Filed by Bowne Pure Compliance
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2008
or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission File No. 001-32342
NALCO HOLDING COMPANY
(Exact name of registrant as specified in its charter)
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Delaware
(State or other jurisdiction of
Incorporation or Organization)
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16-1701300
(I.R.S. Employer
Identification Number) |
1601 West Diehl Road
Naperville, IL 60563-1198
(630) 305-1000
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrants Principal Executive Offices)
Not applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in
Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer þ
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Accelerated filer o
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Non-accelerated filer o
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Smaller reporting company o |
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(Do not check if a smaller reporting company) |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b-2 of the
Exchange Act). Yes o No þ
As of October 22, 2008, the number of shares of the registrants common stock, par value $0.01 per
share, outstanding was 137,593,987 shares.
QUARTERLY REPORT ON FORM 10-Q
NALCO HOLDING COMPANY
Quarter Ended September 30, 2008
TABLE OF CONTENTS
1
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Nalco Holding Company and Subsidiaries
Condensed Consolidated Balance Sheets
(dollars in millions)
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(Unaudited) |
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September 30, 2008 |
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December 31, 2007 |
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Assets |
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Current assets: |
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Cash and cash equivalents |
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$ |
101.7 |
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$ |
119.9 |
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Accounts receivable, less allowances of $20.4 in 2008 and
$19.5 in 2007 |
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807.3 |
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805.6 |
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Inventories: |
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Finished products |
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338.1 |
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268.9 |
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Materials and work in process |
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109.9 |
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81.5 |
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448.0 |
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350.4 |
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Prepaid expenses, taxes and other current assets |
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101.4 |
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112.6 |
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Total current assets |
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1,458.4 |
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1,388.5 |
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Property, plant, and equipment, net |
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736.8 |
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762.3 |
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Intangible assets: |
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Goodwill |
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2,337.6 |
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2,459.8 |
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Other intangibles, net |
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1,094.8 |
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1,121.4 |
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Other assets |
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207.1 |
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246.6 |
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Total assets |
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$ |
5,834.7 |
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$ |
5,978.6 |
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Liabilities and shareholders equity |
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Current liabilities: |
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Accounts payable |
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$ |
347.6 |
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$ |
316.4 |
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Short-term debt |
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85.3 |
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130.4 |
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Other current liabilities |
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347.0 |
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322.5 |
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Total current liabilities |
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779.9 |
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769.3 |
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Other liabilities: |
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Long-term debt |
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3,194.8 |
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3,193.7 |
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Deferred income taxes |
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309.5 |
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327.5 |
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Accrued pension benefits |
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259.7 |
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314.4 |
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Other liabilities |
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223.3 |
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234.7 |
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Minority interest |
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18.3 |
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21.2 |
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Shareholders equity |
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1,049.2 |
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1,117.8 |
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Total liabilities and shareholders equity |
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$ |
5,834.7 |
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$ |
5,978.6 |
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See accompanying notes to condensed consolidated financial statements.
2
Nalco Holding Company and Subsidiaries
Condensed Consolidated Statements of Operations
(Unaudited)
(dollars in millions, except per share amounts)
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Three Months |
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Three Months |
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Nine Months |
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Nine Months |
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ended |
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ended |
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ended |
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ended |
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September 30, 2008 |
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September 30, 2007 |
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September 30, 2008 |
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September 30, 2007 |
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Net sales |
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$ |
1,115.5 |
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$ |
998.2 |
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$ |
3,181.5 |
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$ |
2,878.4 |
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Operating costs and expenses: |
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Cost of product sold |
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642.8 |
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549.2 |
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1,802.1 |
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1,591.1 |
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Selling, administrative, and
research expenses |
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317.2 |
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295.4 |
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958.2 |
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875.1 |
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Amortization of intangible assets |
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14.0 |
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15.6 |
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43.5 |
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46.2 |
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Business optimization expenses |
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10.4 |
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7.2 |
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12.8 |
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9.5 |
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Gain on divestiture |
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(38.1 |
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(38.1 |
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Total operating costs and expenses |
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946.3 |
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867.4 |
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2,778.5 |
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2,521.9 |
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Operating earnings |
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169.2 |
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130.8 |
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403.0 |
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356.5 |
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Other income (expense), net |
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(5.1 |
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(1.9 |
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(12.4 |
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(2.2 |
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Interest income |
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2.3 |
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2.7 |
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6.8 |
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7.2 |
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Interest expense |
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(63.7 |
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(69.1 |
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(195.7 |
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(205.6 |
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Earnings before income taxes and
minority interests |
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102.7 |
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62.5 |
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201.7 |
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155.9 |
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Income tax provision |
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43.9 |
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24.0 |
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66.4 |
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52.4 |
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Minority interests |
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(1.4 |
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(2.0 |
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(4.5 |
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(5.6 |
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Net earnings |
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$ |
57.4 |
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$ |
36.5 |
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$ |
130.8 |
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$ |
97.9 |
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Net earnings per share: |
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Basic |
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$ |
0.41 |
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$ |
0.25 |
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$ |
0.93 |
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$ |
0.68 |
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Diluted |
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$ |
0.41 |
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$ |
0.25 |
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$ |
0.92 |
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$ |
0.66 |
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Weighted-average shares outstanding
(millions): |
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Basic |
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139.9 |
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143.7 |
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141.1 |
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143.9 |
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Diluted |
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140.7 |
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146.6 |
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141.9 |
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147.5 |
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Cash dividends declared per share |
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$ |
0.035 |
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$ |
0.035 |
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$ |
0.105 |
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$ |
0.105 |
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See accompanying notes to condensed consolidated financial statements.
3
Nalco Holding Company and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(dollars in millions)
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Nine Months |
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Nine Months |
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ended |
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ended |
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September 30, 2008 |
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September 30, 2007 |
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Operating activities |
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Net earnings |
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$ |
130.8 |
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$ |
97.9 |
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Adjustments to reconcile net earnings to net cash
provided by operating activities: |
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Depreciation |
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103.8 |
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97.0 |
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Amortization |
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43.5 |
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46.2 |
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Gain on divestiture |
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(38.1 |
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Amortization of deferred financing costs
and accretion of senior discount notes |
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35.8 |
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33.7 |
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Other, net |
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(10.3 |
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(11.4 |
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Changes in operating assets and liabilities |
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(64.2 |
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(68.1 |
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Net cash provided by operating activities |
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201.3 |
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195.3 |
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Investing activities |
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Additions to property, plant, and equipment, net |
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(99.8 |
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(70.3 |
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Net proceeds from divestiture |
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74.1 |
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Other, net |
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(23.8 |
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(2.6 |
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Net cash used for investing activities |
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(49.5 |
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(72.9 |
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Financing activities |
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Cash dividends |
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(14.8 |
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(10.1 |
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Changes in short-term debt, net |
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(68.7 |
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(20.8 |
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Proceeds from long-term debt |
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16.0 |
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50.2 |
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Repayments of long-term debt |
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(0.7 |
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(24.1 |
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Purchases of treasury stock |
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(95.0 |
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(37.0 |
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Other, net |
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(5.2 |
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(4.0 |
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Net cash used for financing activities |
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(168.4 |
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(45.8 |
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Effect of exchange rate changes on cash and cash
equivalents |
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(1.6 |
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4.0 |
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Increase (decrease) in cash and cash equivalents |
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(18.2 |
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80.6 |
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Cash and cash equivalents at beginning of period |
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119.9 |
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37.3 |
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Cash and cash equivalents at end of period |
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$ |
101.7 |
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$ |
117.9 |
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See accompanying notes to condensed consolidated financial statements.
4
Nalco Holding Company and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
September 30, 2008
1. Description of Business
We are engaged in the worldwide manufacture and sale of highly specialized service chemical
programs. This includes production and service related to the sale and application of chemicals and
technology used in water treatment, pollution control, energy conservation, oil production and
refining, steelmaking, papermaking, mining, and other industrial processes.
2. Basis of Presentation
These condensed consolidated financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in the Annual Report for Nalco Holding
Company and subsidiaries for the fiscal year ended December 31, 2007.
The accompanying unaudited condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial information.
Accordingly, they do not include all of the information and footnotes required by accounting
principles generally accepted in the United States for complete financial statements. Management
believes these financial statements include all normal recurring adjustments considered necessary
for a fair presentation of our financial position and results of operations. Operating results for
the nine months ended September 30, 2008 are not necessarily indicative of results that may be
expected for the year ended December 31, 2008.
Certain minor reclassifications have been made to the prior year data to conform to the current
year presentation, which had no effect on net earnings reported for any period.
3. Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 157, Fair Value Measurements, which defines fair value, establishes
a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS
No. 157 applies under other accounting pronouncements that require or permit fair value
measurements. This statement indicates, among other things, that a fair value measurement assumes
that the transaction to sell an asset or transfer a liability occurs in the principal market for
the asset or liability or, in the absence of a principal market, the most advantageous market for
the asset or liability. SFAS No. 157 defines fair value based upon an exit price model. Relative
to SFAS No. 157, the FASB has issued FASB Staff Position (FSP) 157-2, which delays the effective
date of SFAS No. 157 for one year for certain nonfinancial
assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in
the financial statements on a recurring basis. As required, we adopted SFAS No. 157 on January 1,
2008, for financial assets and liabilities and for nonfinancial assets and liabilities that are
remeasured at least annually. There was no material effect on our financial statements upon
adoption. We do not expect a material impact on our financial statements from adoption of SFAS No.
157 as it pertains to nonfinancial assets and nonfinancial liabilities for our first quarter of
2009.
5
3. Recent Accounting Pronouncements (continued)
In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension
and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106 and 132(R). SFAS
No. 158 requires an employer to recognize in its balance sheet an asset for a plans overfunded
status or a liability for a plans underfunded status, measure a plans assets and its obligations
that determine its funded status as of the end of the employers fiscal year, and recognize changes
in the funded status of a defined benefit postretirement plan in the year in which the changes
occur. Those changes are reported in comprehensive income and as a separate component of
shareholders equity. SFAS No. 158 does not change the amount of net periodic benefit cost
included in net earnings. We adopted the recognition and disclosure provisions of SFAS No. 158 as
of December 31, 2006, as required. We will change our measurement date to our December 31 fiscal
year end from the current measurement date of November 30 in 2008, as required.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities Including an amendment of FASB Statement No. 115. SFAS No. 159 permits
entities to choose to measure many financial instruments and certain other items at fair value.
