藝康 (ECL) 2003 Q3 法說會逐字稿

Thank you for waiting, and welcome. Following today's presentation, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference, please press the star followed by the zero. As a reminder, this conference is being recorded, Tuesday, October 21 of 2003. I would now like to turn the conference over to Mr. Michael Monahan from Ecolab. Please go ahead.

Thank you. Hello, everyone, and thanks for joining us. This webcast tele-conference will include estimates of future performance. These are forward-looking statements, and actual results could differ materially. Some of those factors that could cause actual results to differ are described in the section of our most recent form 10K under the heading: Forward-looking Statements and Risk Factors, and in our third quarter earnings release. A copy is available on Ecolab's web site at ecolab.com/investor.

Now, onto the numbers. Third quarter diluted income per share rose 18% to 33 cents per share. EPS from ongoing operations was 32 cents at the top end of our projections and up 14% over last year's results from ongoing operations. We turned in a very strong earnings performance, despite being faced with continuing challenges and uncertainty in world economies during the third quarter. It was a tough environment, but Ecolab once again worked aggressively to outperform and post strong earnings results. International operations offset tough conditions to achieve sales growth and excellent margin improvement. Our core domestic businesses recorded good sales performances in a sluggish environment.

These excellent performances enabled us to produce strong earnings growth, widely outperforming both our markets and the industry, and to gain market share. We remain confident in our ability to grow EPS in the fourth quarter and produce another year of double-digit growth in 2003, consistent with our previous forecast. Ecolab's consolidated sales for the third quarter rose 10%. Looking at the components, volume and mix were up 3%, acquisitions were up 1%, pricing was 1% and currency was 5%. Sales for U.S. cleaning and sanitizing operations increased 4%. Acquisitions had no effect. Institutional sales rose 4% in the third quarter.

Sales continued to outpace the industry as we maintained our new account sales efforts, continued to rollout new products and improved our service levels. We worked hard to produce better growth to the previously discussed efforts toward independent customers as well as our ongoing efforts toward chains and offset slower growth in shipments to distributors. We continued to extend -- we continued our extensive field training and sales programs, new product initiatives and corporate accounts efforts in the third quarter. And we continue to make good competitive gains and strengthen account relationships.

New products introductions like Oasis Pro are also doing well and we're benefiting from new products being introduced in the second half of 2003, including a new line of dish machines and an on-premise laundry system. We also achieved good productivity gains in the sales force while investing in improved hiring and training practices. Looking ahead, the fourth quarter should show similar gains for institutional, with improving growth expected as 2004 unfolds.

Kay domestic sales were up a very strong 13%, led by steady gains in QSR. While the overall QSR industry has been slow, Kay has outperformed it through a combination of new account growth, including the broader QSR market and the developing fast casual restaurant chains, better account penetration, and more effective field sales coverage. Further, the food retail business continues to do very well. As rollouts continued with major grossers and new chains were signed up. New products and programs also bolstered Kay's results.

We expect continued strong sales in Kay's fourth quarter as the division leverages new account activity in QSR and fast casual as well as in the food retail business. Textile care sales fell 11% and continued to reflect a soft economy, weak end user markets and very competitive industry conditions. We continue to build on our enhanced service protocol introduced last year, which will provide long-term benefits, and we are taking a selective approach toward new contracts to ensure they meet profit guidelines. We are also planning new product extensions. These actions should lead to better long-term results, however, the current difficult market conditions indicate that near-term results are likely to remain challenging for the small business unit.

Professional product sales increased 9% as strong gains in Janitorial and Healthcare offset the effects of the comparative gain of last year's phase-out of the specialty business. Janitorial sales for the quarter rose double digits as a significant win with an existing customer continued to drive sales for another quarter.

Healthcare sales also saw good growth in the third quarter, led by strong skin care and surgical instrument care sales. Ecolab introduced the first solid-based offering to the acute care market in the form of a solid surgical instrument cleaning product during the second quarter, and it has met with strong success. We continue to focus on growing corporate accounts in the janitorial business. The business will continue to work with the janitorial distribution network to obtain stronger steady growth. New products will continue to be important with more new products expected later this year.

Looking ahead, we expect double-digit fourth quarter growth in janitorial and healthcare businesses. However, it will continue to be offset by the effects of our exit from the specialty business last year and by the exit from an equipment business initiated in the second half of 2003.

Water care sales were up 7% in the third quarter with strong growth in all of our major markets and the most significant gains coming from hospitality, commercial and institutional healthcare and food and beverage. This emphasis of our circle of customer strategy should continue to benefit results and we expect continued good sales comparisons in the fourth quarter. Food and beverage sales were up 2% in the third quarter as gains in food, meat and poultry were diluted by soft agri and equipment sales. Food, meat and poultry and the soft drink businesses all saw good growth, reflecting the strength of our corporate account relationships.

We continue to benefit from expansion in independent bottlers and key corporate customers adopting new products under the ecoshield and food safety programs. Dairy plant sales grew modestly, even though our customers faced lower cheese prices and consumer demand. The agri business was off as it continued to suffer from historically low milk prices, but the recent uptrend in milk prices is promising.

