藝康 (ECL) 2004 Q2 法說會逐字稿

Welcome to the Ecolab second quarter 2004 earnings release conference call. All participants will be on listen-only until the question-and-answer portion of the call. If you would like to ask a question, please press star 1 on your touch-tone phone. This call is being recorded. If anyone has any objections, please disconnect at this time.

I would like to turn the call over to Mr. Mike Monahan, Vice President, External Relations. Mr. Monahan, please begin.

Thank you. Hello, everyone, and thanks for joining us.

This webcast teleconference will include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Some of the factors that could cause actual results to differ are described in the section of our most recent Form 10-K and annual report under the heading "Forward-Looking Statements and Risk Factors" and in our second quarter earnings release. A copy of our earnings release is available on the Ecolab website at ecolab.com/investor.

Now, on to the numbers. The second quarter showed another quarter of strong earnings gains, improved sales growth and operational improvement as diluted net income per share rose 20% to 30 cents per share. The outstanding earnings performance leveraged the improving markets during the second quarter. The better sales trends and continued margin strength from our U.S. and international businesses were bolstered by favorable currency and lower tax rate.

These excellent performances enabled us to once again outperform both our markets and the industry and to gain market share. We remain confident in our outlook and expect good growth in the third quarter, with full-year 2004 EPS up 15 to 17% to $1.18 to $1.20 per share range compared with $1.03 earned in 2003.

Turning to the details, Ecolab's consolidated sales for the second quarter rose 10%. Looking at the components, volume and mix are up 3%, acquisitions and divestitures were 2%, pricing was up 1% and currency was 4%. Sales for the U.S. Cleaning & Sanitizing operations increased 5%, showing an accelerating sales growth from the first quarter for every division.

U.S. Institutional sales rose 4% in the second quarter. Excluding the Daydot's acquisition and divestiture of Facilitech, Institutional sales also grew 4%, continuing to show improving sequential quarterly sales trends. Institutional sales advanced in all areas, including the restaurant, hospitality, healthcare, travel and government segments, and showed steady and gradual growth trends in line with our expectations.

We continued to drive Institutional growth through enhanced service to improve account retention. New product and program initiatives to better penetrate our existing customers, and aggressive new account sales and development efforts.

We also continued to make good competitive gains across the board. Recent new product introductions like Wash 'n Walk an easy-to-use high-performance kitchen floor product; our improved line of warewashing detergents with etch protection; Orange Force, a citrus based all-purpose cleaner; Formula One, a new on-premise laundry solution; and Grease Express, a fast foam degreaser are all doing very well to remain ahead of budget.

Looking ahead, the strength in product line, enhanced field sales force and improving trends in our core restaurant, travel and lodging markets bode well for us in 2004. The recently-acquired Daydot's food safety products business has continued to perform well and as planned. And we remain excited about our increased food safety business potential. We expect Institutional sales growth rate to show good year-over-year and sequential improvement in the third quarter, and as Institutional returns towards its historical trend-line growth.

Kay sales were up an outstanding 16%, led by strong gains in QSR and food retail. Kay's exceptional performance was the result of new account growth, including the broader QSR market and the developing fast-casual restaurant chains, the rollout of sizeable new QSR chain customer, better account penetration and more effective field sales coverage. QSR performed well with good results from the major and new fast food chains.

The food retail business continues to do very well, as rollouts continue with major grocers and new chains were signed up. New products and programs also bolstered Kay's results. We expect further healthy growth in Kay's third quarter as the division leverages new account activity in QSR, fast-casual and food retail for Kay's growth.

Textile Care sales were up 3% in the quarter, driven by significant corporate account wins made in the first quarter and good account retention. Sales force improvements have benefited results. And we continue to take a firm and selective approach to new contracts to ensure they meet our profit guidelines. As a result of the new account gains and strong retention, we look for the second half to show increased sales for Textile Care.

Sales for Professional Products second quarter reflected Ecolab's phase down in 2004 of the janitorial equipment distribution business. Reported Professional Product sales declined 16%. Adjusting for the business we exited, Professional Product's ongoing sales showed good growth, up 6% for the quarter as a result of strong gains in corporate accounts.

We continue to focus on growing our corporate accounts business in the janitorial market, with an emphasis on the retail, healthcare and building service contractor segment. New products will continue to be important with more new products expected later this year. Looking ahead, we expect similar trends in Professional Products third quarter, as janitorial gains will continue to be more than offset by the effects of our exit from the equipment distribution business initiated in the second half of 2003.

Beginning in 2004 we separated our healthcare business from Professional Products. Second quarter results for the new Healthcare Division reflected the discontinuation of a private label line we made for another company. Reported sales were flat to last year. However, adjusting for that discontinued product line, Healthcare sales enjoyed good growth in the second quarter, led by strong skin care and surgical instrument care revenues.

Ecolab continues to benefit from the recently-introduced solid-based surgical instrument cleaning product which is meeting with strong success. Locking ahead, we expect strong growth in the third quarter for the core Healthcare business.

Water Care enjoyed another good quarter as sales rose 13% in the second quarter with strong growth in all of our major markets. Water Care's cross-selling strategy with the Food & Beverage, Healthcare and Textile Care divisions continues to produce new account gains and healthy growth. With new division leadership, we are investing in headcount and training and will continue to emphasize the Circle the Customer strategy to produce good results in the second half.

Food & Beverage sales growth accelerated in the second quarter, increasing 6%. Dairy plant and AG resales grew nicely as increased volumes with existing accounts and new business leveraged better market conditions to drive sales. The food and soft drink businesses also saw a good growth, reflecting the strength of our corporate account relationships.