This statement also establishes presentation and disclosure requirements designed to facilitate
comparisons between entities that choose different measurement attributes for similar types of
assets and liabilities. At the adoption date, unrealized gains and losses on existing items for
which fair value has been elected are reported as a cumulative adjustment in retained earnings.
Subsequent to adopting SFAS No. 159, changes in fair value are recognized in earnings. As
required, we adopted SFAS No. 159 as of January 1, 2008; however, we have not elected to change the
measurement attribute for any of the permitted items to fair value upon adoption.
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, which replaces SFAS No.
141, Business Combinations. SFAS No. 141(R) retains the underlying concepts of SFAS No. 141 in
that all business combinations are still required to be accounted for under the acquisition method
of accounting, but SFAS No. 141(R) changed the method of applying the acquisition method in a
number of significant aspects. Acquisition costs will generally be expensed as incurred;
noncontrolling interests will be valued at fair value at the acquisition date; in-process research
and development will be recorded at fair value as an indefinite-lived intangible asset at the
acquisition date; restructuring costs associated with a business combination will generally be
expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances
and income tax uncertainties after the acquisition date generally
will affect income tax expense. SFAS No. 141(R) is effective on a prospective basis for all
business combinations for which the acquisition date is on or after the beginning of the first
annual period subsequent to December 15, 2008, with the exception of the accounting for changes in
valuation allowances on deferred taxes and acquired tax contingencies related to acquisitions prior
to the date of adoption. SFAS No. 141(R) amends SFAS No. 109 such that adjustments made to
valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions
that closed prior to the effective date of SFAS No. 141(R) would also apply the provisions of SFAS
No. 141(R). Early adoption is not permitted. We are currently evaluating the effects, if any,
that SFAS No. 141(R) may have on our financial statements.
6
3. Recent Accounting Pronouncements (continued)
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial
Statements an amendment of ARB No. 51. SFAS No. 160 is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008, with earlier adoption
prohibited. This statement requires the recognition of a noncontrolling interest (minority
interest) as equity in the consolidated financial statements and separate from the parents equity.
The amount of net earnings attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. The statement also amends certain of
ARB No. 51s consolidation procedures for consistency with the requirements of SFAS No. 141(R).
This statement also includes expanded disclosure requirements regarding the interests of the parent
and its noncontrolling interest. We are currently evaluating SFAS No. 160 and anticipate that it
will not have a significant impact on the reporting of our results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging
Activities an amendment of FASB Statement No. 133. SFAS No. 161 amends and expands the
disclosure requirements of SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS No. 161 requires qualitative disclosures about objectives and strategies for
using derivatives, quantitative disclosures about fair value amounts of gains and losses on
derivative instruments, and disclosures about credit-risk-related contingent features in derivative
agreements. The statement is effective for financial statements issued for fiscal years beginning
after November 15, 2008. We are currently evaluating SFAS No. 161 and anticipate that it will not
have a significant impact on our financial statements.
7
4. Debt
Debt consists of the following:
|
|
|
|
|
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
December 31, 2007 |
|
Short-term |
|
|
|
|
|
|
|
|
Checks outstanding and bank overdrafts |
|
$ |
25.9 |
|
|
$ |
14.1 |
|
Notes payable to banks |
|
|
31.5 |
|
|
|
6.1 |
|
Current maturities of long-term debt |
|
|
27.9 |
|
|
|
32.4 |
|
Unsecured notes, due May 2008 |
|
|
|
|
|
|
27.8 |
|
Revolving credit facility |
|
|
|
|
|
|
50.0 |
|
|
|
|
|
|
|
|
|
|
$ |
85.3 |
|
|
$ |
130.4 |
|
|
|
|
|
|
|
|
Long-term |
|
|
|
|
|
|
|
|
Securitized trade accounts receivable facility |
|
$ |
150.0 |
|
|
$ |
134.0 |
|
Term loan A, due November 2009 |
|
|
35.7 |
|
|
|
64.8 |
|
Term loan B, due November 2010 |
|
|
887.0 |
|
|
|
887.0 |
|
Senior notes, due November 2011 |
|
|
950.2 |
|
|
|
959.6 |
|
Senior subordinated notes, due November 2013 |
|
|
750.2 |
|
|
|
759.6 |
|
Senior discount notes, due February 2014 |
|
|
449.0 |
|
|
|
420.6 |
|
Other |
|
|
0.6 |
|
|
|
0.5 |
|
|
|
|
|
|
|
|
|
|
|
3,222.7 |
|
|
|
3,226.1 |
|
Less: Current portion |
|
|
27.9 |
|
|
|
32.4 |
|
|
|
|
|
|
|
|
|
|
$ |
3,194.8 |
|
|
$ |
3,193.7 |
|
|
|
|
|
|
|
|
5. Shareholders Equity
Shareholders equity consists of the following:
|
|
|
|
|
|
|
|
|
(dollars in millions, except per share amounts) |
|
September 30, 2008 |
|
|
December 31, 2007 |
|
Preferred stock, par value $0.01 per share;
authorized 100,000,000 shares; none issued |
|
$ |
|
|
|
$ |
|
|
Common stock, par value $0.0l per share;
authorized 500,000,000 shares; 146,764,030 and
144,377,068 shares issued at September 30,
2008 and December 31, 2007, respectively |
|
|
1.4 |
|
|
|
1.4 |
|
Additional paid-in capital |
|
|
763.6 |
|
|
|
749.7 |
|
Treasury stock, at cost; 9,170,043 shares and
4,588,500 shares at September 30, 2008 and
December 31, 2007, respectively |
|
|
(206.5 |
) |
|
|
(108.0 |
) |
Retained earnings |
|
|
215.6 |
|
|
|
100.7 |
|
Accumulated other comprehensive income |
|
|
275.1 |
|
|
|
374.0 |
|
|
|
|
|
|
|
|
Total shareholders equity |
|
$ |
1,049.2 |
|
|
$ |
1,117.8 |
|
|
|
|
|
|
|
|
In November 2004, a warrant to purchase, for $0.01 per share, up to 6,191,854 shares of Nalco
Holding Company common stock was issued as part of a dividend to Nalco LLC, our sole stockholder on
the record date of the dividend. Nalco LLC exercised warrants to acquire 2,126,650 shares of
common stock during the nine months ended September 30, 2008. At September 30, 2008, up to
1,414,399 shares of common stock could be purchased by Nalco LLC under the warrant, subject to
certain vesting conditions. The amount includes 789,099 shares of common stock that would be
required to be deposited into an escrow account under the terms of the warrant. Nalco Holding
Company would beneficially own such shares, which would be used solely for the purpose of
delivering shares of common stock pursuant to incentive compensation plans.
8
5. Shareholders Equity (continued)
In July 2007, our Board of Directors authorized a $300 million share repurchase program, and gave
our management discretion in determining the conditions under which shares may be purchased from
time to time. The program has no stated expiration date. As of December 31, 2007, we had
repurchased 4,588,500 shares at a cost of $108.0 million. During the nine months ended September
30, 2008, we repurchased an additional 4,581,543 shares at a cost of $98.5 million. Of that
amount, we expended $95.0 million in cash and an additional $3.5 million was reported as a payable
on the balance sheet at September 30, 2008, for share repurchases executed in September 2008 and
settling in October 2008.
6. Pension and Other Postretirement Benefit Plans
The components of net periodic pension cost and the cost of other postretirement benefits for the
three months and nine months ended September 30, 2008 and 2007 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits |
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Service cost |
|
$ |
6.4 |
|
|
$ |
7.2 |
|
|
$ |
19.5 |
|
|
$ |
21.4 |
|
Interest cost |
|
|
12.0 |
|
|
|
11.4 |
|
|
|
36.4 |
|
|
|
33.9 |
|
Expected return on
plan assets |
|
|
(9.2 |
) |
|
|
(8.5 |
) |
|
|
(28.1 |
) |
|
|
(25.3 |
) |
Prior service
(credit) cost |
|
|
(0.6 |
) |
|
|
|
|
|
|
(1.7 |
) |
|
|
0.1 |
|
Net actuarial loss |
|
|
0.1 |
|
|
|
0.1 |
|
|
|
0.3 |
|
|
|
0.4 |
|
Settlement charge |
|
|
|
|
|
|
0.1 |
|
|
|
|
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic cost |
|
$ |
8.7 |
|
|
$ |
10.3 |
|
|
$ |
26.4 |
|
|
$ |
30.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Postretirement Benefits |
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Service cost |
|
$ |
1.0 |
|
|
$ |
1.4 |
|
|
$ |
3.2 |
|
|
$ |
4.1 |
|
Interest cost |
|
|
2.3 |
|
|
|
2.1 |
|
|
|
6.7 |
|
|
|
6.2 |
|
Prior service credit |
|
|
(1.2 |
) |
|
|
(1.2 |
) |
|
|
(3.6 |
) |
|
|
(3.6 |
) |
Net actuarial gain |
|
|
(0.6 |
) |
|
|
(0.1 |
) |
|
|
(1.9 |
) |
|
|
(0.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic cost |
|
$ |
1.5 |
|
|
$ |
2.2 |
|
|
$ |
4.4 |
|
|
$ |
6.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We now expect pension contributions in 2008 to total approximately $86.3 million compared to
the $56.4 million we had expected to contribute as of December 31, 2007. The increase is
attributable to an additional $30.0 million contribution made to the principal U.S. plan using a
portion of the proceeds from a divestiture.
9
7. Business Optimization Expenses
We continue to redesign and optimize our business and work processes. Business process
optimization expenses, consisting mostly of employee severance and related costs, were $10.4
million and $7.2 million for the three months ended September 30, 2008 and 2007, respectively.
Business process optimization expenses were $12.8 million and $9.5 million for the nine months
ended September 30, 2008 and 2007, respectively.
8. Gain on Divestiture
In September 2008, we completed the sale of our Finishing Technologies surface treatment unit to
Chemetall Corp., a subsidiary of Rockwood Holdings, Inc. Proceeds from the sale were $74.1
million, net of selling and other cash expenses of $0.9 million, and resulted in a gain of $38.1
million before income taxes. A plant in Jackson, Michigan, dedicated to the Finishing Technologies
unit, was included in the sale, along with dedicated Finishing Technologies sales, service,
marketing, research and supply chain employees. The sale also included products, goodwill,
customer relationships and other related assets. On an after-tax basis, the transaction increased
diluted earnings per share by 11 cents and 10 cents for the three months and nine months ended
September 30, 2008, respectively.
