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Tickers in this Article: ZEP, ECL, WDFC, AYI, PBH
Cleaning products firm Zep, Inc (NYSE:ZEP) reported fourth quarter earnings on Tuesday that disappointed investors. A healthy acquisition program and cost-cutting moves following a spin off in late 2008 offer the potential for share price upside going forward.

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Fourth Quarter Review
Sales grew 20.2% to $161.4 million, most of which was due to the acquisition of Amrep that boosted its capabilities in the automotive aftermarket. On an organic basis, pricing increased but was mostly offset by lower volumes and negative foreign currency translations on overseas sales.

A hefty restructuring charge and acquisition costs sent operating profits down nearly 61% to $4.3 million. Interest expense also rose sharply and contributed in sending net income down 66.7% to $2.1 million, or 9 cents per diluted share. Excluding the charges, management stated that adjusted earnings would have been 33 cents per diluted share.

Full-Year Recap
Zep completed three acquisitions over the last nine months and managed full-year sales growth of 13.5% to $568.5 million. One-time charges totaled approximately $11.5 million, but operating income still improved 31.9% to $23.9 million. Reported net income grew 45.8% to $13.5 million, or 61 cents per diluted share. Management estimated that earnings would have been nearly $1 per diluted share when backing out the one-time charges.

Operating cash flow reached $34 million. Subtracting out $9.8 million in capital expenditures, free cash flow came in at just over $24 million, or about $1.11 per diluted share. Zep took on debt to fund nearly $64 million in acquisitions and ended the year with long-term debt of just over $77 million.

Outlook
For the coming year, analysts project 15% sales growth to $576.1 million and earnings of $1.04 per share. Management expects another round of charges as it restructures its businesses following its spinoff from Acuity Brands (NYSE:AYI) in late 2008.

The Bottom Line
There have been many moving parts as Zep as it continues its transition as an independent company and looks to acquire market share. Cash flow trends are strong but net profit margins are still in the low single digits, suggesting that there is still work to do to improve profitability at the existing businesses. It remains to be seen how profitable the acquired businesses are, though there is potential for cost-cutting moves and other synergies.

Zep has a ways to go to achieve the high single digit margins that rival Ecolab (NYSE:ECL) achieves each year, though Ecolab also typically provides higher-margin cleaning services. WD-40 (Nasdaq:WDFC) is perhaps a more comparable firm that also has very high profit margins, as is Prestige Brands (NYSE:PBH) that also sells cleaning products and announced an acquisition of its own.

Once Zep cuts costs and folds in its recent acquisitions, there will be better clarity on its profit levels and cash flow generation. At a current valuation at more than 12 times forward earnings, the stock is currently priced accordingly on fundamentals. Nonetheless, a share price in the low teens would offer more margin of safety in case the recent activity doesn't go according to plan. (Take a look at how this effective ratio can be influenced by certain critical factors. To learn more, see Use The Price-To-Sales Ratios To Value Stocks.)

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