EX-13.1 9 a12-28463_1ex13d1.htm EX-13.1

Exhibit 13.1

 

MANAGEMENT’S DISCUSSION & ANALYSIS

 

The following management discussion and analysis (“MD&A”) provides information that we believe is useful in understanding our operating results, cash flows and financial condition. The discussion should be read in conjunction with the consolidated financial information and related notes included in this Annual Report and the unaudited pro forma condensed combined statement of income for the twelve months ended December 31, 2011 and corresponding footnotes (the “2011 Merger Pro Formas”) included as a part of Exhibit 99.1 to our Current Report on Form 8-K filed on April 27, 2012. The 2011 Merger Pro Formas are incorporated herein by reference.

 

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). This discussion contains various “Non-GAAP Financial Measures” and various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We refer readers to the information on Non-GAAP Financial Measures, Forward-Looking Statements and Risk Factors found on pages 26 and 27.

 

Comparability of Results

 

2012 versus 2011

 

On December 1, 2011, Nalco Holding Company (“Nalco”) merged into a wholly-owned subsidiary of Ecolab Inc. (“Ecolab”, “the company”, “we” or “our”), creating the global leader in water, hygiene and energy technologies and services that provide and protect clean water, safe food, abundant energy and healthy environments.

 

Our results of operations include Nalco since the close of the merger on December 1, 2011. Because Nalco’s operations had such a significant impact on our operations, a comparison of our reported results for the twelve months ended December 31, 2012 against our reported results for the twelve months ended December 31, 2011 is not entirely meaningful. In order to provide a meaningful comparison of our results of operations, where applicable (generally net sales through operating income), we have supplemented our historical financial data with discussion and analysis that compares reported and adjusted results for the twelve months ended December 31, 2012 against the 2011 Merger Pro Formas.

 

The 2011 Merger Pro Formas are based on the historical consolidated financial statements and accompanying notes of both Ecolab and Nalco and were prepared to illustrate the effects of our merger with Nalco, assuming the merger had been consummated on January 1, 2010. The 2011 Merger Pro Formas also include the movement of certain legacy Ecolab water treatment related businesses from the U.S. Cleaning & Sanitizing and International Cleaning, Sanitizing & Other Services reportable segments to the Global Water reportable segment, which resulted from changes in how we internally manage and report results within our legacy Ecolab Food & Beverage and Asia Pacific operating units. The movement of the water treatment related business did not significantly impact year-over-year comparability; therefore, prior year reported segment information has not been restated to reflect this change.

 

The unaudited 2012 adjusted results and 2011 adjusted pro forma results exclude special (gains) and charge items that are unusual in nature and significant in amount. The exclusion of such items help provide a better understanding of underlying business performance.

 

The unaudited pro forma and adjusted pro forma results are not necessarily indicative of the results of operations that would have actually occurred had the merger been completed as of the date indicated, nor are they indicative of future operating results of the combined company.

 

Reported data for both 2012 and 2011 and comparison against applicable unaudited pro forma data for 2011 included within this MD&A are shown in the following tables. Reconciliations of reported, pro forma, adjusted and pro forma adjusted amounts are provided on pages 14-18 of this MD&A.

 

Selected Statement of Income Data

 

 

 

REPORTED

 

REPORTED

 

PRO FORMA

 

MILLIONS

 

2012

 

2011

 

2011

 

Net sales

 

$

11,838.7

 

$

6,798.5

 

$

11,283.9

 

Cost of sales

 

6,483.5

 

3,475.6

 

6,126.4

 

Selling, general and administrative expenses

 

3,920.2

 

2,438.1

 

3,920.6

 

Special (gains) and charges

 

145.7

 

131.0

 

(19.8)

 

Operating income

 

$

1,289.3

 

$

753.8

 

$

1,256.7

 

 

Special (Gains) and Charges

 

 

 

REPORTED

 

REPORTED

 

PRO FORMA

 

MILLIONS

 

2012

 

2011

 

2011

 

Net sales

 

 

 

 

 

 

 

Customer agreement modification

 

$

 

$

29.6

 

$

29.6

 

Cost of sales

 

 

 

 

 

 

 

Restructuring charges

 

22.7

 

5.3

 

5.3

 

Recognition of Nalco inventory fair value step-up

 

71.2

 

3.6

 

3.6

 

Subtotal

 

93.9

 

8.9

 

8.9

 

Special (gains) and charges

 

 

 

 

 

 

 

Restructuring charges

 

116.6

 

69.0

 

77.9

 

Champion acquisition costs

 

18.3

 

 

 

Nalco merger and integration costs

 

70.9

 

57.7

 

34.0

 

Gain on sales of businesses, litigation related charges and other

 

(60.1)

 

4.3

 

(131.7)

 

Subtotal

 

145.7

 

131.0

 

(19.8)

 

Total special (gains) and charges within operating expense

 

$

239.6

 

$

169.5

 

$

18.7

 

 

Reportable Segments

 

 

 

REPORTED

 

REPORTED

 

PRO FORMA

 

MILLIONS

 

2012

 

2011

 

2011

 

Net sales

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing

 

$

2,992.9

 

$

2,930.3

 

$

2,839.0

 

U.S. Other Services

 

474.6

 

457.1

 

457.1

 

International Cleaning, Sanitizing & Other Services

 

3,175.8

 

3,075.1

 

3,027.4

 

Global Water

 

2,087.4

 

67.2

 

2,014.0

 

Global Paper

 

805.4

 

33.9

 

811.8

 

Global Energy

 

2,268.0

 

92.3

 

1,873.4

 

Corporate

 

 

(29.6)

 

(29.6)

 

Subtotal at fixed currency rates

 

11,804.1

 

6,626.3

 

10,993.1

 

Effect of foreign currency translation

 

34.6

 

172.2

 

290.8

 

Consolidated

 

$

11,838.7

 

$

6,798.5

 

$

11,283.9

 

 

 

 

 

 

 

 

 

Operating Income

 

 

 

 

 

 

 

U.S. Cleaning & Sanitizing

 

$

651.4

 

$

556.7

 

$

568.5

 

U.S. Other Services

 

70.8

 

69.7

 

69.7

 

International Cleaning, Sanitizing & Other Services

 

340.8

 

285.8

 

280.3

 

Global Water

 

235.9

 

11.0

 

196.7

 

Global Paper

 

86.3

 

6.2

 

75.9

 

Global Energy

 

360.1

 

17.7

 

264.0

 

Corporate

 

(459.9)

 

(211.6)

 

(226.6)

 

Subtotal at fixed currency rates

 

1,285.4

 

735.5

 

1,228.5

 

Effect of foreign currency translation

 

3.9

 

18.3

 

28.2

 

Consolidated

 

$

1,289.3

 

$

753.8

 

$

1,256.7

 

 

2011 versus 2010

 

Based on the December 1, 2011 completion of the Nalco merger, one month of legacy Nalco U.S. subsidiary activity was included in the

 

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consolidated Ecolab results during 2011. Consistent with our historical practice, International subsidiaries are included in the financial statements on the basis of their U.S. GAAP November 30 fiscal year-ends.

 

In order to provide the most meaningful comparisons of 2011 results of operations versus 2010 results of operations, where applicable, comparisons made throughout the MD&A of 2011 results against 2010 results have been presented excluding the 2011 post merger Nalco activity. In addition, the unaudited 2011 and 2010 adjusted results exclude special (gains) and charge items that are unusual in nature and significant in amount. The exclusion of such items help provide a better understanding of underlying business performance.

 

Reconciliations of reported and adjusted amounts are provided on pages 14-22 of this MD&A.

 

Fixed Currency Foreign Exchange Rates

 

We evaluate the performance of our international operations based on fixed currency exchange rates, which eliminate the impact of exchange rate fluctuations on our international operations. Fixed currency amounts for all years presented are updated annually based on translation into U.S. dollars at fixed foreign currency exchange rates established by management at the beginning of 2012.

 

EXECUTIVE SUMMARY

 

In 2012, Ecolab significantly outpaced continued mixed conditions in our end markets to deliver strong double-digit adjusted earnings growth. We also made key investments in growth drivers for the future and achieved another year of outstanding shareholder returns.

 

We realized strong fixed currency organic growth as our teams emphasized our innovative product and service strengths to help customers obtain better results and lower costs, and through these, we drove new account gains across our customer segments. We continued to implement appropriate price increases to help offset higher delivered product costs and investments in our business. We also used new products, cost efficiencies and merger synergies to leverage margins and deliver the strong earnings gain.

 

Global hospitality markets continued to show improving trends and food and beverage and healthcare were generally steady, while foodservice markets in the U.S. and Europe remained soft. Regionally, Latin America continued to show very good growth, the U.S. and Asia Pacific showed steady trends and Europe softened. Global industrial end markets showed improving trends, light end markets were mixed and mining slowed throughout the year. Regionally, all water markets showed steady trends in the Americas and Asia Pacific and general softness in Europe, Middle East and Africa (“EMEA”); paper end markets remained soft, especially in the U.S. and Asia Pacific. Energy upstream end markets were strong in the Americas, the Middle East and Africa (“MEA”) and North Sea and downstream end markets were steady globally. Within this backdrop, we continued to focus on driving our sales, working to expand our shares in all markets and regions; investing in new product development that provide outstanding results and enable customers to save labor, water and energy; making smart investments to sustain our growth in the future; strengthening our safety culture; and employing strategic acquisitions to bolster the current business and to develop new areas of growth.

 

We also made important investments for the future, including announcing the creation of a new organization model to support global growth, developing common employee benefits and other key policies and mapping a global shared services organization model. We announced our intent to make a major investment in the energy market, with the pending acquisition of Champion Technologies and its related company Corsicana Technologies (collectively “Champion”). Champion is a Houston, Texas-based global energy specialty products and services company with approximately 3,300 employees in more than 30 countries delivering product and service-based offerings to the oil and gas industry. Champion’s sales for the business to be acquired were approximately $1.4 billion in 2012. The Champion acquisition remains subject to various closing conditions.

 

Through these focused actions, we once again delivered outstanding results for our shareholders in 2012 while building opportunity for the future. Our performance underscored the strength and long term potential of our business, our people and our strategies.

 

Sales: Reported 2012 sales of $11.8 billion increased 74% compared to reported 2011 sales of $6.8 billion and 5% compared to 2011 pro forma sales of $11.3 billion. Sales were negatively impacted by foreign currency exchange compared to the prior year, as 2012 fixed currency sales increased 7% when compared to 2011 adjusted pro forma fixed currency sales. See the section entitled Non-GAAP Financial Measures on page 26 for further information on our Non-GAAP measures, the Net Sales table on page 14, and the Sales by Reportable Segment tables on page 19.

 

Gross Margin: Our reported gross margin was 45.2% of sales for 2012, which compared against a 2011 reported gross margin of 48.9% and a 2011 pro forma gross margin of 45.7%. Excluding the impact of special (gains) and charges included in sales from 2011 and in cost of sales from both 2012 and 2011, our 2012 adjusted gross margin was 46.0% and our 2011 pro forma adjusted gross margin was 45.9%. See the section entitled Non-GAAP Financial Measures on page 26 for further information on our Non-GAAP measures, and the Gross Margin table on page 14.

 

Operating Income: Reported operating income increased 71% to $1,289 million in 2012 when compared to $754 million in 2011. Reported 2012 operating income increased 3% when compared to 2011 pro forma operating income of $1,257 million. Excluding the impact of special (gains) and charges from 2012 reported operating income and from 2011 pro forma operating income, 2012 adjusted operating income increased 20% when compared against 2011 adjusted pro forma operating income. Foreign currency had a negative impact on operating income growth, as 2012 adjusted fixed currency operating income increased 22% when compared to 2011 adjusted pro forma fixed currency operating income. See the section entitled Non-GAAP Financial Measures on page 26 for further information on our Non-GAAP measures, the Operating Income table on page 17, and Operating Income by Reportable Segment tables on pages 21 and 22.

 

Earnings Per Share: Reported diluted earnings per share increased 23% to $2.35 in 2012 compared to $1.91 in 2011. Special (gains) and charges had a significant impact on both years, driven by restructuring charges and Nalco integration costs incurred in both 2012 and 2011, Champion acquisition costs, the gain on sale of our Vehicle Care business and litigation related charges in 2012, and the modification of a long-term customer agreement in 2011. Nalco merger related activity also negatively impacted 2011 reported diluted earnings per share. Non-GAAP adjusted earnings per share, which exclude the impact of special (gains) and charges and discrete tax items from both 2012 and 2011 and Nalco merger related activity from 2011, increased 17% to $2.98 in 2012 compared to $2.54 in 2011. See the section entitled Non-GAAP Financial Measures on page 26 for further information on our Non-GAAP measures, and the Diluted Earnings Per Common Share (“EPS”) table on page 18.

 

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Cash Flow: Cash flow from operating activities was $1.2 billion in 2012. We continued to generate strong cash flow from operations, allowing us to fund our ongoing operations, investments in the business, acquisitions and pension obligations and return cash to our shareholders through share repurchases and dividend payments.

 

Balance Sheet: We remain committed to our stated objective of having an investment grade balance sheet, supported by our current rating of BBB+/Baa1 by the major ratings agencies. We expect to return to “A” ratings metrics by the end of 2015. Our strong balance sheet has allowed us continued access to capital at attractive rates.