9. Summary of Other Income (Expense), Net
The components of other income (expense), net for the three months and nine months ended September
30, 2008 and 2007, include the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Franchise taxes |
|
$ |
(0.4 |
) |
|
$ |
(0.7 |
) |
|
$ |
(1.7 |
) |
|
$ |
(2.3 |
) |
Equity in earnings
of unconsolidated
subsidiaries |
|
|
0.3 |
|
|
|
0.1 |
|
|
|
1.2 |
|
|
|
1.0 |
|
Foreign currency
exchange adjustments |
|
|
(3.0 |
) |
|
|
(1.2 |
) |
|
|
(8.4 |
) |
|
|
(0.7 |
) |
Other |
|
|
(2.0 |
) |
|
|
(0.1 |
) |
|
|
(3.5 |
) |
|
|
(0.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net |
|
$ |
(5.1 |
) |
|
$ |
(1.9 |
) |
|
$ |
(12.4 |
) |
|
$ |
(2.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
10. Income Taxes
The income tax provision for the nine months ended September 30, 2008, was favorably impacted by
the recognition of benefits related to certain U.S. foreign tax credits, and unfavorably impacted
by the proposed settlement of the U.S. federal tax audit of years 2003 and 2004, the creation of
valuation allowances related to the realization of deductible temporary differences and net
operating loss carryforwards in the U.K., and nondeductible goodwill that was a component of a
divestiture gain. The income tax provision also varies from the U.S. federal statutory income tax
rate of 35% primarily due
to the reversal of prior year state valuation allowances, the incremental tax on dividends received
from non-U.S. subsidiaries, foreign taxes provided at other than the 35% U.S. statutory rate, U.S.
state income taxes, nondeductible expenses, and other permanent differences.
10
10. Income Taxes (continued)
Since our sale by Suez S.A. in November 2003, we have incurred incremental tax expense for foreign
withholding taxes that we were able to deduct, but not credit for U.S. federal tax purposes. We
have completed a restructuring, which combined with increased U.S. taxable income, results in the
ability to convert the previously deducted foreign withholding taxes into U.S. foreign tax credits.
The recognition of this benefit lowered the tax provision by $2.7 million in the three-month
period, which brings the benefit for the nine months ended September 30, 2008 to $42.8 million.
The Internal Revenue Service (the Service) had previously concluded its examination of the
consolidated federal income tax returns of our subsidiary, Nalco Company and Nalco Companys
subsidiaries for the years 2003 and 2004. The Service had originally proposed to disallow
deductions totaling $116.2 million relating to debt issuance costs and consulting fees, some of
which amortize through 2011. We believed the expenditures to be valid tax deductions. During the
second quarter of 2008, the Service
offered to reduce the disallowance to $5.8 million and close the audit. We decided to accept the
offer, which caused the recognition of $2.2 million of additional federal and state tax expense in
the second quarter. We have paid the federal tax during the third quarter, and are now awaiting
formal acknowledgement that the periods are settled.
We have a tax basis net operating loss in the U.K., as well as future tax deductions primarily
related to the funding of accrued pension obligations. However, due to the lack of profitability
in recent years, we are not reasonably assured that the future tax benefits of the carryforward or
deductions can be realized. Therefore, a full valuation allowance was established during the nine
months ended September 30, 2008 totaling $24.0 million ($3.6 million in the third quarter).
The effective rate of the provision for income taxes differs from the U.S. statutory tax rate due
to the following items:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
U.S. statutory tax rate |
|
$ |
36.0 |
|
|
$ |
21.9 |
|
|
$ |
70.6 |
|
|
$ |
54.6 |
|
Foreign tax credits |
|
|
(2.7 |
) |
|
|
|
|
|
|
(42.8 |
) |
|
|
|
|
U.K. valuation allowances |
|
|
3.6 |
|
|
|
|
|
|
|
24.0 |
|
|
|
|
|
Divestiture gain |
|
|
9.9 |
|
|
|
|
|
|
|
9.9 |
|
|
|
|
|
U.S. audit |
|
|
|
|
|
|
|
|
|
|
2.5 |
|
|
|
|
|
Other |
|
|
(2.9 |
) |
|
|
2.1 |
|
|
|
2.2 |
|
|
|
(2.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision |
|
$ |
43.9 |
|
|
$ |
24.0 |
|
|
$ |
66.4 |
|
|
$ |
52.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11
11. Comprehensive Income
Total comprehensive income and its components, net of related tax, for the three months and nine
months ended September 30, 2008 and 2007, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Net earnings |
|
$ |
57.4 |
|
|
$ |
36.5 |
|
|
$ |
130.8 |
|
|
$ |
97.9 |
|
Other comprehensive income,
net of income taxes: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives |
|
|
0.8 |
|
|
|
(1.4 |
) |
|
|
2.1 |
|
|
|
(0.5 |
) |
Net prior service credit |
|
|
(1.1 |
) |
|
|
(0.8 |
) |
|
|
(3.4 |
) |
|
|
(2.3 |
) |
Net actuarial (gain) loss |
|
|
(0.5 |
) |
|
|
|
|
|
|
(1.6 |
) |
|
|
0.1 |
|
Foreign currency
translation adjustments |
|
|
(148.9 |
) |
|
|
50.4 |
|
|
|
(96.0 |
) |
|
|
114.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income (loss) |
|
$ |
(92.3 |
) |
|
$ |
84.7 |
|
|
$ |
31.9 |
|
|
$ |
210.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12. Segment Information
We operate four reportable segments:
Industrial and Institutional Services This segment serves the global water treatment and process
chemical needs of the industrial, institutional, and municipal markets.
Energy Services This segment serves the process chemicals and water treatment needs of the
global petroleum and petrochemical industries in both upstream and downstream applications.
Paper Services This segment serves the process chemicals and water treatment needs of the global
pulp and paper industry.
Other This segment includes the Integrated Channels Group, revenue recognition adjustments,
supply chain activities, standard cost variances, and certain other operating expenses not
allocated to a segment.
In 2008, we began reporting the results of our subsidiary in India and the Katayama Nalco joint
venture related to the Industrial and Institutional Services segment, the Energy Services segment,
and the Paper Services segment with those segments. These results had previously been reported in
the Other segment. In addition, certain petrochemical and emerging markets customers that had
previously been reported in the Industrial and Institutional Services segment are now included in
Energy Services. Amounts for prior periods have been restated to conform with this change in the
composition of our segments.
We evaluate the performance of our segments based on direct contribution, which is defined as net
sales, less cost of product sold (excluding variances to standard costs), selling and service
expenses, marketing expenses, research expenses and capital charges directly attributable to each
segment. Each segment is assessed an internal non-GAAP capital charge based on trade accounts receivable, inventories and equipment specifically
identifiable to the segment. The capital charges included in each segments direct contribution
are eliminated to arrive at our consolidated direct contribution. There are no intersegment
revenues.
12
12. Segment Information (continued)
Net sales by reportable segment were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Industrial and
Institutional
Services |
|
$ |
488.1 |
|
|
$ |
449.0 |
|
|
$ |
1,391.0 |
|
|
$ |
1,285.9 |
|
Energy Services |
|
|
395.1 |
|
|
|
326.8 |
|
|
|
1,104.8 |
|
|
|
938.1 |
|
Paper Services |
|
|
203.3 |
|
|
|
195.9 |
|
|
|
607.3 |
|
|
|
577.4 |
|
Other |
|
|
29.0 |
|
|
|
26.5 |
|
|
|
78.4 |
|
|
|
77.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
1,115.5 |
|
|
$ |
998.2 |
|
|
$ |
3,181.5 |
|
|
$ |
2,878.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following table presents direct contribution by reportable segment and reconciles the total
segment direct contribution to earnings before income taxes and minority interests:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Segment direct contribution: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial and Institutional
Services |
|
$ |
103.6 |
|
|
$ |
98.2 |
|
|
$ |
280.7 |
|
|
$ |
276.9 |
|
Energy Services |
|
|
74.1 |
|
|
|
71.1 |
|
|
|
221.9 |
|
|
|
207.6 |
|
Paper Services |
|
|
22.9 |
|
|
|
31.6 |
|
|
|
75.5 |
|
|
|
89.8 |
|
Other |
|
|
(18.0 |
) |
|
|
(18.3 |
) |
|
|
(71.8 |
) |
|
|
(68.0 |
) |
Capital charge elimination |
|
|
24.6 |
|
|
|
22.0 |
|
|
|
72.7 |
|
|
|
63.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment direct contribution |
|
|
207.2 |
|
|
|
204.6 |
|
|
|
579.0 |
|
|
|
569.3 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses not allocated to
segments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Administrative expenses |
|
|
51.7 |
|
|
|
51.0 |
|
|
|
157.8 |
|
|
|
157.1 |
|
Amortization of intangible
assets |
|
|
14.0 |
|
|
|
15.6 |
|
|
|
43.5 |
|
|
|
46.2 |
|
Business optimization expenses |
|
|
10.4 |
|
|
|
7.2 |
|
|
|
12.8 |
|
|
|
9.5 |
|
Gain on divestiture |
|
|
(38.1 |
) |
|
|
|
|
|
|
(38.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating earnings |
|
|
169.2 |
|
|
|
130.8 |
|
|
|
403.0 |
|
|
|
356.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other income (expense), net |
|
|
(5.1 |
) |
|
|
(1.9 |
) |
|
|
(12.4 |
) |
|
|
(2.2 |
) |
Interest income |
|
|
2.3 |
|
|
|
2.7 |
|
|
|
6.8 |
|
|
|
7.2 |
|
Interest expense |
|
|
(63.7 |
) |
|
|
(69.1 |
) |
|
|
(195.7 |
) |
|
|
(205.6 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings before income taxes and
minority interests |
|
$ |
102.7 |
|
|
$ |
62.5 |
|
|
$ |
201.7 |
|
|
$ |
155.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Administrative expenses primarily represent the cost of support functions, including information
technology, finance, human resources and legal, as well as expenses for support facilities,
executive management and management incentive plans.
13
13. Earnings Per Share
Basic earnings per share is computed by dividing net earnings available to common shareholders by
the weighted average number of common shares outstanding during the period. Diluted earnings per
share reflects the potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted in the issuance of common
stock.
