藝康 (ECL) 2006 Q2 法說會逐字稿

Welcome to the Ecolab second-quarter 2006 earnings release conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). This call is being recorded. If you have any objections, you may disconnect at this time.

Now, I would like to turn the call over to Mr. Michael Monahan, Vice President, External Relations. Sir, you may begin.

Thank you and hello, everyone, and thanks for joining us. This webcast teleconference includes 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 section of our most recent Form 10-K under Item 1A, risk factors, and in our second-quarter earnings release. A copy of our earnings release is available on Ecolab's website at ecolab.com/investor.

Before we begin, I want to remind you that all of our financial results for all periods include the impact of expensing stock options. Please recall that, as part of our adoption of the option expensing standard in the fourth quarter of 2005, we restated our historical results. All prior-year numbers in our press release and this teleconference reflect those restated numbers. The restated numbers may be found in our 2005 annual report, Form 10-K, or on our website.

Starting with some highlights from the quarter, Ecolab once again delivered on its forecast, as second-quarter 2006 EPS rose 16% and was on the top end of our forecasted range. We continued to deliver strong organic sales growth, with an increase of 7%. US Institutional, Kay and Pest were particularly robust in the US, each growing double digits. Latin America and Canada also grew double digits, and we saw solid growth in Asia-Pacific.

We made further competitive gains in our business and strengthened our industry-leading position. Operating margins also showed a strong gain, given by better execution, aggressive work to grow our business and further progress on our pricing and cost-savings initiatives.

We remain optimistic about our prospects for the rest of the year. We raised the lower end of our range, and now look for EPS growth of 15 to 16%. In summary, we expect yet another terrific year for Ecolab.

Turning to the details, Ecolab's reported consolidated sales for the second quarter rose 6%. Looking at the components, volume and mix were up 5%, pricing was up 2%, currency reduced growth by a little over 1% and the impact of acquisitions was not significant. Sales for US Cleaning & Sanitizing operations increased 10%. Institutional showed another quarter of double-digit growth, as sales rose 10%. Further significant competitive gains, sales growth in the various end market segments including restaurants, lodging in travel, continued pricing and improved account penetration through the continued expansion of the 360 Degrees of Protection program benefited results.

We continue to make competitive gains as we serve additional new customers that require premium service support for their cleaning and sanitizing needs. With good momentum from its new programs, enhanced service protocols, sales force technology and training and competitive wins, the outlook for Institutional remains very attractive over the balance of the year. We expect Institutional to continue its strong performance in the second half of 2006 and into 2007.

As expected, Kay enjoyed strong second quarter, with sales up 18%, as the division compared against a soft second quarter last year. Even adjusting for that soft year-ago quarter, the business still grew double digits. QSR led the growth. Kay enjoyed good new account gains in the broader QSR market and fast casual restaurants, and benefited from more effective fuel sales coverage. QSR's underlying business remains solid, with good ongoing demand from major existing and new fast food chain accounts. The food retail business also grew, as rollouts continued with major grocers.

New products and programs continued to bolster Kay's results. We expect a good, though not as strong, third quarter from Kay and another year of double-digit growth in 2006.

Textile Care sales growth was modest at 2% in the quarter. We look for much better sales growth in the third quarter, as Textile Care benefits from another major account win. This new account should lead to strong sales growth over the next several quarters as it is rolled out. In addition, improve pricing and new products will help boost sales for Textile Care.

Professional Products sales declined 3% in the second quarter, as growth in floor care sales was offset by a soft market for non-floor care products. We continue to emphasize the retail, health care and building service contractor segments, as well as leverage the sales force impact by partnering with our Institutional Division. Differentiated products, including a line of ultra-durable floor finishes that offer improved wear resistance and reduced maintenance, continue to do well. We expect Professional Products third-quarter sales to show a modest performance as progress in corporate accounts, floor care and ultra-durable floor finish offerings serve to drive sales.

Second-quarter sales for the Health Care Division were about flat. Sales continue to reflect the unfavorable impact of a large distributor order in the fourth quarter. Actual end-user demand continues to grow near double digits. It looks like the effect of that distributor order finally worked through the system in the second quarter, and there may have been some additional net inventory reduction as well. That inventory reduction, along with delays in new contracts, caused the flat sales.

End-user sales of instrument care solids, as well as waterless skin care products, continue to be robust. We're also continuing to achieve good penetration within our existing base of group purchasing organizations and integrated delivery networks that are critical to Health Care sales and our distribution.

We have seen increasing traction with our differentiated new product introductions, which include Endure 450 and Aseptizyme Multi. These new products have shown strong sales trends, and will help further broaden our product offerings in skin care, simple sterile and medical device cleaning and disinfection. Looking ahead, we expect good growth in the third quarter, as the fundamental Health Care business outlook remains robust.