Looking forward, food and beverage expects to make continued gains in the food-related markets, but it may be partially offset by soft equipment and agri results. Vehicle care sales were up 8% in the quarter, led by new account and new product gains.

Vehicle care is expanding its potential on the conveyor markets while focusing on the top 50 chain operators. The key to this strategy is our corporate account sales team and key new products like Velocity 3600 and the Harmony Product Line, both of which continue to do well. A new product line for the self-serve market was introduced in the second quarter and met with good reception. The new accounts won in the first half of 2003 helped vehicle care improve its growth prospects in the second half and will carry over into 2004. In addition, vehicle care will continue to leverage its new product gains and will focus on chain accounts. As a result, we look for vehicle care to show good growth in the fourth quarter and into next year. United States other services sales increased 2% in the third quarter.

Pest elimination sales continued to show strong growth rising 9.9% in the third quarter. New contract sales led to growth. New programs like those for food retail and QSR are doing very well, and other programs are being introduced this year. In addition, Ecoshare continues to show robust growth. We expect pest elimination to show double-digit sales growth in the fourth quarter and enjoy another good year again in 2004.

Sales for the GCS commercial equipment business decreased 9% in the quarter. Results were disappointing and reflected a slower than expected start of the efficiencies associated with the new centralized back office center. As you may recall, in the first half of 2003, we began to consolidate the back office functions from the 33 branches into a single call and administration center. This center is designed to improve customer service, improve live operator response instead of voice menus, reduce operating costs, and provide a platform for faster growth. The center is now up and running.

However, the quarter was hit by operational issues related to starting up the new facility, such as team organization, training, business mix and call system routing inefficiencies. This resulted in lower tech productivity and the bulk of that lost revenue fell to the bottom line. We have taken action to correct these issues and based on the recent data it appears the changes have started to take effect. While the fourth quarter will continue to reflect resolution of these items, we still believe GCS is building momentum toward what we expect to be strong sales growth in the second half of 2004.

International faced a number of challenges in the quarter and performed extremely well, taking advantage of sales opportunities and leveraging margins. Measured in fixed currencies, international sales increased 5%. Excluding acquisitions and divestitures, international sales and fixed currencies grew 2%. When measured in U.S. dollars, international sales, excluding acquisitions and divestitures, increased 15%. Reported sales in the Europe region increased 6% in the third quarter. Excluding acquisitions and divestitures, sales rose 2%.

Please note that Ecolab's Africa and Middle East operations, which represent approximately 1% of Ecolab's total sales, are now reported as part of Europe's results. Ecolab's institutional sales were off 1% as the hospitality and market conditions appear to have worsened in the third quarter. Weak economies in major markets like Germany, France and Italy resulted in lower domestic consumption and compounded reduced travel trends. Institutional responded to these tough conditions with aggressive sales efforts, generating strong new business growth in independent street accounts as well as picking up several new chain accounts. New housekeeping products like Oasis Pro and Penguin also drove growth.

We expect new products and sales initiatives to continue to benefit institutional sales in the fourth quarter and lead to a modest sales improvement. Food and beverage sales rose 2%. Customer volumes remained low as sales of premium-type foods suffered in the weak European economies. The division continues to focus on concept selling and new accounts to offset the market challenges. F&B expects similar trends in the fourth quarter.

Professional product sales adjusted for the U.K. distributor, divestiture in December of 2002 were off 1%. Customer demand remains weak and the market is very competitive due to the slow economies in Europe and cost cutting by end users. The division is introducing new products like the Phazer Floor System and developing unique programs to address market segments and improved growth. The near-term sales outlook for professional products remains challenging.

Healthcare sales rose 36%. Excluding acquisitions, sales rose 4%. Healthcare market end in Europe is reflecting many of the same conditions as the U.S. with government cost controls and limited growth in the hospital area. Further, healthcare systems have stretched out payments to distributors and some have gone bankrupt, causing significant market problems. The division has offset this with aggressive product introductions, more product differentiation, increased use of market segments and opportunities in small practice and nursing home markets.

Textile care sales increased 4%. The division leveraged new account gains and an effective use of water and energy conservation technology to accelerate corporate account gains. More new products are coming in 2004 and should help continue the good growth trends in textile care.

Europe's recently established pest elimination business has begun to make progress in developing its contract business and leveraging the circle of customer strategy. The program for the F&B market is under way and seeing good results. We are continuing to look for more pest elimination acquisitions in Europe as well as other businesses to broaden our circle of customer strategy.

Asia Pacific's third quarter sales continue to reflect the effects of health and security concerns and our aggressive efforts to offset their impact on our business. Sales in the Asia Pacific region were flat in local currencies. When reported in U.S. dollars, sales increased 7%. Northeast Asia and Southeast Asia showed good gains in spite of SARS and concerns about terrorism.

