10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
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(Mark One)
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x
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the quarterly period ended June 30, 2008
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or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to .
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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)
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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 x No o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in Rule
12b-2 of the
Exchange Act. (Check one):
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Large
accelerated
filer x
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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)
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 x
As of July 22, 2008, the number of shares of the
registrants common stock, par value $0.01 per share,
outstanding was 140,786,530 shares.
QUARTERLY
REPORT ON
FORM 10-Q
NALCO HOLDING COMPANY
Quarter Ended June 30, 2008
TABLE OF CONTENTS
1
PART I. FINANCIAL
INFORMATION
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Item 1.
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Financial
Statements
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Nalco
Holding Company and Subsidiaries
(dollars in millions)
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(Unaudited)
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June 30,
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December 31,
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2008
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2007
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Assets
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Current assets:
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Cash and cash equivalents
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$
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86.2
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$
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119.9
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Accounts receivable, less allowances of $23.8 in 2008 and $19.5
in 2007
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811.9
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805.6
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Inventories:
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Finished products
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328.8
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268.9
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Materials and work in process
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107.4
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81.5
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436.2
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350.4
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Prepaid expenses, taxes and other current assets
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100.9
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112.6
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Total current assets
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1,435.2
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1,388.5
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Property, plant, and equipment, net
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771.9
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762.3
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Intangible assets:
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Goodwill
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2,488.2
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2,459.8
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Other intangibles, net
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1,122.2
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1,121.4
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Other assets
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215.8
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246.6
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Total assets
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$
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6,033.3
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$
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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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$
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357.9
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$
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316.4
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Short-term debt
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90.8
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130.4
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Other current liabilities
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300.5
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322.5
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Total current liabilities
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749.2
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769.3
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Other liabilities:
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Long-term debt
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3,241.9
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3,193.7
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Deferred income taxes
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268.3
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327.5
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Accrued pension benefits
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322.6
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314.4
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Other liabilities
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220.2
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234.7
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Minority interest
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19.0
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21.2
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Shareholders equity
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1,212.1
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1,117.8
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Total liabilities and shareholders equity
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$
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6,033.3
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$
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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
(Unaudited)
(dollars in millions, except per share amounts)
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Three Months
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Three Months
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Six Months
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Six 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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June 30, 2008
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June 30, 2007
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June 30, 2008
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June 30, 2007
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Net sales
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$
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1,066.3
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$
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970.9
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$
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2,066.0
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$
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1,880.2
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Operating costs and expenses:
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Cost of product sold
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594.9
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537.5
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1,159.3
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1,041.9
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Selling, administrative, and research expenses
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332.2
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292.2
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641.0
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579.7
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Amortization of intangible assets
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15.9
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15.4
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29.5
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30.6
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Business optimization expenses
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1.4
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2.3
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2.4
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2.3
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Total operating costs and expenses
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944.4
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847.4
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1,832.2
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1,654.5
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Operating earnings
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121.9
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123.5
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233.8
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225.7
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Other income (expense), net
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(4.3
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(7.3
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(0.3
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Interest income
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2.0
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1.9
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4.5
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4.5
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Interest expense
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(64.7
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(68.2
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(132.0
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(136.5
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Earnings before income taxes and minority interests
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54.9
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57.2
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99.0
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93.4
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Income tax provision
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9.0
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13.7
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22.5
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28.4
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Minority interests
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(1.7
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(1.7
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(3.1
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(3.6
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Net earnings
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$
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44.2
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$
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41.8
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$
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73.4
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$
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61.4
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Net earnings per share:
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Basic
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$
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0.32
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$
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0.29
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$
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0.52
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$
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0.43
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Diluted
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$
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0.31
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$
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0.28
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$
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0.51
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$
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0.41
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Weighted-average shares outstanding (millions):
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Basic
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141.4
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144.4
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141.7
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144.0
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Diluted
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142.2
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148.0
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142.5
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148.0
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Cash dividends declared per share
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$
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0.035
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$
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0.035
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$
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0.07
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$
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0.07
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See accompanying notes to condensed consolidated financial
statements.
3
Nalco
Holding Company and Subsidiaries
(Unaudited)
(dollars in millions)
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Six Months
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Six Months
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ended
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ended
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June 30, 2008
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June 30, 2007
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Operating activities
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Net earnings
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$
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73.4
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$
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61.4
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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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69.9
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64.0
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Amortization
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29.5
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30.6
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Amortization of deferred financing costs and accretion of senior
discount notes
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23.8
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22.3
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Other, net
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1.7
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(10.4
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Changes in operating assets and liabilities
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(64.6
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(97.2
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Net cash provided by operating activities
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133.7
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70.7
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Investing activities
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Additions to property, plant, and equipment, net
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(61.9
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(47.6
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Other, net
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(14.0
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(1.0
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Net cash used for investing activities
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(75.9
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(48.6
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Financing activities
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Cash dividends
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(9.9
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(5.0
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Changes in short-term debt, net
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(61.2
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(8.3
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Proceeds from long-term debt
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3.1
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48.8
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Repayments of long-term debt
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(0.7
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(24.0
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Purchases of treasury stock
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(21.7
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Other, net
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(3.9
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(4.1
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Net cash provided by (used for) financing activities
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(94.3
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7.4
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Effect of exchange rate changes on cash and cash equivalents
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2.8
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1.8
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Increase (decrease) in cash and cash equivalents
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(33.7
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31.3
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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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$
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86.2
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$
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68.6
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See accompanying notes to condensed consolidated financial
statements.
4
June 30, 2008
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1.
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Description
of Business
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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.
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 six months
ended June 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.
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3.
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Recent
Accounting Pronouncements
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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.
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
5
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3.
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Recent
Accounting Pronouncements (continued)
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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.
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
6
|
|
3.
|
Recent
Accounting Pronouncements (continued)
|
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. Early application is encouraged, as are
comparative disclosures for earlier periods, but neither are
required.