Basic and diluted earnings per share were calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Numerator for basic and
diluted earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
$ |
57.4 |
|
|
$ |
36.5 |
|
|
$ |
130.8 |
|
|
$ |
97.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic
earnings per share
weighted average common
shares outstanding |
|
|
139.9 |
|
|
|
143.7 |
|
|
|
141.1 |
|
|
|
143.9 |
|
Effect of dilutive securities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock purchase warrant |
|
|
0.6 |
|
|
|
2.8 |
|
|
|
0.6 |
|
|
|
3.5 |
|
Share-based compensation
plans |
|
|
0.2 |
|
|
|
0.1 |
|
|
|
0.2 |
|
|
|
0.1 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted
earnings per share |
|
|
140.7 |
|
|
|
146.6 |
|
|
|
141.9 |
|
|
|
147.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14. Contingencies and Litigation
Various claims, lawsuits and administrative proceedings are pending or threatened against us,
arising from the ordinary course of business with respect to commercial, contract, intellectual
property, product liability, employee, environmental and other matters. Historically, these
matters have not had a material impact on our consolidated financial position, and the resolution
of those proceedings is not expected to have a material effect on our results of operations,
financial condition or cash flows. However, we cannot predict the outcome of any litigation or the
potential for future litigation.
We have been named as a potentially responsible party (PRP) by the Environmental Protection Agency
or state enforcement agencies at five waste sites where some financial contribution is or may be
required. These agencies have also identified many other parties who may be responsible for clean
up costs at these waste disposal sites. We are also remediating a small spill at our plant in
Pilar, Argentina. Our financial contribution to remediate these sites is not expected to be
material. There has been no significant financial impact on us up to the present, nor is it
anticipated that there will be in the future, as a result of these matters.
Our undiscounted reserves for known environmental clean up costs were $1.1 million at September 30,
2008. These environmental reserves represent our current estimate of our proportional clean-up
costs and are based upon negotiation and agreement with enforcement agencies, our previous
experience with respect to clean-up activities, a detailed review by us of known conditions, and
information about other PRPs. They are not reduced by any possible recoveries from insurance
companies or other PRPs not
specifically identified. Although we cannot determine whether or not a material effect on future
operations is reasonably likely to occur, given the evolving nature of environmental regulations,
we believe that the recorded reserve levels are appropriate estimates of the potential liability.
Although settlement will require future cash outlays, it is not expected that such outlays will
materially impact our liquidity position.
14
14. Contingencies and Litigation (continued)
Expenditures for the nine months ended September 30, 2008, relating to environmental compliance and
clean up activities, were not significant.
We have been named as a defendant in lawsuits based on claimed involvement in the supply of
allegedly defective or hazardous materials and the claimed presence of hazardous substances at our
plants. We have also been named as a defendant in lawsuits where our products have not caused
injuries, but the claimants seek amounts so they might be monitored in the future for potential
injuries arising from our products. The plaintiffs in these cases seek damages for alleged
personal injury or potential injury resulting from exposure to our products or other chemicals.
These matters have had a de minimis impact on our business historically, and we do not anticipate
these matters will present any material risk to our business in the future. Notwithstanding, we
cannot predict the outcome of any such lawsuits or the involvement we might have in these matters
in the future.
On November 27, 2006, the U.K. Health and Safety Executive (HSE) issued a criminal summons
charging our U.K. subsidiary with a violation of the Health and Safety at Work Act. The summons
was re-issued in the Crown Court of Worcester on July 23, 2007. The charge relates to a Legionella
outbreak that is claimed to have originated at cooling towers owned by one of the subsidiarys
customers. The Legionella outbreak is believed to have resulted in two fatalities and multiple
injuries. The customer, H. P. Bulmer Limited, was also charged. Our subsidiary entered a guilty
plea to a portion of the charge, exposing non-employees to a health risk, on September 3, 2007.
Similarly, our subsidiarys customer submitted a guilty plea. On July 1, 2008, the Crown Court
issued a penalty of £300,000 ($0.6 million) and court costs of £50,000 ($0.1 million) against our
subsidiary relating to this violation. An identical penalty was issued against the subsidiarys
customer.
In the ordinary course of our business, we are also a party to a number of lawsuits and are subject
to various claims relating to trademarks, employee matters, contracts, transactions, chemicals and
other matters, the outcome of which, in our opinion, should not have a material effect on our
consolidated financial position. However, we cannot predict the outcome of any litigation or the
potential for future litigation. Were an unfavorable ruling to occur, there exists the possibility
of a material adverse impact on the results of operations for the period in which the ruling
occurs. We maintain accruals where the outcome of the matter is probable and can be reasonably
estimated.
15
15. Fair Value Measurements
As stated in Note 3, Recent Accounting Pronouncements, we adopted SFAS No. 157, Fair Value
Measurements, on January 1, 2008, for financial assets and liabilities and for nonfinancial assets
and liabilities that are remeasured at least annually. SFAS No. 157 defines fair value as the
price that would be received for an asset or paid to transfer a liability in an orderly transaction
between market participants on the measurement date. SFAS No. 157 establishes a fair value
hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three
broad levels:
Level 1 Quoted prices in active markets that are accessible at the measurement date for
identical assets and liabilities. The fair value hierarchy gives the highest priority to
Level 1 inputs.
Level 2 Observable inputs other than quoted prices in active markets.
Level 3 Unobservable inputs for which there is little or no market data available.
The fair value hierarchy gives the lowest priority to Level 3 inputs.
The fair value of financial assets and liabilities measured at fair value on a recurring basis was
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance |
|
|
|
|
|
|
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
Level 1 |
|
|
Level 2 |
|
|
Level 3 |
|
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
$ |
2.1 |
|
|
$ |
|
|
|
$ |
2.1 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts |
|
$ |
1.4 |
|
|
$ |
|
|
|
$ |
1.4 |
|
|
$ |
|
|
Natural gas forward contracts |
|
|
0.7 |
|
|
|
|
|
|
|
0.7 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$ |
2.1 |
|
|
$ |
|
|
|
$ |
2.1 |
|
|
$ |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts are valued using quoted forward foreign exchange prices at the
reporting date. Natural gas forward contracts are valued using NYMEX futures prices for natural
gas at the reporting date.
16. Guarantees
No significant guarantees were outstanding at September 30, 2008, other than subsidiary-related
performance guarantees.
We had $20.6 million of letters of credit outstanding at September 30, 2008.
16
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
Overview
Key financial highlights for the third quarter 2008 include:
|
|
Third quarter 2008 revenues of $1,115.5 million increased 11.8% over third quarter 2007
revenues of $998.2 million. This increase consisted of organic growth of 11.2%, a currency
benefit of 2.9%, less an acquisition/divestiture impact of 2.3%. We define organic growth as
nominal, or actual, sales growth less the impacts of changes in foreign currency translation
rates and acquisitions and divestitures. Hurricane impacts reduced revenues by about $11.0
million in the third quarter 2008. |
|
|
|
We experienced increases in product and freight costs approximating $64 million in the
third quarter of 2008 over the prior-year period that were significantly offset with price
increases of about $50 million. |
|
|
|
The effective tax rate rose to 42.7% for the third quarter of 2008 from 38.4% for the
year-ago quarter. The increase was attributable to a gain from a divestiture. Excluding the
impacts of that gain, our effective tax rate would have been 32.0%. |
|
|
|
Third quarter 2008 net earnings of $57.4 million were up 57% over year-ago net earnings of
$36.5 million, which was mostly attributable to a divestiture gain. Diluted earnings per
share (EPS) of 41 cents were up 16 cents over the 25 cents reported in the third quarter of
2007, of which 11 cents resulted from the divestiture gain. |
|
|
|
Adjusted EBITDA, a measure used to determine compliance with our debt covenants, was $192.7
million for the third quarter of 2008, a 2.1% increase over year-ago Adjusted EBITDA of $188.8
million that excludes the waste coal agglomeration (synfuel) business that ended with a
December 31, 2007 tax code expiration. With that synfuel business included, Adjusted EBITDA
was $195.3 million in the third quarter of 2007. |
17
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
|
|
Free Cash Flow, defined as cash from operating activities less capital expenditures and
minority interest charges, was $28.3 million in the third quarter of 2008, a reduction of
$71.6 million from Free Cash Flow of $99.9 million in the year-ago period. The decrease
primarily resulted from higher net working capital requirements, most notably for inventories
due to accelerated cost increases and additions to support business growth in emerging
geographies, and a $30 million pension contribution (made possible with proceeds from the
divestiture). Net cash provided by operating activities is reconciled to Free Cash Flow as
follows: |
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Net cash provided by operating activities |
|
$ |
67.6 |
|
|
$ |
124.6 |
|
Minority interests |
|
|
(1.4 |
) |
|
|
(2.0 |
) |
Additions to property, plant, and equipment, net |
|
|
(37.9 |
) |
|
|
(22.7 |
) |
|
|
|
|
|
|
|
Free cash flow |
|
$ |
28.3 |
|
|
$ |
99.9 |
|
|
|
|
|
|
|
|
|
|
We monitor our goodwill for impairment indicators on an ongoing basis in addition to
performing an annual goodwill impairment analysis, as required by Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets. While we currently do not
see any specific impairment indicators related to the carrying value of our businesses
goodwill or other assets, the current economic environment is impacting our business results
everywhere, most notably in our Paper Services segment. Were this seen to be prolonged,
either from continued raw material cost escalations or declines in end market demand, the
value of the goodwill related to this business could be subject to an impairment charge. |
Outlook
Although third quarter hurricane impacts added substantially to the challenge, we continue to
strive to achieve our previously communicated target for Adjusted EBITDA growth of about 8% over
synfuel-adjusted 2007 results of $707 million. We will need strong demand from our customers to
continue in the face of clearly slowing global economic conditions and weakening currencies
relative to the U.S. dollar in order to approach our Adjusted EBITDA target for the year, but we
will also need raw material and freight cost relief and continued cost savings execution
internally. We expect our effective tax rate for the year to average out at about 32%-33%, with an
effective tax rate expected to be about 30% on a going-forward basis. Free Cash Flow could exceed
$200 million for the year with continued sales performance, aggressive cost control, declines in
raw material costs, and working capital improvements, particularly inventories, during the fourth
quarter.
Results of Operations Consolidated
Quarter Ended September 30, 2008 Compared to the Quarter Ended September 30, 2007
Net sales for the three months ended September 30, 2008 were $1,115.5 million, an 11.8% increase
over the $998.2 million reported for the quarter ended September 30, 2007. On an organic basis,
which excludes the impacts of changes in foreign currency translation rates and acquisitions and
divestitures, net sales were up 11.2%. Organic growth was reported in every region, with Latin
America, North America, Europe/Africa/Middle East (EAME) and Asia reporting organic increases of
28.2%, 10.8%, 8.1% and 8.0%, respectively.