We continue to benefit from corporate accounts adopting new products under the EcoShield Food Safety program. Looking forward, Food & Beverage under new leadership, expects to continue to show attractive growth as it focuses on customer retention and drives new account acquisitions.

Vehicle Care sales declined 1% in the quarter. Vehicle Care sales were affected by the very wet weather in May and June. However, it continued to improve its profitability. Vehicle Care will introduce several new products in 2004 for the tunnel and detail market. And introduce a new generation of solid products. With its focus on securing new business and continuing to make upgrades to the sales force, Vehicle Care will leverage its new products and focus on chain accounts to drive sales growth and further improve margins in 2004.

U.S. Other Services sales increased 4% in the second quarter. Pest Elimination sales continued to show good growth, rising 8% in the second quarter as it compared against a strong period a year ago. Business remains solid for Pest and it continues to expand its offerings and markets.

New account activity remains strong and Pest picked up a major multi-unit account in the quarter that will benefit future growth as it begins a gradual rollout later this year. New, full service restaurant program was introduced early in the quarter as Pest continues to tailor programs for specific markets to enhance growth. Additional targeted new programs will be introduced later this year.

The EcoSure Food Safety audit business continues to show robust growth as it picks up new business with major chain accounts. We expect Pest Elimination to show continued good sales growth in the third quarter of 2004.

Sales for GCS were off in the second quarter versus last year. We continued to improve operations at the Central Call Center and to develop better technician efficiency. We also continued to take action to enhance the customer service and -- customer and service functions. And while we still have more to do, it is clear to us that the operations are moving in the right direction.

We have begun some limited marketing to chains for services and had good success, and will be stepping up activities over the coming quarter. We believe GCS results will gradually improve through the second half of 2004. Third quarter sales are expected to rise compared to the prior year, and we expect the losses to decline. As we have said before, this business continues to be attractive to us. Customers continue to tell us they need this service and there is no independent national service provider. Our opportunity in this market remains excellent and we are determined to fully and successfully develop it.

Measured in fixed currencies, international sales increased 8%. Excluding acquisitions and divestitures, international sales and fixed currencies grew 4% and also showed accelerated sales growth from the first quarter in all regions. When measured in U.S. dollars, international sales excluding acquisitions and divestitures, increased 13%.

Europe, Africa and Middle East sales rose 8% at fixed currency rates in the second quarter. Excluding acquisitions and divestitures, sales rose 3%. Europe's Institutional sales rose 5%, improving its growth rate from the first quarter as the business worked effectively to offset continued sluggish hospitality and food service market conditions.

Institutional's aggressive sales efforts generated strong business growth, with independent street accounts, as well as picking up several new chain accounts. New patented products were introduced, including Bar Guard a fully-automated, on-premise beverage line cleaning system for restaurants, bars and hotels. And Extreme Tech, a new innovative warewashing line. These join the successful Oasis Pro and Penguin housekeeping product lines and the very successful EcoTemp expansion. We expect these new initiatives and innovations, along with added sales and service headcount, to improve Institutional sales growth in the third quarter.

The Food & Beverage sales growth rate also improved, rising 4%. Customer volumes remain low in the food production and agrimarkets. And milk prices are down in Europe, hurting dairy. Beverage and Pharmaco's [ph] had strong results and we made good competitive gains in the food and brewery markets. The line of a septic bottle-filling cleaning product and Topmix, a new advanced foam range for high care areas in the food processing segment are doing well. And are expected to help yield better growth in the second half.

Professional Product sales were off 3% as sluggish markets continued to hurt results. Division -- the division has introduced new products like the Phaser floor system and a new line of Racent [ph] mops. It is also developing unique programs to address other market segments and improve growth, such as retail stores and better penetration opportunities within BSEs.

Healthcare sales rose 3%. Healthcare reform in Europe has impacted this division, as U.S. styled managed care and buying groups take hold. The division is using new products, geographic expansion and aggressive new account development to offset these trends. In addition, the Adams business, acquired last year continues to do very well. We look for the third quarter to show improved growth trends for the Healthcare Division.

Textile Care sales increased 2%. More new products are coming in 2004 and should help continue the growth trends in Textile Care. Our recently acquired pest -- European Pest Elimination businesses are continuing to make progress. And we are integrating these organizations and developing the right sales and service standards to generate consistent long-term growth.

In the UK, the program for the F&B market is underway and seeing good results as we introduce a segment program for the catering market. Electronic reporting be introduced next year. France is implementing new reporting and organizational changes to lay the foundation for growth, and we are adding people and introducing targeted market opportunities -- market programs.

We presently look for fixed currency sales growth in Europe's third quarter to improve. As the new initiatives and products, along with more field sales and service associates, work to offset market challenges. We also look for continued margin expansion in the third quarter.

Asia-Pacific second quarter sales grew 5% when compared to last year in fixed currencies. Strong growth in North and Southeast Asia drove the results. When reported in U.S. dollars, sales increased 16%.

Looking at the segments, Institutional sales showed good growth. Australia and Japan used new programs like Market Guard and corporate account gains to offset soft consumption trends. East Asia continues to record strong sales in growth areas including Hong Kong and China. Food & Beverage sales showed good growth. New Zealand sales continued to enjoy good results in the farm and dairy markets and East Asia reported strong gains.

PET bottle cleaning has been strong, particularly in China, bolstering good conveyor lube sales. Japan saw a moderate increase in sales, as Avian flu continues to hurt sales growth in Southeast Asia. However, the impact appears to be lessening with each passing month. We look for improved sales trends in the second half for Asia-Pacific as the new programs and investments in the sales force impact results.