Debt consists of the following:
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
(dollars in millions)
|
|
2008
|
|
|
2007
|
|
|
Short-term
|
|
|
|
|
|
|
|
|
Checks outstanding and bank overdrafts
|
|
$
|
31.3
|
|
|
$
|
14.1
|
|
Notes payable to banks
|
|
|
27.3
|
|
|
|
6.1
|
|
Current maturities of long-term debt
|
|
|
22.2
|
|
|
|
32.4
|
|
Unsecured notes, due May 2008
|
|
|
|
|
|
|
27.8
|
|
Revolving credit facility
|
|
|
10.0
|
|
|
|
50.0
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
90.8
|
|
|
$
|
130.4
|
|
|
|
|
|
|
|
|
|
|
Long-term
|
|
|
|
|
|
|
|
|
Securitized trade accounts receivable facility
|
|
$
|
137.0
|
|
|
$
|
134.0
|
|
Term loan A, due November 2009
|
|
|
39.5
|
|
|
|
64.8
|
|
Term loan B, due November 2010
|
|
|
887.0
|
|
|
|
887.0
|
|
Senior notes, due November 2011
|
|
|
980.2
|
|
|
|
959.6
|
|
Senior subordinated notes, due November 2013
|
|
|
780.2
|
|
|
|
759.6
|
|
Senior discount notes, due February 2014
|
|
|
439.3
|
|
|
|
420.6
|
|
Other
|
|
|
0.9
|
|
|
|
0.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,264.1
|
|
|
|
3,226.1
|
|
Less: Current portion
|
|
|
22.2
|
|
|
|
32.4
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
3,241.9
|
|
|
$
|
3,193.7
|
|
|
|
|
|
|
|
|
|
|
Shareholders equity consists of the following:
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
(dollars in millions, except per share amounts)
|
|
2008
|
|
|
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 June 30, 2008 and December 31, 2007,
respectively
|
|
|
1.4
|
|
|
|
1.4
|
|
Additional paid-in capital
|
|
|
761.2
|
|
|
|
749.7
|
|
Treasury stock, at cost; 5,977,500 shares and
4,588,500 shares at June 30, 2008 and
December 31, 2007, respectively
|
|
|
(138.4
|
)
|
|
|
(108.0
|
)
|
Retained earnings
|
|
|
163.1
|
|
|
|
100.7
|
|
Accumulated other comprehensive income
|
|
|
424.8
|
|
|
|
374.0
|
|
|
|
|
|
|
|
|
|
|
Total shareholders equity
|
|
$
|
1,212.1
|
|
|
$
|
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 six months ended June 30, 2008. At
June 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
7
|
|
5.
|
Shareholders
Equity (continued)
|
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.
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 six months ended June 30,
2008, we repurchased an additional 1,389,000 shares at a
cost of $30.4 million. Of that amount, we expended
$21.7 million in cash and an additional $8.7 million
was reported as a payable on the balance sheet at June 30,
2008, for share repurchases executed in June 2008 and settling
in July 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 six
months ended June 30, 2008 and 2007 were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension Benefits
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
(dollars in millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Service cost
|
|
$
|
6.4
|
|
|
$
|
7.1
|
|
|
$
|
13.1
|
|
|
$
|
14.2
|
|
Interest cost
|
|
|
12.2
|
|
|
|
11.4
|
|
|
|
24.4
|
|
|
|
22.5
|
|
Expected return on plan assets
|
|
|
(9.7
|
)
|
|
|
(8.6
|
)
|
|
|
(18.9
|
)
|
|
|
(16.8
|
)
|
Prior service (credit) cost
|
|
|
(0.5
|
)
|
|
|
0.1
|
|
|
|
(1.1
|
)
|
|
|
0.1
|
|
Net actuarial loss
|
|
|
0.1
|
|
|
|
0.2
|
|
|
|
0.2
|
|
|
|
0.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic cost
|
|
$
|
8.5
|
|
|
$
|
10.2
|
|
|
$
|
17.7
|
|
|
$
|
20.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other Postretirement Benefits
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
|
June 30,
|
|
(dollars in millions)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Service cost
|
|
$
|
0.9
|
|
|
$
|
1.1
|
|
|
$
|
2.2
|
|
|
$
|
2.7
|
|
Interest cost
|
|
|
2.0
|
|
|
|
1.9
|
|
|
|
4.4
|
|
|
|
4.1
|
|
Prior service credit
|
|
|
(1.2
|
)
|
|
|
(1.3
|
)
|
|
|
(2.4
|
)
|
|
|
(2.4
|
)
|
Net actuarial gain
|
|
|
(1.0
|
)
|
|
|
(0.1
|
)
|
|
|
(1.3
|
)
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic cost
|
|
$
|
0.7
|
|
|
$
|
1.6
|
|
|
$
|
2.9
|
|
|
$
|
4.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
$1.4 million and $2.3 million for the three months
ended June 30, 2008 and 2007, respectively. Business
process optimization expenses were $2.4 million for the six
months ended June 30, 2008 and $2.3 million for the
six months ended June 30, 2007, as employee severance and
related costs were partly offset by the impact of a
$0.4 million reduction in the impairment provision for a
facility that was held for sale.
8
|
|
8.
|
Summary
of Other Income (Expense)
|
The components of other income (expense), net for the three
months and six months ended June 30, 2008 and 2007, include
the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Franchise taxes
|
|
$
|
(0.7
|
)
|
|
$
|
(0.8
|
)
|
|
$
|
(1.3
|
)
|
|
$
|
(1.6
|
)
|
Equity in earnings of unconsolidated subsidiaries
|
|
|
0.5
|
|
|
|
0.5
|
|
|
|
0.9
|
|
|
|
0.9
|
|
Foreign currency exchange adjustments
|
|
|
(2.4
|
)
|
|
|
0.7
|
|
|
|
(5.4
|
)
|
|
|
0.5
|
|
Other
|
|
|
(1.7
|
)
|
|
|
(0.4
|
)
|
|
|
(1.5
|
)
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(4.3
|
)
|
|
$
|
|
|
|
$
|
(7.3
|
)
|
|
$
|
(0.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The income tax provision for the three months and six months
ended June 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, as well
as the creation of valuation allowances related to the
realization of a deductible temporary difference and net
operating loss carryforwards in the U.K. 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.
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 that 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 $40.1 million in the three
months and six months ended June 30, 2008.
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
current quarter, the Service offered to reduce the disallowance
to $5.8 million and close the audit. We intend to accept
the offer, which caused the recognition of $2.2 million of
additional federal and state tax expense in the three months and
six months ended June 30, 2008.
We have a net operating loss carryforward in the U.K. of
approximately $32.9 million ($9.2 million tax effect)
that does not expire. In addition, we have a net deferred tax
asset in the U.K. primarily related to $40.0 million of
future tax deductions ($11.2 million tax effect) for
pension contributions. A valuation allowance of
$72.9 million ($20.4 million tax effect) was
established in the second quarter of 2008, due to a lack of
profitability in recent years.