Looking at the segments, institutional sales were flat. Southeast Asia continues to be hurt by SARS concerns. Northeast Asia sales were solid with double-digit gains in several countries. However, Hong Kong and Southeast Asia have seen a reduction in the sale of disinfect disinfectant as the SARS crisis abated. The hospitality business is beginning to slowly recover. Japan is seeing a slowdown related to reduced travel and tourism as a result of poor summer weather. Australia and New Zealand had strong growth with good results in most months of segments.

Food to beverage sales were flat to last year. Sales in Japan and Australia were off as a result of soft dairy, brewery and beverage markets. New Zealand sales slowed as the farm and dairy segments weakened due to drought conditions. East Asia reported excellent growth with Korea, Taiwan, Singapore, Thailand and Malaysia showing strong gains. We expect Asia Pacific sales growth to recover in the fourth quarter and the health and security concerns are expected recede and as business continues to recover toward prior levels.

Third quarter sales for Ecolab's Canadian operations increased 3% in local currency and are up 15% in U.S. dollars. Institutional sales measured in local currencies were up 5%, more than offsetting the lingering impact on the national hospitality industry from reduced summer tourism due to the SARS outbreak in Canada. The focus on new street accounts, additional product sales to existing accounts and corporate account retention sustained the business.

Food and beverage rose moderately in spite of reduced plant manufacturing following the central Canadian power outage in the quarter. Plants were asked to limit consumption after power was restored with the blackout and it led to several days of lost production. Professional product sales were weak. In laundry, sales fell due to the impact of SARS and hospitality and health care accounts in the quarter, customer consolidation, and distributor changes.

The Kay business was very strong, reflecting the rollout of large food retail customer. Sales in Latin America were up 10% in local currencies and increased 7% when reported in U.S. dollars. Results were up in nearly all countries in the region led by strong performances in Mexico, the Carribean and central America. This was an outstanding performance in the region, given the challenging economies of Latin America and the impact of political problems in Venezuala. Institutional posted double-digit growth as it leveraged market share gains and new account development. These are results were helped by continued good growth in food retail programs and national account sales.

Food and beverage also recorded solid growth, capitalizing on the demand for improved sanitation driven by exports as well as new programs for meat and poultry processors, the beverage market and an enhanced presence in poultry, agri and seafood.

The pest elimination business continued its tremendous growth trend in Latin America, recording another double-digit gain. Professional products also grew as an improved product line and changes in the sales force benefited growth. We will continue to work hard in 2003 to offset mixed economic and political conditions and continue to expect solid fixed currency growth in the fourth quarter.

Turning to the expense side of the income statement, the third quarter 2003 gross margin was 51.3% compared to 2002's gross margin excluding special charges of 51.5%. The consolidated gross margin declined 20 basis points as benefits from the higher sales volume and cost savings initiatives were offset by business mix and raw material price increases.

SG&A expenses were 36.4% of net sales compared with 2002's margin of 36.6%. SG&A expense declined 20 basis points largely due to cost savings initiatives and business mix being partially offset by sales force and service investments and higher payroll costs.

Operating income for our U.S. cleaning and sanitizing business rose 3%. Operating margins were off 30 basis points to 18.5% due to higher operating costs and investments in sales force development. Operating income for U.S. other services fell 19%. Pest elimination continued to show a good profit growth while GCS reflected slower sales and the previously discussed start up issues related to the new administration center.

On a constant currency basis, international's operating income rose 17%. Profit gains were achieved through new products and careful cost management. In U.S. dollars and excluding acquisitions, international's operating income increased 23%. Ecolab's third quarter consolidated tax rate fell to 39.4% from 39.9%. Unusual items affected the rate for 2003. For ongoing operations, the third quarter rate for 2003 was 38.7%. The 120 basis point decline in 2003 was primarily due to lower rates and international mix. Our annual rate estimate for ongoing operations applied to 9-month results for 2003 was 38.8%. Diluted shares outstanding were up .1% to 262 million shares. We repurchased 2.7 million shares during the quarter. The net of this activity is that diluted net income per share for the third quarter was 33 cents, up 18% over last year's reported net income per share. EPS from ongoing operations of 32 cents rose 14% over last year's 28 cents pro forma EPS from ongoing operations. That's a review of the P&L.

In summary, we are pleased with our earnings performance in the third quarter. Given that many challenges we faced around the world, we achieved strong growth from our core domestic and international businesses against tough conditions, realized excellent international margin improvement, and grew our margin share. It was a good performance; we're very proud of our associates who made it an happen. Our total debt to tol capitalization ended the quarter at 38.4%, down from 38.9% at the end of 2002 and 39% a year ago. Our total debt to tol capitalization ended the quarter at 34.5%, down from 38.9% at the end of 2002 and 39% a year ago. Depreciation was 52 million in the quarter, and amortization was 8 million. Capital spending for the quarter was 51 million.

DSO and fixed currencies was 61 days, up two days from the third quarter 2002 due to business mix and GCS. DOH was down two days from last year in fixed currencies.

That's a review of the third quarter. Looking ahead to the fourth quarter, we begin by cautioning that the following statements based on current expectations. These statements are forward-looking and actual results may differ materially. These statements don't include the potential impact of acquisitions or other material corporate transactions that may be completed after the day of this release. The business outlook section should be considered in conjunction with the forward-looking statements in our press release, which lists factors that may cause results to differ.