Second quarter sales for Ecolab's Canadian operations grew 7% in local currency and were up 13% in U.S. dollars. Institutional sales measured in local currencies, rose sharply reflecting an improved hospitality industry and recovery from the impact of last year's SARS outbreak. The focus on new street accounts, additional product sales to existing accounts and corporate account retention drove the business.

Food & Beverage sales were soft in the quarter as new business and good account retention were offset by reduced equipment sales. Textile Care sales saw strong gains in local currency due to new business and improved market conditions.

Sales in Latin America were up 13% in fixed currency and increased 16% when reported in U.S. dollars. Results were led by a strong performance in Mexico and nearly all other countries showed double-digit growth. This was another strong performance for the region given the always-challenging economy in Latin America and the unsettled conditions in Venezuela. Growth was driven by gains in Institutional, Food & Beverage, Professional Products and Pest Elimination, as well as strong competitive gains.

Institutional's double-digit growth benefited from an improved service focus in Brazil and continued success with the food and retail programs. Strong tourism market in Mexico, the Caribbean and Central America also bolstered results.

Food & Beverage results were positively impacted by new product introductions to the beverage plants in Mexico, continued recovery in Venezuela and gains in the Caribbean.

Pest Elimination continued strong performance in Latin America recording another double-digit increase for the quarter. We expect continued strong results from Latin America over the remainder of 2004.

Turning to the expense side of the income statement. Second quarter 2004 gross margin was 51.6% compared to last year's 50.7%. The 90 basis point increase was due to the benefits of improved business and product mix and cost savings initiatives. SG&A expenses were 38.6% of sales, up 70 basis points from last year due to sales force and other investments, higher sales commissions and incentives.

Operating income for our U.S. Cleaning & Sanitizing business rose 5%. Operating margins were maintained at 16.7% as favorable business mix and cost efficiency improvements in several divisions offset sales force and other investments. Operating income for U.S. Other Services increased 20% as margins grew 130 basis points to 9.5%. Pest Elimination showed good profit gains.

On a constant currency basis, international's operating income rose 12%. Operating margins increased 40 basis points to 10.3%. Profits were up double digits across the board for all regions and were achieved through higher sales and careful cost management. In U.S. dollars and excluding acquisitions and divestitures, international's operating income increased 20%.

Ecolab's second quarter consolidated tax rate fell 150 basis points to 37.2% from 38.7% a year ago. The rate benefited from lower international rates and tax savings efforts. Diluted shares outstanding were down 1.4% to 261 million shares. We repurchased 180,000 shares during the quarter. The smaller repurchase activity primarily reflects Ecolab being out of the market during the SEC registration process for our pending Alcide acquisition. Net of this activity is that diluted net income per share for the second quarter was up -- was 30 cents, up 20% over last year's reported net income per share.

Looking at the balance sheet, Ecolab's total debt to total capitalization ended the quarter at 34%, down from 36% a year ago and even with the end of 2003 despite 2004's more active acquisition activity. Depreciation was 53 million in the quarter and amortization was 8 million. Capital spending for the quarter was $61 million. DSO and fixed currencies was essentially flat with a year ago, and DOH was down compared with last year in fixed currencies.

That's a review of the second quarter. Looking ahead to the third quarter, we begin by cautioning that the following statements are based on current expectations. These statements are forward-looking and actual results may differ materially from statements that do not include the potential impact of business acquisitions, divestitures or other material corporate transactions and may be completed after the date of this release.

This business outlook section should be considered in conjunction with the information on forward-looking statements in our press release and periodic reports, which lists factors that may cause results to differ.

For the third quarter our Institutional business is expected to continue to show improved sales growth. We look for Kay, Pest Elimination, Healthcare and Water Care to continue to sustain their good momentum. Professional Products is building its ongoing business through product -- though product line discontinuations will mask that progress and reported sales through most of 2004. GCS is expected to see improving sales trends. We also expect continued good growth from each of our international regions.

Further, we will make elective investments in areas including technology and R&D and continue our investments in sales and service headcount. These will likely cause operating margins to soften in the third quarter as we take advantage of the strong earnings trends in 2004 to build for a longer term growth.

In addition, the number of shares outstanding will increase in the second half due to the Alcide acquisition which was for shares. We expect to restart our share repurchase program after the Alcide deal closes. The current environment is improving and we continue to work hard to deliver our strong earnings results. We think our future continues to look excellent.

As a result, we expect diluted earnings per share for the third quarter to be in the 34 to 36 cents range. This will represent a solid gain over the 32 cents earned in 2003's third quarter. Reflecting the better second quarter results and our unchanged outlook for steady growth in the second half, our full-year 2004 diluted earnings per share outlook has been raised a penny to the $1.18 to $1.20 range, representing a 15 to 17% gain over 2003's $1.03 from ongoing operations.

We remain both very confident and optimistic about our future. We want to once again caution people against getting aggressive on a 2004 full-year earnings outlook. As we have discussed before, the second half will compare against a period in 2003 which enjoyed the benefits of a weakening dollar and comparatively lower tax rates. Two factors we expect will not provide as much help in the second half this year compared with a year ago.

Further, as we previously mentioned in the call, we are making elective investments in the business that we believe will provide strategic value and which help sustain our growth into the future. Therefore, we continue to caution investors regarding raising estimates above our forecast at this time.

We have no new information to report regarding the situation with Henkel. Henkel's purchase of Dow [ph] was approved by Dow shareholders and closed in late March. Henkel has stated that they will announce their plans in late fall. As we have said before, we have a stand-still agreement with Henkel, which among other things, insures an orderly process in the event Henkel may decide to dispose of any of our shares.