9
|
|
9.
|
Income
Taxes (continued)
|
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
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
U.S. statutory tax rate
|
|
$
|
19.2
|
|
|
$
|
20.0
|
|
|
$
|
34.6
|
|
|
$
|
32.7
|
|
Foreign tax credits
|
|
|
(40.1
|
)
|
|
|
|
|
|
|
(40.1
|
)
|
|
|
|
|
U.K. valuation allowances
|
|
|
20.4
|
|
|
|
|
|
|
|
20.4
|
|
|
|
|
|
U.S. audit
|
|
|
2.2
|
|
|
|
|
|
|
|
2.5
|
|
|
|
|
|
Other
|
|
|
7.3
|
|
|
|
(6.3
|
)
|
|
|
5.1
|
|
|
|
(4.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income tax provision
|
|
$
|
9.0
|
|
|
$
|
13.7
|
|
|
$
|
22.5
|
|
|
$
|
28.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income and its components, net of related
tax, for the three months and six months ended June 30,
2008 and 2007, were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Net earnings
|
|
$
|
44.2
|
|
|
$
|
41.8
|
|
|
$
|
73.4
|
|
|
$
|
61.4
|
|
Other comprehensive income, net of income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
0.6
|
|
|
|
(0.2
|
)
|
|
|
1.3
|
|
|
|
0.9
|
|
Net prior service credit
|
|
|
(1.2
|
)
|
|
|
(0.8
|
)
|
|
|
(2.3
|
)
|
|
|
(1.5
|
)
|
Net actuarial (gain) loss
|
|
|
(0.9
|
)
|
|
|
|
|
|
|
(1.1
|
)
|
|
|
0.1
|
|
Foreign currency translation adjustments
|
|
|
14.9
|
|
|
|
48.8
|
|
|
|
52.9
|
|
|
|
64.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
57.6
|
|
|
$
|
89.6
|
|
|
$
|
124.2
|
|
|
$
|
125.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
10
|
|
11.
|
Segment
Information (continued)
|
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.
Net sales by reportable segment were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Industrial and Institutional Services
|
|
$
|
474.8
|
|
|
$
|
432.5
|
|
|
$
|
902.9
|
|
|
$
|
836.9
|
|
Energy Services
|
|
|
363.0
|
|
|
|
316.9
|
|
|
|
709.7
|
|
|
|
611.3
|
|
Paper Services
|
|
|
203.0
|
|
|
|
194.8
|
|
|
|
404.0
|
|
|
|
381.5
|
|
Other
|
|
|
25.5
|
|
|
|
26.7
|
|
|
|
49.4
|
|
|
|
50.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
1,066.3
|
|
|
$
|
970.9
|
|
|
$
|
2,066.0
|
|
|
$
|
1,880.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Segment direct contribution:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial and Institutional Services
|
|
$
|
96.1
|
|
|
$
|
93.6
|
|
|
$
|
177.1
|
|
|
$
|
178.7
|
|
Energy Services
|
|
|
72.4
|
|
|
|
74.5
|
|
|
|
147.8
|
|
|
|
136.5
|
|
Paper Services
|
|
|
24.3
|
|
|
|
31.9
|
|
|
|
52.6
|
|
|
|
58.2
|
|
Other
|
|
|
(24.6
|
)
|
|
|
(27.2
|
)
|
|
|
(53.8
|
)
|
|
|
(49.7
|
)
|
Capital charge elimination
|
|
|
24.6
|
|
|
|
20.9
|
|
|
|
48.1
|
|
|
|
41.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total segment direct contribution
|
|
|
192.8
|
|
|
|
193.7
|
|
|
|
371.8
|
|
|
|
364.7
|
|
Expenses not allocated to segments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Administrative expenses
|
|
|
53.6
|
|
|
|
52.5
|
|
|
|
106.1
|
|
|
|
106.1
|
|
Amortization of intangible assets
|
|
|
15.9
|
|
|
|
15.4
|
|
|
|
29.5
|
|
|
|
30.6
|
|
Business optimization expenses
|
|
|
1.4
|
|
|
|
2.3
|
|
|
|
2.4
|
|
|
|
2.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating earnings
|
|
|
121.9
|
|
|
|
123.5
|
|
|
|
233.8
|
|
|
|
225.7
|
|
Other income (expense), net
|
|
|
(4.3
|
)
|
|
|
|
|
|
|
(7.3
|
)
|
|
|
(0.3
|
)
|
Interest income
|
|
|
2.0
|
|
|
|
1.9
|
|
|
|
4.5
|
|
|
|
4.5
|
|
Interest expense
|
|
|
(64.7
|
)
|
|
|
(68.2
|
)
|
|
|
(132.0
|
)
|
|
|
(136.5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings before income taxes and minority interests
|
|
$
|
54.9
|
|
|
$
|
57.2
|
|
|
$
|
99.0
|
|
|
$
|
93.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
11
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
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Numerator for basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net earnings
|
|
$
|
44.2
|
|
|
$
|
41.8
|
|
|
$
|
73.4
|
|
|
$
|
61.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for basic earnings per share weighted
average common shares outstanding
|
|
|
141.4
|
|
|
|
144.4
|
|
|
|
141.7
|
|
|
|
144.0
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock purchase warrant
|
|
|
0.6
|
|
|
|
3.5
|
|
|
|
0.6
|
|
|
|
3.9
|
|
Share-based compensation plans
|
|
|
0.2
|
|
|
|
0.1
|
|
|
|
0.2
|
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator for diluted earnings per share
|
|
|
142.2
|
|
|
|
148.0
|
|
|
|
142.5
|
|
|
|
148.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13.
|
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 $1.8 million at June 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.
Expenditures for the six months ended June 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
12
|
|
13.
|
Contingencies
and Litigation (continued)
|
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, is 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.
|
|
14.
|
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.
|
13
|
|
14.
|
Fair
Value Measurements (continued)
|
The fair value of financial assets and liabilities measured at
fair value on a recurring basis was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
|
|
|
|
|
|
|
|
(dollars in millions)
|
|
2008
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts
|
|
$
|
0.1
|
|
|
$
|
|
|
|
$
|
0.1
|
|
|
$
|
|
|
Natural gas forward contracts
|
|
|
1.3
|
|
|
|
|
|
|
|
1.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1.4
|
|
|
$
|
|
|
|
$
|
1.4
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign exchange forward contracts
|
|
$
|
4.0
|
|
|
$
|
|
|
|
$
|
4.0
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
No significant guarantees were outstanding at June 30,
2008, other than subsidiary-related performance guarantees.
We had $21.5 million of letters of credit outstanding at
June 30, 2008.
On July 25, 2008, we announced that we had entered into a
definitive agreement to sell our Finishing Technologies surface
treatment business to Rockwood Holdings for $75.0 million.