For the fourth quarter, our institutional business should deliver a solid performance in Kay and pest elimination should sustain good momentum. Professional products is experiencing strong growth in its ongoing businesses. We continue to expect to outperform our markets in Europe, Asia Pacific and Latin America and record good earnings results. Further, we expect good margin trends resulting from a better product mix and cost reductions.

We will continue to invest in our sales and service force in the fourth quarter and in our businesses like GCS, to set the stage for 2004. The current environment has been tough but we are continued to work hard to deliver our strong earnings results. We think our future looks excellent.

As a result, we expect diluted earnings per share from ongoing operations for the fourth quarter to be in the 23 to 25-cent range. This will compare with pro forma EPS from ongoing operations of 22 cents earned in 2002's fourth quarter and net income of 19 cents. This should result in full-year diluted earnings per share from ongoing operations increasing to the consensus earnings range of $1.01 to $1.03, representing a double-digit gain over 2002's 92 cents from ongoing operations and right in line with our long-standing full year guidance regarding 2000 earnings. We remain both very confident and optimistic in our future. That concludes my remarks. This conference call will be available for replay on our website through October 31. Operator will you please begin the questions and answer period?

Q&A

Thank you, sir. Ladies and gentlemen, at this time, we will begin the question and answer session. If you have a question, please press the star followed by the 1 on your push-button phone. To cancel your request for a question, please press the star followed by the 2. You will hear a prompt acknowledging your question. The questions will be pulled in the order they are received. If you're using speaker equipment, lift your handset before pressing the numbers. One moment, please, for the first question. The first question comes from Mary Beth Connelly with Goldman Sachs. Please go ahead.

Hi, Mike.

Hi, Mary Beth.

How are you?

Good, how are you?

Good. First of all, I want to ask a couple of questions about Europe, first of all I want to get the operating margin this quarter.

Was there a question, Mary Beth?

Yes, what was the operating margin in Europe?

In Europe?

Uh-huh.

Operating margins for Europe were 13%.

Okay. And I wanted to find out, too, given the challenging hospitality environment there, are you seeing any -- any change in the competitive landscape, particularly with regard to Johnson diversity [inaudible] there?

No, not really.

Okay. Thank you.

Thank you.

Thank you. The next question comes from David Begleiter with Deutsche Banc. Please go ahead.

Hi, Mike. On --

Hi, David.

Hi. On GCS, are you still expecting profits to rebound along with the sales growth in the back half of '04?

Yes, definitely.

And on food and beverage, now now in our fourth year of pretty weak results, in terms of top line growth, do we ever get back to those late 1990-type top line growth rates of double-digits?

We think that -- well, first of all, we've always said that the long-term growth rate for food and beverage is probably in the 6 to 8% range and if we go back to those halson days, David, I think that was the organic growth rate, in that range. So, that's kind of our objective for growth for -- for food and beverage.

Right now they've been going through a repositioning of the division to meet the changed market environment over the last several years where you've seen a great deal of consolidation in the industry and we think that we'll start to see that come across. If we look at specific segments in the business, the meat and poultry, the beverage, et cetera, those areas, the food areas, those are going very well. It's really been in the agri area, which is the dairy-related, that has hurt us. So, and in this quarter, equipment was off a little bit. But mainly it's the dairy area that's hurt us. So, I think with the improvement milk prices we're starting to see, we should see pickup there. And with good results in the other areas of food and beverage, we should get the growth back up and I assure you next year they're looking for better growth than 2%.

Can you remind us how big ag is as a portion of the entire asbestos? -- entire business?

It's around 50% or so.

Thanks a lot.

It's a big portion of their sales.

Thanks, Mike.

Thank you.

Thank you. The next question is from PJ Juvocar with Smith Barney. Please go ahead.

Hi, Mike.

Hi, PJ.

SG&A as a portion of sales, declined nicely. Now, you're guiding up from 36 to 38% roughly for the fourth quarter. Are there any special accruals in the fourth quarter that would take that rate higher?

In the third quarter, PJ, there was a couple of one-time things, there was release of a bad debt accrual for Deranius, which we had sold, and a small pension adjustment out of Europe. It wasn't big it was like a couple million bucks, but kind of like one timers that helped it in the third quarter.

Okay.

But otherwise, we've been very diligent on costs. We've had a tight focus on costs this year. You're seeing some of the benefits of that in the overall SG&A expenses.

And then secondly on GCS, can you quantify how much was the cost of that new administration center?

Just a second, PJ, let me take a look here. PJ, for the year to date, I mean we're probably looking at a couple, $3 million we invested in there, plus, there's also been ongoing expense related to staffing, training, et cetera.

So, roughly 5 to $10 million?

Probably more like 5.

5? And then how long do you think this investment in GCS will continue? Will it continue into next year?

