specific earnings or sales guidance for the full year is provided in the supplied filing text.
- A new restructuring plan targets approximately 530 positions and includes asset disposals and lease terminations. Ecolab recorded $33 million of Q2 charges and expected total charges of $40–$45 million ($30–$35 million after tax), with remaining charges expected in the second half of 2017. Most pretax costs were expected to be cash expenditures.
- Total special gains and charges were $61.2 million in Q2 and $68.9 million year to date, versus $88.1 million and $94.4 million in 2016. Items included restructuring, Anios/Swisher acquisition and integration costs, Global Energy vendor-contract and litigation charges, and Venezuela cash-recovery gains. No 2017 energy-related charges were recorded; 2016 included $63.6 million of such charges.
- Legal and environmental contingencies include Deepwater Horizon-related litigation involving Nalco, environmental remediation at approximately 40 locations, and other claims. The company said it did not currently believe material losses beyond accruals were reasonably possible for the described legal matters, but outcomes remain uncertain. The filing also reports a Texas environmental-agency administrative penalty of approximately $1.06 million, partly paid or conditionally offset.
- Other key exposures include oil and gas market volatility, foreign-exchange and political risks, raw-material costs, substantial indebtedness, acquisition integration, regulation and litigation. A non-U.S. subsidiary disclosed Iran-related sales of $321,071 in its second quarter and a further $379,000 in June 2017 under U.S. General License H.
- New revenue-recognition guidance was expected to take effect January 1, 2018. Management anticipated separate reporting of service revenue—service-related performance obligations represented more than 10% of consolidated sales when aggregated with currently reported service revenue—and possible reclassification of certain SG&A costs to cost of sales. The company anticipated full retrospective adoption, subject to completing its analysis.
Most important facts for investors to verify
- Whether organic and acquisition-adjusted sales growth, particularly in Institutional and Energy, translates into sustained operating-income and margin improvement.
- How delivered product costs and unfavorable currency-hedge effects evolve, and whether restructuring delivers savings sufficient to offset its charges and cash costs.
- Debt repayment and liquidity plans, including the elevated $1.77 billion of short-term debt and the Anios-related increase in leverage.
- The final Anios purchase-price allocation, integration performance and contribution to earnings and cash flow.
- Potential outcomes and financial exposure from Deepwater Horizon claims, environmental matters and other litigation, as well as the effects of tax items and upcoming accounting changes.