18
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Gross profit, defined as the difference between net sales and cost of product sold, of $472.7
million for the quarter ended September 30, 2008 increased by $23.7 million, or 5.3%, over the
$449.0 million for the year-ago period. On an organic basis, gross profit increased by 3.7%. The
improvement was mainly attributable to higher sales volumes and cost savings, partly offset by
unfavorable changes in product mix and higher product and freight costs. Price increases to our
customers largely offset the higher costs, but accelerated cost increases during the latter portion
of the quarter contributed to a gross profit margin for the three months ended September 30, 2008
of 42.4% compared to 45.0% for the three months ended September 30, 2007.
Selling, administrative, and research expenses for the three months ended September 30, 2008 of
$317.2 million rose $21.8 million, or 7.4%, from $295.4 million for the year-ago period. On an
organic basis, selling, administrative, and research expenses increased 3.3%. This was mostly
attributable to higher salaries and travel expenses. Lower bad debt expense partly offset these
increases.
Amortization of intangible assets was $14.0 million and $15.6 million for the three months ended
September 30, 2008 and 2007, respectively. Lower amortization of customer relationships, which are
amortized using an accelerated method, more than offset amortization resulting from the December
2007 acquisition of Nalco Mobotec.
Business optimization expenses, representing mostly employee severance and related costs associated
with the continuing redesign and optimization of business and work processes, were $10.4 million
and $7.2 million for the three months ended September 30, 2008 and September 30, 2007,
respectively.
Gain on divestiture of $38.1 million resulted from the September 2008 sale of our Finishing
Technologies unit. Proceeds from the sale were $74.1 million, net of selling and other cash
expenses of $0.9 million.
Other income (expense), net was a net expense of $5.1 million and $1.9 million for the three months
ended September 30, 2008 and 2007, respectively. An unfavorable change in foreign currency
transaction gains and losses of $1.8 million accounted for more than half of the variation.
Net interest expense, defined as the combination of interest income and interest expense, of $61.4
million for the three months ended September 30, 2008 decreased by $5.0 million from the $66.4
million reported for the three months ended September 30, 2007. Translation rate changes due to the
weaker U.S. dollar versus the euro increased interest expense by $1.1 million, and accretion of our
senior discount notes was $0.8 million higher than a year ago. However, these increases were more
than offset by the impact of lower interest rates on our variable rate debt.
19
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The income tax provision of $43.9 million for the three months ended September 30, 2008 was
favorably impacted by an increase in the recognition of benefits related to U.S. foreign income tax
credits, and unfavorably impacted by an increase in the valuation allowance related to the
realization of deductible temporary differences and net operating loss carryforwards in the U.K.
These items are discussed in more detail in Note 10 to the condensed consolidated financial
statements, included in Part I, Item 1. The income tax provision also varies from the U.S. federal
statutory income tax rate of 35% primarily due to the impact of nondeductible goodwill that was a
component of a divestiture gain, foreign taxes provided at other than the 35% U.S. statutory rate,
U.S. state income taxes, nondeductible expenses and other permanent differences.
Incremental tax on dividends received from non-U.S. subsidiaries, foreign taxes provided at other
than the 35% U.S. statutory rate, U.S. state income taxes, nondeductible expenses and other
permanent differences contributed to the variation between the U.S. federal statutory income tax
rate and our income tax provision of $24.0 million for the three months ended September 30, 2007.
Minority interest expense of $1.4 million for the three months ended September 30, 2008 was $0.6
million lower than the $2.0 million reported in the year-ago period. The impact of lower earnings
by our Katayama Nalco joint venture in Japan compared to the year-ago period accounted for most of
the change.
Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007
Net sales for the nine months ended September 30, 2008 were $3,181.5 million, a 10.5% increase from
the $2,878.4 million reported for the nine months ended September 30, 2007. On an organic basis,
which excludes the impacts of changes in foreign currency translation rates and acquisitions and
divestitures, net sales were up 7.5%. On a geographic basis, Latin America, North America, Asia
and EAME reported organic growth of 13.7%, 10.2%, 7.7% and 1.0%, respectively.
Gross profit, defined as the difference between net sales and cost of product sold, of $1,379.4
million for the nine months ended September 30, 2008 increased by $92.1 million, or 7.2%, over the
$1,287.3 million for the nine months ended September 30,
2007. On an organic basis, gross profit increased by 3.3%. Most of the organic improvement was
attributable to higher sales volumes and cost savings, partly offset by unfavorable changes in
product mix and increases in product and freight costs, which exceeded price increases to our
customers by $25.6 million. Gross profit margin for the nine months ended September 30, 2008 was
43.4% compared to 44.7% for the year-ago period.
20
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Selling, administrative, and research expenses for the nine months ended September 30, 2008 of
$958.2 million increased $83.1 million, or 9.5%, from $875.1 million for the nine months ended
September 30, 2007. On an organic basis, selling, administrative, and research expenses were up
3.7%. Higher salaries and travel were partly offset by lower outside consulting for work process
redesign initiatives and the rationalization of our legal entity structure.
Amortization of intangible assets was $43.5 million and $46.2 million for the nine months ended
September 30, 2008 and 2007, respectively. Lower amortization of customer relationships, which are
amortized using an accelerated method, more than offset amortization of intangibles of Nalco
Mobotec, which was acquired in December 2007.
Business optimization expenses, representing mostly employee severance and related costs associated
with the continuing redesign and optimization of business and work processes, were $12.8 million
and $9.5 million for the nine months ended September 30, 2008 and 2007, respectively.
Gain on divestiture of $38.1 million resulted from the September 2008 sale of our Finishing
Technologies unit. Proceeds from the sale were $74.1 million, net of selling and other cash
expenses of $0.9 million.
Other income (expense), net was a net expense of $12.4 million and $2.2 million for the nine months
ended September 30, 2008 and 2007, respectively. The increase of $10.2 million was mostly
attributable to an unfavorable change in foreign currency transaction gains and losses of $7.7
million.
Net interest expense, defined as the combination of interest income and interest expense, of $188.9
million for the nine months ended September 30, 2008 decreased by $9.5 million from the $198.4
million reported for the nine months ended September 30, 2007. Translation rate changes due to the
weaker U.S. dollar versus the euro increased interest expense by $4.8 million, and accretion of our
senior discount notes was $2.4 million higher than a year ago. However, lower interest rates on
our variable rate debt and a slightly lower average debt level compared to the first nine months of
2007 more than offset those increases.
The income tax provision of $66.4 million for the nine months ended September 30, 2008 was
favorably impacted by the recognition of benefits related to certain U.S. foreign income tax
credits, and unfavorably impacted by the proposed settlement of the U.S. federal tax audit of years
2003 and 2004, as well as the creation of valuation allowances related to the realization of
deductible temporary differences and net operating loss carryforwards in the U.K. These items are
discussed in more detail in Note 10 to the condensed
consolidated financial statements, included in Part I, Item 1. The income tax provision also
varies from the U.S. federal statutory income tax rate of 35% primarily due to the impact of
nondeductible goodwill that was a component of a divestiture gain, the reversal of prior year state
valuation allowances, the incremental tax on dividends received from non-U.S. subsidiaries, foreign
taxes provided at other than the 35% U.S. statutory rate, U.S. state income taxes, nondeductible
expenses and other permanent differences.
21
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Incremental tax on dividends received from non-U.S. subsidiaries, foreign taxes provided at other
than the 35% U.S. statutory rate, U.S. state income taxes, nondeductible expenses and other
permanent differences contributed to the variation between the U.S. federal statutory income tax
rate and our income tax provision of $52.4 million for the nine months ended September 30, 2007.
In addition, the 2007 provision included the recognition of net benefits related to settling tax
positions in The Netherlands.
Minority interest expense was $4.5 million and $5.6 million for the nine months ended September 30,
2008 and 2007, respectively. The impact of lower earnings by our Katayama Nalco joint venture and
our subsidiary in Saudi Arabia accounted for most of the change.
Results of Operations Segment Reporting
Quarter Ended September 30, 2008 Compared to the Quarter Ended September 30, 2007
Net sales by reportable segment for the three months ended September 30, 2008 and September 30,
2007 may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes |
|
|
|
|
|
|
|
|
|
|
in the Following Factors |
|
|
|
Three Months Ended |
|
|
|
|
|
|
Currency |
|
|
Acquisitions/ |
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
% Change |
|
|
Translation |
|
|
Divestitures |
|
|
Organic |
|
Industrial &
Institutional
Services |
|
$ |
488.1 |
|
|
$ |
449.0 |
|
|
|
8.7 |
% |
|
|
3.6 |
% |
|
|
(3.5 |
)% |
|
|
8.6 |
% |
Energy Services |
|
|
395.1 |
|
|
|
326.8 |
|
|
|
20.9 |
% |
|
|
1.6 |
% |
|
|
(2.1 |
)% |
|
|
21.4 |
% |
Paper Services |
|
|
203.3 |
|
|
|
195.9 |
|
|
|
3.7 |
% |
|
|
3.0 |
% |
|
|
|
|
|
|
0.7 |
% |
Other |
|
|
29.0 |
|
|
|
26.5 |
|
|
|
9.5 |
% |
|
|
4.0 |
% |
|
|
|
|
|
|
5.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
1,115.5 |
|
|
$ |
998.2 |
|
|
|
11.8 |
% |
|
|
2.9 |
% |
|
|
(2.3 |
)% |
|
|
11.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Industrial and Institutional Services division reported sales of $488.1 million for the quarter
ended September 30, 2008, an 8.7% increase over the $449.0 million for the year-ago-period. Sales
rose 8.6% organically, with strong double-digit growth posted in Latin America. Overall, EAME grew
9.7% organically, while North America and Asia posted 5.2% and 5.0% increases, respectively. The
3.5% decrease in sales from acquisitions/divestitures was attributable to our waste coal
agglomeration (synfuel) business, which ceased with the expiration of customer tax incentives at
the end of 2007, partly offset by sales of Nalco Mobotec, which was acquired in December 2007.
22
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The Energy Services division reported sales of $395.1 million for the three months ended September
30, 2008, a 20.9% gain over the $326.8 million for the quarter ended September 30, 2007.