A plant in Jackson, Michigan, dedicated to the Finishing
Technologies business, is included in the sale, along with
dedicated Finishing Technologies sales, service, marketing,
research and supply chain employees. The transaction is expected
to close prior to the end of the third quarter, following
regulatory approval, and result in an after-tax gain that will
increase diluted earnings per share by an estimated 29 cents per
share.
14
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
Overview
Key financial highlights for the second quarter 2008 include:
|
|
|
|
|
Second quarter 2008 revenues of $1,066.3 million increased
9.8% over second quarter 2007 revenues of $970.9 million.
This increase consisted of organic growth of 5.7%, a currency
benefit of 5.4%, less an acquisition/divestiture impact of 1.3%.
We define organic growth as nominal, or actual, sales growth
less the impacts of changes in foreign currency translation
rates and acquisitions and divestitures.
|
|
|
|
|
|
We experienced increases in product and freight costs
approximating $36 million in the second quarter of 2008
over the prior-year period, but these were largely offset with
price increases of about $29 million.
|
|
|
|
The effective tax rate dropped to 16.4% for the second quarter
of 2008 from 24.0% for the year-ago quarter, as a result of
recognizing federal tax benefits for the expected utilization of
foreign tax credit carryforwards generated in previous years.
This resulted from continued improvements in profitability in
the U.S. and the rationalization of our legal entity
structure to make it more tax efficient.
|
|
|
|
Second quarter 2008 net earnings of $44.2 million were
up 5.7% over year-ago net earnings of $41.8 million.
Diluted earnings per share (EPS) of 31 cents rose 10.7% over the
28 cents reported in the second quarter of 2007.
|
|
|
|
Adjusted EBITDA, a measure used to determine compliance with our
debt covenants, was $175.7 million for the second quarter
of 2008, a 1.5% increase over year-ago Adjusted EBITDA of
$173.1 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 $179.9 million in the second quarter of 2007.
|
|
|
|
Free Cash Flow, defined as cash from operating activities less
capital expenditures and minority interest charges, was
$25.9 million in the second quarter of 2008, an improvement
of $41.3 million from the negative Free Cash Flow of
$15.4 million in the year-ago period. The increase
primarily resulted from lower net working capital requirements,
most notably for receivables; however, cash required for
inventories was up over the year-ago period primarily because of
higher raw material costs and additions to support business
growth in emerging geographies. Lower pension funding
requirements also contributed to the improvement. Net cash
provided by operating activities is reconciled to Free Cash Flow
as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Net cash provided by operating activities
|
|
$
|
63.1
|
|
|
$
|
12.8
|
|
Minority interests
|
|
|
(1.7
|
)
|
|
|
(1.7
|
)
|
Additions to property, plant, and equipment, net
|
|
|
(35.5
|
)
|
|
|
(26.5
|
)
|
|
|
|
|
|
|
|
|
|
Free cash flow
|
|
$
|
25.9
|
|
|
$
|
(15.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We repurchased an additional 639,000 shares at a cost of
$14.2 million during the second quarter of 2008. For the
first six months of 2008, we have repurchased
1,389,000 shares at a cost of $30.4 million, of which
$21.7 million was expended in cash and $8.7 million
was reported as a payable at June 30, 2008, for share
repurchases executed in June 2008 and settling in July 2008.
|
15
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
Outlook
We expect to deliver our previously communicated target for
Adjusted EBITDA growth of about 8% over synfuel-adjusted 2007
results of $707 million, assuming raw material and freight
costs stabilize within the next few months. We expect our
effective tax rate for the year to average out at about 27%-28%,
with an effective tax rate expected to be about 30% on a
going-forward basis. Free Cash Flow continues to be projected in
the high $200 million range.
Results
of Operations Consolidated
Quarter
Ended June 30, 2008 Compared to the Quarter Ended
June 30, 2007
Net sales for the three months ended June 30,
2008 were $1,066.3 million, a 9.8% increase over the
$970.9 million reported for the quarter ended June 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 5.7%. On a geographic basis,
North America, Latin America and Asia reported organic growth of
8.8%, 8.0% and 7.4%, respectively, while sales in the Europe,
Africa, and Middle East (EAME) region were down 1.3% organically.
Gross profit, defined as the difference between
net sales and cost of product sold, of $471.4 million for
the quarter ended June 30, 2008 increased by
$38.0 million, or 8.8%, over the $433.4 million for
the year-ago period. On an organic basis, gross profit increased
by 3.9%. The improvement was mainly attributable to cost savings
and higher sales volumes, partly offset by higher service costs
and unfavorable changes in product mix. Higher product and
freight costs were largely offset by price increases to our
customers. Gross profit margin for the three months ended
June 30, 2008 was 44.2% compared to 44.6% for the three
months ended June 30, 2007.
Selling, administrative, and research expenses for
the three months ended June 30, 2008 of $332.2 million
rose $40.0 million, or 13.7%, from $292.2 million for
the year-ago period. On an organic basis, selling,
administrative, and research expenses increased 6.8%. This was
mostly attributable to higher salaries, travel and bad debts.
Lower outside consulting for work process redesign initiatives
and the rationalization of our legal entity structure partly
offset these increases.
Amortization of intangible assets was
$15.9 million and $15.4 million for the three months
ended June 30, 2008 and 2007, respectively. Higher
amortization resulting from the December 2007 acquisition of
Nalco Mobotec was partly offset by lower amortization of
customer relationships, which are amortized using an accelerated
method.
Business optimization expenses, representing
mostly employee severance and related costs associated with the
continuing redesign and optimization of business and work
processes, were $1.4 million and $2.3 million for the
three months ended June 30, 2008 and June 30, 2007,
respectively.
Other income (expense), net was a net expense of
$4.3 million and nil for the three months ended
June 30, 2008 and 2007, respectively. An unfavorable change
in foreign currency transaction gains and losses of
$3.1 million, resulting from the continued weakening of the
U.S. dollar versus the euro and other currencies, accounted
for most of the variation.
Net interest expense, defined as the combination
of interest income and interest expense, of $62.7 million
for the three months ended June 30, 2008 decreased by
$3.6 million from the $66.3 million reported for the
three months ended June 30, 2007. Translation rate changes
due to the weaker U.S. dollar versus the euro increased
interest expense by $1.9 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 and a
slightly lower average debt level compared to the year-ago
period.
16
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
The income tax provision for the three months
ended June 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, as well
as the creation of valuation allowances related to the
realization of a deductible temporary difference and net
operating loss carryforwards in the U.K. These items are
discussed in more detail in Note 9 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 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.