Water Care sales rose 5% in the second quarter. We experienced double-digit growth in the food and beverage market, as we leverage cross-selling opportunities. This more than offset slow industrial markets. We expect our continued focus on leveraging our Circle the Customer strategy will help bolster growth for the full year 2006.

Food & Beverage sales increased 6% in the second quarter, led by strong performances in the dairy, plant, food and meat and poultry segments. Focused investment in the Sanova antimicrobial food surface treatment line continues to provide solid growth in the meat and poultry market. Ecolab is committed to building on its market leadership position in the meat and poultry industry and growing sales through broadening our antimicrobial offering. Corporate account wins, account penetration and new products have contributed to very good dairy plant sales growth.

The Agri, Beverage & Food businesses also saw good growth, reflecting new account sales and the strength of our corporate account relationships. We expect the leveraging of our market leadership in meat and poultry as well as dairy, food and beverage, to continue our sales momentum in the third quarter of 2006 as we focus on new account acquisition and expansion of the Sanova platform.

Vehicle Care sales grew 10%, comparing against a strong quarter last year, as new product sales and increased pricing drove results. With its focus on winning new business, upgrading its sales force, leveraging new products and utilizing our Circle the Customer strategy, Vehicle Care expects good sales growth in the third quarter.

Sales for US Other Services increased 9% in the second quarter. Pest Elimination sales continue to show strong growth, rising 13%. Business fundamentals are solid. New account activity remains strong, driven by good corporate account gains in field sales.

Field service associates also boosted results by driving non-contract service growth. Programs tailored for specific markets like limited service hospitality have provided better customer penetration and new growth opportunities for Pest Elimination. We expect Pest Elimination to continue its double-digit growth trend in 2006.

GCS sales rose 1%. Our primary focus remains on the systems and process infrastructure investments that will drive competitive advantage and profitability in 2007. We are making good progress on those improvements.

Customer interest continues to be good. The sales pipeline looks healthy, and we are adding to our sales team. Sales reflect the longer sales cycle encountered with large accounts. The number of customers in trial increased, and no trials were lost. But final decisions have taken time, as this is the first notional program in equipment repair for these companies.

Key operating measures, including customer satisfaction ratings and technician productivity, also continue to show that we are delivering effectively. The software upgrade to accelerate GCS's development and profitability, which involved the integration of several systems into one, and adding additional capabilities to support scalable growth and improved profitability, is moving forward on its accelerated plan and should be implemented in mid-2007. We remain confident in the GCS business proposition, in our work to improve its operations and in our outlook to achieve attractive and profitable growth.

Measured in fixed currencies, international sales increased 5%. The Europe, Middle East and Africa sales rose 3% in the second quarter at fixed currency rates. When reported in US dollars, sales were down 1%. Good sales gains in Northern and Eastern Europe were offset by lackluster German, French and Italian economies.

Europe's institutional sales grew modestly, as new accounts, good sales through foodservice distributors and strong gains in housekeeping more than offset soft consumption in the major countries. Sales initiatives toward street accounts and an expanding program with foodservice distributors are working to offset the impact of slower economies and reduced tourism. By the way, the World Cup represented a modest plus in volume for us that is spread between the second and third quarters.

Food & Beverage reported a good gain, as growth in the beverage and food areas were offset by soft dairy and agri sales. Textile Care sales again showed strong growth. Good customer gains and sales of award-winning water and energy-conserving technology drove the higher sales.

Professional Products sales declined. Good gains with major customers in new programs were more than offset by further reductions from consolidation among building service contractors and smaller accounts.

Health Care sales showed a good gain, led by strong growth in contamination control and long-term care and increased sales of instruments, surface and skin disinfection products. These helped to offset continued health care strikes in Germany.

You may have also seen that we recently acquired Shield, a UK-based manufacturer and marketer of contamination control products used in pharmaceutical, medical device and hospital clean rooms in the UK and Europe. It has annual sales of approximately $19 million. The acquisition was effective beginning in our third quarter.

The European Pest Elimination business continued to show good growth in its contract business, though this was partially offset by lower one-shot business.

We continue to improve market share in the UK. We have also begun to roll out our MarketGuard program in the UK, which will help our Circle the Customer effort in food retail.

The French Pest Elimination operation also continues to move forward. Like the UK, new contract growth is showing good trends, and we have introduced new programs including EcoPro for food and beverage. In addition, we are developing a strengthened sales force with more effective selling tools. We look for Europe's third quarter of fixed currency sales to continue to show moderate growth, as sales and product initiatives, along with more field sales and service associates, work to leverage a modest improvement in major European economies.

Asia-Pacific sales grew a robust 8% in fixed currencies, as growth in Australia and East Asia drove the results. When reported in US dollars, sales increased 3%.