 

Dividends: We increased our quarterly cash dividend 15% in December 2012 to an indicated annual rate of $0.92 per share. The increase represents our 21st consecutive annual dividend rate increase and the 76th consecutive year we have paid cash dividends. We have achieved this outstanding dividend record through our excellent business model and strong financial position, and we believe our recent actions have strengthened our growth prospects, cash flow and ability to deliver superior shareholder returns going forward.

 

Restructuring Initiatives: In February 2011, we commenced a comprehensive plan to improve substantially the efficiency and effectiveness of our European business, sharpen its competitiveness and accelerate its growth and profitability. Despite the very slow conditions in Europe, we grew our sales and expanded operating margins, benefiting from our work to leverage our scale, improve process efficiency, consolidate facilities, and simplify and enhance our product portfolio. We expect the restructuring activities related to this plan will be substantially completed by the end of 2013.

 

Following the completion of the Nalco merger, we commenced plans in January 2012 to undertake restructuring actions related to the reduction of our global workforce and optimization of our supply chain and office facilities. We expect that restructuring activities related to the Nalco merger will be substantially completed by the end of 2013.

 

Nalco Merger Integration: The integration of Ecolab and Nalco continues to be on track. Our teams came together quickly and smoothly, meeting or beating all of our merger goals for the first year. Customer reaction to our combined offering was excellent, allowing us to be more confident than ever in the value we will create through the merger. We were also successful using joint innovation processes to introduce several new products across our legacy platforms.

 

CRITICAL ACCOUNTING ESTIMATES

 

Our consolidated financial statements are prepared in accordance with U.S. GAAP. We have adopted various accounting policies to prepare the consolidated financial statements in accordance with U.S. GAAP. Our most significant accounting policies are disclosed in Note 2 of the Notes to the Consolidated Financial Statements.

 

Preparation of our consolidated financial statements, in conformity with U.S. GAAP, requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Estimates are considered to be critical if they meet both of the following criteria: (1) the estimate requires assumptions to be made about matters that are highly uncertain at the time the accounting estimate is made, and (2) different estimates that the company reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, have a material impact on the presentation of the company’s financial condition or results of operations.

 

Besides estimates that meet the “critical” estimate criteria, we make many other accounting estimates in preparing our financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets, liabilities, revenues or expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and other information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, even from estimates not deemed critical. Our critical accounting estimates include the following:

 

Revenue Recognition

 

We recognize revenue on product sales at the time evidence of an arrangement exists, title to the product and risk of loss transfers to the customer, the price is fixed and determinable and collection is reasonably assured. We recognize revenue on services as they are performed. While we employ a sales and service team to ensure our customer’s needs are best met in a high quality way, the vast majority of our revenue is generated from product sales. Outside of the service businesses discussed in Note 16, any other services are either incidental to a product sale and not sold separately or are insignificant.

 

Our sales policies do not provide for general rights of return. Critical estimates used in recognizing revenue include the delay between the time that products are shipped, when they are received by customers, when title transfers and the amount of credit memos issued in subsequent periods. We record estimated reductions to revenue for customer programs and incentive offerings including pricing arrangements, promotions and other volume-based incentives at the time the sale is recorded. We also record estimated reserves for anticipated uncollectible accounts and for product returns and credits at the time of sale. Depending on market conditions, we may increase customer incentive offerings, which could reduce gross profit margins at the time the incentive is offered.

 

Valuation Allowances and Accrued Liabilities

 

We estimate sales returns and allowances by analyzing historical returns and credits, and apply these trend rates to calculate estimated reserves for future credits. We estimate the allowance for doubtful accounts by analyzing accounts receivable balances by age and applying historical write-off and collection trend rates. In addition, our estimates also include separately providing for customer balances based on specific circumstances and credit conditions, and when it is deemed probable that the balance is uncollectible. Actual results could differ from these estimates under different assumptions. Our allowance for doubtful accounts balance was $73 million and $49 million, as of December 31, 2012 and 2011, respectively. These amounts include our allowance for sales returns and credits of $13 million and $12 million as of December 31, 2012 and 2011, respectively. Our bad debt expense as a percent of net sales was 0.3%, 0.2% and 0.3% in 2012, 2011 and 2010, respectively. We believe that it is reasonably likely that future results will be consistent with historical trends and experience. However, if the financial condition of our customers were to deteriorate, resulting in an inability to make payments, or if unexpected events, economic downturns, or significant changes in future trends were to occur, additional allowances may be required.

 

Our business and operations are subject to extensive environmental laws and regulations governing, among other things, air emissions, wastewater discharges, the use and handling of hazardous substances, waste disposal and the investigation and remediation of soil and groundwater contamination. As with other companies

 

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engaged in similar manufacturing activities and providing similar services, some risk of environmental liability is inherent in our operations. Estimates used to record liabilities related to pending litigation and environmental claims are based on our best estimate of probable future costs. We record the amounts that represent the points in the range of estimates that we believe are most probable or the minimum amount when no amount within the range is a better estimate than any other amount. Potential insurance reimbursements generally are not anticipated in our accruals for environmental liabilities or other insured losses. Expected insurance proceeds are recorded as receivables when recovery is probable. While the final resolution of litigation and environmental contingencies could result in amounts different than current accruals, and therefore have an impact on our consolidated financial results in a future reporting period, we believe the ultimate outcome will not have a significant effect on our financial or liquidity position.

 

Actuarially Determined Liabilities

As part of the merger with Nalco, we assumed sponsorship of the Nalco qualified and non-qualified pension and other postretirement benefit plans.

 

The measurement of our pension and postretirement benefit obligations are dependent on a variety of assumptions determined by management and used by our actuaries. These assumptions affect the amount and timing of future contributions and expenses.

 

The assumptions used in developing the required estimates include, among others, discount rate, projected salary and health care cost increases, and expected return on assets. The discount rate assumptions for the U.S. Plans are assessed using a yield curve constructed from a subset of bonds yielding greater than the median return from a population of non-callable, corporate bond issues rated Aa by Moody’s Investor Services or AA by Standard & Poors. The discount rate is calculated by matching the Plans’ projected cash flows to the bond yield curve. Projected salary and health care cost increases are based on our long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategies and views of investment advisors.

 

The effects of actual results differing from our assumptions, as well as changes in assumptions, are reflected in the unrecognized actuarial loss and amortized over future periods and, therefore, generally affect our recognized expense in future periods. Significant differences in actual experience or significant changes in assumptions may materially affect pension and other post-retirement obligations. The unrecognized actuarial loss on our U.S. qualified and non-qualified pension plans increased from $690 million to $769 million (before tax) as of December 31, 2011 and 2012, respectively, primarily due to a decrease in our discount rate. The assumptions used to estimate our U.S. pension and postretirement obligations vary by plan. In determining our U.S. pension obligations for 2012, our discount rate decreased to 4.14% from a weighted average 4.86% at year-end 2011 and our weighted-average projected salary increase increased from 4.08% as of December 31, 2011 to 4.32% as of December 31, 2012. In determining our U.S. postretirement health care obligation for 2012, our discount rate decreased to 3.95% from a weighted-average 4.80% at year-end 2011. Our weighted-average expected return on U.S. plan assets, which reflects our expected long-term returns on plan assets used for determining 2012 and 2013 U.S. pension expense, was 8.25%. Our weighted-average expected return on plan assets used for determining 2012 and 2013 U.S. postretirement health care expense was 8.25%.

 

The effect on December 31, 2012 funded status and 2013 expense of a decrease in the discount rate or expected return on assets assumption as of December 31, 2012 is shown below assuming no changes in benefit levels and no amortization of gains or losses for our major plans:

 

MILLIONS

 

EFFECT ON U.S. PENSION PLANS

 

ASSUMPTION

 

ASSUMPTION
CHANGE

 

INCREASE IN
RECORDED
OBLIGATION

 

HIGHER
2013
EXPENSE

 

Discount rate

 

-0.25 pts

 

$60.2

 

$5.0

 

Expected return on assets

 

-0.25 pts

 

N/A

 

$3.9

 

 

MILLIONS

 

EFFECT ON U.S. POSTRETIREMENT
HEALTH CARE BENEFITS PLANS

 

ASSUMPTION

 

ASSUMPTION
CHANGE

 

INCREASE IN
RECORDED
OBLIGATION

 

HIGHER
2013
EXPENSE

 

Discount rate

 

-0.25 pts

 

$8.2

 

$0.6

 

Expected return on assets

 

-0.25 pts

 

N/A

 

$0.1

 

 

Our international pension obligations and underlying plan assets are approximately one third of our global pension plans, with the majority of the amounts held in the U.K. and Eurozone countries. We use similar assumptions to measure our international pension obligations. However, the assumptions used vary by country based on specific local country requirements and information.

 

See Note 15 for further discussion concerning our accounting policies, estimates, funded status, planned contributions and overall financial positions of our pension and post-retirement plan obligations.

 

In the U.S. we have high deductible insurance policies for casualty and property losses, subject to per occurrence and liability limitations. Globally, we have high deductible insurance policies for property losses. We are insured for losses in excess of these limitations and have recorded both a liability and an offsetting receivable for amounts in excess of these limitations. We are self-insured for health care claims for eligible participating employees, subject to certain deductibles and limitations. We determine our liabilities for claims on an actuarial basis. A change in these assumptions would cause reported results to differ.

 

Restructuring

We incur costs for restructuring activities associated with plans to enhance our efficiency and effectiveness and sharpen the competitiveness of our businesses. These restructuring plans include costs associated with significant actions involving employee-related severance charges, contract termination costs and asset write-downs. Employee termination costs are largely based on policies and severance plans, and include personnel reductions and related costs for severance, benefits and outplacement services. These charges are reflected in the quarter in which the actions are probable and the amounts are estimable, which is generally when management approves the associated actions. Contract termination costs include charges to terminate leases prior to the end of their respective terms and other contract termination costs. Asset write-downs include leasehold improvement write-downs and other asset write-downs associated with combining operations.

 

Restructuring charges have been included as a component of both cost of sales and special (gains) and charges on the Consolidated Statement of Income. Amounts included as a component of cost of sales include supply chain and manufacturing related actions. Restructuring liabilities have been classified as a component of other current liabilities on the Consolidated Balance Sheet. We

 

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expect to incur a total of $330 million in charges for our two active restructuring plans from 2011 to 2013 and at December 31, 2012, we had a restructuring liability of $117 million. For additional information on our current restructuring activities, see Note 3.

 

Income Taxes

Judgment is required to determine the annual effective income tax rate, deferred tax assets and liabilities and any valuation allowances recorded against net deferred tax assets. Our effective income tax rate is based on annual income, statutory tax rates and tax planning available in the various jurisdictions in which we operate. Our annual effective income tax rate includes the impact of reserve provisions. We recognize the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority. We adjust these reserves in light of changing facts and circumstances. During interim periods, this annual rate is then applied to our year-to-date operating results. In the event that there is a significant discrete item recognized in our interim operating results, the tax attributable to that item would be separately calculated and recorded in the same period.

 

Tax regulations require items to be included in our tax returns at different times than the items are reflected in our financial statements. As a result, the effective income tax rate reflected in our financial statements differs from that reported in our tax returns. Some of these differences are permanent, such as expenses that are not deductible on our tax return, and some are temporary differences, such as depreciation expense.

 

Temporary differences create deferred tax assets and liabilities. Deferred tax assets generally represent items that can be used as a tax deduction or credit in our tax return in future years for which we have already recorded the tax benefit in our income statement. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the utilization of the entire deduction or credit. Relevant factors in determining the realizability of deferred tax assets include future taxable income, the expected timing of the reversal of temporary differences, tax planning strategies and the expiration dates of the various tax attributes. Deferred tax liabilities generally represent items for which we have already taken a deduction in our tax return, but have not yet recognized that tax benefit in our financial statements.

 

U.S. deferred income taxes are not provided on certain unremitted foreign earnings that are considered permanently reinvested. Undistributed earnings of foreign subsidiaries are considered to have been reinvested indefinitely or are available for distribution with foreign tax credits available to offset the amount of applicable income tax and foreign withholding taxes that might be payable on earnings. It is impractical to determine the amount of incremental taxes on an ongoing basis that might arise if all undistributed earnings were distributed.

 

A number of years may elapse before a particular tax matter, for which we have established a reserve, is audited and finally resolved. The number of tax years with open tax audits varies depending on the tax jurisdiction. The Internal Revenue Service (IRS) has completed its examinations of our federal income tax returns through 2004. The legacy Ecolab U.S. income tax returns for the years 2009 and 2010 are currently under audit. The legacy Nalco U.S. income tax returns for the years 2005 through 2010 are currently under audit. In addition to the U.S. federal examinations, we have limited audit activity in several U.S. state and foreign jurisdictions. The tax positions we take are based on our interpretations of tax laws and regulations in the applicable federal, state and international jurisdictions. We believe that our tax returns properly reflect the tax consequences of our operations, and that our reserves for tax contingencies are appropriate and sufficient for the positions taken. Because of the uncertainty of the final outcome of these examinations, we have reserved for potential reductions of tax benefits (including related interest and penalties) for amounts that do not meet the more-likely-than-not thresholds for recognition and measurement as required by authoritative guidance. The tax reserves are reviewed throughout the year, taking into account new legislation, regulations, case law and audit results. Settlement of any particular issue could result in offsets to other balance sheet accounts, cash payments or receipts and/or adjustments to tax expense. The majority of our tax reserves are presented in the balance sheet within other non-current liabilities. As of December 31, 2012, our gross liability for uncertain tax positions was $93 million. For additional information on income taxes, see Note 11.