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 contributed to the variation between
the U.S. federal statutory income tax rate and our income
tax provision for the three months ended June 30, 2007. In
addition, the 2007 provision included the recognition of net
benefits related to settling tax positions in The Netherlands.
Minority interest expense of $1.7 million for
the three months ended June 30, 2008 was comparable to the
year-ago period. The impact of slightly higher earnings by our
Malaysian subsidiary and our Katayama Nalco joint venture in
Japan compared to the year-ago period was offset by the effect
of lower earnings of our subsidiary in Saudi Arabia.
Six
Months Ended June 30, 2008 Compared to the Six Months Ended
June 30, 2007
Net sales for the six months ended June 30,
2008 were $2,066.0 million, a 9.9% increase from the
$1,880.2 million reported for the six months ended
June 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 5.6%. On a
geographic basis, North America, Asia and Latin America reported
organic growth of 9.9%, 7.5% and 6.2%, respectively. Sales in
EAME declined 2.7% organically.
Gross profit, defined as the difference between
net sales and cost of product sold, of $906.7 million for
the six months ended June 30, 2008 increased by
$68.4 million, or 8.2%, over the $838.3 million for
the six months ended June 30, 2007. On an organic basis,
gross profit increased by 3.1%. Most of the improvement was
attributable to higher sales volumes and cost savings, partly
offset by higher service costs and unfavorable changes in
product mix. Increases in product and freight costs exceeded
price increases to our customers by $11.7 million. Gross
profit margin for the six months ended June 30, 2008 was
43.9% compared to 44.6% for the year-ago period.
Selling, administrative, and research expenses for
the six months ended June 30, 2008 of $641.0 million
increased $61.3 million, or 10.6%, from $579.7 million
for the six months ended June 30, 2007. On an organic
basis, selling, administrative, and research expenses were up
4.0%. Higher salaries, travel and bad debts, partly offset by
lower outside consulting for work process redesign initiatives
and the rationalization of our legal entity structure, accounted
for most of the increase.
Amortization of intangible assets was
$29.5 million and $30.6 million for the six months
ended June 30, 2008 and 2007, respectively. Lower
amortization of customer relationships, which are amortized
using an accelerated method, was partly offset by 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 $2.4 million and $2.3 million for the
six months ended June 30, 2008 and June 30, 2007,
respectively.
17
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
Other income (expense), net was a net expense of
$7.3 million and $0.3 million for the six months ended
June 30, 2008 and 2007, respectively. The increase of
$7.0 million was mostly attributable to an unfavorable
change in foreign currency transaction gains and losses of
$5.9 million.
Net interest expense, defined as the combination
of interest income and interest expense, of $127.5 million
for the six months ended June 30, 2008 decreased by
$4.5 million from the $132.0 million reported for the
six months ended June 30, 2007. Translation rate changes
due to the weaker U.S. dollar versus the euro increased
interest expense by $3.7 million, and accretion of our
senior discount notes was $1.6 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 half
of 2007 more than offset those increases.
The income tax provision for the six months ended
June 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, as well as
the creation of valuation allowances related to the realization
of a deductible temporary difference and net operating loss
carryforwards in the U.K. These items are discussed in more
detail in Note 9 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 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.
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 contributed to the variation between
the U.S. federal statutory income tax rate and our income
tax provision for the six months ended June 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 $3.1 million
and $3.6 million for the six months ended June 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 June 30, 2008 Compared to the Quarter Ended
June 30, 2007
Net sales by reportable segment for the three
months ended June 30, 2008 and June 30, 2007 may
be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes
|
|
|
Three Months Ended
|
|
|
|
in the Following Factors
|
|
|
June 30,
|
|
June 30,
|
|
|
|
Currency
|
|
Acquisitions/
|
|
|
(dollars in millions)
|
|
2008
|
|
2007
|
|
% Change
|
|
Translation
|
|
Divestitures
|
|
Organic
|
|
Industrial & Institutional Services
|
|
$
|
474.8
|
|
|
$
|
432.5
|
|
|
|
9.8
|
%
|
|
|
6.6
|
%
|
|
|
(3.0
|
)%
|
|
|
6.2
|
%
|
Energy Services
|
|
|
363.0
|
|
|
|
316.9
|
|
|
|
14.5
|
%
|
|
|
3.6
|
%
|
|
|
|
|
|
|
10.9
|
%
|
Paper Services
|
|
|
203.0
|
|
|
|
194.8
|
|
|
|
4.2
|
%
|
|
|
5.9
|
%
|
|
|
|
|
|
|
(1.7
|
)%
|
Other
|
|
|
25.5
|
|
|
|
26.7
|
|
|
|
(4.3
|
)%
|
|
|
5.9
|
%
|
|
|
|
|
|
|
(10.2
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
1,066.3
|
|
|
$
|
970.9
|
|
|
|
9.8
|
%
|
|
|
5.4
|
%
|
|
|
(1.3
|
)%
|
|
|
5.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Industrial and Institutional Services division reported
sales of $474.8 million for the quarter ended June 30,
2008, a 9.8% increase over the $432.5 million for the
year-ago-period. Sales rose 6.2% organically, as double-digit
growth was posted in Asia and the Emerging Markets of EAME,
while North America and Latin America reported organic
improvements of 4.3% and 5.8%, respectively.
18
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
Overall, EAME posted an organic increase of 5.8%, as flat growth
in our Western European water business tempered the double-digit
gains in the Emerging Markets. The 3.0% 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.
The Energy Services division reported sales of
$363.0 million for the three months ended June 30,
2008, a 14.5% gain over the $316.9 million for the quarter
ended June 30, 2007. Organically, sales rose 10.9%, as
double-digit gains were posted by our Oilfield and Adomite
businesses, and a more modest improvement was reported by our
Downstream business. Organic growth was strongest in North
America on continued strong domestic demand and export sales to
West Africa operations.
The Paper Services division reported sales of
$203.0 million for the three months ended June 30,
2008, a 4.2% increase over the $194.8 million reported for
the second quarter of 2007. Sales were down 1.7% organically,
reflecting declining paper production in North America and
Western Europe.