Organically, sales rose 21.4%, as solid double-digit gains were posted by our Oilfield and Adomite
businesses and a more modest double-digit increase was reported by Downstream, despite hurricane
impacts that reduced revenues an estimated $10.0 million in the quarter. The 2.1% decrease in
sales from acquisitions/divestitures primarily relates to business that has been transferred to a
joint venture.
The Paper Services division reported sales of $203.3 million for the three months ended September
30, 2008, a 3.7% increase over the $195.9 million reported for the third quarter of 2007. Sales
grew 0.7% organically, reflecting growth in North America, Latin America and Asia, offset by
continued weakness in Western Europe.
The 5.5% organic increase in sales in our Other segment was mostly attributable to our Integrated
Channels business.
Direct contribution by reportable segment for the three months ended September 30, 2008 and
September 30, 2007 may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes |
|
|
|
|
|
|
|
|
|
|
in the Following Factors |
|
|
|
Three Months Ended |
|
|
|
|
|
|
Currency |
|
|
Acquisitions/ |
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
% Change |
|
|
Translation |
|
|
Divestitures |
|
|
Organic |
|
Industrial &
Institutional
Services |
|
$ |
103.6 |
|
|
$ |
98.2 |
|
|
|
5.5 |
% |
|
|
4.3 |
% |
|
|
(7.9 |
)% |
|
|
9.1 |
% |
Energy Services |
|
|
74.1 |
|
|
|
71.1 |
|
|
|
4.3 |
% |
|
|
1.7 |
% |
|
|
(2.6 |
)% |
|
|
5.2 |
% |
Paper Services |
|
|
22.9 |
|
|
|
31.6 |
|
|
|
(27.5 |
)% |
|
|
1.5 |
% |
|
|
|
|
|
|
(29.0 |
)% |
Other |
|
|
(18.0 |
) |
|
|
(18.3 |
) |
|
|
1.7 |
% |
|
|
(0.1 |
)% |
|
|
(0.3 |
)% |
|
|
2.1 |
% |
Direct contribution of the Industrial and Institutional Services division was $103.6 million for
the three months ended September 30, 2008, an increase of 5.5% over the $98.2 million reported for
the three months ended September 30, 2007. Organically, higher gross profit accounted for the 9.1%
increase in direct contribution, as operating expenses were up only 2.9%. The 7.9% decrease in
direct contribution from acquisitions/divestitures was mostly attributable to the expiration of our
synfuel business at the end of 2007.
The Energy Services division reported direct contribution of $74.1 million for the three months
ended September 30, 2008, a 4.3% increase over the $71.1 million reported for the year-ago period.
On an organic basis, direct contribution only grew 5.2%, as selling and service costs to support
lost hurricane sales were incurred, but the sales did not materialize.
23
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The Paper Services division reported direct contribution of $22.9 million for the three months
ended September 30, 2008, a 27.5% decrease from the direct contribution of $31.6 million reported
for the third quarter of 2007. Organically, direct contribution was down 29.0%, due to marginal
sales volume growth, higher product costs, and an 8.4% organic increase in operating expenses, over
half of which was attributable to bad debts.
The direct contribution loss of $18.0 million reported in Other for the three months ended
September 30, 2008 represented a $0.3 million decrease from the $18.3 million direct contribution
loss reported in the third quarter 2007.
Nine Months Ended September 30, 2008 Compared to the Nine Months Ended September 30, 2007
Net sales by reportable segment for the nine months ended September 30, 2008 and September 30, 2007
may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes |
|
|
|
|
|
|
|
|
|
|
in the Following Factors |
|
|
|
Nine Months Ended |
|
|
|
|
|
|
Currency |
|
|
Acquisitions/ |
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
% Change |
|
|
Translation |
|
|
Divestitures |
|
|
Organic |
|
Industrial &
Institutional
Services |
|
$ |
1,391.0 |
|
|
$ |
1,285.9 |
|
|
|
8.2 |
% |
|
|
5.6 |
% |
|
|
(3.2 |
)% |
|
|
5.8 |
% |
Energy Services |
|
|
1,104.8 |
|
|
|
938.1 |
|
|
|
17.8 |
% |
|
|
3.1 |
% |
|
|
(0.7 |
)% |
|
|
15.4 |
% |
Paper Services |
|
|
607.3 |
|
|
|
577.4 |
|
|
|
5.2 |
% |
|
|
5.1 |
% |
|
|
|
|
|
|
0.1 |
% |
Other |
|
|
78.4 |
|
|
|
77.0 |
|
|
|
1.9 |
% |
|
|
5.9 |
% |
|
|
|
|
|
|
(4.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales |
|
$ |
3,181.5 |
|
|
$ |
2,878.4 |
|
|
|
10.5 |
% |
|
|
4.6 |
% |
|
|
(1.6 |
)% |
|
|
7.5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Industrial and Institutional Services division reported sales of $1,391.0 million for the nine
months ended September 30, 2008, an 8.2% increase over the $1,285.9 million for the nine months
ended September 30, 2007. Organically, sales grew 5.8%, with double-digit growth in Latin America
and more modest growth in Asia, EAME and North America at 8.2%, 5.1% and 4.0%, respectively. The
growth in EAME was mostly attributable to a double-digit improvement in Emerging Markets. The 3.2%
decrease in sales from acquisitions/divestitures was attributable to our now-ended waste coal
agglomeration (synfuel) business, partly offset by sales of Nalco Mobotec, which was acquired in
December 2007.
The Energy Services division reported sales of $1,104.8 million for the nine months ended September
30, 2008, a 17.8% gain over the $938.1 million for the year-ago period. Organically, sales rose
15.4%, with double-digit gains reported by our Oilfield and Adomite businesses, and near
double-digit growth posted by our Downstream business.
The Paper Services division reported sales of $607.3 million for the nine months ended September
30, 2008, a 5.2% increase over the $577.4 million reported for the first nine months of 2007.
Sales were flat on an organic basis, as declines in EAME were marginally offset by a 4.5% organic
increase in Latin America and more modest improvements in Asia and North America.
24
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The 4.0% organic decrease in sales in our Other segment was mostly attributable to
quarter-over-quarter variations in revenue recognition. We have historically applied our corporate
revenue recognition adjustments to our Other segment. These adjustments are primarily made for
shipments reflected in Division results, but which were shipped late enough in the quarter that
they would not have been received by customers and properly recognized as revenue in the period.
Direct contribution by reportable segment for the nine months ended September 30, 2008 and
September 30, 2007 may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes |
|
|
|
|
|
|
|
|
|
|
in the Following Factors |
|
|
|
Nine Months Ended |
|
|
|
|
|
|
Currency |
|
|
Acquisitions/ |
|
|
|
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
% Change |
|
|
Translation |
|
|
Divestitures |
|
|
Organic |
|
Industrial &
Institutional
Services |
|
$ |
280.7 |
|
|
$ |
276.9 |
|
|
|
1.4 |
% |
|
|
6.0 |
% |
|
|
(7.4 |
)% |
|
|
2.8 |
% |
Energy Services |
|
|
221.9 |
|
|
|
207.6 |
|
|
|
6.9 |
% |
|
|
3.3 |
% |
|
|
(0.9 |
)% |
|
|
4.5 |
% |
Paper Services |
|
|
75.5 |
|
|
|
89.8 |
|
|
|
(16.0 |
)% |
|
|
4.3 |
% |
|
|
|
|
|
|
(20.3 |
)% |
Other |
|
|
(71.8 |
) |
|
|
(68.0 |
) |
|
|
(5.5 |
)% |
|
|
(2.7 |
)% |
|
|
(0.1 |
)% |
|
|
(2.7 |
)% |
Direct contribution of the Industrial and Institutional Services division was $280.7 million for
the nine months ended September 30, 2008, an increase of 1.4% over the $276.9 million reported for
the nine months ended September 30, 2007. Organically, direct contribution grew 2.8% as a result
of higher sales volume and a modest increase in operating expenses of 1.1%. The 7.4% decrease in
direct contribution from acquisitions/divestitures was mostly attributable to the expiration of our
synfuel business at the end of 2007.
The Energy Services division reported direct contribution of $221.9 million for the nine months
ended September 30, 2008, a 6.9% improvement over the $207.6 million reported for the first nine
months of 2007. On an organic basis, direct contribution rose 4.5% on the strength of higher sales
volumes. Operating expenses were up 12.1% organically, with the largest increases in salaries,
employee benefits, travel and outside services to support the current and expected growth in
business.
The Paper Services division reported direct contribution of $75.5 million for the nine months ended
September 30, 2008, a 16.0% decrease from the direct contribution of $89.8 million reported for the
year-ago period. Direct contribution declined 20.3% on an organic basis, which was attributable to
lower sales volumes and higher product costs. In addition, operating expenses grew 5.2%
organically, nearly half of which resulted from higher bad debt expense.
The direct contribution loss of $71.8 million reported in Other for the nine months ended September
30, 2008 represented a 5.5% increase over the $68.0 million direct contribution loss reported in
the first nine months of 2007, which was mainly attributable to our Integrated Channels business
and increased investments in global research.
25
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Liquidity and Capital Resources
Operating activities. Historically, our main source of liquidity has been our cash flow generated
by operating activities. For the nine months ended September 30, 2008, cash provided by operating
activities was $201.3 million, slightly higher than the $195.3 million for the same period last
year.
Investing activities. Cash used for investing activities was $49.5 million for the nine months
ended September 30, 2008, which was mostly the result of net property additions of $99.8 million
and business acquisitions of $16.2 million. These investments were partly offset by $74.1 million
in net proceeds from the divestiture of our Finishing Technologies unit.
Cash used for investing activities was $72.9 million
for the nine months ended September 30, 2007, which was mostly the result of net property additions of $70.3 million.
Financing activities. Purchases of treasury stock of $95.0 million, a net decrease in borrowings
of $53.4 million, and cash dividends of $14.8 million accounted for most of the $168.4 million of
net cash used for financing activities for the nine months ended September 30, 2008. During the
period, we repaid $50.0 million on our revolving credit facility, $29.1 million of term loans, and
$27.8 million of unsecured notes, while borrowing additional funds, primarily against our
receivables facility and to finance plant construction in Nanjing, China.
Net cash used for financing activities totaled $45.8 million during the nine months ended September
30, 2007, which was mostly attributable to $37.0 million of share repurchases and $10.1 million of
cash dividends.
Our liquidity requirements are significant, primarily due to debt service requirements, as well as
research and development and capital investment. As of September 30, 2008, we had $250.0 million
of borrowing capacity available under a revolving credit facility (excluding $20.6 million of
outstanding standby letters of credit), subject to certain conditions. We believe that our
financial position and financing structure will provide flexibility in worldwide financing
activities and permit us to respond to changing conditions in credit markets.