Yeah, the investment's done, PJ. What happened in this quarter is that we did not get the efficiencies that we expected and still expect to receive for -- from the call center and as we outlined, you know, when you transfer everything from the 33 branch office these one big center, you're going to have some start-up issues. We thought we had those resolved. It turned out we were wrong, we're working on those.

But what it resulted in is we weren't able to dispatch our people as effectively or efficiently as we wanted to. If you don't do that, we're basically losing the revenue. It drops straight from the top line to the bottom line. It's not so much investment as we need to get our efficiency and productivity up, which we've taken action on those and the early signs is that's coming around. And as we get through 2004, we think we will make a substantial -- substantial improvement in the profitability on GCS.

Right. And just finally, just roughly, how does GCS compare to pest elimination in terms of margins?

Well clearly pest elimination margins are in the range of corporate average or the U.S. avg, which is, you know, 14, 15%. So, it's around there. But if you look at pest elimination and its development it took several years as we developed that model and GCS, I think, is going to follow that one, too. So, in some ways, we're seeing a very public birth of a business, which is not always very pretty, but some of the stages we went through with pest elimination, we were able develop that business and grow it. I'm sure we'll get there with GCS.

Is it single digits now?

GCS is negative.

Negative.

Yeah.

Thank you.

Thank you.

Thank you. The next question comes from Robert Ottenstein with Morgan Stanley. Please go ahead.

Hey, Mike. You said management was happy with the results and you did a good job on the bottom line, on the cost side. I'm trying to get a sense of how happy management is in terms of the top line? And if you look, I mean institutional this quarter was up 4. Last year this quarter was up 5. The prior year was up 1. That averages about 3.3. If you take the total company, you know, the sales has been averaging kind of --

Robert, Robert? You know Allan Schuman?

Yeah.

How happy do you think he is?

Well, I don't know, I'm asking the question --

Well, you know, no one here is real happy with the top line growth. The only reason we're happy with it is in context of the markets that we face, that we outperformed and did well, but no one here is satisfied with the unit growth that we've got and we're all working hard. We've had a lot of meetings on this. We've had a lot flames we're starting up to offset that to get the growth going on and I think you're going start to see that as we go into the fourth quarter.

For example, you know, we're still having good growth out of past Kay, Latin America, et cetera. They will see a pickup in growth in their base business for janitorial and healthcare business. It will be a little masked [inaudible] a couple of other ones, Latin America continues to grow well. So, you know, vehicle care, even the small ones, vehicle care, water care continue to do well.

We think, you know, we're clearly recognizing we're not happy at all with what's going on. We're taking action on those things, and start to see that come back. Certainly better economies will help us and we're getting better growth out of Europe in the U.S. For example, the lodging demand in 2004 is expected to rise 4% after only being up maybe flat to 1% this year. So, we will get big improvement that end market. U.S. economy, you know, they may be saying the GDP is going well, but not something we're seeing. So, we're optimist that as we get out here, hopefully this is the bottom. That as we get out of here, the unit growth is going to pick up. So, bottom line, nobody is happy with it we're doubling our efforts to get the unit growth higher.

So, you basically blame it all on the market and don't think you've got any kind of changes that you need to do in terms of organizational changes compensation changes?

We've been very direct. We just talked about GDS, which hurt us this quarter --

Well, well, take institutional. Right. You know --

Well,institutional, if we look at our field sales growth, Robert, it's the same as it was in the first half of the year. We had a slow down in the shipment to distributors. We've seen some consolidation in the foodservice distributor business where Wal-Mart, you know, had a reduction in the business there. We've seen reductions in inventories by some of our people.

So, we think we're going through a little bit of a transition on the foodservice distributor side and the growth of our distributor sales in the third quarter. So, but in terms of a broader sense, Robert, as you also know, we're always working hard to improve the growth. We've been talking all year about the programs we've had in service excellence plus that we talked about early in the year and at our investor meeting to enhance the training for our field sales people. We've been looking at compensations, we've talked to you about, and others, for cross selling. We clearly recognize we need to do more there and we will be this year, next year and the next several years to enhance the cross selling.

So, fundamentally I think that we're continuing to work on those things. I don't think there's any gaping holes there. We have businesses we need to work on, like we mentioned GCS, we have a lot of work to do and need to get it fixed. Textile care, we need to work on that one, too, but in terms of systemic things, we have the right process in place, and we're trying to get them better.

Do you think you have been able to add enough to the sales force, particularly in institution, to get back to kind of 6, 7% growth there?

Yeah, I mean the division certainly thinks so. Remember, we did the redistricting this year, which helped us get more concentrated territory, so, we freed up more time for our people this year. Secondly, we've been doing a lot more training with them. We talked about the dialogue sales coach program that we've got up in place. The sales management teams have been working with their people.

And third, for example, in hiring, I mean institutional is hiring I think it is 20, 30 people just in the fourth quarter alone. So, we're going to be hiring more team -- people and especially going into next year,, too, to get more people in the field sales force. So, you know, we don't think that it's been a manpower issue. You know, for us it's really been a lot of the environments that we're in and again, as we think those are getting better, we will be ready to pounce on them and take advantage of them. But bottom line to your answer is we are very aggressively going after for much better growth.