The 10.2% organic decrease in sales in our Other segment was
mostly attributable to quarter-over-quarter variations in
revenue recognition adjustments. 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
three months ended June 30, 2008 and June 30,
2007 may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes
|
|
|
Three Months Ended
|
|
|
|
in the Following Factors
|
|
|
June 30,
|
|
June 30,
|
|
|
|
Currency
|
|
Acquisitions/
|
|
|
(dollars in millions)
|
|
2008
|
|
2007
|
|
% Change
|
|
Translation
|
|
Divestitures
|
|
Organic
|
|
Industrial & Institutional Services
|
|
$
|
96.1
|
|
|
$
|
93.6
|
|
|
|
2.8
|
%
|
|
|
7.0
|
%
|
|
|
(7.4
|
)%
|
|
|
3.2
|
%
|
Energy Services
|
|
|
72.4
|
|
|
|
74.5
|
|
|
|
(2.8
|
)%
|
|
|
3.5
|
%
|
|
|
0.1
|
%
|
|
|
(6.4
|
)%
|
Paper Services
|
|
|
24.3
|
|
|
|
31.9
|
|
|
|
(24.0
|
)%
|
|
|
4.4
|
%
|
|
|
|
|
|
|
(28.4
|
)%
|
Other
|
|
|
(24.6
|
)
|
|
|
(27.2
|
)
|
|
|
9.8
|
%
|
|
|
(3.5
|
)%
|
|
|
|
|
|
|
13.3
|
%
|
Direct contribution of the Industrial and Institutional Services
division was $96.1 million for the three months ended
June 30, 2008, an increase of 2.8% over the
$93.6 million reported for the three months ended
June 30, 2007. Organically, higher gross profit accounted
for the 3.2% increase in direct contribution, as operating
expenses were up only 0.5%. 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
$72.4 million for the three months ended June 30,
2008, a 2.8% decrease from the $74.5 million reported for
the year-ago period. On an organic basis, direct contribution
was down 6.4%, primarily as a result of investments in sales and
marketing staff that ran ahead of revenue growth, but which are
expected to support future growth.
The Paper Services division reported direct contribution of
$24.3 million for the three months ended June 30,
2008, a 24.0% decrease from the direct contribution of
$31.9 million reported for the second quarter of 2007.
Organically, direct contribution was down 28.4%, due to lower
sales volumes, higher product costs, and a 4.6% organic increase
in operating expenses, nearly half of which was attributable to
bad debts.
The direct contribution loss of $24.6 million reported in
Other for the three months ended June 30, 2008 represented
a $2.6 million decrease from the $27.2 million direct
contribution loss reported in the second quarter 2007, which was
mostly attributable to a favorable change in manufacturing
variances.
19
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
Six
Months Ended June 30, 2008 Compared to the Six Months Ended
June 30, 2007
Net sales by reportable segment for the six months
ended June 30, 2008 and June 30, 2007 may be
compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes
|
|
|
Six Months Ended
|
|
|
|
in the Following Factors
|
|
|
June 30,
|
|
June 30,
|
|
|
|
Currency
|
|
Acquisitions/
|
|
|
(dollars in millions)
|
|
2008
|
|
2007
|
|
% Change
|
|
Translation
|
|
Divestitures
|
|
Organic
|
|
Industrial & Institutional Services
|
|
$
|
902.9
|
|
|
$
|
836.9
|
|
|
|
7.9
|
%
|
|
|
6.6
|
%
|
|
|
(3.0
|
)%
|
|
|
4.3
|
%
|
Energy Services
|
|
|
709.7
|
|
|
|
611.3
|
|
|
|
16.1
|
%
|
|
|
3.9
|
%
|
|
|
|
|
|
|
12.2
|
%
|
Paper Services
|
|
|
404.0
|
|
|
|
381.5
|
|
|
|
5.9
|
%
|
|
|
6.1
|
%
|
|
|
|
|
|
|
(0.2
|
)%
|
Other
|
|
|
49.4
|
|
|
|
50.5
|
|
|
|
(2.2
|
)%
|
|
|
6.8
|
%
|
|
|
|
|
|
|
(9.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
2,066.0
|
|
|
$
|
1,880.2
|
|
|
|
9.9
|
%
|
|
|
5.6
|
%
|
|
|
(1.3
|
)%
|
|
|
5.6
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Industrial and Institutional Services division reported
sales of $902.9 million for the six months ended
June 30, 2008, a 7.9% increase over the $836.9 million
for the six months ended June 30, 2007. Organically, sales
grew 4.3%, with near double-digit growth in Asia and more modest
gains in North America, Latin America and EAME. The growth
in EAME was nearly entirely attributable to the Emerging
Markets. The 3.0% 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
$709.7 million for the six months ended June 30, 2008,
a 16.1% gain over the $611.3 million for the year-ago
period. Organically, sales rose 12.2%, with double-digit gains
reported by our Oilfield and Adomite businesses, and solid
growth posted by our Downstream business.
The Paper Services division reported sales of
$404.0 million for the six months ended June 30, 2008,
a 5.9% increase over the $381.5 million reported for the
first half of 2007. Sales were flat on an organic basis, as
slight declines in EAME and Asia were nearly offset by modest
improvements in North America and Latin America.
The 9.0% organic decrease in sales in our Other segment was
mostly attributable to variations in revenue recognition
adjustments and the Integrated Channels Group in North America.
Direct contribution by reportable segment for the
six months ended June 30, 2008 and June 30,
2007 may be compared as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Attributable to Changes
|
|
|
Six Months Ended
|
|
|
|
in the Following Factors
|
|
|
June 30,
|
|
June 30,
|
|
|
|
Currency
|
|
Acquisitions/
|
|
|
(dollars in millions)
|
|
2008
|
|
2007
|
|
% Change
|
|
Translation
|
|
Divestitures
|
|
Organic
|
|
Industrial & Institutional Services
|
|
$
|
177.1
|
|
|
$
|
178.7
|
|
|
|
(0.9
|
)%
|
|
|
6.9
|
%
|
|
|
(7.1
|
)%
|
|
|
(0.7
|
)%
|
Energy Services
|
|
|
147.8
|
|
|
|
136.5
|
|
|
|
8.3
|
%
|
|
|
4.1
|
%
|
|
|
|
|
|
|
4.2
|
%
|
Paper Services
|
|
|
52.6
|
|
|
|
58.2
|
|
|
|
(9.7
|
)%
|
|
|
5.9
|
%
|
|
|
|
|
|
|
(15.6
|
)%
|
Other
|
|
|
(53.8
|
)
|
|
|
(49.7
|
)
|
|
|
(8.2
|
)%
|
|
|
(3.7
|
)%
|
|
|
|
|
|
|
(4.5
|
)%
|
Direct contribution of the Industrial and Institutional Services
division was $177.1 million for the six months ended
June 30, 2008, a decrease of 0.9% from the
$178.7 million reported for the six months ended
June 30, 2007. Organically, direct contribution declined
0.7%, as a result of slightly lower gross profit and a 0.3%
increase in operating expenses. The 7.1% decrease in direct
contribution from acquisitions/divestitures was mostly
attributable to the expiration of our synfuel business at the
end of 2007.