This includes our right of first refusal for any Ecolab shares to be sold by Henkel. And the agreement contains appropriate provisions to ensures an orderly public or private sale of any Ecolab shares should Henkel choose to sell. We expect to work with Henkel as this moves forward and we have plenty of financial options available to ensure that we protect all of our Ecolab shareholders and retain our financial fire power for growth investments.

Regarding our merger agreement with Alcide, Alcide has distributed a proxy statement to its shareholders and has scheduled a shareholder meeting for July 30 to vote on the transaction. Assuming a favorable vote and satisfaction of other customer and closing conditions, we expect to close on the deal that day.

So that is the story for Ecolab's second quarter, with a strong earnings performance that leveraged steadily improving markets. Ecolab's rising sales trends, continued margin strength from our U.S. and international businesses enabled us to once again outperform, both our markets and the industry and to gain market share.

We remain confident in our ability to continue our double-digit EPS growth in the third quarter and look for full-year EPS to rise 15 to 17% over 2003, representing the 12th year of double-digit EPS growth from ongoing operations in the last 13 years for Ecolab.

That concludes my remarks. This conference call will be available for replay in our website through August 2nd. Operator, please begin the question-and-answer period.

Thank you. At this time if you would like to ask a question, please press star 1 on your touch-tone phone. You will be prompted to record your name. To withdraw your question, please press star 2. Once again, to ask a question, please press star 1 on your touch-tone phone. One moment, please.

Okay, everyone, I just wanted to that say that Doug Baker has just dropped by for a minute and wanted to say a couple of words here. And let me turn it over to Doug before we start the Q&A.

Good afternoon, everybody. I did want to stop by and say hello. I'll apologize in advance, I don't think I can keep up the word-per-minute pace that Mike just set on the first half of the call.

As most of you know, I took over as CEO on July 1st and the transition has gone about as smooth as anyone could hope. And I have met with many of you over the last few years, so I don't think it will come as any great surprise that I'm thrilled to have the job, and even more importantly, I'm really excited and thrilled about our future.

Clearly, you just heard, we're coming off a very strong quarter. We continue to like our prospects going forward. The markets we serve are growing. The business we have are well-positioned, they're performing well on balance, and most importantly, they are trending the right way.

We have got a great team and I believe a great strategy and a great plan moving forward. Net, the plan is is to continue to deliver great results as we continue to move on. We are going to continue to push the top line. We're going to continue to push our Circle the Customer, Circle the Globe strategy. We are going to continue to push our culture, which is marked by passion, aggressiveness and customer orientation, and we're going to continue to push execution. Now we believe the game is in our hands. If we execute we deliver and we plan to do both.

The last thing I will add is we view you as a very important constituency. I'm going to continue to have an active communication role with our investors. Mike does a great job handling IR and in these events in particular, so I'll probably just stop by these calls once in awhile to check in, but I am going to continue to have a pretty robust schedule on the road to meet with you at conferences and one on ones, et cetera.

So with that, I have a few minutes for a couple of questions and then I have been on the road all week, I'm going have to scoot.

Operator, can we go back to the Q&A.

Thank you. Our first question comes from P.J. Juvekar of Smith Barney.

Good afternoon, Doug and Mike.

Good afternoon, P.J.

International operating margins seem to be turning around nicely. You mentioned that they can go higher in the third quarter. Once everything is said and done, how high can they go and can they come close to the U.S. margins?

I think we have stated before that we continue to see expansion opportunities in international. Hopefully, we have a long-term rates where we have expansion in both U.S. and international margins. There is clearly still room to expand international margins. We're up a couple hundred basis points since we bought the joint venture or Henkel out in Europe, which is faster than we had forecasted when we made the deal, but you're seeing I think the results of a couple things.

We are seeing some sales growth. We're doing a good -- so we're finally getting some real leverage on these businesses, and if you look at the track record of Asia-Pacific, Latin America and now Europe, we have got a good one and we don't feel we are by any means at end of it. I think we can get at least to the U.S. level.

Okay. And then secondly, you're adding to your sales this year. What percentage of additions are in the U.S. versus outside of the U.S.? And then is the commission structure different in the U.S. versus outside U.S.?

Well, the answer, you know, by and large we try execute the same compensation philosophy, but you have got legal issues and you have got some other things that forced us to modify it in certain countries. The answer is, it is not identical in all countries that we operate in for legal and other reasons, but we like to have variable comp. We want our people tied in to both our success and if we lose an account to also share the pain. These are some of the principles that have been built in our comp and they exist throughout the world. All right?

In terms of adding people, it is relatively balanced along where you see sales right now. We are investing in the U.S. We see the markets turning around here. We have been investing in Europe as well. Where we don't see the same turn around or the same rate of turn around, but we certainly have more stable markets and then there are clearly some other countries throughout, you might imagine China and some of the real explosive countries, we have got significant headcount additions going on.

Great. Lastly, Doug, can you quickly give us an update on the cross-selling effort? Last year at the analyst meeting you talked about putting incentives in place for cross-selling. Is that structure in place now? Can you give us an update? Thank you.

Yeah. There is 2 levels that we talked about. The first was at the corporate account level, which was modifying the way they earn their annual bonus to include a component for selling other services into their accounts. That was put in place effective January 1. We have got measurement, regular routine measurement. At this point in time, the data is more qualitative than quantitative because we are only 6-7 months into it, but by reports it is having exactly the intended response. We are getting even more cooperation in looking at the business the way that you hoped we would.

The second measure is going to be a field quarterly bonus, which frankly, is rolling out right now into the field. I'm in the midst of a number of field meetings where I'm, frankly, talking to the organization about the importance of Circle the Customer and other issues and other things that we are doing to make it easier to execute. So that will be -- that is in place as well.

Thank you. Our next question comes from Mark Gulley of Banc of America.