 

Long-Lived, Intangible Assets and Goodwill

We periodically review our long-lived and intangible assets, the total value of which were $6.8 billion as of December 31, 2012, for impairment and assess whether significant events or changes in business circumstances indicate that the carrying value of the assets may not be recoverable. Such circumstances may include, for example, a significant decrease in the market price of an asset, a significant adverse change in the manner in which the asset is being used or in its physical condition or history of operating or cash flow losses associated with the use of the asset. Impairment losses could occur when the carrying amount of an asset exceeds the anticipated future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. The amount of the impairment loss to be recorded, if any, is calculated as the excess of the asset’s carrying value over its estimated fair value.

 

We also periodically reassess the estimated remaining useful lives of our long-lived assets. Changes to estimated useful lives would impact the amount of depreciation and amortization expense recorded in earnings. We have experienced no significant changes in the carrying value or estimated remaining useful lives of our long-lived assets. As part of the Nalco merger, we added intangible asset trade names with indefinite useful lives. The carrying value of the indefinite life trade names were subject to annual impairment testing during the second quarter of 2012. Based on this testing, no adjustment to the carrying value was necessary.

 

As of December 31, 2012, we had total goodwill of $5.9 billion. We test our goodwill for impairment on an annual basis during the second quarter. Our reporting units are our operating segments. If circumstances change significantly, we would also test a reporting unit for impairment during interim periods between the annual tests. Goodwill impairment has historically been determined using a two-step process. However, in September 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance on the testing of goodwill impairment to allow an entity the option to first assess qualitative factors to determine whether performing the current two-step process is necessary. Under the new option, the calculation of the reporting unit’s fair value is not required unless as a result of the qualitative assessment, it is more likely than not that the fair value of the reporting unit is less than the unit’s carrying amount. We adopted this guidance effective with our annual goodwill impairment testing during the second quarter of 2012.

 

In spite of the change in accounting guidance, assessing goodwill for impairment remains judgmental in nature and often involves the use of significant estimates and assumptions. Fair values of reporting units are established using a discounted cash flow method. Where available and as appropriate, comparable market multiples are used to corroborate the results of the discounted cash flow method.

 

13



 

These valuation methodologies use estimates and assumptions, which include projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, perpetual growth rates, and determination of appropriate market comparables.

 

Our merger with Nalco resulted in the addition of $4.5 billion of goodwill. Subsequent performance of the reporting units holding the additional goodwill relative to projections used in our purchase price allocation could result in impairment if there is either underperformance by the reporting unit or if the carrying value of the reporting unit were to fluctuate due to working capital changes or other reasons that did not proportionately increase fair value.

 

Based on our testing, there has been no impairment of goodwill during the three years ended December 31, 2012. Additionally, based on the ongoing performance of our operating units, updating the impairment testing during the second half of 2012 was not deemed necessary.

 

RESULTS OF OPERATIONS

 

Net Sales

 

 

 

 

 

 

 

 

 

PERCENT

 

 

 

 

 

PERCENT

 

MILLIONS

 

 

2012

 

 

2011

 

CHANGE

 

2011

 

2010

 

CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported GAAP net sales

 

 

$

11,838.7

 

 

$

6,798.5

 

74

%

 

$

   6,798.5

 

$

6,089.7

 

12

%

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nalco merger pro forma adjustment

 

 

 

 

4,485.4

 

 

 

 

 

 

 

 

 

Net sales

 

 

11,838.7

 

 

11,283.9

*

5

 

 

6,798.5

 

6,089.7

 

12

 

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special (gains) and charges

 

 

 

 

29.6

 

 

 

 

29.6

 

 

 

 

 

Nalco merger impact to 2011 reported results

 

 

 

 

 

 

 

 

(193.4

)

 

 

 

 

Non-GAAP adjusted sales

 

 

11,838.7

 

 

11,313.5

*

5

 

 

6,634.7

 

6,089.7

 

9

 

 

Effect of foreign currency translation

 

 

(34.6

)

 

(290.8

)*

 

 

 

(172.2

)

(20.0

)

 

 

 

Non-GAAP adjusted fixed currency sales

 

 

$

11,804.1

 

 

$

11,022.7

*

7

%

 

$

   6,462.5

 

$

6,069.7

 

6

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent to the 2012 amounts presented.

 

The increase in reported sales for 2012 is due primarily to the inclusion of the Nalco business in our results. Reported sales for 2012 increased 5% when compared to both 2011 pro forma sales and 2011 adjusted pro forma sales. Foreign currency negatively impacted sales growth in 2012.

 

The increase in reported sales for 2011 was also impacted by the Nalco merger. Excluding Nalco merger related activity and special (gains) and charges from 2011 results, adjusted sales increased 9% when compared to 2010 reported sales. Foreign currency positively impacted sales growth in 2011.

 

The change components of the year-over-year 2012 reported net sales versus 2011 adjusted pro forma sales and the year-over-year 2011 adjusted sales versus 2010 reported sales are as follows:

 

PERCENT

 

2012

2011

 

 

 

 

Volume

 

5

%

3

%

Price changes

 

2

 

1

 

Acquisitions and divestitures

 

 

2

 

Non-GAAP adjusted fixed currency sales increase

 

7

 

6

 

Foreign currency translation

 

(2

)

2

 

Non-GAAP adjusted sales increase

 

5

%

9

%

 

 

 

 

 

 

 

Note: Amounts in the table above do not necessarily sum due to rounding.

 

Gross Margin

 

PERCENT

 

2012

 

2011

 

2011

2010

 

 

 

 

 

 

 

 

 

 

 

 

Reported gross margin

 

45.2

%

 

48.9

%

 

48.9

%

50.5

%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Nalco merger pro forma adjustment

 

 

 

(3.2

)

 

 

 

Gross margin

 

45.2

%

 

45.7

%*

 

48.9

%

50.5

%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Special gains and charges

 

0.8

 

 

0.2

 

 

0.3

 

 

Nalco merger impact to reported 2011 results

 

 

 

 

 

0.2

 

 

Non-GAAP adjusted gross margin

 

46.0

%

 

45.9

%*

 

49.4

%

50.5

%

 

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent to the 2012 amounts presented.

 

Our gross profit margin (“gross margin”) is defined as the difference between sales less cost of sales, divided by sales. Our reported gross margin was 45.2% and 48.9% for 2012 and 2011, respectively. The inclusion of Nalco’s business mix in 2012 negatively impacted our 2012 reported gross margin when comparing against our reported 2011 gross margin. Our 2012 reported gross margin was also negatively impacted by special (gains) and charges including the recognition of fair value step-up in Nalco inventory of $71.2 million and restructuring charges of $22.7 million. Our 2011 gross margin was negatively impacted by restructuring charges of $5.3 million, recognition of fair value step-up in Nalco inventory of $3.6 million and $29.6 million related to the modification of a customer agreement.

 

Adjusting 2011 for the pro forma effect of the Nalco merger and excluding the impact of restructuring charges and the recognition of fair

 

14



 

value step-up inventory from 2012 and 2011 results and the impact of the customer agreement modification from our 2011 results, our 2012 adjusted gross margin was 46.0%, which compared against an adjusted pro forma gross margin of 45.9% for 2011. The increase in the 2012 adjusted gross margin as compared to the 2011 adjusted pro forma gross margin was driven by pricing gains, sales volume increases, synergies and cost savings which outpaced increased delivered product costs (including raw materials, freight and fuel) as well as the negative business mix impact of increased Global Energy sales, which on average have a lower gross margin compared to our other businesses.

 

Our reported gross margin was 48.9% and 50.5% for 2011 and 2010, respectively. As previously discussed, our 2011 gross margin was negatively impacted by restructuring charges, recognition of fair value step-up in Nalco inventory and a customer agreement modification. Additionally, the Nalco merger had a negative impact on our gross margins subsequent to the close of the merger in December of 2011. Our 2010 gross margin was not impacted by special gains and charges or the Nalco merger.

 

Excluding the impact of restructuring charges, the recognition of fair value step-up in Nalco inventory, the impact of the customer agreement modification and the negative impact of Nalco’s post-merger results, our 2011 adjusted gross margin was 49.4%, which compared against a reported gross margin of 50.5% for 2010. The decrease when comparing the 2011 adjusted gross margin to the reported 2010 gross margin was driven by significantly higher delivered product costs which more than offset sales and pricing gains.

 

Selling, General and Administrative Expenses

 

PERCENT

 

2012

 

2011

 

2011

2010

 

 

 

 

 

 

 

 

Reported SG&A ratio

 

33.1

%

 

35.9

%

 

35.9

%

37.1

%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Nalco merger pro forma adjustment

 

 

 

(1.2

)

 

 

 

SG&A ratio

 

33.1

%

 

34.7

%*

 

35.9

%

37.1

%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Nalco merger impact to reported 2011 results

 

 

 

 

 

(0.2

)

 

Non-GAAP adjusted SG&A ratio

 

33.1

%

 

34.7

%*

 

35.7

%

37.1

%

 

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent to the 2012 amounts presented.

 

Reported selling, general and administrative (“SG&A”) expenses as a percentage of reported net sales were 33.1% during 2012 compared to the reported equivalent of 35.9% in 2011. The inclusion of Nalco’s business mix in 2012 positively impacted our 2012 reported SG&A expense ratio when comparing against our reported 2011 SG&A expense ratio.

 

Adjusting 2011 results for the pro forma effect of the Nalco merger, our reported 2012 SG&A expense ratio of 33.1% compared against a 2011 pro forma SG&A expense ratio of 34.7%. The decrease in expense percentage during 2012 was driven by leverage from sales gains, along with cost savings efforts including those associated with restructuring actions, which more than offset investments and other cost increases. We continued to make key business investments that drive innovation and efficiency, through R&D and information technology systems.

 

Reported SG&A expenses as a percentage of reported net sales decreased to 35.9% in 2011 compared to 37.1% in 2010. As shown in the previous table, the impact on the SG&A expense ratio in 2011 from the Nalco merger was minimal. The decrease in the expense ratio from 2010 to 2011 was driven by leverage from sales gains and acquisitions, along with savings from restructuring in 2011, which more than offset investments in the business and cost increases.

 

Special (Gains) and Charges

 

Special (gains) and charges reported on the Consolidated Statement of Income included the following items:

 

MILLIONS

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

 

 

 

 

 

 

 

 

Customer agreement modification

 

$        —

 

 

$

29.6

 

 

$

 

Cost of sales

 

 

 

 

 

 

 

 

 

Restructuring charges

 

22.7

 

 

5.3

 

 

 

Recognition of Nalco inventory fair value step-up

 

71.2

 

 

3.6

 

 

 

Subtotal

 

93.9

 

 

8.9

 

 

 

Special (gains) and charges

 

 

 

 

 

 

 

 

 

Restructuring charges

 

116.6

 

 

69.0

 

 

 

Champion acquisition costs

 

18.3

 

 

 

 

 

Nalco merger and integration costs

 

70.9

 

 

57.7

 

 

 

Gain on sale of businesses, litigation related charges and other

 

(60.1

)

 

4.3

 

 

3.3

 

Venezuela currency devaluation

 

 

 

 

 

4.2

 

Subtotal

 

145.7

 

 

131.0

 

 

7.5

 

Operating income subtotal

 

239.6

 

 

169.5

 

 

7.5

 

Interest expense, net

 

 

 

 

 

 

 

 

 

Debt extinguishment costs

 

18.2

 

 

 

 

 

Merger and acquisition debt costs

 

1.1

 

 

1.5

 

 

 

Subtotal

 

19.3

 

 

1.5

 

 

 

Net income attributable to noncontrolling interest

 

 

 

 

 

 

 

 

 

Recognition of Nalco inventory fair value step-up

 

(4.5

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total special (gains) and charges

 

$   254.4

 

 

$

171.0

 

 

$

7.5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For segment reporting purposes, special (gains) and charges have been included in our corporate segment, which is consistent with our internal management reporting.

 

Restructuring Charges

 

2011 Restructuring Plan

 

In February 2011, we commenced a comprehensive plan to substantially improve the efficiency and effectiveness of our European business, sharpen its competitiveness and accelerate its growth and profitability. Additionally through this Plan, restructuring has been and will continue to be undertaken outside of Europe (collectively the “2011 Restructuring Plan”). As a result of restructuring activities under the 2011 Restructuring Plan, we recorded restructuring charges of $66.2 million ($46.1 million after tax) or $0.15 per diluted share and $68.1 million ($54.2 million after tax) or $0.22 per diluted share during 2012 and 2011, respectively.

 

We expect to incur pretax restructuring charges of approximately $150 million ($125 million after tax) under the 2011 Restructuring Plan through the completion of the Plan in 2013. We anticipate that approximately $140 million of the pre-tax charges will represent cash expenditures. The remaining $10 million of the pre-tax charges represent estimated asset disposals or other non-cash expenses. No decisions have been made for any remaining asset disposals and estimates could vary depending on the actual actions taken.