20
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
The Energy Services division reported direct contribution of
$147.8 million for the six months ended June 30, 2008,
an 8.3% improvement over the $136.5 million reported for
the first half of 2007. On an organic basis, direct contribution
rose 4.2% on the strength of higher sales volumes. Operating
expenses were up 13.0% organically, with the largest increases
in salaries, employee benefits, travel, outside services and
commission expenses to support the current and expected growth
in business.
The Paper Services division reported direct contribution of
$52.6 million for the six months ended June 30, 2008,
a 9.7% decrease from the direct contribution of
$58.2 million reported for the year-ago period. Direct
contribution declined 15.6% on an organic basis, which was
attributable to lower sales volumes, higher product costs, and a
3.6% organic increase in operating expenses.
The direct contribution loss of $53.8 million reported in
Other for the six months ended June 30, 2008 represented an
8.2% increase over the $49.7 million direct contribution
loss reported in the first half of 2007, which was mainly
attributable to variations in revenue recognition adjustments.
Liquidity
and Capital Resources
Operating activities. Historically, our
main source of liquidity has been our cash flow generated by
operating activities. For the six months ended June 30,
2008, cash provided by operating activities was
$133.7 million, an increase of $63.0 million over the
same period last year. Slightly more than half of the
improvement was attributable to a reduction in cash used for
working capital, with the remainder mainly due to lower pension
funding requirements.
Investing activities. Cash used for
investing activities was $75.9 million for the six months
ended June 30, 2008, which was mostly the result of net
property additions of $61.9 million and business
acquisitions of $9.1 million.
Cash used for investing activities was $48.6 million for
the six months ended June 30, 2007. This was mostly the
result of net property additions of $47.6 million.
Financing activities. A net decrease in
borrowings of $58.8 million, purchases of treasury stock of
$21.7 million, and cash dividends of $9.9 million
accounted for most of the $94.3 million of net cash used
for financing activities for the six months ended June 30,
2008.
Net cash provided by financing activities totaled
$7.4 million during the six months ended June 30,
2007, which was mostly attributable to a $48.8 million
increase in borrowings against our receivables facility, partly
offset by $35.8 million of term loan repayments and the
payment of $5.0 million of common stock dividends.
Our liquidity requirements are significant, primarily due to
debt service requirements as well as research and development
and capital investment. As of June 30, 2008, we had
$240.0 million of borrowing capacity available under a
revolving credit facility (excluding $21.5 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. The applicable margin for borrowings
under the revolving credit facility and the term loan A facility
range from 1.00% to 1.50% with respect to base rate borrowings
and 2.00% to 2.50% with respect to LIBOR or Eurocurrency
borrowings depending on our leverage ratio as defined by the
facilities. The applicable margin for borrowings under the term
loan B facility is 0.75% with respect to base rate borrowings
and 1.75% with respect to
21
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
LIBOR or Eurocurrency borrowings. The applicable margin for
borrowings under the term loan B facility is not subject to
adjustment.
In addition to paying interest on outstanding principal under
the senior credit facilities, we are required to pay a
commitment fee to the lenders under the revolving credit
facility in respect of the unutilized commitments at a rate
equal to 0.50%. We also pay customary letter of credit fees.
The term loan A facility was scheduled to amortize each year in
quarterly amounts at a rate of 5% per annum in year one, 10% per
annum in year two, 15% per annum in year three, 20% per annum in
year four and 25% per annum in each of years five and six.
The term loan B facility was scheduled to amortize each year in
an amount equal to 1% per annum in equal quarterly installments
for the first six years and nine months, with the remaining
amount payable on November 4, 2010.
At June 30, 2008, the outstanding balance of the term loan
A and term loan B facilities was $39.5 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 June 30, 2008, we had
$10.0 million of borrowings outstanding under the revolving
credit facility.
The senior credit facilities contain a number of covenants that,
among other things, restrict, subject to certain exceptions, our
ability and our subsidiaries ability, including Nalco
Company, to sell assets, incur additional indebtedness or issue
preferred stock, repay other indebtedness, pay dividends and
distributions or repurchase certain capital stock, create liens
on assets, make investments, loans or advances, make certain
acquisitions, engage in mergers or consolidations, enter into
sale and leaseback transactions, engage in certain transactions
with affiliates, amend certain material agreements governing our
indebtedness, change the business conducted by us and our
subsidiaries (including Nalco Company) and enter into hedging
agreements. In addition, the senior credit facilities 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 June 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.
On January 21, 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. Our primary source of
liquidity for such payments will be cash flow generated from the
operations of subsidiaries, including Nalco Holdings LLC and
Nalco Company. However, the terms of Nalco Companys senior
credit agreement limit the amount of dividends and other
transfers by Nalco Holdings LLC and our other subsidiaries to
the issuers of the senior discount notes. In addition, the terms
of certain of the indentures governing the existing senior notes
and senior subordinated notes of Nalco Company significantly
restrict Nalco Company and our other subsidiaries from paying
dividends, making distributions and otherwise transferring
assets to the issuers. The ability of Nalco Company to make such
payments is governed by
22
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
a formula based on its consolidated net income. In addition, as
a condition to making such payments to the issuers based on such
formula, Nalco Holdings LLC must have an Adjusted EBITDA to
interest expense ratio of at least 2.0 to 1 after giving effect
to any such payments. Notwithstanding such restrictions, such
indentures permit an aggregate of $50.0 million of such
payments to be made whether or not there is availability under
the formula or the conditions to its use are met.
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. The issuers paid a $14.6 million premium
to redeem the notes. 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.
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.