So, the restaurant markets out there, just haven't picked up for three years now?

Well, I mean they've been doing decently. Like we say, our field sales for institutional continue to grow very well, mainly on the growth of the -- the food distributor business. You know, and again, you look back at this year and we faced a tough year. We had war, we had SARS, we had, you know, a tough recession. It's been a year -- a lot of stuff going against us. And I look at it and say hey, we've got double-digit growth year to date, we're going do double-digit growth this year and we're optimistic about next year.

Okay, all right. Thanks a lot, Mike.

Thank you.

Thank you. The next question comes from Chris Catch with Black Diamond Research. Please go ahead.

Hey, Mike, I just want to follow up on that line of thought and the domestic institutional business. I mean the tough environment that you're talking about has been in place for a while and over the last, you know, six or eight quarters or so you've offset a lot of that sort of market weakness with really -- from, you know, picking up like a ton of street accounts with your relationship with Cisco and the food distributor, so, to hear that all of a sudden that there's a little bit of sluggishness in that channel, you know, I'm curious as to what changed there?

Is it you didn't have a blitz campaign ongoing? Or the inventories are full? So, I'm wondering a little bit more color on that slowdown. And also, is there any way you can quantify how big an impact that had on the domestic institutional business?

You know, again, going back to what we said, our field sales for institutional continue to be pretty much what they were in the first half, was simply there was somewhat of a slowdown in food distributors and, Chris, we continue to do a lot with the overload program, the work with independent street accounts, we continue to pick up a bunch of new accounts that way.

I said I think there's been some consolidation of -- of inventories basically in the foodservice area as we've seen people like Cisco has taken a -- a focus on their receivables, their working capital -- pardon me, on their working capital this year. We've seen United -- U.S. foodservice do the same thing and further, we've seen some distribution shrink. So, I think what you're seeing is what we believe is a transitionary, some adjustment in the distribution business, you know, that we're going through right now. That's what we think has been impacting our growth.

Can you quantify the impact from that? Do you think?

On us?

Yeah, in the third quarter. And do you think it's confined to just a couple of quarters, the transition period and, you know, the foodservice distribution channel?

I got to think it's a couple of percentage points of growth. I mean if you look at what we do in the first half, you know, compared to now.

Okay. Thanks, Mike.

Thank you.

Thank you. Thank you. The next question comes from Jeff Dukakis with JP Morgan. Please go ahead.

Hi, good afternoon.

Hey, Jeff.

I have a couple of questions. The first is can you talk about your acquisition efforts generally sort of what you're seeing in terms of properties? You know, how close you are to consummating various deals and sort of order of magnitude of size?

Well, what we're seeing in acquisition results is not enough, obviously, since we haven't had one this year. In terms of our pipeline, the pipeline remains very full, Jeff. And as I say, you guys know the deal business as well as, you know, we do. You never know when a deal's going to drop. We've been working on some of these. One of them we've been working on for a year and a half.

You're typically dealing with small entrepreneurs who are probably reaching an age where they need to transition out of the business, either a solid or handed off to a family member, it's a very emotional thing so, it's never very easy to do it. You know, we certainly are -- we're as aggressive as we ever have been before in looking for deals. We continue to feel we have some that are very close to happening. We are focused on the pest elimination globally, in particular in Europe and we think we have some good things coming. So, simply it's getting them to drop and getting them to drop at a price that's reasonable.

Second question is, you know, just to sort of return to PJ's question on the SG&A line, if you look at -- you guys made amazing progress between the second and third quarter. That is on a sequential basis. In that your SG&A expenses are flat to down even though your sales are up about a little more than $35 million. Can you kind of analyze that? That's a little bit unusual for Ecolab. Is that much progress in SG&A? That is all things being equal, one would have imagined that your SG&A on a sequential basis, I don't know, would have gone up $10 million, quarter of magnitude, something like that?

Hey, Jeff, part of it is there is a volume leverage impact which we normally get in the third quarter.

Okay.

Being our largest sales quarter. So, you're normally going to see a more favorable SG&A in the third quarter.

Right.

Reflecting some of the variable comp and operating leverage things. Second is we've had a focus on costs. Obviously with the top line environment we've talked about, we've been very focused on costs and reducing unnecessary meetings and cutting expenses wherever we can. And the third thing that I've mentioned a couple of times is there was a couple of million dollars of some one-time stuff out of Europe on reversible bad debt on a business we sold, Deranius and then a pension adjustment.

How big was the pension adjustment?

Combined it was a couple of million for the two.

Oh, combined. I guess lastly, you said that your Asian sales -- if I understood you correctly, your Asian sales were sort of flat in local currency.

Right.

So, it is my general -- sort of my general sense is that Japan is growing very strongly. That is the general economy. And China is growing relatively strongly and the other Asian economies are really growing at an above-average rate. So, I mean is it the case that you're maintaining share? Or is that an area perhaps where you have an acquisition focus?