Hello, guys. Doug, I appreciated your comments towards the end of the call about your vision and passion for the business. But the volume growth has not met your own high expectations, I think maybe since, what, '99. So it's been several years since you have been able to do that and we are -- the economic recovery is beginning to really have some effect. So can you review again what your volume goals are and what is it going to take to get the volume growth out of this kind of 2, 3, 4% rut that we seem to be in?

Yeah. Well, I would say I think we are getting out of the rut, but to use your metaphor. I would say this, Mark, we don't -- the volume, the pace of volume growth in the second quarter isn't the pace that we're satisfied with on a long-term basis and our goals remain the same. You know, we've talked anywhere from 6 to 9%, in that range for our big core businesses. And I believe those are very achievable and I think you're going to see those type rates in the near future.

We are clearly accelerating. This is a business that neither goes down quickly or accelerates quickly, and we have had sequential improvement. If I have any impatience I wish it was faster. We're not delighted. I don't have a lot of disappointments in the quarter. We would like to push the sales growth even more aggressively, and I think you're going to see stronger growth in the third and fourth quarter as we go forward.

As a follow-up, you have done some nice clean up of some areas that didn't meet expectations. We've talked some about on this call. If I look at vehicle, if I look at water, are those areas that just really aren't pulling their weight and may suffer the same fate as other businesses have that weren't performing?

Yeah, you know, no I would say I think we really have gotten after a number of those areas with quite a bit of success. You brought up Water Care it's growing at double-digit rates. It's strategically well positioned. They are getting after it. We have got a new team on board. They are doing a heck of a job. We feel very good about what has happened in Water Care recently. They had a double-digit quarter on the top line.

Vehicle Care we had a soft quarter admittedly on the top line, but a strong quarter on bottom line and we have had very good margin growth and SG&A ratio improvement in that line and Vehicle Care the last couple years has really had dramatic increase in OI. So, you know, net is, I think those businesses are improved and trending the right way.

Thanks, Doug.

Yeah. Let me -- I can take one more question and then I have got to go and I will put you in Mike's very able hands.

Thank you. Our next question comes from Robert Ottenstein of Morgan Stanley.

Doug, I just -- I have asked you this question a lot and it is really -- it's follow-up on the previous question. Again, on the growth, Mike said that you're gaining share. You know, are really the markets growing that slowly? Question kind of number 1. And 2, in terms of your ability to kind of get to your goals is it do you think a function of slower than historical sales force hiring in the past or more internal focus on costs and internal issues, you know, currently?

I think, you know, I think there is a couple of things. One, our growth is coming back. But if you go look at the post 9/11 trends in our core markets in Institutional in particular, but also Food & Beverage is under some of the same pressure and dairy and others, we had real historical dropoffs in customer counts and food service and, obviously, rooms sold, et cetera. A lot of these data points. And, frankly, we fought through those things very well. Now some of those trends just very recently, quite honestly, started turning around if you look at them and our business is responding. We have been growing faster than the market throughout that whole period and we continue to do.

Robert, I would say we are accelerating, we feel -- we like the underlying things going in the business as well. We feel good about the acceleration. We know we're going in the right direction. And I think if you look and you see our second half results on the top line they will continue to have very strong sequential improvement in the third and the fourth quarter.

Yeah, Robert, I just wanted to add that, as we mentioned in there, we have seen sequential improvements fourth quarter, first quarter, second quarter. Is it as fast as we want? Well, no, but it is never fast enough for what we want. But we're confident as we get to the second half of the year you will see the growth rates approaching the traditional rates that we've had in our businesses. And in 2005, if things stay clear and safe I think we will be in great shape.

You think kind of 5, 6, 7% volume growth in 2005 is where you are headed?

Yeah.

Yeah, absolutely.

Great.

We like the momentum in our business.

Super. Thanks a lot, guys. All right.

Thanks, Doug, appreciate it. We can continue on with the Q&A now.

Thank you. Currently at this time our next question comes from David Begleiter of Deutsche Banc.

Thank you. Mike, when you look out over the landscape, where is Ecolab's biggest opportunity over the next 2-3 years on the top line and both -- in the bottom line as well?

Business-wise or region or how are you defining it?

Is it Asia, is it GCS? Where is the biggest opportunity for improvement in the financials?

Well, I mean if you start on bottom line, I mean clearly our international margins have the most room to grow. We have said that in our U.S. business we have a number of divisions which are below we think their achievable operating margins and as those come up we will able to see some improvement in the U.S. operating margins, but the big move is going to be in international Asia-Pacific, Latin America and Europe. So for the margin move that is where we would see, you know, the bulk of the opportunity.

When it comes to top line, you know, first of all, the Circle the Customer strategy is really going to drive us as we seek a lot of new opportunities in new areas. Within the areas that we have today, I mean we are, you know, certainly you have got some divisions like Kay, Kay was up 16% this quarter. So some existing areas are still incredibly strong and we've got some newer areas like Healthcare, which is, we think it's got great potential. The Water Care business with some renewed investment and enthusiasm in that business. We're seeing some great stuff. The Pest business in Europe looks terrific opportunities. And with Institutional, I mean Institutional may be an 80-year-old business, but we still think there is tremendous options and opportunities in that business.

Look at Food & Beverage is another one, Food & Beverage growth which was something like 3% last year was up 6% this quarter, and we think that it is back to higher growth again. So I don't want to say that is just across the board, but what I'm saying is we think we have some tremendous opportunities and some traditional businesses, some newer businesses in our existing areas. As far as margins. Some opportunity in the U.S. but a lot of opportunity internationally.

Mike, can you just quantify the additional investments you will be making in the back half of the year that are impacting the operating margin? Do you have a dollar amount?