 

Actions under the 2011 Restructuring Plan are expected to result in approximately $120 million in annualized cost savings when fully realized, with approximately $70 million of cost savings realized through 2012.

 

15



 

Merger Restructuring Plan

 

In January 2012, following the completion of the Nalco merger, we formally commenced plans to undertake restructuring actions related to the reduction of our global workforce and optimization of our supply chain and office facilities, including planned reduction of plant and distribution center locations (the “Merger Restructuring Plan”). In anticipation of the Plan, a limited number of actions were taken in 2011, and as a result, we recorded restructuring charges of $6.6 million ($4.1 million after tax) or $0.02 per diluted share in 2011. During 2012, as a result of restructuring activities under the Plan, we recorded restructuring charges of $73.2 million ($54.5 million after tax) or $0.18 per diluted share.

 

We expect that restructuring activities under the Merger Restructuring Plan will be completed by the end of 2013, with total cost through the end of 2013 anticipated to be approximately $180 million ($120 million after tax). We anticipate that approximately $160 million of the pre-tax restructuring charges will represent cash expenditures. The remaining $20 million of the pre-tax charges represent estimated asset disposals or other non-cash expenses. No decisions have been made for any remaining asset disposals and estimates could vary depending on the actual actions taken.

 

We anticipate savings from the Merger Restructuring Plan, along with synergies achieved in connection with the merger, will be approximately $250 million on an annual basis with the run rate achieved by the end of 2014. The corresponding savings and synergies were approximately $75 million in 2012, with $135 million expected in 2013.

 

Restructuring charges have been included as a component of both cost of sales and special (gains) and charges on the Consolidated Statement of Income. Further details related to our restructuring charges are included in Note 3.

 

Non-restructuring special (gains) and charges

 

Nalco merger and integration costs

 

As a result of the Nalco merger, during 2012 and 2011, we incurred charges of $155.8 million ($113.7 million after tax), or $0.38 per diluted share and $62.8 million ($45.6 million after tax), or $0.19 per diluted share, respectively. Nalco merger and integration charges have been included as a component of cost of sales, special (gains) and charges, net interest expense and net income (loss) attributable to noncontrolling interest on the Consolidated Statement of Income. Amounts included in cost of sales and net income (loss) attributable to noncontrolling interest include recognition of fair value step-up in Nalco international inventory which is maintained on a FIFO basis. Amounts included in special (gains) and charges include merger and integration charges, closing costs and advisory fees. Amounts included in net interest expense include a loss on the extinguishment of Nalco’s senior notes, which were assumed as part of the merger, and fees to secure short-term credit facilities to initially fund the Nalco merger.

 

Champion acquisition costs

 

As a result of the pending acquisition of Champion, during 2012 we incurred charges of $19.4 million ($16.7 million after tax), or $0.06 per diluted share. Champion acquisition charges have been included as a component of special (gains) and charges and net interest expense on the Consolidated Statement of Income. Amounts included in special (gains) and charges include acquisition costs and advisory fees. Amounts included in net interest expense include fees to secure term loans and short-term debt and the interest expense impact of our $500 million public debt issuance in December 2012, all of which were initiated to fund the Champion acquisition.

 

Other special (gains) and charges

 

During 2012, we recorded a net gain of $60.1 million ($35.7 million after tax), or $0.12 per diluted share related to the sale of our Vehicle Care division, the receipt of additional payments related to the sale of an investment in a U.S. business, originally sold prior to 2012 and litigation related charges.

 

In the fourth quarter of 2011, we modified a long-term customer agreement that was assumed as part of a previous acquisition. The impact of the modification was included in net sales on the Consolidated Statement of Income, resulting in a sales reduction of $29.6 million ($18.4 million after tax), or $0.08 per diluted share.

 

In the first quarter of 2011, we completed the purchase of the assets of the Cleantec business of Campbell Brothers Ltd., Brisbane, Queensland, Australia (“Cleantec”). Special (gains) and charges in 2011 included acquisition integration costs incurred to optimize the Cleantec business structure.

 

As shown in the pro forma table on page 9, pro forma 2011 special (gains) and charges include the impact of the sale of Nalco’s personal care products business and its marine chemicals business, which resulted in a gain of $136.0 million.

 

Special (gains) and charges in 2010 include costs to optimize the company’s business structures of $10.9 million, of which $8.5 million were recorded in the fourth quarter. In the third quarter of 2010, we sold an investment in a small U.S. business and recognized a $5.9 million gain on the sale. The investment was not material to our consolidated results of operations or financial position.

 

Beginning in 2010, Venezuela was designated hyper-inflationary and as such all foreign currency fluctuations are recorded in income. On January 8, 2010 the Venezuelan government devalued its currency (Bolivar Fuerte). We are remeasuring the financial statements of our Venezuelan subsidiary using the official exchange rate of 4.30 Bolivars to U.S. dollar. As a result of the devaluation, we recorded a charge of $4.2 million in the first quarter of 2010 due to the remeasurement of the local balance sheet. We are unable to predict the ongoing currency gains and losses for the remeasurement of the balance sheet.

 

Further details related to our non-restructuring special (gains) and charges are included in Note 3.

 

16



 

Operating Income

 

 

 

 

 

 

 

 

 

PERCENT

 

 

 

 

 

PERCENT

 

MILLIONS

 

 

2012

 

 

2011

 

CHANGE

 

2011

 

2010

 

CHANGE

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported GAAP operating income

 

 

$

1,289.3

 

 

$

753.8

 

71

%

 

$

753.8

 

$

806.8

 

(7

)%

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nalco merger pro forma adjustment

 

 

 

 

502.9

 

 

 

 

 

 

 

 

 

Operating income

 

 

1,289.3

 

 

1,256.7

*

3

 

 

753.8

 

806.8

 

(7

)

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special (gains) and charges

 

 

239.6

 

 

18.7

*

 

 

 

169.5

 

7.5

 

 

 

 

Nalco merger impact to 2011 reported results

 

 

 

 

 

 

 

 

(13.8

)

 

 

 

 

Non-GAAP adjusted operating income

 

 

1,528.9

 

 

1,275.4

*

20

 

 

909.5

 

814.3

 

12

 

 

Effect of foreign currency translation

 

 

(3.9

)

 

(28.2

)*

 

 

 

(18.3

)

2.5

 

 

 

 

Non-GAAP adjusted fixed currency operating income

 

 

$

1,525.0

 

 

$

1,247.2

*

22

%

 

$

891.2

 

$

816.8

 

9

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent to the 2012 amounts presented.

 

Reported operating income in 2012 increased 71% compared to reported operating income in 2011. Reported operating income in 2012 increased 3% against 2011 pro forma operating income. Our 2012 reported operating income and 2011 pro forma operating income were both impacted by special (gains) and charges. Excluding the impact of special (gains) and charges from 2012 reported and 2011 pro forma operating income, 2012 adjusted operating income increased 20% when compared against 2011 adjusted pro forma operating income. Foreign currency had a negative impact on operating income growth as shown in the previous table. The 2012 adjusted fixed currency operating income increase of 22% as compared to 2011 adjusted pro forma fixed currency operating income was driven by sales volume and pricing gains, as well as synergies and other cost savings, which more than offset higher delivered product costs and investments in the business.

 

Reported operating income decreased 7% in 2011 compared to 2010. The operating income decrease was impacted by the year-over-year comparison of special (gains) and charges, offset partially by the impact of including Nalco merger related activity in our consolidated results in December 2011. Excluding the impact of special (gains) and charges and Nalco merger related activity, adjusted operating income increased 12% in 2011. Foreign currency had a positive impact on operating income growth as shown in the previous table. The 2011 adjusted fixed currency operating increase of 9% as compared to 2010 adjusted fixed currency operating income was driven by sales volume gains, pricing and cost savings which more than offset increased delivered product costs and investments in the business.

 

Interest Expense, Net

 

 

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

MILLIONS

 

 

2012

 

2011

 

2010

 

 

2012

 

2011

Reported GAAP interest expense, net

 

 

$

276.7

 

$

74.2

 

$

59.1

 

 

273

%

 

26

%

Less adjustments:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Special (gains) and charges

 

 

19.3

 

1.5

 

 

 

 

 

 

 

 

Nalco merger impact

 

 

 

17.4

 

 

 

 

 

 

 

 

Non-GAAP adjusted interest expense, net

 

 

$

257.4

 

$

55.3

 

$

59.1

 

 

365

%

 

(6

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported net interest expense totaled $276.7 million, $74.2 million and $59.1 million during 2012, 2011 and 2010, respectively.

 

Special (gains) and charges reported within net interest expense during 2012 included a net loss on the extinguishment of Nalco’s senior notes, which were assumed as part of the merger. Special (gains) and charges within net interest during 2012 also included fees to secure term loans and short-term debt and the interest expense impact of our $500 million public debt issuance in December 2012, all of which were initiated to fund the Champion acquisition. Special (gains) and charges reported within net interest expense during 2011 include short-term credit facility costs incurred to initially finance the Nalco merger. Both reported and adjusted net interest expense increased from 2011 to 2012, due primarily to debt issued to fund the cash portion of the Nalco merger consideration, the repayment of Nalco debt and share repurchases.

 

The year-over-year comparability of 2011 compared to 2010 was also impacted by inclusion of Nalco’s merger related activity in our consolidated results in 2011, which includes the interest expense impact of our $3.75 billion public debt issuance in December 2011 as well as interest expense on the Nalco senior notes outstanding as of December 31, 2011. Excluding the impact of special (gains) and charges and the Nalco merger impact, 2011 adjusted net interest expense decreased 6% compared to 2010 due primarily to the repayment of our $150 million 6.875% notes in February 2011.

 

Provision for Income Taxes

The following table provides a summary of our tax rate:

 

PERCENT

 

2012

2011

2010

Reported tax rate

 

30.7

%

31.8

%

29.0

%

Tax rate impact of:

 

 

 

 

 

 

 

Special gains and charges

 

(1.5

)

(0.9

)

(0.1

)

Discrete tax items

 

0.7

 

(1.0

)

1.0

 

Nalco merger impact

 

 

0.0

 

 

Non-GAAP adjusted effective tax rate

 

29.9

%

29.9

%

29.9

%

 

Our reported tax rate for 2012, 2011 and 2010 includes the tax impact of special (gains) and charges and discrete tax items. Depending on the nature of our special gains and charges and discrete tax items, our reported tax rate may not be consistent on a period to period basis, as amounts included in our special gains and charges are derived from tax jurisdictions with rates that vary from our overall non-GAAP adjusted

 

17



 

tax rate. Additionally, our 2011 reported tax rate includes the impact of including Nalco’s U.S. activity in our consolidated results beginning in December 2011.

 

Our 2012 reported tax rate includes $59.4 million of net tax benefits on special (gains) and charges and $9.2 million of discrete tax net benefit. The corresponding impact of these items to the reported tax rate is shown in the previous table.

 

Discrete tax benefits in 2012 are based largely on benefits of $11 million related to remeasurement of certain deferred tax assets and liabilities resulting from changing tax jurisdictions, recognizing adjustments from filing the company’s 2011 U.S. federal tax return as well as a release of a valuation allowance related to a capital loss carryforward. Discrete benefits were partially offset by the remeasurement of certain deferred tax assets and liabilities resulting from changes in local country tax rates and state and foreign country audit settlements and adjustments.

 

Our 2011 reported tax rate includes $45.4 million of net tax benefits on special (gains) and charges, $1.5 million of tax benefits related to U.S. Nalco activity included in our consolidated results beginning in December 2011, and $7.4 million of discrete tax net expense. The corresponding impact of these items to the reported tax rate is shown in the previous table.

 

Discrete tax items in 2011 include an $8 million charge recorded in the fourth quarter related to the realizability of foreign net operating loss carryforwards, as well as discrete tax net expense related to the remeasurement of our deferred tax assets due to the impact of a change in our blended state tax rate. These items were partially offset by net benefits related to recognizing adjustments from filing our 2010 U.S. federal returns and other International income tax returns and recognizing settlements and adjustments related to our 1999 through 2001 U.S. income tax returns. We also had benefits from prior year state refund claims and benefits from recognizing settlements and adjustments related to our 2007 through 2008 U.S. income tax returns.

 

Our 2010 reported tax rate included $0.9 million of net tax benefits on special (gains) and charges as well as $8.0 million of discrete tax net benefits. The corresponding impact of these items to the reported tax rate is shown in the previous table.

 

Discrete tax benefits in 2010 primarily include recognizing favorable settlements related to our 2002 through 2004 IRS appeals case and adjustments related to our prior year tax reserves. The discrete tax net benefit for the year also includes a $6 million tax benefit from the settlement of an international tax audit recorded in the first quarter, offset by a $5 million charge also recorded in the first quarter due to the passage of the U.S. Patient Protection and Affordable Care Act which changes the tax deductibility related to federal subsidies and resulted in a reduction of the value of our deferred tax assets related to the subsidies, as well as a $2 million charge in the second quarter for the impact of international tax costs from optimizing our business structure.

 

Our adjusted effective tax rate has been consistent at 29.9% across 2012, 2011 and 2010.