Well, in terms of Asia, first of all, we -- we don't see Japan growing, I mean I know some other companies may, like I know 3M may, but that's not been our experience in Japan and the Japanese economy from what we've seen, is in particularly in terms of travel and consumer, et cetera, purchases, has not been strong. It's been very weak.

Secondly, when we look at the various -- secondly, when we look at the various -- and further they've had a weak tourist season because of bad weather. But if we look at the other countries, Jeff, one of the things we mentioned in the prepared remarks was Korea, Taiwan, Singapore, Thailand, Malaysia, all were very strong in the quarter. So, we're seeing growth elsewhere.

Where I think one of the factors there is that for us, Japan is, you know, maybe about a third of Asia Pacific, maybe 40% of Asia Pacific. So, it's a large part of it and that weighs on us. The second thing is, you know, China is a great growth market but at this point it's still a very new developing market for -- for our business. So, it doesn't -- China is a smaller part of our sales.

Okay. Thank you very much.

And, oh, the last thing, Jeff I would add is that yes, we are also looking for acquisitions in aira Pacific as we are across-the-board for our other businesses, too.

Okay, great.

Thank you. The next question comes from Mark Gulley with Banc of America. Please go ahead.

Hey, Mike, good afternoon, it's Marshall Reed for Mark.

Hey, Marshall.

Just a quick question on GCS. I know you're dealing with some of the productivity issues there. But did the problems at GCS in the quarter hurt you with the big national accounts?

No, actually it didn't. We've continued to go forward with national accounts and we hope to be able to talk about something -- some things soon on that one, but I think that given the focus of the last couple of quarters, which has been on getting the call center up and how cautious we've been about going nationally, we still have nonetheless I think done pretty well on national accounts and we hope to talk about those sometime soon. So, I think making process there.

Thanks, Mike.

Thank you.

Thank you. The next question comes from Jeffrey Cianci with UBS. Please go head.

Hey, Mike. Looking at the other services line, if you could probably extrapolate what the full year is supposed to look like, it implies that the decline we'll see is roughly equal to the GCS, you know, extra expenses. If I read you right. Or it would be down around 5, $6 million, that's what you're expending on. What it doesn't really answer, though, is what else is going wrong for a division that typically had grown double digits. I know you're down double digits, maybe the GCS was half of that. What do you think the other half is -- you know, the lack of the growth, so to speak?

You know, like I said, first of all, this year, you know, our focus turned to standardizing these branch operations. So, the focus really turned more from sales early this year toward the call center and the admin side. So, I think that's been probably one of the biggest drivers behind it is just the amount of attention we've spent on it. You can certainly argue we should have spent more, but I think that's been the big focus. So, you know, if we look at pest elimination, they've tonight grow nice double digits and GCS, I don't think there is any other reason for it not to have, other than we've been focused on trying to get the operations straightened around.

and the expense plus the lost sales may cost you another $5 million in income is what it sounds like?

No, basically the top line drops right down to the bottom. In the sense that if you don't have your people out there producing revenue, it's -- you know, you lose the revenue it drops to the bottom line. You know, our thought is that as we start to turn the corner in 2004, you're going to see a good improvement in the top line as well as the bottom.

Guys, one more question on international income and here perhaps the opposite type of question, you know, Asia is hurting you and -- and -- and, you know, the Southeast Asia in particular, yet it appears growth there is still pretty strong on the income side. How much was last year's number for comp purpose hurt by costs, extra costs for restructuring, perhaps,international and Europe? And just wondering if you could kind of segment out this Asia cost, how much it hurt you because it appears, anyway, from reading it right, that, you know, international did pretty well despite that.

Could you repeat the question, Jeff, I'm not sure I followed it.

All right, well, international was up about, looks like it would be about -- for the full year be up, you know, 20, $30 million in profit. And yet Asia's costing you, you said SARS and hotels an awful lot. So, was last year just an unofficially low number?

are you talking about the operating income line?

Yes, yes.

Yes, I mean Asia hasn't really hurt us on a year to date basis on operating income. Actually it's grown.

Your comments earlier suggested it had hurt. No?

Talking about the top line there.

So, what are you saying? [ OVERLAPPING SPEAKERS ]

For the first half of the year was up like 3, 4%, I think, on fixed currency sales growth.

Right.

If I implied that Asia Pacific hurt us on operating income, on the year to date basis that was wrong. It's actually helped us.

Is your costs down there?

Yes, they've done a great job of controlling costs and improving the product mix, things like that, to get the margins up.

Okay. All right, thanks.

Thank you. The next question comes from Dimitri Silversteyn with Long Bow Research. Please go ahead.

Good morning. Or I guess good afternoon, Michael. Couple of questions. One, the 2.7 million shares that you repurchased, what was the average price you paid for them?

About $25.

Okay. About $25? And what are care market was up 7% this quarter, which, you know, looks at the first half up about 1% year-over-year. Was there something specific as far as new product launches that accounted for that? And do you expect that to continue into the fourth quarter in '04?

In which business?

In water care. In the domestic water care.