I don't have a dollar amount present with me, David. But the area that they are going to be in is additional R&D headcount. Investments in our technology area. And sales and service headcount.

Okay. Thanks a lot of, Mike.

Thank you, David.

Thank you. Our next question comes from Bob Koort of Goldman Sachs.

Good afternoon, Mike.

Hi, Robert.

You answered all my questions. Thank you.

Thank you.

Thank you. Just as reminder, to ask a question, please press star 1. To withdraw your question, you can press star 2. Our next question comes from John Roberts of Buckingham Research.

Good afternoon, Mike.

Hi, John, how are you?

Good. At economy continues to improve and business improves here, do you ever get more than the 1% pricing that you have been getting in recent quarters? Does it ever get up to 2-3% price trends?

Well, I mean on specific contracts or?

Overall [inaudible] report for the company.

I'm sorry, I couldn't hear the last part.

The way you report it for the company. Overall for the segment. You had 1% in the U.S., you know, cleaning business.

Well, you know, clearly when we look at contracts we're getting more than 1% of the contracts, but since they are multi-year contracts, you know, it is what impacts each year. I would also point out that as you have seen in the past our pricing has more than covered our raw materials, so in that type of environment I think we have done pretty well by it. I think that also if you look at overall inflation in our markets, it hasn't really exceeded that by much.

So can we? Sure. I mean, certainly in the past years if we go further back we have. It's just that in the recent years the raw materials and pricing and inflation environments have not really awarded that.

If we went back to say the late '90s going into 2000 pricing was running above 1%?

Oh, yeah.

Okay.

Oh, yeah. I mean, you know, I can go back, remember in the '80s when pricing was 7-8%. I mean we clearly got more than that, it depends on the environment that you're in.

I don't think you gave the growth in the Healthcare segment.

7%.

7%. Thank you.

Thank you. Our next question comes from Kevin Monroe of Thomas Weisel Partners.

Good afternoon.

Hi, Kev.

On the U.S. Cleaning & Sanitizing business you had a good acceleration of organic growth there, but your margins were still flat year-over-year. Is there any reason why you're not getting more leverage out of that business?

First of all, we are continuing to make, as we've talked about, and I hate to keep beating it to death, but a lot of investments in sales and service for us. And secondly, I mean the margins there are pretty fair margins. I think given the investments we are making and that we have got, you know, [inaudible] margins there that we are doing pretty well.

Okay. In terms of your guidance for the third quarter on the gross margin line, you know, 52% gross margin, I mean that is -- that would be among the highest gross margins you have had in a quarter for a couple of years here, so what are the drivers of, you know, that kind of margin improvement for the next quarter?

Let me go back to your prior question Kevin, which is not to say that we think we peaked out on U.S. C&S margins. I'm just saying that for one quarter we think we are doing fine, that our objective clearly is to continue improve those margins and we will improve those as we go forward.

In terms of the gross margin, I mean, for us, we have been focused on our costs. We have had a lot of emphasis on what we call fielding of future costs, which is look at the process improvements we can make in our business. And, you know, to continue the same improvement that we've had for the last few quarters in terms of our gross margin. So it's attention to our costs. It's attention to our product mix. Improving the new products that we've got, the highly differentiated products that we have got, and our objective there would be to try continue to try and improve that gross margin as we go forward.

Thank you.

Thank you. Our next question comes from Jeff Cianci of UBS.

Hey, Mike. Usually your job is to kind of reign in the comments of the CEO. Since we have a different CEO, maybe nothing has changed. I'm trying to understand the margin comment on international. He did say that he thought he could get them up to the U.S. level? Did I hear that correctly? And is there a time frame on that? Seems quite aggressive given the structure.

Well, it is consistent with what we have always said, which is our intermediate objective is to get the international margins up to U.S. levels and like we said, once we get there then we'll take another look at whether we can drive them higher. The time frame, what we've always said about international margins is we're shooting for roughly 50 basis points a year as an objective, where we're trying to balance growth with profitability.

But we're 300 basis points away, that is kind of a 6-year plan?

Yeah.

Okay. Thanks.

Thank you.

Thank you. The next question comes from Bruce Simpson of William Blair.

Hi, Mike, good afternoon.

Hi, Bruce, how are you?

Will you quantify for us the year-over-year expectation for growth in SSRs?

SSRs, you mean sales and service?

Yeah, in your sales people. I just hear you talk broadly about investments globally but I don't know if your talking about equivalent with sales growth or.

Our objective this year is 4 to 5% organic growth.

4 to 5% more people in your sales ranks; is that right?

We intend to increase our sales and service force 4 to 5% organically. Acquisitions would be in addition to that.

And is that disproportionately located in Institutional?

Well, no, I mean as I think Doug was alluding is that you are going see it in our higher growth areas and maybe a little less elsewhere, but I don't think it is incredibly disproportionate by division.

Okay. And if I could focus on Institutional for a minute, can you give us some color as to help us understand kind of how to desegregate the growth there? How much of it is just overall background trends are getting better and hotels and restaurants, how much of the growth is focused on independents versus chain accounts and so forth?

It's kind of tough to try and slice it multiple ways. If we look at the inherent markets, we would say that they're doing well. The forecasts for this year are that we would see in the restaurant area, you know, real growth probably in 2 to 3% range and, you know, room demand up in the 2 to 3% range, so we're seeing, you know, a little bit better than that type of growth out of those markets for our business.

We picked up to the independent and street account business, as we said over the last 18 months, 2 years we have had overload, we picked up over 60,000 new accounts so they are clearly benefiting the business. It is hard for me to take that number, Bruce, and try to slice it into X is market, Y is new accounts and Z is better product penetration.