 

Net Income Attributable to Ecolab

 

 

 

 

 

 

PERCENT CHANGE

MILLIONS

 

2012

2011

2010

2012

2011

Reported GAAP net income

 

 $

703.6

 

  $

462.5

 

 $

530.3

 

52

%

(13

)%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Special (gains) and charges

 

195.0

 

125.6

 

6.6

 

 

 

 

 

Discrete tax expense (benefit)

 

(9.2

)

7.4

 

(8.0

)

 

 

 

 

Nalco merger impact

 

 

2.1

 

 

 

 

 

 

Non-GAAP adjusted net income

 

 $

889.4

 

  $

597.6

 

 $

528.9

 

49

%

13

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted Earnings Per Common Share (“EPS”)

 

 

 

 

 

 

PERCENT CHANGE

DOLLARS

 

2012

2011

2010

2012

2011

Reported GAAP EPS

 

 $

2.35

 

  $

1.91

 

 $

2.23

 

23

%

(14

)%

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

Special (gains) and charges

 

0.65

 

0.52

 

0.03

 

 

 

 

 

Discrete tax expense (benefit)

 

(0.03

)

0.03

 

(0.03

)

 

 

 

 

Nalco merger impact

 

 

0.08

 

 

 

 

 

 

Non-GAAP adjusted EPS

 

 $

2.98

 

  $

2.54

 

 $

2.23

 

17

%

14

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Note: Per share amounts do not necessarily sum due to rounding.

 

Reported net income attributable to Ecolab totaled $704 million, $463 million and $530 million during 2012, 2011 and 2010, respectively, which resulted in reported earnings per share of $2.35, $1.91 and $2.23 for the corresponding periods.

 

Amounts for 2012, 2011 and 2010 include special (gains) and charges and discrete tax items. Additionally, 2011 amounts include Nalco merger related activity in our consolidated results beginning in December 2011, as well as shares issued as consideration for the equity portion of the Nalco merger.

 

Excluding special (gains) and charges and the impact of discrete items from 2012, 2011 and 2010, and the impact of the Nalco merger from 2011, adjusted net income and adjusted earnings per share increased 49% and 17%, respectively, when comparing 2012 to 2011 and increased 13% and 14%, respectively, when comparing 2011 to 2010.

 

Currency translation had an unfavorable impact of approximately $0.06 per share on diluted earnings per share for 2012 compared to 2011. Currency translation had a favorable impact of approximately $0.06 per share on diluted earnings per share for 2011 compared to 2010.

 

Segment Performance

Effective with the Nalco merger, we added Nalco’s three legacy operating units (Water Services, Paper Services and Energy Services) as additional reportable segments to the merged company’s reporting structure.

 

Beginning in the first quarter of 2012, the Water Services, Paper Services and Energy Services reportable segments were renamed as the Global Water, Global Paper and Global Energy reportable segments, respectively. With the exception of the water treatment related business change discussed in the following paragraphs, the underlying structure of the Global Water, Global Paper and Global Energy segments remains the same as 2011.

 

Beginning in the first quarter of 2012, the International reportable segment was renamed as the International Cleaning, Sanitizing & Other Services reportable segment. With the exception of the water treatment related business change discussed below, the underlying structure of the International Cleaning, Sanitizing & Other Services segment remains the same as 2011.

 

18



 

Beginning in the first quarter of 2012, due to changes in how we internally manage and report results within our legacy Ecolab Food & Beverage and Asia Pacific operating units, certain water treatment related businesses were moved from the U.S. Cleaning & Sanitizing and International Cleaning, Sanitizing & Other Services reportable segments to the Global Water reportable segment. The movement of these businesses did not significantly impact year-over-year comparability; therefore, prior year reported segment information has not been restated to reflect this change.

 

Our fourteen operating units are aggregated into six reportable segments: U.S. Cleaning & Sanitizing, U.S. Other Services, International Cleaning, Sanitizing & Other Services, Global Water, Global Paper and Global Energy.

 

We evaluate the performance of our international operations within our International Cleaning, Sanitizing & Other Services, Global Water, Global Paper and Global Energy reportable segments based on fixed currency exchange rates used by management for 2012. The difference between the fixed currency exchange rates and the actual currency exchange rates is reported as “effect of foreign currency translation” in the following tables. All other accounting policies of the reportable segments are consistent with accounting principles generally accepted in the United States of America and the accounting policies of the company described in Note 2. Additional information about our reportable segments is included in Note 16.

 

Sales by Reportable Segment

 

Reported sales for 2012, 2011 and 2010 for each of our reportable segments were as follows:

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

MILLIONS

 

2012

 

2011

 

2010

 

2012

 

2011

 

U.S. Cleaning & Sanitizing

 

 $

2,992.9

 

 

$

2,930.3

 

$

2,721.9

 

2

 

8

%

 

U.S. Other Services

 

474.6

 

 

457.1

 

448.5

 

4

 

 

2

 

 

Int’l Cleaning, Sanitizing & Other Services

 

3,175.8

 

 

3,075.1

 

2,899.4

 

3

 

 

6

 

 

Global Water

 

2,087.4

 

 

67.2

 

 

 

 

 

 

 

 

Global Paper

 

805.4

 

 

33.9

 

 

 

 

 

 

 

 

Global Energy

 

2,268.0

 

 

92.3

 

 

 

 

 

 

 

 

Corporate

 

 

 

(29.6

)

 

 

 

 

 

 

 

Subtotal at fixed currency

 

11,804.1

 

 

6,626.3

 

6,069.8

 

78

 

 

9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign currency translation

 

34.6

 

 

172.2

 

19.9

 

 

 

 

 

 

 

Consolidated

 

 $

11,838.7

 

 

$

6,798.5

 

$

6,089.7

 

74

 

12

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reported sales for 2012 and pro forma sales, including Nalco’s results and reclassification of certain water treatment related businesses, for 2011 for each of our reportable segments were as follows:

 

 

 

 

 

 

 

 

PERCENT

 

MILLIONS

 

2012

 

 

2011

 

CHANGE

 

U.S. Cleaning & Sanitizing

 

 $

 2,992.9

 

 

$

2,839.0

*

5

 

U.S. Other Services

 

474.6

 

 

457.1

 

4

 

 

Int’l Cleaning, Sanitizing & Other Services

 

3,175.8

 

 

3,027.4

*

5

 

 

Global Water

 

2,087.4

 

 

2,014.0

*

4

 

 

Global Paper

 

805.4

 

 

811.8

*

(1

)

 

Global Energy

 

2,268.0

 

 

1,873.4

*

21

 

 

Corporate

 

 

 

(29.6

)

 

 

 

Subtotal at fixed currency

 

11,804.1

 

 

10,993.1

*

7

 

 

 

 

 

 

 

 

 

 

 

 

Effect of foreign currency translation

 

34.6

 

 

290.8

*

 

 

 

Consolidated

 

 $

 11,838.7

 

 

$

11,283.9

*

5

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent of the 2012 amounts presented.

 

As discussed previously in this MD&A, in order to provide the most meaningful comparison of results by reportable segment, in addition to discussing changes in 2012 reported results versus 2011 reported results, the following sales discussions also provide analysis on 2012 reported results versus 2011 pro forma results. Discussions around comparisons of 2011 versus 2010 focus on the reported results for those respective periods.

 

U.S. CLEANING & SANITIZING

 

GRAPHIC

 

Reported U.S. Cleaning & Sanitizing sales increased 2% in 2012 compared to reported 2011 sales. Reported 2012 sales increased 5% when compared to 2011 pro forma sales. Reported 2011 sales increased 8% when compared to reported sales from 2010. Excluding the impact of acquisitions and divestitures from all periods, 2012 sales increased 5% when compared to 2011 pro forma sales and 2011 sales increased 5% against 2010 sales.

 

Sales for our largest U.S. Cleaning & Sanitizing businesses were as follows:

 

Institutional - Reported sales increased 4% in 2012 compared to 2011 reported sales. Sales initiatives, targeting new accounts, and effective product programs continued to lead our results. Demand from our lodging customers continued to show modest growth, while overall foodservice foot traffic remained soft.

 

Reported sales grew 4% in 2011 compared to 2010 reported sales. Sales initiatives, pricing gains, new accounts and effective product programs led our results. Demand from our lodging customers showed good growth, while overall foodservice foot traffic was soft.

 

19



 

Food & Beverage - Reported sales increased 4% in 2012 compared to 2011 pro forma sales. Sales growth was led by gains in the dairy, food and agri market segments. Food & Beverage remains focused on pricing as well as customer and new product penetration.

 

Reported sales increased 7% in 2011 compared to reported sales from 2010. The dairy and food market segments drove the increase, led by corporate account wins, pricing and product penetration. 2011 sales also benefited from a large project sale through our Ecovation business during the second quarter of 2011.

 

Kay - Reported sales grew 9% in 2012 compared to 2011 reported sales. The increase was led by double-digit growth from our food retail business which benefited from new accounts, and solid results from our quick service business.

 

Reported sales for 2011 increased 7% compared to 2010 reported sales. The sales increase for 2011 was led by our food retail business. Sales at Kay benefited from good demand from existing and new food retail and quick service accounts.

 

Healthcare - Reported sales increased 9% in 2012 compared to 2011 reported sales. Excluding the impact of acquisitions, sales increased 6% in 2012. Sales growth was led by our patient temperature management business, environmental hygiene and our infection barrier solutions, which offset general softness in the overall U.S. healthcare market.

 

Reported sales increased 28% in 2011 compared to reported sales from 2010. Excluding the impact of the acquisitions, sales increased 4% in 2011. Growth in sales of hand hygiene and surgical instrument cleaning products were partially offset by slower growth in patient and equipment drapes. Comparison sales in 2011 for hand hygiene were against slower sales in 2010 due to the increase in 2009 from H1N1 preparations.

 

U.S. OTHER SERVICES

 

GRAPHIC

 

U.S. Other Services sales increased 4% in 2012 compared to 2011 and increased 2% in 2011 compared to 2010.

 

Sales for our U.S. Other Services businesses were as follows:

 

Pest Elimination - Sales for 2012 grew 4% when compared to the prior year. Gains in the food & beverage and healthcare segment and improved results in the foodservice segment led the growth. Contract sales showed modest improvements, while non-contract sales growth was strong.

 

Sales were flat in 2011 compared to 2010. Gains in the food & beverage plant, healthcare, hospitality and grocery segments were offset by slow conditions in other major segments. Contract sales increased marginally, offset by a decrease in non-contract sales.

 

Equipment Care - Sales grew 4% in 2012 compared to the prior year. Service and installed parts sales increased, benefiting from new accounts and pricing gains. Direct parts sales decreased compared to results from 2011.

 

Sales increased 6% in 2011 compared to 2010. Pricing gains and new accounts helped drive service and installed parts sales increases during 2011. Direct parts sales decreased slightly in 2011 compared to 2010.

 

INTERNATIONAL CLEANING, SANITIZING & OTHER SERVICES

 

GRAPHIC

 

Fixed currency sales for our International Cleaning, Sanitizing & Other Services segment increased 3% for 2012 compared to fixed currency sales from 2011. 2012 fixed currency sales increased 5% when compared to 2011 pro forma fixed currency sales. Fixed currency sales from 2011 increased 6% when compared to 2010 fixed currency sales.

 

Excluding the impact of acquisitions and divestitures from all periods, 2012 fixed currency sales increased 4% compared to 2011 pro forma fixed currency sales and 2011 fixed currency sales increased 4% when compared to 2010 fixed currency sales.

 

When measured at public currency rates, 2012 reported International Cleaning, Sanitizing & Other Services sales decreased 1% against public currency reported sales from 2011 and were flat compared to public currency pro forma sales from 2011. Public currency reported sales from 2011 increased 11% when compared to 2010 public currency reported sales.

 

Fixed currency sales changes for our International Cleaning, Sanitizing & Other Services operating units were as follows:

 

Europe, Middle East and Africa - Sales increased 3% in 2012 compared to 2011. Excluding the impact of acquisitions, sales increased 2% in 2012. Solid results in MEA and moderate growth in the UK, Italy and Germany led the increase. From a divisional perspective, Healthcare, Pest Elimination and Food & Beverage showed good results, while Institutional sales were flat to the prior year. Textile Care sales declined slightly.

 

Sales increased 2% in 2011 compared to 2010. Sales growth in MEA, Germany and the U.K. were partially offset by lower sales in France and Italy. From a divisional perspective, Europe’s Healthcare sales showed a solid increase based on gains in the pharmaceutical and infection prevention markets. Food & Beverage and Pest Elimination sales both increased modestly. Institutional sales increased slightly, while Textile Care sales declined slightly.

 

Asia Pacific - Sales for 2012 increased 5% compared to 2011 pro forma sales. Sales growth was driven by increases in China and emerging Asian countries, with modest gains in Japan, Australia and New Zealand. From a divisional perspective, both Institutional and Food & Beverage continued to show good growth driven by new account gains and increased product penetration.

 

Sales increased 15% in 2011 compared to 2010. Excluding the impact of acquisitions, sales increased 5% in 2011. Natural disasters within the region in 2011 reduced sales growth by approximately two percentage points. Sales growth was driven primarily by increases in China and Australia. From a divisional perspective, Institutional sales

 

20



 

were strong driven by new programs and a focus on expansion in emerging Asian markets. Food & Beverage also continued to report strong sales growth, driven by new accounts and improved product penetration.