Senior credit facilities. Our revolving credit facility is part of our senior credit facilities
that were entered into on November 4, 2003. Our senior credit facilities initially included a $300
million term loan A facility (including an 88.0 million tranche) maturing on November 4, 2009 and
a $1,300 million term loan B facility maturing on November 4, 2010. Borrowings under the senior
credit facilities bear interest at a floating base rate plus an applicable margin.
At September 30, 2008, the outstanding balance of the term loan A and term loan B facilities was
$35.7 million and $887.0 million, respectively.
Principal amounts outstanding under the revolving credit facility will be due and payable in full
at maturity on November 4, 2009. At September 30, 2008, no borrowings were outstanding under the
revolving credit facility.
26
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
The senior credit facilities contain a number of covenants that, among other things, require Nalco
Company to maintain the following financial covenants: a maximum total leverage ratio, a minimum
interest coverage ratio and a maximum capital expenditures limitation. We were in compliance with
all covenants at September 30, 2008.
Senior discount notes, senior notes and senior subordinated notes. In November 2003, Nalco Company
issued $665 million aggregate principal amount of 73/4% U.S. dollar-denominated senior notes due
2011, 200 million aggregate principal amount of 73/4% euro-denominated senior notes due 2011, $465
million aggregate principal amount of 87/8% U.S. dollar-denominated senior subordinated notes due
2013 and 200 million aggregate principal amount of 9% euro-denominated senior subordinated notes
due 2013.
In January 2004, our subsidiaries, Nalco Finance Holdings LLC and Nalco Finance Holdings Inc.,
issued $694.0 million aggregate principal amount at maturity of 9.0% senior discount notes due
2014. Prior to February 1, 2009, interest will accrue on the notes in the form of an increase in
the accreted value of such notes. The accreted value of each note will increase from the date of
issuance until February 1, 2009 at a rate of 9.0% per annum, reflecting the accrual of non-cash
interest, such that the accreted value will equal the principal amount at maturity on February 1,
2009. Cash interest payments on the notes will be due and payable beginning in 2009.
In December 2004, Nalco Finance Holdings LLC and Nalco Finance Holdings Inc. redeemed a portion of
the senior discount notes with an accreted value of $162.3 million using proceeds from the initial
public offering of common stock of Nalco Holding Company. After the partial redemption, the
aggregate principal amount at maturity of the notes declined to $460.8 million from $694.0 million.
The indentures governing the senior discount notes, the senior notes and senior subordinated notes
limit our ability and the ability of our restricted subsidiaries to:
|
|
|
incur additional indebtedness; |
|
|
|
|
pay dividends on or make other distributions or repurchase certain capital stock; |
|
|
|
|
make certain investments; |
|
|
|
|
enter into certain types of transactions with affiliates; |
|
|
|
|
limit dividends or other payments by our restricted subsidiaries; |
|
|
|
|
use assets as security in other transactions; and |
|
|
|
|
sell certain assets or merge with or into other companies. |
Subject to certain exceptions, the indentures governing the senior discount notes, the senior notes
and senior subordinated notes permit our restricted subsidiaries and us to incur additional
indebtedness, including secured indebtedness.
27
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Covenant compliance. The breach of covenants in our senior credit agreement that are tied to ratios
based on Adjusted EBITDA could result in a default under that agreement and the lenders could elect
to declare all amounts borrowed due and payable. Any such acceleration would also result in a
default under our indentures. Additionally, under our debt agreements, our ability to engage in
activities such as incurring additional indebtedness, making investments and paying dividends is
also tied to ratios based on Adjusted EBITDA.
Adjusted EBITDA is used to determine our compliance with many of the covenants contained in the
indentures governing the notes and in our senior credit agreement.
Adjusted EBITDA is defined as EBITDA further adjusted to exclude unusual items and other
adjustments permitted in calculating covenant compliance under the indentures and our senior credit
facility. We believe that the inclusion of supplementary adjustments to EBITDA applied in presenting Adjusted EBITDA are appropriate to provide additional information to
investors to demonstrate compliance with our financing covenants.
Adjusted EBITDA is calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings |
|
$ |
57.4 |
|
|
$ |
36.5 |
|
|
$ |
130.8 |
|
|
$ |
97.9 |
|
Interest, net |
|
|
61.4 |
|
|
|
66.4 |
|
|
|
188.9 |
|
|
|
198.4 |
|
Income tax provision |
|
|
43.9 |
|
|
|
24.0 |
|
|
|
66.4 |
|
|
|
52.4 |
|
Depreciation |
|
|
33.9 |
|
|
|
33.0 |
|
|
|
103.8 |
|
|
|
97.0 |
|
Amortization |
|
|
14.0 |
|
|
|
15.6 |
|
|
|
43.5 |
|
|
|
46.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA |
|
|
210.6 |
|
|
|
175.5 |
|
|
|
533.4 |
|
|
|
491.9 |
|
Non-cash charges (1) |
|
|
10.0 |
|
|
|
12.5 |
|
|
|
24.9 |
|
|
|
26.0 |
|
Business
optimization
expenses (2) |
|
|
10.4 |
|
|
|
7.2 |
|
|
|
12.8 |
|
|
|
9.5 |
|
Unusual items (3) |
|
|
(36.2 |
) |
|
|
1.6 |
|
|
|
(30.6 |
) |
|
|
10.9 |
|
Other adjustments (4) |
|
|
(2.1 |
) |
|
|
(1.5 |
) |
|
|
(6.5 |
) |
|
|
(5.1 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA |
|
$ |
192.7 |
|
|
$ |
195.3 |
|
|
$ |
534.0 |
|
|
$ |
533.2 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Non-cash charges are further detailed on the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Profit sharing and
401(k) expense
funded by Suez |
|
$ |
7.3 |
|
|
$ |
7.3 |
|
|
$ |
22.2 |
|
|
$ |
20.5 |
|
Other |
|
|
2.7 |
|
|
|
5.2 |
|
|
|
2.7 |
|
|
|
5.5 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash charges |
|
$ |
10.0 |
|
|
$ |
12.5 |
|
|
$ |
24.9 |
|
|
$ |
26.0 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
|
|
|
|
|
Profit Sharing and 401(k) Expense Funded by Suez |
|
|
|
In conjunction with the Acquisition, defined as the November 2003 acquisition of Ondeo Nalco
Group, comprised of Nalco Company and Nalco International SAS Subsidiaries, by our subsidiary,
Nalco Holdings LLC, from Suez S.A. (Suez), we entered into an agreement with Suez whereby
Suez will reimburse us for certain profit-sharing and 401(k) matching contributions made by us
to the Profit-Sharing Trust. |
|
|
|
Other |
|
|
|
Other non-cash charges include the non-cash impact on earnings of our equity investments and
minority interests. Non-cash charges also includes the non-cash portion of rent expense under
the sublease that we entered into with Suez in conjunction with the Acquisition. |
|
(2) |
|
Business optimization expenses include costs associated with the redesign and optimization of
work processes. See Note 7 to Item 1 for more information. |
|
(3) |
|
Unusual items are further detailed on the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Three Months |
|
|
Nine Months |
|
|
Nine Months |
|
|
|
ended |
|
|
ended |
|
|
ended |
|
|
ended |
|
(dollars in millions) |
|
September 30, 2008 |
|
|
September 30, 2007 |
|
|
September 30, 2008 |
|
|
September 30, 2007 |
|
Pension settlement |
|
$ |
|
|
|
$ |
0.1 |
|
|
$ |
|
|
|
$ |
0.1 |
|
Loss (gain) on
sales, net of
expenses |
|
|
(38.2 |
) |
|
|
(0.4 |
) |
|
|
(37.3 |
) |
|
|
0.9 |
|
Other unusual items |
|
|
2.0 |
|
|
|
1.9 |
|
|
|
6.7 |
|
|
|
9.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unusual items |
|
$ |
(36.2 |
) |
|
$ |
1.6 |
|
|
$ |
(30.6 |
) |
|
$ |
10.9 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on sales, net of expenses, for the three months and nine months ended September 30, 2008
was mostly comprised of a $38.1 million gain on divestiture. See Note 8 to Item 1 for more
information. |
|
(4) |
|
We are required to make adjustments to EBITDA for franchise taxes and 401(k) matching
contributions. |
29
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Our covenant levels and ratios for the four quarters ended September 30, 2008 are as follows:
|
|
|
|
|
|
|
|
|
|
|
September 30, 2008 |
|
|
|
Required |
|
|
Actual |
|
Senior credit facility (1) |
|
|
|
|
|
|
|
|
Minimum Adjusted EBITDA to cash interest ratio |
|
|
1.85 |
x |
|
|
3.55 |
x |
Maximum net debt to Adjusted EBITDA ratio |
|
|
5.25 |
x |
|
|
3.74 |
x |
Indentures (2) |
|
|
|
|
|
|
|
|
Minimum Adjusted EBITDA to fixed charge ratio
required to incur additional debt pursuant to
ratio provisions |
|
|
2.00 |
x |
|
|
3.00 |
x |
|
|
|
(1) |
|
During 2008, our senior credit facility requires us to maintain an Adjusted
EBITDA to cash interest ratio at a minimum of 1.85x and a net debt to Adjusted EBITDA
ratio at a maximum of 5.25x, in each case for the most recent four quarter period.
Failure to satisfy these ratio requirements would constitute a default under the senior
credit agreement. If our lenders failed to waive any such default, our repayment
obligations under the senior credit agreement could be accelerated, which would also
constitute a default under our indentures. |
|
(2) |
|
Our ability to incur additional debt and make certain restricted payments under
our indentures, subject to specified exceptions, is tied to an Adjusted EBITDA to fixed
charge ratio of at least 2.0 to 1, except that we may incur certain debt and make
certain restricted payments and certain permitted investments without regard to the
ratio, such as up to an aggregate principal amount of $1,950 million (including $922.7
million that was outstanding under our term loan facilities as of September 30, 2008)
and investments in similar business and other investments equal to 6% of Nalco Holding
Company consolidated assets. |
Local lines of credit. Certain of our non-U.S. subsidiaries have lines of credit to support local
requirements. As of September 30, 2008, the aggregate outstanding balance under these local lines
of credit was approximately $57.9 million. Certain of these lines of credit are equally and ratably
secured with obligations under our senior credit facilities.