From a divisional prospective, Institutional sales were driven new products, including Wash n' Walk, and by growth in the MarketGuard program for retail stores. We achieved important account wins in chain restaurants and hotels, as well as food retail markets, and benefited from a focus on independent restaurant accounts.

Food & Beverage also reported a strong increased. Both the beverage and brewery sectors continued to show good growth. The Food & Beverage Division overall has benefited from increased product penetration and account gains. With good momentum throughout the region, we expect solid growth trends to continue in the third quarter for the Asia-Pacific region.

Second-quarter sales for Ecolab's Canadian operations grew a strong 10% in fixed currency, and were up 20% in US dollars. Institutional sales measured in fixed currency were strong, resulting from corporate account gains and new product sales. Food & Beverage sales also improved.

Latin America reported another double-digit sales gain, rising 11% at fixed exchange rates. When measured in US dollars, sales rose 18%. Results were good throughout the region. Institutional growth was driven by new account gains, increased product penetration, as well as continued success with global accounts. Strong tourism markets in countries such as the Caribbean and Central America also helped drive excellent results. Food & Beverage sales reflected strong demand in the beverage and brewery markets, as well as the benefits of new products. Pest Elimination continues its outstanding performance throughout Latin America, recording another double-digit gain for the quarter. Overall, we expect healthy growth trends to continue in Latin America throughout 2006.

Turning to the expense side of the income statement, the second-quarter gross margins were 50.4%, 30 basis points below last year. We continue to benefit from pricing and cost-savings initiatives which more than offset the continued delivered product cost increases. However, new customer installations resulted in lower margins.

While we still expect raw material costs to increase through 2006 and perhaps 2007, we expect the year-on-year increase in raws to be lower than experienced in 2005. We will stay aggressive on our pricing, cost reduction and business simplification actions, and expect gross margins to show year-over-year improvement in the third quarter and second half of 2006.

SG&A expenses were 37.9% of net sales, a decline of 90 basis points from last year's 38.8%. The SG&A ratio improved primarily due to our pricing, cost-savings initiatives and leveraging our strong organic sales growth, which more than offset the investments we're making in the business, including sales and service headcount, R&D and information technology.

Ecolab's US Cleaning & Sanitizing segment operating income increased 19%, driven by higher sales, increased pricing and improved cost efficiencies. These served to more than offset higher delivered product costs, investments in the business and a charge related to a licensing agreement.

Operating income for the US Other Services increased 3%. Continued strong growth at Pest Elimination was offset by a regulatory expense at Pest, as well as accelerated investments and slower-than-expected sales in GCS.

International's fixed currency operating income increased 5%. Sales growth, pricing initiatives and cost efficiencies outpaced higher delivered product costs and business investments.

Ecolab's second-quarter consolidated tax rate was 34.4% compared with 35.4% a year ago. The second-quarter 2006 tax rate includes a $1.8 million benefit from a tax settlement related to stewardship costs. Excluding that benefit, the tax rate was 35.7% in the second quarter of 2006. We expect the effective income tax rate will be in the lower end of the 35% to 36% range for the full year 2006.

We repurchased 2.9 million shares during the second quarter under our share repurchase program, as we worked toward better leverage on our balance sheet. The net of this activity was that diluted net income per share for the second quarter was $0.36, up 16% over the $0.31 earned a year ago.

Please note that for EPS, in terms of quality of earnings, the $1.8 million benefit from the tax settlement mentioned earlier was offset by the charge for the licensing agreement in the US Cleaning & Sanitizing segment. The net impact of these two items was neutral on second-quarter EPS.

Looking at the balance sheet, Ecolab's total debt to total capitalization ended the quarter at 32%, down slightly from the 33% recorded a year ago. Net debt was 29%, the same as last year. Depreciation was $60 million in the quarter, and amortization was $8 million. Capital spending for the quarter was $79 million.

That's a review of the second quarter. In summary, Ecolab delivered another double-digit EPS gain, quite an achievement considering the continuing difficult environments in raw materials and global oil prices. Our strong performance was the result of excellent growth and competitive gains in our US, Canadian, Asia-Pacific and Latin America businesses. Our operating margins rose in the quarter, as leverage from our strong topline growth, cost savings actions and pricing offset rising delivered product costs.

We also continued to make ongoing investments in our sales and service force, and double-digit investments in our R&D, technology and other key areas, to sustain our future growth. It was another great performance that showed the resilience of Ecolab to unfavorable economies and markets. We are very proud of the associates who worked so hard to make it happen.