 

Latin America - We continued to experience strong sales growth in Latin America as sales in the region increased 18% in 2012 compared to 2011. Excluding the impact of acquisitions, sales increased 14% in 2012. At a country level, Brazil, Chile and Mexico all produced double-digit sales growth. Sales growth in our Institutional, Food & Beverage and Pest businesses all continued to be strong, as new accounts and continued successes with existing customers benefited all three divisions.

 

Sales in the region increased 14% in 2011 compared to 2010. At a country level, Brazil, Chile and Mexico all showed strong sales gains. Our Institutional, Food & Beverage and Pest Elimination businesses all reported double-digit increases in sales. Institutional sales growth was driven by increased product penetration and new accounts, while Food & Beverage benefited from strong demand in the beverage and brewing markets.

 

Canada - Sales grew 7% in 2012 compared to the prior year. Continued solid performances in Food & Beverage and Institutional led to the sales increase.

 

Sales increased 4% in 2011 compared to 2010. Solid gains in Food & Beverage, good growth in Institutional and a strong recovery in Healthcare led the sales increase.

 

GLOBAL WATER

 

Global Water had $2,087 million of fixed currency sales in 2012, which based on the closing date of the merger, compared against 2011 sales of $67 million, and no sales in 2010.

 

2012 Global Water fixed currency sales increased 4% compared to 2011 pro forma fixed currency sales of $2,014 million. Acquisitions and divestitures did not have a significant impact when comparing 2012 fixed currency sales against 2011 pro forma fixed currency results. When comparing fixed currency sales for 2012 against pro forma fixed currency sales for 2011, growth was led by increases in the food & beverage, power and primary metals businesses. 2011 pro forma sales also benefited from a wastewater project sale, impacting the comparison against the current year. At a regional level, sales growth in the U.S., Latin America and Asia Pacific offset general softness in EMEA, which continues to reflect the weak economic conditions in that region.

 

When measured at public currency exchange rates, 2012 reported Global Water sales increased 1% when compared to 2011 pro forma sales.

 

GLOBAL PAPER

 

Global Paper had $805 million of fixed currency sales in 2012, which based on the closing date of the merger, compared against 2011 sales of $34 million, and no sales in 2010.

 

Global Paper 2012 sales, when measured in fixed rates of currency exchange, decreased 1% when compared against 2011 pro forma fixed currency sales of $812 million. When comparing fixed currency sales for 2012 against pro forma fixed currency sales for 2011, the decrease was driven by lower customer plant utilization and down time, as well as the strategic elimination of certain low margin business. From a regional perspective, modest growth in Latin America and EMEA was more than offset by sales declines in the U.S. and Asia Pacific.

 

When measured at public currency exchange rates, 2012 reported Global Paper sales decreased 3% against 2011 pro forma sales.

 

GLOBAL ENERGY

 

Global Energy had $2,268 million of fixed currency sales in 2012, which based on the closing date of the merger, compared against 2011 sales of $92 million, and no sales in 2010.

 

When measured in fixed rates of currency exchange, 2012 Global Energy sales increased 21% versus 2011 pro forma fixed currency sales of $1,873 million. When comparing fixed currency sales for 2012 against pro forma fixed currency sales for 2011, the increase in sales reflected strong volume growth in our upstream business resulting from good market conditions, share gains and continued focus on high growth energy sources, including deepwater and shale accounts. Upstream end markets were strong in the Americas and the Middle East. We continued to see steady sales growth and market share gains in our downstream business across all regions.

 

When measured at public currency exchange rates, 2012 reported Global Energy sales increased 19% against 2011 pro forma sales.

 

CORPORATE

 

The corporate segment includes $30 million of sales reductions in 2011 related to the modification of a customer agreement.

 

Operating Income by Reportable Segment

 

Reported operating income for 2012, 2011 and 2010 for each of our reportable segments was as follows:

 

 

 

 

 

 

 

 

 

PERCENT CHANGE

 

MILLIONS

 

2012

 

2011

 

2010

 

2012

 

2011

 

U.S. Cleaning & Sanitizing

 

 $

651.4

 

$

556.7

 

$

513.9

 

17

%

 

8

%

 

U.S. Other Services

 

70.8

 

69.7

 

71.4

 

2

 

 

(2

)

 

Int’l Cleaning, Sanitizing & Other Services

 

340.8

 

285.8

 

254.5

 

19

 

 

12

 

 

Global Water

 

235.9

 

11.0

 

 

 

 

 

 

 

 

Global Paper

 

86.3

 

6.2

 

 

 

 

 

 

 

 

Global Energy

 

360.1

 

17.7

 

 

 

 

 

 

 

 

Corporate

 

(459.9)

 

(211.6)

 

(30.5)

 

 

 

 

 

 

 

Subtotal at fixed currency

 

1,285.4

 

735.5

 

809.3

 

75

 

 

(9

)

 

Effect of foreign currency translation

 

3.9

 

18.3

 

(2.5)

 

 

 

 

 

 

 

Consolidated

 

 $

1,289.3

 

$

753.8

 

$

806.8

 

71

%

 

(7

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21



 

Reported operating income for 2012 and pro forma operating income, including Nalco’s results and reclassification of certain water treatment related businesses, for 2011 for each of our reportable segments was as follows:

 

 

 

 

 

 

 

 

 

 

PERCENT

 

MILLIONS

 

 

2012

 

 

2011

 

 

CHANGE

 

U.S. Cleaning & Sanitizing

 

 

$

651.4

 

 

$

568.5

*

 

15

%

 

U.S. Other Services

 

 

70.8

 

 

69.7

 

 

2

 

 

Int’l Cleaning, Sanitizing & Other Services

 

 

340.8

 

 

280.3

*

 

22

 

 

Global Water

 

 

235.9

 

 

196.7

*

 

20

 

 

Global Paper

 

 

86.3

 

 

75.9

*

 

14

 

 

Global Energy

 

 

360.1

 

 

264.0

*

 

36

 

 

Corporate

 

 

(459.9

)

 

(226.6

)*

 

 

 

 

Subtotal at fixed currency

 

 

1,285.4

 

 

1,228.5

*

 

5

 

 

Effect of foreign currency translation

 

 

3.9

 

 

28.2

*

 

 

 

 

Consolidated

 

 

$

1,289.3

 

 

$

1,256.7

*

 

3

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*Amounts represent the pro forma equivalent to the 2012 amounts presented.

 

Operating income as a percentage of reported net sales (“operating income margin”) for each of our reportable segments was as follows:

 

 

 

 

REPORTED

 

REPORTED

 

PRO FORMA

 

REPORTED

 

PERCENTAGE

 

 

2012

 

2011

 

2011

 

2010

 

U.S. Cleaning & Sanitizing

 

 

21.8

%

 

19.0

%

 

20.0

%

 

18.9

%

 

U.S. Other Services

 

 

14.9

 

 

15.2

 

 

15.2

 

 

15.9

 

 

Int’l Cleaning, Sanitizing & Other Services

 

 

10.7

 

 

9.3

 

 

9.3

 

 

8.8

 

 

Global Water

 

 

11.3

 

 

*

 

 

9.8

 

 

 

 

Global Paper

 

 

10.7

 

 

*

 

 

9.3

 

 

 

 

Global Energy

 

 

15.9

 

 

*

 

 

14.1

 

 

 

 

Consolidated

 

 

10.9

%

 

11.1

%

 

11.1

%

 

13.2

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

*The 2011 operating margins for the legacy Nalco segments have not been included as they are not necessarily indicative of full year or future trends, as based on the close date of the merger, they include only one month of U.S. activity.

 

Operating income margins of our segments that have international operations (Int’l Cleaning, Sanitizing & Other Services, Global Water, Global Paper and Global Energy) are generally less than those realized within our U.S. Cleaning & Sanitizing and U.S. Other Services segments. The lower international margins are due to (i) the additional cost of operating in numerous and diverse foreign jurisdictions, (ii) higher costs of importing certain raw materials and finished goods in some regions and (iii) the smaller scale of International operations where certain operating locations are smaller in size. Proportionately larger investments in sales and technical support are also necessary in order to facilitate the growth of our International operations. However, we believe all have margin improvement potential and have implemented actions to attain them.

 

As discussed previously in this MD&A, in order to provide the most meaningful comparison of results by reportable segment, in addition to discussing changes in 2012 reported results versus 2011 reported results, the following operating income discussions also provide analysis on 2012 reported results versus 2011 pro forma results. Discussions around comparisons of 2011 versus 2010 focus on the reported results for those respective periods.

 

U.S. Cleaning & Sanitizing - Reported operating income increased 17% to $651 million for 2012 compared to 2011 reported operating income. 2012 reported operating income increased 15% when compared to 2011 pro forma operating income of $569 million. Excluding the impact of acquisitions and divestitures, 2012 operating income increased 14% when compared to 2011 pro forma operating income. Reported operating income margins for 2012 showed improvement against both reported and pro forma 2011 operating income margins. The increase in operating income was driven by sales volume, pricing gains, synergies and cost savings, which more than offset delivered product cost increases.

 

U.S. Cleaning & Sanitizing operating income increased 8% to $557 million in 2011 compared to 2010. Excluding the impact of acquisitions, operating income increased 2% in 2011. Our reported operating income margin improved slightly in 2011 compared to 2010. The increase in acquisition adjusted operating income was driven primarily by sales volume and pricing gains which more than offset increases in delivered product costs.

 

U.S. Other Services - Operating income increased 2% in 2012 compared to 2011. The increase in operating income was driven primarily by sales volume and pricing gains, which more than offset higher service delivery costs and investments in the field sales organization. Our operating income margin decreased slightly in 2012 compared to 2011.

 

U.S. Other Services operating income decreased 2% to $70 million in 2011 compared to 2010. Our operating income margin decreased in 2011 compared to 2010. The operating income decrease was driven by higher service delivery costs which outpaced sales gains and cost savings actions.

 

International Cleaning, Sanitizing & Other Services - Operating income at fixed currency rates increased 19% in 2012 compared to 2011. 2012 fixed currency operating income increased 22% when compared to 2011 pro forma fixed currency operating income. Acquisitions did not have a significant impact on operating income growth. Operating income margins for 2012 showed improvement against both reported and pro forma 2011 operating income margins. Operating income growth was driven by sales volume and pricing gains as well as savings from our 2011 Restructuring Plan and other synergies, which more than offset higher delivered product costs and investments in the business. When measured at public currency rates, 2012 International Cleaning, Sanitizing & Other Services reported operating income increased 13% against reported operating income for 2011 and 15% against pro forma operating for 2011.

 

International Cleaning, Sanitizing & Other fixed currency operating income increased 12% to $286 million in 2011 compared to 2010. Excluding the impact of acquisitions and divestitures, fixed currency operating income increased 11% during 2011 when compared to 2010. Our operating income margin showed improvement in 2011 compared to 2010. Operating income growth was driven by volume and pricing gains and cost savings actions from our 2011 Restructuring Plan, which more than offset higher delivered product and other costs. When measured at public currency rates, operating income increased 21% to $304 million in 2011 compared to 2010.

 

Global Water - Global Water had $236 million of fixed currency operating income in 2012, which based on the closing date of the merger, compared against 2011 operating income of $11 million, and no operating income in 2010.

 

2012 Global Water fixed currency operating income increased 20% compared to 2011 pro forma fixed currency operating income of $197 million. Excluding the impact of acquisitions and divestitures, 2012 fixed currency operating income increased 23% when compared to 2011 pro forma fixed currency operating. Our 2012 reported operating income margin improved compared to our 2011 pro forma operating income margin. When comparing fixed currency operating income for 2012 against pro forma fixed currency operating income for 2011, operating income growth was driven by pricing and sales volume gains, as well as synergies and other cost savings, which more than offset higher delivered product costs.

 

When measured at public currency exchange rates, 2012 Global Water reported operating income increased 18% compared to 2011 pro forma operating income.

 

22



 

Global Paper - Global Paper had $86 million of fixed currency operating income in 2012, which based on the closing date of the merger, compared against 2011 operating income of $6 million, and no operating income in 2010.

 

2012 Global Paper operating income, when measured in fixed rates of currency exchange, increased 14% when compared against 2011 pro forma fixed currency operating income of $76 million. Our 2012 reported operating income margin improved compared to our 2011 pro forma operating income margin. When comparing fixed currency results for 2012 against pro forma fixed currency results for 2011, operating income growth was driven by pricing gains, synergies and other cost savings which more than offset decreased sales volume from the strategic elimination of low margin business and higher delivered product costs.

 

When measured at public currency exchange rates, 2012 Global Paper reported operating income increased 11% compared to 2011 pro forma operating income.

 

Global Energy - Global Energy had $360 million of fixed currency operating income in 2012, which based on the closing date of the merger, compared against 2011 operating income of $18 million, and no operating income in 2010.

 

When measured in fixed rates of currency exchange, 2012 Global Energy operating income increased 36% versus 2011 pro forma fixed currency operating income of $264 million. Our 2012 reported operating income margin improved compared to our 2011 pro forma operating income margin. When comparing fixed currency results for 2012 against pro forma results for 2011, operating income growth was driven by strong sales volume growth, pricing gains and synergies, which more than offset higher delivered product costs and investments in the business.

 

When measured at public currency exchange rates, 2012 Global Energy reported operating income increased 34% compared to 2011 pro forma operating income.