Which is helping drive more growth now, your independent street business or your regular chain business?

I would say it is about the same right now.

Okay. Last question is if I could just focus in on GCS for a moment. In the past, I think particularly in the fourth quarter of last year when there was a considerable impact on operating margin, you actually quantified the dollar amount that had been invested there. Can you do that here and sort of give us a sense of sequentially how much was invested in GCS or perhaps what its impact was on the other services operating margin in the quarter?

It was a loss of about 3 million.

Is that a pretax loss, Mike?

Yeah.

Okay, thanks.

Thank you.

Thank you. Our next question comes from John McNulty of Credit Suisse First Boston.

Hi, Mike. You answered a lot of the questions. One quick one for you. Higher interest expense in the third quarter, is that basically just due to you having a lot of floating rate debt or is there anything else that we should be looking into that at all?

It is acquisitions and share repurchase or expected share repurchase.

Any -- which acquisitions are actually affecting you from the second to the third quarter, because I thought the Alcide one was stock relay or stock-for-stock acquisition, so what else should we be looking at there? Because it looks like you're calling for a $2 million increase in interest expense, it just seemed like a relatively large one.

It is the Musico [ph], Limco [ph] and expected share repurchase, John, is about all I can tell you at this point.

Okay. And then in terms of share repurchases, how aggressive can we --?

And, John, I mean, there's some expected things as we forecast ahead that we think will cause interest expense to rise. That's really about all I can tell you right now.

That certainly covers it. In the share repurchase area, should we expect things to be kind of relatively quiet until kind of it is determined what Henkel is going to go with their shares? Is that a safe assumption as well?

No, as we said, we've been out of the market because of the pending Alcide acquisition. As soon as that is done, we expect to be back in the market. The degree to which, I really can't comment on, but we clearly know that our objective is to end up neutralizing shares and we're going to do our best to do that this year.

Great. Thanks a lot.

Thank you. Our next question comes from Rosemarie Morbelli of Ingalls & Snyder.

Good morning, Mike. Or rather good afternoon.

Hi, Rosemarie.

Hold on. Okay. I guess I am having a hard time getting you off of this speaker phone. So I will continue on the speaker phone. Doug said that he was expecting operating margin for the U.S. business to increase from its level today. Now, I understand you have a few businesses with lower margins, but my understanding was also that those improvements would more or less cover the additional investment in people, technology, R&D and so on and that close to 18% this is about pretty close to as high as to where we go in the U.S. What is the goal?

Well, what Doug was referring to is over the long-term as the other businesses improve their margins that we would raise U.S. operating margins above where it is today. I mean if -- you know, we would have a assume a static nature of the business, and as you know our Circle the Customer strategy means that we're going continue to acquire businesses as we go further down the road. But I mean for us, U.S. C&S operating margins are close to 17% now. I think that they could improve modestly above that as we go forward simply because of mix issues. So our goal is to continue to improve that, but I'm not going to try and pretend that we're going have huge increases out of the U.S. operating margins.

I mean, the biggest bang for the buck is going to be out of international as we said where we clearly have, you know, 3, 4, 500 basis points potential between where they are today and the U.S. levels and our hope is to get them to the U.S. levels, and at that point then take a look at whether we can do better.

I think that someone already asked the question, and if my memory serves me right, there was no way that you guys ever planned those margins internationally to reach the level of those of the U.S. because of the higher costs of doing business internationally. So what has created the change? Why do you now think you can actually get to that particular level?

Well, when I'm saying international, Rosemarie, maybe I'm not being precise. International would be Asia-Pacific and Latin America where we think those margins should at least equal the U.S. You're right about Europe, that we've said that our objective for Europe right now is about 12 to 13% which is about 200 to 300 basis points higher than where they are today. We do think there is some structural issues in Europe that may prevent us from getting a lot higher than that. But right now, our point of view is let's get to 12 and 13% and then we'll find out if we have any problems beyond that. Right now we have 200 to 300 basis points ahead of us in Europe that we're going to go out and get.

Right. But based on what you say, it sounds as though when we look at international anyway we look at Europe, as well as Latin America and Asia-Pacific. So there is no way with European structure that you will ever get to, let's call it 18%, as you may get to in the U.S., 18 or 19, whatever the magic number will be.

Well, we'll see.

And you said that GCS lost in 3 million in the second quarter. Can you remind me how much it lost in the first quarter and are you expecting it to at least break even in the third?

Lost about 3.5 in the first quarter and no, we are -- our objective is to reduce the loss in the third quarter. We've never expected it to break even in the third quarter of this year.

Do you think it will be profitable in 2005?

That is our objective.

Profitable as opposed to break even?

Profitable as opposed to break even.

Okay. And what kind of a tax rate are you expecting for the second half?

Rosemarie, part of the reason, as I mentioned in there, you know, GCS has to a large extent a fixed cost base and one of the things that we have done is we want to be sure that we have got the systems, the processes right so that we are going have great customer satisfaction when we go out and market it, so as a result of that we have been really limited in our marketing. As I said in the call, we have done a couple very selective marketing efforts with some customers where we felt very comfortable that we would be able to deliver that customer satisfaction that they want.

Once we are satisfied that our systems are right and our people and productivity is right, then we're really going to go after that and I think you will see substantial leverage on that essentially fixed cost base in GCS.

Okay. And you made a big point and then -- well actually you could tell me the tax rate before I forget.

For the full year?

For the second half.

We're expecting 37.2.

Okay. And then going back to GCS. You made a big point in your introductory comments about the fact that you are going to fix it, you are going to grow it, et cetera, but I didn't hear any of that regarding Vehicle Care. Is that one that just does not fit?