Looking to the third quarter of 2006, we begin by cautioning these statements are based on current expectations. These statements are forward-looking, and actual results may differ materially. These statements do not include the potential impact of business acquisitions, divestitures, higher-than-anticipated raw material price increases or other material events that may occur after the date of this webcast. This business outlook section should be considered in conjunction with the information on forward-looking statements in our press release and Form 10-K, which lists risk factors that may cause results to differ.

In the third quarter, we look for US operations to show continued solid momentum. We expect strong sales growth from Institutional and steady gains from our other domestic businesses to deliver solid sales growth in the US. We look for International growth to again be led by strong Latin America and Asia-Pacific results, with moderate gains in Europe. We believe this will result in overall steady International growth in fixed currencies.

Gross margins should show sequential and year-over-year improvement and approximately 51% -- barring, of course, a repeat of the extraordinary market conditions for input costs we saw in last year's second half.

We look for earnings per share for the third quarter to be in the $0.42 to $0.43 range and compare against the $0.38 earned last year. For the full year, we raised the lower end of our range by $0.01, and now look for earnings in the range of $1.41 to $1.43. We think we will achieve another strong year of earnings growth in 2006, and if we get additional earnings strength, we will be able to use it to further invest in our business for the future.

That concludes our remarks. This conference call will be available for replay on our website through August 4. Operator, please begin the question-and-answer period.

(OPERATOR INSTRUCTIONS). David Begleiter, Deutsche Bank.

How much of the JD business have you picked up so far? Is your estimate of, I think, 7% capture still the right estimate going forward for the business that has been walked away from by JD?

As you know, we don't disclose competitive gains. We have previously said we get a large portion of the JD business, which we estimate to be around $150 million in sales, but potential opportunity for us in total, with Circle the Customer, may be $600 million. We think that we will still gain a large portion of that, and we are well on our way already. But we're not going to disclose specific numbers to that.

In the quarter, GCS -- how much did GCS actually lose in the quarter?

GCS loss in the quarter was about $3 million. Part of that is the investments in the systems work. Part of that is from operations.

What is your current forecast of GCS becoming profitable?

We have not said anything about profitability. Clearly, we look at the investments we are making right now to be completed in the first half of 2007. At that time, we think that we will be ready to go with the business, and so profitability should follow thereafter.

Rosemarie Morbelli, Ingalls & Snyder.

Going back to David's question, I understand that you won't give us how much you got from the diversity business. But can you give us a feel in terms of the new accounts, percentagewise, how much was from your accounts you have in -- which were not part of Diversey?

Well, what we have said is that for Institutional, we are probably growing at around 7%, 8%, their traditional growth, and we are getting the rest from JohnsonDiversey.

Do you mind -- you speak so fast that I missed some of those numbers. Can you remind me of how much Institution was up this quarter?

Institution was up 10%.

You are increasing pricing in medical care. How elastic is the pricing in that category? There are parts in New York when you can get a car washed for $5. I don't know if it goes to $8, whether as many people would do it, and I don't know what it is like in the rest of the country. Can you enlighten me?

I really can't speak to the elasticity of consumer demand for vehicle wash. In terms of our markets, we continue to price effectively and competitively for the value that we produce. For example, we have a new Rain-X product which provides great value for the car wash operators. That is something that we can certainly obtain a good margin on. But again, I can't speak to consumer elasticity on pricing for it, the actual car wash they pay for.

What do you mean by good value for the operator?

Well, that it's a product for which they can obtain a good margin. They can price it well.

You made a comment regarding Europe and the fact that you are trying to build -- well, maybe I am adding "trying." You are building a similar sales force to that of the United States. But you're dealing with different countries, you are dealing with different personality, temperaments and so on, not only in Europe overall, but in each of the European countries. How can you be so sure that you can actually obtain the same results there that you do here, and approach the market the same way? So far, it doesn't seem to really be working.

Well, to start with, in Europe, that you've got some countries that are showing some very slow growth and have been for a number of years. As we've said, if you look at Germany, it's our largest country, and that has shown very slow growth for the last several years. France and Italy have also shown slow growth, so part of it is the economies there are not growing fast.

If we look at what we're doing around the world, you'll find, I think, that, number one, the Ecolab culture of hiring and training and being aggressive in the marketplace is very common. Number two is incentive pay is very important to them.

But clearly, if you have got economies that are going no place, it's tough to work against those. For example, in Germany and Europe, we believe and from the numbers we see, we're gaining share and growing faster than the markets themselves. Right now, if you look at the GDPs in Germany, it's pretty well export-led right now; it's not really consumption. Consumption is not really moving there. Part of that is because of unemployment. As you see, unemployment rates are around the double-digit levels for those three major countries.

Right, but it seems to me as though, on the health care -- well, that is not really consumption. Restaurants are probably still packed, and you have quite a bit of tourism. There are many [areas tests]. If you have roaches floating around your apartment or building, you are going to do something about it.