 

Corporate - Consistent with our internal management reporting, the Corporate segment includes amortization specifically from the Nalco merger intangible assets, merger integration costs and investments we are making in business systems and structure.

 

The Corporate segment also includes special (gains) and charges reported on the Consolidated Statement of Income. Items included within reported special (gains) and charges are shown in the table on page 15, and items included in pro forma special (gains) and charges are shown in the table on page 9.

 

FINANCIAL POSITION & LIQUIDITY

 

 

Financial Position

Total assets were $17.6 billion as of December 31, 2012, compared to total assets of $18.2 billion as of December 31, 2011. The decrease in assets is primarily due to a net reduction in cash, related to the redemption of $1.7 billion of Nalco’s senior notes in January 2012, partially offset by a buildup of cash at the end of 2012 in anticipation of the Champion acquisition. The negative impact of foreign currency exchange rates on the value of our international assets was offset by the increase of assets through general business activities. Acquisitions and divestitures during 2012 did not have a significant impact on our total assets.

 

Total liabilities were $11.4 billion as of December 31, 2012, compared to total liabilities of $12.4 billion as of December 31, 2011. Total debt was $6.5 billion as of December 31, 2012 and $7.6 billion as of December 31, 2011. The ratio of total debt to capitalization (total debt divided by the sum of total equity and total debt) was 52% at year-end 2012 and 57% at year-end 2011, reflecting the redemption of $1.7 billion of Nalco’s senior notes in January 2012, offset by debt issued in 2012 to fund the pending Champion acquisition and for other general corporate purposes. We view our debt to capitalization ratio as an important indicator of our creditworthiness.

 

GRAPHIC

 

Cash Flows

Operating Activities – Cash provided by operating activities totaled $1,203 million, $686 million, and $950 million in 2012, 2011 and 2010, respectively. Fluctuations in earnings, primarily driven by the Nalco merger, timing of voluntary and required contributions to our U.S. pension plans and cash activity related to restructuring impacted comparability of operating cash flows. In addition to required contributions, we made voluntary contributions to our U.S. pension plans of $150 million and $100 million in 2012 and 2011, respectively, and no contributions in 2010. Operating cash flows were impacted by $73 million, $25 million and $17 million of payments made under our restructuring plans in 2012, 2011 and 2010, respectively. In addition, operating cash flows in 2011 were reduced by Nalco merger related financial advisory service payments of $48 million, a Nalco lease payment of $31 million and a payment on the customer agreement modification of $30 million.

 

The cash flow impact across the three years from accounts receivable was driven by increased sales volumes and timing of collections. Our bad debt expense was $37 million or 0.3% of sales in 2012, $15 million or 0.2% of net sales in 2011 and $18 million or 0.3% of net sales in 2010. We continue to monitor our receivable portfolio and the creditworthiness of our customers closely and do not expect our future cash flow to be materially impacted.

 

We continue to generate strong cash flow from operations. We expect to continue to use this cash flow to fund our ongoing operations and investments in the business, to fund acquisitions, to return cash to shareholders through dividend payments and share repurchases and to repay debt.

 

GRAPHIC

 

Investing Activities - Cash used for investing activities was $488 million in 2012, $2.0 billion in 2011 and $304 million in 2010. The fluctuation across the three years is driven primarily by the timing of business acquisitions and dispositions. Total cash received from dispositions, net of acquisitions during 2012 was $88 million, driven primarily by the sale of our Vehicle Care division. Total cash paid for acquisitions, net of cash acquired, in 2011 was $1.6 billion, with the

 

23



 

Nalco merger accounting for $1.3 billion of this total. Other significant acquisitions in 2011 included the Cleantec business of Campbell Brothers Ltd. and O.R. Solutions, Inc. Cash paid for acquisitions in 2010 was driven by the purchase of the commercial laundry division of Dober Chemical. We continue to target strategic business acquisitions which complement our growth strategy and expect to continue to make capital investments and acquisitions in the future to support our long-term growth. See Note 4 for further information on our business acquisition and disposition activity.

 

Increases in capital expenditures compared to the prior year were due primarily to investments in Nalco business units. We continue to make investments in the business including equipment used by our customers to dispense our cleaning and sanitizing products as well as chemical feed, process control and process monitoring equipment.

 

Financing Activities - Cash used for financing activities was $1.4 billion and $462 million in 2012 and 2010, respectively. Cash provided by financing activities was $2.9 billion in 2011. Our cash flows from financing activities reflect issuances and repayment of debt, common stock repurchases, dividend payments and proceeds from common stock issuances related to our equity incentive programs.

 

Our 2012 financing activities included $1.7 billion of long-term debt repayments, primarily related to the redemption of Nalco’s senior notes in January 2012. Partially offsetting the debt repayment, we separately issued $500 million of senior notes in public debt offerings in August 2012 and December 2012. Net repayments of commercial paper and notes payable led to a decrease in debt of $387 million during 2012.

 

Our 2011 financing activities included the issuance of $3.75 billion of senior notes through a public debt offering completed in December 2011 and the issuance of $500 million of private placement senior notes, completed in November 2011. Our 2011 financing activities also included the scheduled repayment of our $150 million 6.875% notes and the repayment of $1.3 billion of long-term debt assumed as part of the Nalco merger. Net borrowings of commercial paper and notes payable led to an increase of $907 million during 2011.

 

Our 2010 financing activities included a $67 million pay down of commercial paper and notes payable.

 

Shares are repurchased for the purpose of partially offsetting the dilutive effect of stock options and incentives and stock issued in acquisitions and to efficiently return capital to shareholders. Cash proceeds and tax benefits from option exercises provide a portion of the funding for repurchase activity. During 2012, 2011, and 2010, we had $210 million, $690 million and $349 million of share repurchases, respectively.

 

In September 2011, we announced a $1.0 billion share repurchase program, contingent upon closing the merger with Nalco. As part of this program, in December 2011, we entered into an accelerated share repurchase agreement (“ASR”) with a financial institution to repurchase $500 million of our common stock. Under the ASR, we received 8,330,379 shares of our common stock in December 2011. The final per share purchase price and the total number of shares to be repurchased under the ASR agreement were generally based on the volume weighted average price of the company’s common stock during the term of the agreement. The ASR agreement ended in the first quarter of 2012. In connection with the finalization of the accelerated share repurchase agreement we received an additional 122,314 shares of common stock, with no additional cash impact in 2012. As of December 31, 2012, approximately $279 million remained to be purchased as part of the $1.0 billion share repurchase program. The company expects to complete this remaining portion of the $1.0 billion share repurchase program in 2013.

 

In December 2012, we increased our indicated annual dividend rate by 15%. This represents the 21st consecutive year we have increased our dividend. We have paid dividends on our common stock for 76 consecutive years. Cash dividends declared per share of common stock, by quarter, for each of the last three years were as follows:

 

 

 

FIRST

 

SECOND

 

THIRD

 

FOURTH

 

 

 

 

 

QUARTER

 

QUARTER

 

QUARTER

 

QUARTER

 

YEAR

 

2012

 

$

0.2000

 

$

0.2000

 

$

0.2000

 

$

0.2300

 

$

0.8300

 

2011

 

0.1750

 

0.1750

 

0.1750

 

0.2000

 

0.7250

 

2010

 

0.1550

 

0.1550

 

0.1550

 

0.1750

 

0.6400

 

 

Liquidity and Capital Resources

We currently expect to fund all of our cash requirements which are reasonably foreseeable for 2013, including scheduled debt repayments, new investments in the business, share repurchases, dividend payments, possible business acquisitions and pension contributions with cash from operating activities, cash reserves and additional short-term and/or long-term borrowings.

 

As of December 31, 2012, we had $1.2 billion of cash and cash equivalents on hand, of which $300 million was held outside of the U.S. We continue to expect our operating cash flow to remain strong.

 

As of December 31, 2012, we had a $1.5 billion multi-year credit facility, which expires in September 2016. In August 2012, we replaced our existing $1.0 billion 364 day credit facility (which in April 2012 had been reduced from $2.0 billion to $1.0 billion) with a $500 million 364 day credit facility, which expires in August 2013. Both the $1.5 billion and $500 million credit facilities have been established with a diverse portfolio of banks. There were no borrowings under the credit facilities as of December 31, 2012 or 2011.

 

The credit facilities support our U.S. commercial paper program, which was reduced to $2.0 billion subsequent to the replacement of our 364 day credit facility discussed above, and our $200 million European commercial paper program. Combined borrowing under these two commercial paper programs may not exceed $2.0 billion. As of December 31, 2012, we had $594 million in outstanding U.S. commercial paper, with an average annual interest rate of 0.5%, and no amounts outstanding under our European commercial paper program. As of December 31, 2012, both programs were rated A-2 by Standard & Poor’s and P-2 by Moody’s.

 

Additionally, we have other committed and uncommitted credit lines of $501 million with major international banks and financial institutions to support our general global funding needs. Approximately $346 million of these credit lines were undrawn and available for use as of year-end 2012.

 

In November 2012, we entered into a $900 million term loan credit agreement with various banks. Under the agreement, which had not been drawn upon as of December 31, 2012, the term loan will bear interest at a floating base rate plus a credit rating based margin. Proceeds from the term loan are expected to be used to fund a portion of the pending Champion acquisition. Funding under the agreement will be available through April 15, 2013 and, to the extent funded, the term loan will expire on the third anniversary of the funding date.

 

In December 2012, in a public offering, we issued $500 million of debt securities that mature in 2017 at a rate of 1.45%. We anticipate that the proceeds will be used to finance a portion of the cash consideration to be paid in connection with the pending Champion acquisition. If the Champion acquisition is not completed by May 3, 2013, or if the Champion acquisition merger agreement is terminated on or before such date, we may redeem these debt securities in whole but not in part, at a price equal to 101% of the principal amount

 

24



 

thereof, plus any accrued and unpaid interest to the redemption date.

 

In August 2012, in a public offering, the company issued $500 million of debt securities that mature in 2015 at a rate of 1.00%. The proceeds were used to refinance outstanding commercial paper and for general corporate purposes.

 

As of December 31, 2012, Standard & Poor’s and Moody’s rated our long-term credit at BBB+ (stable outlook) and Baa1 (negative review), respectively. A reduction in our long-term credit ratings could limit or preclude our ability to issue commercial paper under our current programs. A credit rating reduction could also adversely affect our ability to renew existing, or negotiate new, credit facilities in the future and could increase the cost of these facilities. Should this occur, we could seek additional sources of funding, including issuing additional term notes or bonds. In addition, we have the ability, at our option, to draw upon our $2.0 billion of committed credit facilities prior to termination.

 

We are in compliance with our debt covenants and other requirements of our credit agreements and indentures.

 

A schedule of our obligations under various notes payable, long-term debt agreements, operating leases with noncancelable terms in excess of one year, interest obligations and benefit payments are summarized in the following table:

 

MILLIONS

 

 

 

PAYMENTS DUE BY PERIOD

 

CONTRACTUAL
OBLIGATIONS

 

TOTAL

 

LESS
THAN
1 YEAR

 

2-3
YEARS

 

4-5
YEARS

 

MORE
THAN
5 YEARS

 

Notes payable

 

$

44

 

$

44

 

$

 

$

 

$

 

Commercial paper

 

594

 

594

 

 

 

 

Long-term debt

 

5,890

 

163

 

1,255

 

1,979

 

2,493

 

Capital lease obligations

 

14

 

5

 

6

 

1

 

2

 

Operating leases

 

525

 

108

 

154

 

108

 

155

 

Interest*

 

2,157

 

209

 

378

 

291

 

1,279

 

Total contractual cash obligations

 

$

9,224

 

$

1,123

 

$

1,793

 

$

2,379

 

$

3,929

 

 

*

Interest on variable rate debt was calculated using the interest rate at year-end 2012.

 

As of December 31, 2012, our gross liability for uncertain tax positions was $93 million. We are not able to reasonably estimate the amount by which the liability will increase or decrease over an extended period of time or whether a cash settlement of the liability will be required. Therefore, these amounts have been excluded from the schedule of contractual obligations.

 

We are not required to make any contributions to our U.S. pension and postretirement healthcare benefit plans in 2013, based on plan asset values as of December 31, 2012. We are required to fund certain international pension benefit plans in accordance with local legal requirements. We estimate contributions to be made to our international plans will approximate $51 million in 2013. These amounts have been excluded from the schedule of contractual obligations.

 

We lease certain sales and administrative office facilities, distribution centers, research and manufacturing facilities and other equipment under longer-term operating leases. Vehicle leases are generally shorter in duration. Vehicle leases have guaranteed residual value requirements that have historically been satisfied primarily by the proceeds on the sale of the vehicles.

 

Except for approximately $82 million of letters of credit supporting domestic and international commercial relationships and transactions, primarily for our North America high deductible insurance program, we do not have significant unconditional purchase obligations, or significant other commercial commitments, such as commitments under lines of credit, standby letters of credit, guarantees, standby repurchase obligations or other commercial commitments.

 

Off-Balance Sheet Arrangements

Other than operating leases, we do not have any off-balance sheet financing arrangements. See Note 12 for information on our operating leases. We do not have relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “special purposes entities”, which are sometimes established for the purpose of facilitating off-balance sheet financial arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

New Accounting Pronouncements

Information regarding new accounting pronouncements is included in Note 2.