Well, it's completely different situation with Vehicle Care. I mean Vehicle Care was affected by the weather. I mean May and June were just very wet months. There was not a lot of business. We have gone out we've surveyed the market, the conveyor car washes, et cetera, and that business is way down for everybody. So we know it is not a systematic problem with Vehicle Care. And secondly, Vehicle Care's profitability continues to grow so they are very, very different situations.

So you are happy with it?

With Vehicle Care?

Mm hmm.

We're very happy with the profit growth there. We're not satisfied with the sales growth. And that is one of the things we're going after is what can we do to get that better, so we're being very aggressive on accounts and sales force, et cetera. The tough part is when you are dealing with the weather, but we're out there selling accounts.

I mean, last year we had a couple of quarters where it was up double digits. So it was a tough quarter this time no doubt about it, but we know the factors and again, the profits continue to grow there, so it as good place to be in the sense that if you got to have one or the other, I would rather have the profits growing.

Okay, thanks.

Thank you.

Thank you. Our next question comes from Dmitri Silversteyn of Longbow Research.

Good afternoon, Mike. A couple of questions. First of all, you mentioned that Daydot's contribution to Institutional was offset by a divestiture that you had, but what was the Daydot's as a percentage of sales contribution?

It was very small. It was a $20 million business when we acquired it, Dmitri, so just annualized up it's roughly $5 million.

Okay, so I [inaudible] about year-over-year growth then.

Yeah, it roughly offset the Facilitech and that is why there was no acquisition impact.

I understand that, I just wanted to see what that was. That's fine. When you look at your businesses, it hasn't been -- you know, it was kind of difficult to observe it if you look over the last couple of years because of all of the transient issues [ph] with the end markets. You mentioned growth from the fourth to first and the first to the second quarter. Am I to assume that the seasonality plays a much lesser role than the initiatives and the market penetration that Ecolab is getting?

Well, there is just normal seasonality to the business where because of vacations, back to school, et cetera, the third quarter tends to be our bigger quarter. The second and fourth tend to be about equal. And lesser than a third and the first one tends to be the lightest quarter, so that overall general seasonality doesn't change much. Is that what you are referring to?

It is. That was my understanding, which is why I couldn't understand your comment from fourth to first to second which would just be normal seasonality is why you're having a revenue growth. I was trying to figure out if I was missing something.

No, I mean, we're just simply trying to show that on a year-over-year basis, which is why we are going on the growth year-over-year, as you go through each of the quarters the growth is getting better. It's comparing it to the same seasonal period a year ago but --

Okay, okay. So you're talking about year-over-year growth rates rather than sequential growth improvements. Okay, I got it.

Yeah, right. I hear you.

Okay. I got it. You know, there's been a lot of talk and there's actually some evidence with 1 1/2 months of the summer in, 1 month, if you are looking at June 21st, of people actually traveling not so far away from home and, you know, driving more than flying. Does that have any impact on you in the restaurants and hotels that it is observable or is it all a wash?

As long as they got to eat we're happy, whether they fly there or drive there.

My thinking is that if they drive they are more likely to pull off the road and stop at McDonald which would be into your Kay business and less likely to go to a fancier restaurant at a hotel at a destination, but you're saying that is all immaterial.

Well, as long as they go to a restaurant, I mean Kay's business is up big so maybe you're on to something there about Kay. I don't know. I mean, we haven't seen anything that says that, Dmitri.

Okay.

That there has been a downscaling in the restaurants.

Okay. Fair enough. And the final question. You mentioned that your price increases typically -- that you have in your multi-year contracts typically take care of the raw material increases that you may be feeling. This year has been -- you have seen quite a bit of raw material increases. Steel and plastics are up tremendous amounts on percentage basis year-over-year. Are you starting to feel a little bit of a raw material pressure or do you still enough cushion built in your pricing contracts or is there a pass-through mechanism for these outsized raw material increases?

Nothing yet. So far raw materials have been pretty decent for us. But, again, when it comes to pricing we will do what we need to do to get the pricing that keeps us with a fair return to our shareholders and competitive. So, we will do what we need to do when we need to do it.

Just I was wondering if you could provide me, at least give me an order of magnitude of how much of your raw material costs are, what I would call packaging, the plastic bottles, the steel pots and pans and the hanging dispensers on the walls.

I don't have that number in front of me, Dmitri. I can't answer that off hand or right now.

Okay.

I will have to do a little research on that.

Very good. That's it. Thank you.

Thank you.

Just as a reminder, to ask a question, please press star 1. Our next question comes from Mark Gulley, Banc of America.

Mike, to the point about volume growth. We have talked about this a little bit. Does it make sense to kind of break out the voluntary discontinuances, the things that you are sluffing off as to see what the true volume growth is, or is that number so small that it doesn't really make much of a difference?

Well, the businesses that we have been getting rid of, you mean the Healthcare and the Professional Products business?

Right.

It is like about $4 million this quarter.

Okay. So that does not explain the volume shortfall then?

For U.S. CNS?

Yes, or across the board for that matter.

Short fall to what? It wasn't a short fall to us.

In terms of the slowness of the volume growth.

You mean why it wasn't faster?

Right.

I agree, it's a few tenths of a point. But again, I go back to is it as fast as we would like it? No. But are we seeing continued improvement? Yes. Do we continue to expect that the second half growth will be much better than the first half? Yeah. I mean we continue to see and expect to see steadily improving sales growth basically through our businesses.

Okay. Thank you.

Thank you. I would now like to turn the call back over to you, Mr. Monahan.

I realize it is the top of the hour, so thank you very much for all of your time and if you have further questions we will be around to answer them for you. Thank you.