Which are the markets that you are serving which are really hit by -- affected by consumption? Because you usually talk about the US, and claim that you actually are not really that much affected by the economy here. So what is different?

Well, for example, in Health Care, Health Care was strong in the quarter despite health care strikes in Germany. In terms of the Institutional business, it has continued to grow against what we believe are declines in consumption in Germany. So we say that we can outperform economies. I don't think that we have ever said we are immune to economies. We believe that in Europe we can continue to grow the business just as we have, outpacing the trends there.

Clearly, there is more development work that we want to do in Europe with the sales and service force to develop them as we have in the US. Remember that we have had 80 years with our US sales and service force; with Europe, we have only had them really on our own for the last four years. So there's still work that can be done.

I don't want to diminish anything that is being done with the sales and service force in Europe, because we think they are working awfully hard. We think there's more training and things we can do with them. But there are some fundamental differences in the makeup of the markets and the performance of those markets that they are dealing with.

Could you give us a little more detail on the licensing agreement and the regulatory expense within Pest or related to Pest?

Sure. Regarding the licensing agreement, in conversations -- for example, some investors have said the same thing, too. But as we look at our business, we have been encouraged to leverage some of our technology base and expand our market opportunities. We have sought some licensing agreements with third parties. These are small ventures and fairly low-profile, and we have a few of them. We simply decided to end one of them, and took a charge to reflect that. Since the negotiations are still in process and because of competitive reasons, we really can't disclose much further than that.

Regarding the regulatory expense, Pest Elimination, as you know, is subject to various regulations across the states, since we apply pesticide. This matter relates to a supervisory issue relative to application procedures in one particular state. We believe our general procedures are sound, and we are working with the regulators to determine if any changes are needed. We took the reserve in the quarter on the issues of precaution in case of a financial penalty.

Laurence Alexander, Jefferies.

On GCS, when you look at the longer selling cycle due to your larger customers, do you have a sense -- or once you start winning accounts, how GCS might ramp up?

Yes. Well, I think you have got a business with a lot of operating leverage in it. So I think that as you start to ramp up the sales, you'll see the margins and profitability ramp up pretty quickly.

That's what I mean. Do you have any sense for, if you did win one of the large accounts, how large that would be as an incremental unit of sales?

Well, it all depends on the account that we would be winning. But we are looking at accounts that would be, certainly, material.

Do you have any opportunity through --?

Yes, we could hit double-digit growth with one or two of those that would hit.

Do you have any opportunity to reduce your tax rate over the next few years as your International operations expand?

Well, as you know, our tax rates are kind of limited in the sense that we produce in the countries that we manufacture, so we are not able to take advantage of low tax environments. So, as we go forward, we will continue to look at opportunities to raise taxes. But there's not the opportunity that some countries have, let's say, in putting all your manufacturing in Ireland or someplace like that to have radical reductions in rates. So we will continue to look at it and continue to work it down, but I don't know that you'll see any major decreases in the tax rate.

Your balance sheet is in the best shape in years. M&A activity has been fairly quiet the last six months there. What's your sense in terms of M&A outlook going forward? If (technical difficulty) M&A, do you want to accelerate the pace of share buybacks above the 3 million you did this quarter?

Well, as you know, we just closed on the Shield acquisition in Europe. As Doug said in the last call, we expect to have a much more active second half. We have got a number of things in the pipeline, and based on the process that we are in with all of those people, we think that we will be closing some soon. So at this point, we expect to be making a lot of investments in acquisitions in the second half.

Obviously, as we've said before, that if we have excess cash as we look at the balance sheet in terms of leverage, we will use share repurchase to our advantage. But at this point, we would like to focus our cash on acquisitions.

Michel Morin, Merrill Lynch.

I was wondering if you could -- maybe I missed it, but did you give the actual numbers, in terms of the licensing agreement charge and the pest regulatory charge?

I did not. The pest charge was about $0.5 million, and the regulatory charge was just under $3 million.

Sorry, the last one is the licensing one?

The licensing was just under $3 million.

Where do those flow in the P&L? Is that all in SG&A?

Yes.

I was a bit surprised to see the gross margin. I think on the last call, the tone was also pretty upbeat, maybe comparable to what you just mentioned about the outlook for the third quarter. I think in your prepared remarks, you mentioned something about installation charges. Could you add a bit of color as to what happened there?

That relates to a number of the accounts that we have picked up and equipment installations that we have made into those. Also, clearly during the quarter we had some increases in fuel costs, et cetera. So that has an impact on us. So in the whole mix of things, as we said, our pricing and cost savings offset the delivered product costs. But there are some moving products within those that have an impact as well as, like I say, the increase in installations we are making because of the competitive wins.