 

Market Risk

We enter into contractual arrangements (derivatives) in the ordinary course of business to manage foreign currency exposure and interest rate risks. We do not enter into derivatives for speculative or trading purposes. Our use of derivatives is subject to internal policies that provide guidelines for control, counterparty risk and ongoing monitoring and reporting and is designed to reduce the volatility associated with movements in foreign exchange and interest rates on our income statement and cash flows.

 

We enter into foreign currency forward contracts to hedge certain intercompany financial arrangements, and to hedge against the effect of exchange rate fluctuations on transactions related to cash flows denominated in currencies other than U.S. dollars. See Note 8 for further information on our hedging activity.

 

We manage interest expense using a mix of fixed and floating rate debt. To help manage borrowing costs, we may enter into interest rate swap agreements. Under these arrangements, we agree to exchange, at specified intervals, the difference between fixed and floating interest amounts calculated by reference to an agreed-upon notional principal amount. As of December 31, 2012 and 2011, we did not have any interest rate swaps outstanding.

 

Based on a sensitivity analysis (assuming a 10% adverse change in market rates) of our foreign exchange and interest rate derivatives and other financial instruments, changes in exchange rates or interest rates would not materially affect our financial position and liquidity. The effect on our results of operations would be substantially offset by the impact of the hedged items.

 

European Economy

The current economic conditions in several European countries (particularly Italy, Spain, Portugal, Greece and Ireland) deteriorated during 2012. Further weakening of the European economy may cause a decline in the value of the European currencies, including the euro. One potential extreme outcome of the European financial situation is the re-introduction of individual currencies in one or more Eurozone countries or the dissolution of the euro entirely. The potential dissolution of the euro, or market perceptions concerning this and related issues, could adversely affect the value of our euro-denominated assets and obligations and impact our future results of operations. As of year end 2012, net assets of the five European countries listed above represented 3% of our consolidated net assets. During 2012, sales in the five European countries listed above represented approximately 4% of our consolidated net sales.

 

25



 

Additionally, this crisis has caused instability in European credit markets, including diminished liquidity and credit availability, which could negatively impact our customers located in these and other geographic areas. We continue to monitor the situation and the creditworthiness of our customers. Although we do not currently foresee a credit risk associated with a material portion of our customers’ receivables, repayment is dependent upon the financial stability of the economies of those countries.

 

Subsequent Events

 

Acquisitions

 

In January 2013, we completed the acquisition of Mexico-based Quimiproductos S.A. de C.V., a wholly-owned subsidiary of Fomanto Economico Mexicano, S.A.B. de C.V. Annual sales of the business are approximately $43 million.

 

Venezuela Foreign Currency Translation

 

Venezuela is a highly inflationary economy under U.S. GAAP. As a result, the U.S. dollar is the functional currency for our subsidiaries in Venezuela. Any currency remeasurement adjustments for non-dollar denominated monetary assets and liabilities held by these subsidiaries and other transactional foreign exchange gains and losses are reflected in earnings. Our net monetary assets and liabilities included in our Venezuelan subsidiary balance sheets as of year end 2012 was approximately $69 million. On February 8, 2013 the Venezuelan government devalued its currency (Bolivar Fuerte). As a result of the devaluation, we will record a charge of approximately $20 million, net of tax, in the first quarter of 2013 due to the remeasurement of the local balance sheet.

 

Our ability to effectively manage sales and profit levels in Venezuela will be impacted by several factors, including our ability to mitigate the effect of any potential future devaluation, further actions of the Venezuelan government, economic conditions in Venezuela, the availability of raw materials, utilities and energy and the future state of exchange controls in Venezuela including the availability of U.S. dollars at the official foreign exchange rate. Sales and profit levels in Venezuela could also be impacted by any actions taken by the government under the recently passed law aimed at controlling market prices. We expect that the ongoing impact related to measuring our Venezuelan statement of income at the new exchange rate will not have a material impact to our results of operations. During 2012, sales in Venezuela represented approximately 1% of our consolidated net sales.

 

Segment Structure

 

Effective in 2013, we have a new organizational model to support global growth. This will result in a change to our segment structure with a focus on global businesses. These changes will result in the establishment of ten global operating units, including Global Energy, Global Institutional, Global Specialty, Global Healthcare, Global Food & Beverage, Global Water, Global Paper, Global Textile Care and Global Pest Elimination and Equipment Care. These operating units will be aggregated into four reportable segments which include Global Energy, Global Institutional, Global Industrial and Other. Our internal budgeting and reporting will be realigned in 2013 to reflect these changes. The movement of these businesses will impact year-over-year comparability; therefore, prior year segment information will be recast during the first quarter of 2013 to reflect this change.

 

Non-GAAP Financial Measures

This MD&A includes financial measures that have not been calculated in accordance with U.S. GAAP. These Non-GAAP measures include:

 

·                  Adjusted sales

·                  Adjusted pro forma sales

·                  Fixed currency sales

·                  Adjusted fixed currency sales

·                  Adjusted pro forma fixed currency sales

·                  Pro forma sales

·                  Pro forma fixed currency sales

·                  Adjusted gross margin

·                  Adjusted pro forma gross margin

·                  Pro forma SG&A ratio

·                  Adjusted SG&A ratio

·                  Fixed currency operating income

·                  Pro forma operating income

·                  Pro forma fixed currency operating income

·                  Adjusted operating income

·                  Adjusted pro forma operating income

·                  Adjusted fixed currency operating income

·                  Adjusted pro forma fixed currency operating income

·                  Adjusted net interest expense

·                  Adjusted effective income tax rate

·                  Adjusted net income attributable to Ecolab

·                  Adjusted diluted earnings per share attributable to Ecolab

 

We provide these measures as additional information regarding our operating results. We use these Non-GAAP measures internally to evaluate our performance and in making financial and operational decisions, including with respect to incentive compensation. We believe that our presentation of these measures provides investors with greater transparency with respect to our results of operations and that these measures are useful for period-to-period comparison of results.

 

We include in special (gains) and charges items that are unusual in nature and significant in amount. In order to better allow investors to compare underlying business performance period-to-period, we provide adjusted sales, adjusted pro forma sales, adjusted fixed currency sales, adjusted pro forma fixed currency sales, adjusted gross margin, adjusted pro forma gross margin, adjusted operating income, adjusted fixed currency operating income, adjusted pro forma operating income, adjusted pro forma fixed currency operating income, adjusted net interest expense, adjusted net income attributable to Ecolab and adjusted diluted earnings per share, which exclude special (gains) and charges and discrete tax items. The exclusion of special (gains) and charges and discrete tax items in such adjusted amounts help provide a better understanding of underlying business performance. In addition, to allow for a more meaningful comparison against 2010 results, where applicable, we have excluded the impact of Nalco’s post-merger results in our 2011 non-GAAP measures.

 

The adjusted effective tax rate measure promotes period-to-period comparability of the underlying effective tax rate because the amounts excluded do not necessarily reflect costs associated with historical trends or expected future costs.

 

We evaluate the performance of our international operations based on fixed currency rates of foreign exchange. Fixed currency sales, adjusted fixed currency sales, fixed currency operating income and adjusted fixed currency operating income measures (and the 2011 pro forma equivalent for each) eliminate the impact of exchange rate fluctuations on our sales, adjusted sales, operating income and adjusted operating income, respectively, and promote a better understanding of our underlying sales and operating income trends. Fixed currency amounts are based on translation into U.S. dollars at

 

26



 

fixed foreign currency exchange rates established by management at the beginning of 2012.

 

In order to provide a meaningful comparison of our results of operations, where applicable, we have supplemented our 2011 historical financial data with discussion and analysis that compares reported and adjusted results for 2012 against the 2011 Merger Pro Formas. The unaudited pro forma results are based on the historical consolidated results of operations of both Ecolab and Nalco and were prepared to illustrate the effects of our merger with Nalco, assuming the merger had been consummated on January 1, 2010. The unaudited pro forma and adjusted pro forma results are not necessarily indicative of the results of operations that would have actually occurred had the merger been completed as of the date indicated, nor are they indicative of future operating results of the combined company.

 

These measures are not in accordance with, or an alternative to U.S. GAAP, and may be different from Non-GAAP measures used by other companies. Investors should not rely on any single financial measure when evaluating our business. We recommend that investors view these measures in conjunction with the U.S. GAAP measures included in this MD&A and have provided reconciliations of reported U.S. GAAP amounts to the Non-GAAP amounts.

 

Forward-Looking Statements and Risk Factors

This MD&A and other portions of this Annual Report to Shareholders contain various “Forward-Looking Statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include expectations concerning items such as:

 

  scope, timing, costs, cash expenditures, benefits and headcount impact of our restructuring initiatives

  closing of the Champion acquisition

  objective to improve credit rating

  ability to deliver superior shareholder returns

  long-term potential of our business

  impact of changes in exchange rates and interest rates

  losses due to concentration of credit risk

  Cleantec escrow settlement

  recognition of share-based compensation expense

  future benefit plan payments

  amortization expense

  European economic uncertainty including euro currency issues

  demographic trends and their impact on end-markets

  outlook for growth

  special (gains) and charges

  benefits of and synergies from the Nalco merger

  bad debt experiences and customer credit worthiness

  disputes, claims and litigation

  environmental contingencies

  returns on pension plan assets

  currency gains and losses

  investments

  potential for margin improvement in our non-U.S. business

  cash flow and uses for cash

  business acquisitions and sources of funding

  dividends

  share repurchases

  debt repayments

  contributions to pension and postretirement healthcare plans

  liquidity requirements and borrowing methods

  impact of credit rating downgrade

  impact of new accounting pronouncements

  tax deductibility of goodwill

  non performance of counterparties

  timing of hedged transactions

  income taxes, including loss carryforwards, unrecognized tax benefits and uncertain tax positions

 

Without limiting the foregoing, words or phrases such as “will likely result,” “are expected to,” “will continue,” “is anticipated,” “we believe,” “we expect,” “estimate,” “project” (including the negative or variations thereof) or similar terminology, generally identify forward-looking statements. Forward-looking statements may also represent challenging goals for us. These statements, which represent the company’s expectations or beliefs concerning various future events, are based on current expectations that involve a number of risks and uncertainties that could cause actual results to differ materially from those of such forward-looking statements. We caution that undue reliance should not be placed on such forward-looking statements, which speak only as of the date made. Some of the factors which could cause results to differ from those expressed in any forward-looking statements are set forth under Item 1A of our Form 10-K for the year ended December 31, 2012, entitled Risk Factors.

 

In addition, we note that our stock price can be affected by fluctuations in quarterly earnings. There can be no assurances that our earnings levels will meet investors’ expectations. Except as may be required under applicable law, we undertake no duty to update our Forward-Looking Statements.

 

27



 

CONSOLIDATED STATEMENT OF INCOME

 

YEAR ENDED DECEMBER 31 (MILLIONS, EXCEPT PER SHARE AMOUNTS)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

Net sales (including special charges of $29.6 in 2011)

 

$

11,838.7

 

$

6,798.5

 

$

6,089.7

 

Operating expenses

 

 

 

 

 

 

 

Cost of sales (including special charges of $93.9 in 2012 and $8.9 in 2011)

 

6,483.5

 

3,475.6

 

3,013.8

 

Selling, general and administrative expenses

 

3,920.2

 

2,438.1

 

2,261.6

 

Special (gains) and charges

 

145.7

 

131.0

 

7.5

 

Operating income

 

1,289.3

 

753.8

 

806.8

 

Interest expense, net (including special charges of $19.3 in 2012 and $1.5 in 2011)

 

276.7

 

74.2

 

59.1

 

Income before income taxes

 

1,012.6

 

679.6

 

747.7

 

Provision for income taxes

 

311.3

 

216.3

 

216.6

 

Net income including noncontrolling interest

 

701.3

 

463.3

 

531.1

 

Less: Net income (loss) attributable to noncontrolling interest (including special charges of $4.5 in 2012)

 

(2.3)

 

0.8

 

0.8

 

Net income attributable to Ecolab

 

$

703.6

 

$

462.5

 

$

530.3

 

 

 

 

 

 

 

 

 

Earnings attributable to Ecolab per common share

 

 

 

 

 

 

 

Basic

 

$

2.41

 

$

1.95

 

$

2.27

 

Diluted

 

$

2.35

 

$

1.91

 

$

2.23

 

 

 

 

 

 

 

 

 

 

 

Dividends declared per common share

 

$

0.8300

 

$

0.7250

 

$

0.6400

 

 

 

 

 

 

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

Basic

 

292.5

 

236.9

 

233.4

 

Diluted

 

298.9

 

242.1

 

237.6

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

28



 

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

 

YEAR ENDED DECEMBER 31 (MILLIONS)

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income including noncontrolling interest

 

 $

701.3

 

 

$

463.3

 

 

$

531.1

 

Other comprehensive income (loss), net of tax

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustments

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

4.8

 

 

34.0

 

 

(111.6

)

Gain (loss) on net investment hedges

 

9.8

 

 

(9.5

)

 

37.6

 

 

 

14.6

 

 

24.5

 

 

(74.0

)

Derivatives and hedging instruments

 

 

 

 

 

 

 

 

 

Unrealized losses during the period

 

(1.9

)

 

(15.1