Receivables facility. Nalco Company entered into a three-year receivables facility on June 22,
2007 that provides up to $160 million in funding from a commercial paper conduit sponsored by Bank
of America, N.A., one of the lenders under Nalco Companys senior credit facilities, based on
availability of eligible receivables and satisfaction of other customary conditions.
30
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Availability of funding under the receivables facility in a given month depends primarily upon the
outstanding trade accounts receivable balance at the end of the previous month. Aggregate
availability is determined by using a formula that reduces the gross receivables balance by factors
that take into account historical default and dilution rates, excessive concentrations and average
days outstanding and the costs of the facility. As of September 30, 2008, we had $150.0 million of
outstanding borrowings under this facility, based on the amount of receivables eligible for
financing as of August 31, 2008.
This facility is treated as a general financing agreement resulting in the borrowings and related
receivables being shown as liabilities and assets, respectively, on our consolidated balance sheet
and the costs associated with the receivables facility being recorded as interest expense.
Recent Accounting Pronouncements
See Note 3 to the condensed consolidated financial statements, included in Part I, Item 1, for
information on recent accounting pronouncements.
Safe Harbor Statement Under Private Securities Litigation Reform Act of 1995
This Quarterly Report for the fiscal quarter ended September 30, 2008 (the Quarterly Report)
includes forward-looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements
include statements concerning our plans, objectives, goals, strategies, future events, future revenue or performance, capital expenditures, financing
needs, plans or intentions relating to acquisitions, business trends and other information that is
not historical information. When used in this Quarterly Report, the words estimates, expects,
anticipates, projects, plans, intends, believes, forecasts, or future or conditional
verbs, such as will, should, could or may, and variations of such words or similar
expressions are intended to identify forward-looking statements. All forward-looking statements,
including, without limitation, managements examination of historical operating trends and data are
based upon our current expectations and various assumptions. Our expectations, beliefs and
projections are expressed in good faith and we believe there is a reasonable basis for them.
However, there can be no assurance that managements expectations, beliefs and projections will be
achieved.
31
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
There are a number of risks and uncertainties that could cause our actual results to differ
materially from the forward-looking statements contained in this Quarterly Report. Additionally,
important factors could cause our actual results to differ materially from the forward-looking
statements we make in this Quarterly Report. Such risks, uncertainties and other important factors
include, among others:
|
|
|
our substantial leverage, particularly in view of current troubled conditions in
global debt markets; |
|
|
|
|
limitations on flexibility in operating our business contained in our debt agreements; |
|
|
|
|
increases in interest rates as a result of our variable rate indebtedness; |
|
|
|
|
pricing pressure from our customers; |
|
|
|
|
our ability to respond to the changing needs of a particular industry and develop new
offerings; |
|
|
|
|
technological change and innovation; |
|
|
|
|
risks associated with our non-U.S. operations; |
|
|
|
|
fluctuations in currency exchange rates; |
|
|
|
|
high competition in the markets in which we operate; |
|
|
|
|
adverse changes to environmental, health and safety regulations; |
|
|
|
|
operating hazards in our production facilities; |
|
|
|
|
inability to achieve expected cost savings; |
|
|
|
|
difficulties in securing the raw materials we use; |
|
|
|
|
significant increases in the costs of raw materials we use and our ability to pass any
future raw material price increases through to our customers; |
|
|
|
|
our significant pension benefit obligations and the current underfunding of our
pension plans; |
|
|
|
|
our ability to realize the full value of our intangible assets; |
|
|
|
|
our ability to attract and retain skilled employees, particularly research scientists,
technical sales professionals and engineers; and |
|
|
|
|
our ability to protect our intellectual property rights. |
There may be other factors that may cause our actual results to differ materially from the
forward-looking statements. For further information regarding risk factors, please refer to Part
I, Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2007.
All forward-looking statements attributable to us or persons acting on our behalf apply only as of
the date of this Quarterly Report and are expressly qualified in their entirety by the cautionary
statements included in this Quarterly Report. We undertake no obligation to update or revise
forward-looking statements which may be made to reflect events or circumstances that arise after
the date made or to reflect the occurrence of unanticipated events.
Use of Non-GAAP Financial Measures
Direct contribution, EBITDA, Adjusted EBITDA and Free Cash Flow are measures used by management to
measure operating performance. Adjusted EBITDA is also used to determine our compliance with
financial covenants and our ability to engage in certain activities such as incurring additional
debt and making certain payments.
32
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
(continued)
Direct contribution is defined as net sales, less cost of product sold, selling and service
expenses, marketing expenses, research expenses and capital charges (an internal non-GAAP charge
based on trade accounts receivable, inventories and equipment specifically identifiable to each of
our operating segments). EBITDA is defined as net earnings plus interest, taxes, depreciation and
amortization. Adjusted EBITDA is defined as EBITDA further adjusted for certain cash and non-cash
charges, as permitted under our senior discount note, senior note and senior subordinated note
indentures and our senior credit facility. Free Cash Flow is defined as net cash provided by
operating activities, less capital expenditures and minority interest charges.
Direct contribution provides investors with the measurement used by our management to evaluate the
performance of our segments. We believe EBITDA is useful to the investors because it is frequently
used by securities analysts, investors and other interested parties in the evaluation of companies
in our industry. We consider the inclusion of supplementary adjustments to EBITDA applied in
presenting Adjusted EBITDA appropriate to provide additional information to investors to
demonstrate compliance with our financing covenants. We believe Free Cash Flow provides investors
with a measure of our ability to generate cash for the optimization of our capital structure.
Direct contribution, EBITDA, Adjusted EBITDA and Free Cash Flow are not recognized terms under U.S.
GAAP and do not purport to be alternatives to net earnings as an indicator of operating performance
or to cash flows from operating activities as a measure of liquidity. Direct contribution is
reconciled to consolidated earnings before income taxes and minority interests in Note 12 of our
consolidated financial statements included in Part I, Item 1 of this Quarterly Report. The most
direct comparable GAAP financial measures of each non-GAAP financial measure, as well as the
reconciliation between each non-GAAP financial measure and the GAAP financial measure, are
presented in the discussions of the non-GAAP financial measures above. Because not all companies
use identical calculations, our measures may not be comparable to other similarly titled measures
of other companies.
33
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes to our exposures to market risk since December 31, 2007.
Item 4. Controls and Procedures
(a) |
|
Evaluation of disclosure controls and procedures. |
|
|
|
Our chief executive officer and chief financial officer, after evaluating the effectiveness
of our disclosure controls and procedures (as defined in the Securities Exchange Act of
1934 Rules 13a-15(e) and 15d-15(e)) as of the end of the period, have concluded that our
disclosure controls and procedures were effective as of September 30, 2008. |
|
(b) |
|
Changes in internal controls over financial reporting. |
|
|
|
There were no changes in our internal controls over financial reporting that occurred
during the third quarter of 2008 that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting. |
34
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
On November 27, 2006, the U.K. Health and Safety Executive (HSE) issued a criminal summons
charging our U.K. subsidiary with a violation of the Health and Safety at Work Act. The summons
was re-issued in the Crown Court of Worcester on July 23, 2007. The charge relates to a Legionella
outbreak that is claimed to have originated at cooling towers owned by one of the subsidiarys
customers. The Legionella outbreak is believed to have resulted in two fatalities and multiple
injuries. The customer, H. P. Bulmer Limited, was also charged. Our subsidiary submitted a guilty
plea to a portion of the charge, exposing non-employees to a health risk, on September 3, 2007.
Similarly, our subsidiarys customer submitted a guilty plea. On July 1, 2008, the Crown Court
issued a penalty of £300,000 ($0.6 million) and court costs of £50,000 ($0.1 million) against our
subsidiary relating to this violation. An identical penalty was issued against the subsidiarys
customer.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The table below sets forth information regarding repurchases of our common stock during the three
months ended September 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(d) |
|
|
|
|
|
|
|
|
|
|
|
(c) |
|
|
Approximate |
|
|
|
|
|
|
|
|
|
|
|
Total Number of |
|
|
Dollar Value of |
|
|
|
(a) |
|
|
|
|
|
|
Shares Purchased |
|
|
Shares that May |
|
|
|
Total Number |
|
|
(b) |
|
|
as Part of Publicly |
|
|
Yet Be Purchased |
|
|
|
of Shares |
|
|
Average Price |
|
|
Announced Plans |
|
|
Under the Plans |
|
|
|
Purchased |
|
|
Paid per Share |
|
|
or Programs (1) |
|
|
or Programs (1)(2) |
|
July 1, 2008
July 31, 2008 |
|
|
|
|
|
$ |
|
|
|
|
|
|
|
$ |
161,585,078 |
|
August 1, 2008
August 31, 2008 |
|
|
1,213,930 |
|
|
$ |
22.13 |
|
|
|
1,213,930 |
|
|
$ |
134,723,347 |
|
September 1, 2008
September 30,
2008 |
|
|
1,978,613 |
|
|
$ |
20.85 |
|
|
|
1,978,613 |
|
|
$ |
93,464,216 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
3,192,543 |
|
|
$ |
21.34 |
|
|
|
3,192,543 |
|
|
$ |
93,464,216 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
On July 31, 2007, our Board of Directors authorized a $300 million share repurchase program,
and gave our management discretion in determining the conditions under which shares may be
purchased from time to time. We intend to repurchase all shares under this authorization in
open market transactions. There is no set timetable for share repurchases, and the program
has no stated expiration date. |
|
(2) |
|
For the quarter ended September 30, 2008, we expended $73.3 million in cash for the
repurchase of shares, which included $8.7 million that was reported as a payable on the
balance sheet at June 30, 2008 for share repurchases executed in June 2008 and settled in July
2008. At September 30, 2008, $3.5 million was reported as a payable on the balance sheet for
share repurchases executed in September 2008 and settling in October 2008. |
35
Item 6. Exhibits
(a) |
|
The following are included herein: |
Exhibit 31.1 Certification of Chief Executive Officer, Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial Officer, Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
36
SIGNATURE
The registrant has duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
|
|
|
|
|
|
NALCO HOLDING COMPANY
|
|
|
/s/ BRADLEY J. BELL
|
|
|
Name: |
Bradley J. Bell |
|
|
Title: |
Executive Vice President and
Chief Financial Officer |
|
Dated: October 30, 2008
37
EXHIBIT INDEX
Exhibit 31.1 Certification of Chief Executive Officer, Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification of Chief Financial Officer, Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.1 Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
38