Is there any change to the raw material trends that you have been talking about? Kind of mid-single-digit growth is kind of what you would expect, in terms of higher costs this year?

Yes, exactly. There's really no change in what we are looking for, for the full year.

Edward Yang, CIBC World Markets.

Following up on the questions on JDI, I thought the multiple for Circle the Customer was three times over the $450 million for the total Diversey opportunity. I think you said $600 million in this call. Is this an increase?

No, we said four times before.

Second, you chatted a bit about the Company's very [consistent] growth, and you have been with Ecolab basically forever and probably have seen a lot of different cycles. When you think about the different reasons for the resilience, is it basically your end markets are growing? Is it market share gain? Is it cross-selling? When things to start to slow, are there any sort of specific levers that you pull to get that 15% EPS growth?

Well, I think it starts with, just as you said, the end markets themselves are stable growth markets, if we look at the food service, if we look at health care, you look at education. Those tend to be very stable, steady growth markets. Even the lodging market, if we look at that in terms of room demand, it doesn't change that much. That's what really drives our business.

But within that, we have got a lot of opportunities to pick up market share within our markets, which we have done. As I think Doug said before, that in good times we go after new markets. In tough times, we go after market share in the markets that we are already in.

Further, we have got a lot of margin opportunities. As you have seen, we have got margin opportunities in terms of scale growth internationally. For the rest of the business, we're pursuing business simplification and improved efficiency through the Lean/Six Sigma. So the way we look at it is we have got a lot of top-line and bottom-line levers that will enable us to grow in tough times, just as we have in past recessions and in past slowdowns.

Bruce Simpson, William Blair.

Looking at the US Institutional business, what is the rate of growth of headcounts for the TMs there?

We expect to be up 4% or 5% this year.

Is it considerably less than that for Institutional around the world?

I don't have a number for Institutional outside the US. We operate pretty much regionally.

What's the focus on new account growth within that segment? Are you focusing more on street accounts and indies, these days, or it's primarily still big chains?

In institutional?

Yes.

Well, right now, we are focused on the JohnsonDiversey change and going after accounts there. But secondly, we continue to pursue chains, primarily penetration of chains as well as street accounts.

So it's really a mix of both, rather than one or the other?

Yes, exactly. (Multiple speakers) either way.

On the pricing dynamic in the United States Institutional market, are we seeing a positive spot on the seesaw, where now the year-over-year increase in raw prices has moderated, but you are beginning to add on full-year impact of more and more price increases as you push through to your customer?

Yes, particularly in Institutional. But as we have said, last year we got maybe about $45 million worth of pricing. (Indiscernible) $70 million worth of pricing. This year, we expect to get more like $90 million. So we are getting incrementally more pricing this year than last.

Is that simply a function of the full-year impact, or are you continuing to raise prices in 2006?

No, we continue to raise prices.

Is it kind of a discrete price increase like last year, in terms of offsetting raws, or is it more just bundled into the relationship and price of your new product introductions?

It's the latter. Remember that we're approaching every customer with every contract separately, and we are working with that customer on the pricing. So it's very specific to the customer.

The last thing is a little bit of color on GCS -- you guys were quite consistent in your message in 2005 about reaching breakeven profitability in that business at the end of 2005, which you did. I realize that it's important to pour more money into consolidation of IT systems and so forth. But half a year after that, is it a disappointment, not just the rate of sales growth and the wins rate, but rather the fact that it is still costing you $3 million a year to bring that up to where you want it to be? Or was that kind of all in the plan, all the way along?

Well, the first thing is as we approached the end of 2005, we felt confident enough about the business that we decided to accelerate investments. We had planned, really, for 2007. We pulled them into 2006, because we wanted to get the business as efficient and productive as we can, because we wanted to scale up the business as we go forward. So we wanted to make those investments early. So we accelerated a bunch of investments into 2006.

The second thing is, obviously, when we adopted the option expensing, that had an impact on GCS as well that was not included when we talked about a 2006 profitability. So those are two primary factors. And yes, to some extent, the sales cycle has been a little slower. But I'd say the bigger thing is we pulled the investments in a year earlier.

So, given that the sales pace there in 2006 has really been fairly slow, what was it that was encouraging that made you want to accelerate the investments 2007 into 2006? Is it just progress elsewhere in operational efficiency and customer satisfaction, or --?

No, it's more a customer response. What we have seen is customers indicate a lot of interest in the business. As I said, we continue to increase the number of trials. We haven't lost a trial. Trials have been increasing. Customer satisfaction has been running in the 94%, 95% range. So all the signs are there, but remember that for a lot of these customers, while they may buy cleaning products, et cetera, nationally or globally, et cetera, they have never really bought equipment repair nationally or globally. It's kind of a local purchase.