23
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
Adjusted EBITDA is calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Net earnings
|
|
$
|
44.2
|
|
|
$
|
41.8
|
|
|
$
|
73.4
|
|
|
$
|
61.4
|
|
Interest, net
|
|
|
62.7
|
|
|
|
66.3
|
|
|
|
127.5
|
|
|
|
132.0
|
|
Income tax provision
|
|
|
9.0
|
|
|
|
13.7
|
|
|
|
22.5
|
|
|
|
28.4
|
|
Depreciation
|
|
|
35.4
|
|
|
|
32.2
|
|
|
|
69.9
|
|
|
|
64.0
|
|
Amortization
|
|
|
15.9
|
|
|
|
15.4
|
|
|
|
29.5
|
|
|
|
30.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
EBITDA
|
|
$
|
167.2
|
|
|
$
|
169.4
|
|
|
$
|
322.8
|
|
|
$
|
316.4
|
|
Non-cash charges (1)
|
|
|
5.7
|
|
|
|
4.0
|
|
|
|
14.9
|
|
|
|
13.5
|
|
Business optimization expenses (2)
|
|
|
1.4
|
|
|
|
2.3
|
|
|
|
2.4
|
|
|
|
2.3
|
|
Unusual items (3)
|
|
|
3.3
|
|
|
|
5.7
|
|
|
|
5.6
|
|
|
|
9.3
|
|
Other adjustments (4)
|
|
|
(1.9
|
)
|
|
|
(1.5
|
)
|
|
|
(4.4
|
)
|
|
|
(3.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted EBITDA
|
|
$
|
175.7
|
|
|
$
|
179.9
|
|
|
$
|
341.3
|
|
|
$
|
337.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Non-cash charges are further detailed on the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Profit sharing and 401(k) expense funded by Suez
|
|
$
|
6.7
|
|
|
$
|
6.5
|
|
|
$
|
14.9
|
|
|
$
|
13.2
|
|
Other
|
|
|
(1.0
|
)
|
|
|
(2.5
|
)
|
|
|
|
|
|
|
0.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash charges
|
|
$
|
5.7
|
|
|
$
|
4.0
|
|
|
$
|
14.9
|
|
|
$
|
13.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. |
24
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
|
|
|
(3) |
|
Unusual items are further detailed on the following table: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months
|
|
|
Three Months
|
|
|
Six Months
|
|
|
Six Months
|
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
|
ended
|
|
(dollars in millions)
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
June 30, 2008
|
|
|
June 30, 2007
|
|
|
Loss (gain) on sales, net of expenses
|
|
$
|
0.1
|
|
|
$
|
1.1
|
|
|
$
|
0.9
|
|
|
$
|
1.3
|
|
Other unusual items
|
|
|
3.2
|
|
|
|
4.6
|
|
|
|
4.7
|
|
|
|
8.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unusual items
|
|
$
|
3.3
|
|
|
$
|
5.7
|
|
|
$
|
5.6
|
|
|
$
|
9.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4) |
|
We are required to make adjustments to EBITDA for franchise
taxes and 401(k) matching contributions. |
Our covenant levels and ratios for the four quarters ended
June 30, 2008 are as follows:
|
|
|
|
|
|
|
|
|
|
|
June 30, 2008
|
|
|
|
Required
|
|
|
Actual
|
|
|
Senior credit facility (1)
|
|
|
|
|
|
|
|
|
Minimum Adjusted EBITDA to cash interest ratio
|
|
|
1.85x
|
|
|
|
3.45x
|
|
Maximum net debt to Adjusted EBITDA ratio
|
|
|
5.25x
|
|
|
|
3.83x
|
|
Indentures (2)
|
|
|
|
|
|
|
|
|
Minimum Adjusted EBITDA to fixed charge ratio required to incur
additional debt pursuant to ratio provisions
|
|
|
2.00x
|
|
|
|
2.95x
|
|
|
|
|
(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 $926.5 million that was
outstanding under our term loan facilities as of June 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
June 30, 2008, the aggregate outstanding balance under
these local lines of credit was approximately
$57.0 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.
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
25
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
the costs of the facility. As of June 30, 2008, we had
$137.0 million of outstanding borrowings under this
facility, based on the amount of receivables eligible for
financing as of May 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 June 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.
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. As stated elsewhere in this Quarterly Report,
such risks, uncertainties and other important factors include,
among others:
|
|
|
|
|
our substantial leverage;
|
|
|
|
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;
|
26
|
|
Item 2.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations (continued)
|
|
|
|
|
|
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.
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 11 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.
27
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Item 3.
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Quantitative
and Qualitative Disclosures About Market Risk
|
There have been no material changes to our exposures to market
risk since December 31, 2007.
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Item 4.
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Controls
and Procedures
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(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 June 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 second quarter of 2008 that
have materially affected, or are reasonably likely to materially
affect, our internal controls over financial reporting.
28
PART II. OTHER
INFORMATION
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|
Item 1.
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Legal
Proceedings
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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, is 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
($0.1 million) against our subsidiary relating to this
violation. An identical penalty was issued against the
subsidiarys customer.
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Item 2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
The table below sets forth information regarding repurchases of
our common stock during the three months ended June 30,
2008:
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(d)
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(c)
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Approximate
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|
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Total Number of
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Dollar Value of
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(a)
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Shares Purchased
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Shares that May
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Total Number
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(b)
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as Part of Publicly
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Yet Be Purchased
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of Shares
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Average Price
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Announced Plans
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Under the Plans
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Purchased
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Paid per Share
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or Programs (1)
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or Programs (1)(2)
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April 1, 2008 April 30, 2008
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$
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|
|
|
|
|
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$
|
175,770,562
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|
May 1, 2008 May 31, 2008
|
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|
|
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$
|
|
|
|
|
|
|
|
$
|
175,770,562
|
|
June 1, 2008 June 30, 2008
|
|
|
639,000
|
|
|
$
|
22.20
|
|
|
|
639,000
|
|
|
$
|
161,585,078
|
|
|
|
|
|
|
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|
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Total
|
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|
639,000
|
|
|
$
|
22.20
|
|
|
|
639,000
|
|
|
$
|
161,585,078
|
|
|
|
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(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 June 30, 2008, we expended
$14.1 million in cash for the repurchase of shares. An
additional $8.7 million was reported as a payable on the
balance sheet at June 30, 2008 for share repurchases
executed in June 2008 and settling in July 2008. |
|
|
Item 4.
|
Submission
of Matters to a Vote of Security Holders
|
The Annual Meeting of Shareholders was held on May 2, 2008.
At the meeting, Messrs. Douglas A. Pertz and Daniel S.
Sanders were each elected by the shareholders to a term to
expire in 2011.
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Nominee
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For
|
|
Withheld
|
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Douglas A. Pertz
|
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103,531,314
|
|
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14,301,733
|
|
Daniel S. Sanders
|
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103,627,760
|
|
|
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14,205,287
|
|
Messrs. Chase, Fyrwald and Marchese each have terms of
office as directors that continued after the 2008 Annual Meeting.
29
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Item 4.
|
Submission
of Matters to a Vote of Security Holders (continued)
|
The shareholders also ratified the appointment of
Ernst & Young LLP as the Independent Registered Public
Accounting Firm for 2008:
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|
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For
|
|
Against
|
|
Abstain
|
|
|
117,712,250
|
|
|
|
117,329
|
|
|
|
3,468
|
|
(a) The following are included herein:
|
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Exhibit 10
|
.1
|
|
Asset Purchase Agreement by and between Chemetall Corp. and
Nalco Company, dated as of July 24, 2008
|
|
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
|
30
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: July 31, 2008
31