Oh. What they've done, you know, as we've mentioned before, they've been following several different customer strategies and have partnered a lot with say our food and beverage business and have been doing a lot with the food and beverage plants. And then secondly, they have been continuing to do a lot on the -- with the institutional customers, particularly in the cruise ship area, where over the last couple of years they've done very, very well. But in this quarter, it was particularly their partnership with F&B that pulled through for them. We're looking for a good fourth quarter out of water care as they continue to move forward.

It sounds like it's gone to a new growth plateau, if you will, in terms of going from mid to high single digits versus low single digits in the Bing of the year.

We have our fingers crossed.

All right. Can you tell us about the impact of foreign currency on European operations? You talked about volume and acquisitions, what was the effects impact?

On just Europe?

On just Europe.

I don't have the number. I've only got consolidated basis. I will have to get back to you with the number.

Okay, no problem. To clarify PJ's question on GCS earlier, when you talked about the business having a negative EBIT, was that for this quarter or for year to date?

For GCS?

Yes.

No, they lost money this year.

So it's year date?

Yeah.

Okay. And last question if I may, the European healthcare business, you know, you mentioned some write-offs because of bankruptcy of distributors. What were the amounts of writeoffs? And have you increased your reserves going forward if the situation persists?

The losses were not much. We have not increased our reserves, though. We don't think we need to. The bankruptcies we're talking about, Dimitri were some healthcare distributors in the eastern Europe and it was for our healthcare business. So, you're starting to get down to a business which is, I don't know, 25, 30, $40 million in total revenues. You're taking just one part of it, which is the east European part and a couple of distributors there.

I understand.

And my comment was much more not about impact on Ecolab's receivables or businesses, as much as it was it's just tough good get sales done there because the distribution network is kind of collapsing.

I understand, okay, Michael. Thank you very much thank you.

Thank you. The next question comes from Kevin Monroe with Thomas Weisel Partners. Please go ahead.

Thank you. Good afternoon, Mike.

Hey, Kev.

Quick question, on the U.S. cleaning and sanitizing revenue, can you tell us what percentage is institutional? And then what percentage of institutional are distributors versus field sales?

In the U.S.?

Yeah.

Well, it depends on how you look at it. We've said that about 80% of our sales in institutional are made direct but when you go to look at the delivery of the product, maybe about half of it is through distributors. And that's because sometimes you go to our restaurant and they say I've already got enough people coming to my door. You've got the fruit guy, the meat guy, whatever, have your stuff delivered by the foodservice distributor like Cisco and we're fine with that.

Okay. And last question is on the balance sheet tax built up pretty significantly in the quarter. Is there a reason for that? Hello?

Just a second. It's a timing of payments issue, Kevin.

Okay.

Was there anything else?

That's it.

Thanks, Kevin.

Thanks.

Thank you. Next is Robert Goldberg with New Vernon Associates. Please go ahead.

Hey, Mike.

Hey, Bob.

Just looking back at your history over the last four years or so, it seems like the gross margin has been down at least a point each year from the third quarter to the fourth quarter and your guidance is assuming 51% for the fourth quarter, which is just down modestly from the third quarter. I wonder if you could talk about what's going on in the business in terms of mix or in terms of cost reduction that would allow you to break that -- that recent seasonal trend.

Well, first of all regarding the decline, there's two primary reasons for that, Bob. Number one is we've had an increase in the mix of business to service businesses and if we look at a service business, they can have gross margins that are 10, 20 percentage points less than a product business. And yet because they have a much lower sales and service content, their operating margin could be very much the same.

So, if you look at institutional and pest elimination, you can have a substantial -- I mean very substantial difference in gross margin, but very similar operating margin. So, part of it is the business mix. The second thing is there is a -- I forget what the number was, it was EITF statement which caused us to have to transfer certain expenses from SG&A into cost of sales. -- cost of sales. So, that was simply filing an accounting change.

Okay. So that accounting change might -- might change that seasonal trend?

If you're referring to the -- the third quarter and the fourth quarter trend, is that right, Bob? Are you referring to the third quarter or fourth quarter trend?

Yes, exactly, exactly. It was down every year the last four by at least a point.

Well, I think that probably what you're looking at is more of the effects of what we've been trying to do in our cost areas, trying to reduce costs for -- across-the-board. Secondly, as we mentioned, I think last year's fourth quarter was depressed gross margin. And that usually you've seen not much of a change between the third and fourth quarters. So, I'd say it's a more normal pattern is not too much of a change. The second thing is the cost reductions we've put in place and third, we're looking for better performances in the fourth quarter than the third quarter for a number of our businesses.

Okay. And lastly, Mike, if you have it, I was just curious what cash flow from operations was for the quarter. Do you have that yet?

Yes, I do. Cash from operations was 186,269,000 for the third quarter.

Thank you, Mike.

Thank you.

Thank you. Ladies and gentlemen, if there are any additional questions, please press the star followed by the 1 at this time. As a reminder, if you're on speaker equipment, you will need to lift your handset before pressing the numbers. One moment, please. Mr. Mike Monahan, at this time, there are no additional questions. Please continue with any closing comments.

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