So, while at corporate we are finding that people say, "Hey, this is a great deal; we really want to go for it," we are finding that a lot of their unit people, et cetera, are kind of resistant to change in this respect. So we think the economics are going to win out here. As we continue to expand these tests and people get more familiar with it and comfortable with it, we will start making the sales hits as we go forward.

So for us, would we like faster sales growth? Absolutely. Do we have any diminishment in our confidence and optimism regarding GCS? Absolutely not. That is underscored, like I said, by the fact that we haven't lost a trial. Trials expand and continue, so we're confident we will start collecting some sales soon.

Despite the server consolidation or the European system consolidation, you guys are actively out there marketing it hard now, right?

Yes. In fact, we --

It's not as if you're kind of holding it in reserve for some achievement?

Yes, in fact, we increased our sales force. So we're out there doing it, and we're going to be doing more.

P.J. Juvekar, Citigroup.

Can you give us the number of salespeople you have right now? Was it close to 13,000?

Yes, it is. Right now, we have got a little over 13,000 people.

How many of those are in the US versus international?

US is almost 7,000.

So roughly half of them are outside the US?

Yes.

And water treatment -- how big is that business for you? I know you had hired some people from Nalco. Is that going to be a growth area going forward for you?

Yes, the business is around $50 million in size. It's one of the areas that we focus on going forward. We just made an acquisition a year ago, Midland. So it's clearly an area that we're investing in and want to grow in the future.

So in terms of acquisitions, what are you looking at in that area? Just going to do this small --?

Well, as you know, we're focused on the middle market, first of all. We are not focused on heavy or --

The industrial market?

-- or municipal. We're looking at expanding in the US and globally.

Dmitry Silversteyn, Longbow Research.

A lot of my questions have been answered already. I don't want to beat the dead horse here, but do you have a new timetable for getting the GCS business back to breakeven, given the investments you're making, as well as smaller revenue growth for a longer sales cycle?

Twice burned, once shy. We haven't made a forecast for GCS profitability. As we said, we expect the investments to be completed in the first half of 2007, and that after that, we expect as the sales click in and we are able to get up to scale, that we will get profitability soon thereafter. But we have not set a timeframe.

So would it be fair to say that for the next 12 months, at least -- or three, four quarters -- you are going to be bouncing along at some single-digit millions of dollars a quarter loss in that business?

I don't think we're going to reach profitability before the second quarter of next year.

That answers the question.

Secondly, on Water Care growth, it was lumpy last year. But if you strip out the acquisition that you made, it was still kind of mid single digits. The lumpiness has returned in this business, apparently. At what point do you have to reach in the scale of this business for this to be operating more like your more mature businesses? And when do you think it can get there?

Well, part of it is some of the business got damaged in the hurricanes last year. Part of Midland's business is a sugar business, which was kind of wiped out by the hurricanes. So they had that kind of taken away from them.

But obviously, a $50 million business with a national footprint is not as big as we would like it. So I think we would like to see a business larger than this, and that is part of our acquisition efforts.

Is it a profitable business at this scale?

Yes.

We've heard some companies on these conference calls here in the second quarter very cryptically mention some signs of a slowdown in one market or the other, or the general North American market condition. I know you are not as sensitive to it as some of the more industrial names, but are you seeing any indication that business conditions are slowing down in North America?

No. First of all, we tend to lag the economy, so I don't think we would be someone who would see it first. But there's nothing that we've seen -- our business continues to be pretty steady, good across the board.

On the share authorization, how much do you still have left outstanding?

I think it's around 5 million shares.

So at the pace you're going, probably by the end of the year it will be run through?

If we continue at this pace. But as we have said, we're continuing to evaluate it on an ongoing basis, what our share repurchase will be. If we see acquisitions heat up again, you will probably see us slow down.

John Roberts, Buckingham.

There were two areas you talked about slowing. I just wanted to probe them in a little bit more detail. I think you said in Water Care, the Industrial side was slow. I think you said in Professional Products, non-floor was slow. Neither is individually large, but what are the trends going on there?

Well, in Professional Products, we're focusing more on the direct side, corporate account sales, rather than through distributors. So I think you're seeing the effects of that focus. As we pay attention more to the direct side and focus our energies on that and not so much on distributor, that has kind of slowed down.

In terms of the Water Care, again, it's a $50 million business. A small piece of business can have a big effect on that. I think that's an area that we continue to be very optimistic about, and look for good growth ahead. I think it was mentioned in one of the earlier questions -- it has had some pretty good growth. It's going to bounce around a little bit, but we expect that it will continue to do good growth going forward. So we expect better growth in the second half for Water Care.

John McNulty, Credit Suisse.

In terms of International margins, I know you guys have been trying to and expecting to kind of close the gap between the US margins and International at a rate of -- if I remember correctly -- around 50 basis points a year. This past quarter, obviously, there was not a whole lot of progress made there. I'm wondering what we should be expecting for the rest of the year? Given that Europe actually is starting to see at least a little bit of a turnaround in terms of the economy, I would have thought you could even do better between that and the World Cup and the type of thing.

Well, right. In terms of the Europe turnaround, as we said, a lot of that has been export-driven. So that hasn't translated into consumption yet. We think it will, certainly, as we go forward.

The second thing is, on the 50 BPS per year -- that's an objective that we have. Some years we have beaten it, some years we haven't. So, in terms of this year, we would be looking for International margins to improve in the second half.

When you look at the JohnsonDiversey business that is out there, I know originally, when the news first kind of came that they were exiting parts of the US business, the target for you guys was not necessarily just that US business, but you were hoping to really kind of push it internationally as well. I'm wondering if you have made any headway there or any that you can see at this point?

Well, as we said, the US business was kind of this year's focus. I think the International business, the global business, is going to be a longer-term result for us. That is what we have tried to stress, is that this is not just a one-year phenomenon, this is a multiyear phenomenon for us. We think that the value proposition we can bring to customers in terms of the superior service in products, and also the global coverage that we can provide them, is something that will be very appealing to non-US chains, non-US-based chains. So we think that's a long-term growth thing. So multiple years.

Have you seen JohnsonDiversey dig in a little tighter with the European business or their international business at this point, just because they have -- that is kind of what they have got left at this point? Or is it still kind of business as usual that you (multiple speakers)?

I have not heard any reports of that.

I know you guys have been kind of gradually working on an SKU reduction program. Can you give us update on that at this point?

Yes, we're continuing to make progress on that. In terms of numbers, I think we are about 10% of the way along in our efforts and (indiscernible). But I think the bigger hits are going to be coming forward in the next couple of years. It's not something you can just go out and slash it. You have got to make sure that these are products that the customers can use, the products you end up with, that you've got formulations that are applicable across all of Europe, not just in particular countries. This is something the sales force -- you have got to get a lot of agreement buy-in from a lot of areas and make sure it's the right thing. So you want to be careful upfront. It's kind of like the analogy "measure twice, cut once" in carpentry applies here as well.

Bob Koort, Goldman Sachs.

Hi, this is Amy Zhang sitting in for Bob. First question on QSR side -- I noted that QSR was particularly strong in this quarter. Can you just provide some color on the primary driver for that business momentum, and whether your guys benefit from some easier comps from last year, and also, how sustainable we can expect this trend to be going forward?

Well, as we always said, that Kay's sustainable growth rate is somewhere in the 8% to 10% range. So it's been clicking above there for a few years. In terms of -- there was somewhat of an easier comparison this year, in this quarter. But it still grows double digits, nonetheless, even when you adjust for that.

When we look at the customer base, we're involved with the big three, and they are doing very well. We just saw McDonald's had some really great results, and Yum! and BK are doing well. So we're enjoying good business with the big three, as well as the next tier of 15 QSRs. So they are all doing very well. We have got some great new products. We're introducing dispense systems, which are high-value to the customers and good business for us.

So I think it's the same old thing, that you're involved with the right customers with the right products that add value to them. We are have been able to enjoy success through that.

Given that you guys also have some exposure to the mid-end or high-end restaurants, and if people are sort of concerned a little bit about the consumer spending slowdown, probably the mid-end and the high-end restaurant industry will get some impact from that. Going forward, do you expect [to keep] accelerating growth in Kay, kind of sort of like partially or fully [outside] the slowdown, probably other, either the high end or mid end of the restaurant market?

Well, we have seen cycles all over the place, over time. That's the advantage of Ecolab, is that we cover the full range, from five-star restaurants down to ballpark counters. So, to us, it's all good business.

When we look at the cycles, yes, it's not uncommon to have people downscale. But, to that end, the white tablecloth, the high-end stuff, is a very small part of the market. Casual dining is far more significant, a larger piece of the market. That continues to grow very nicely. According to the data that we look at, full-service restaurants should continue to grow at a 6%, 7% rate over the next couple of years.

So we are pretty confident that in the sweet spot of the market, the casual dining, et cetera, that we are in a good place. In the QSR, we have got a very strong position and we will enjoy good growth there.

And my next question is sort of like a follow-up regarding the acquisition site. If I look at the first half of this year, basically there is no [material] impact on the top line from acquisition. So I just wonder, what was your expectation, the full-year contribution from acquisitions to top-line growth?

Well, the reason there is not much on the top line, as we have said, was 2005 was a slower-than-hoped-for year for acquisitions. In terms of what we expect for this year, certainly a lot more. But it all depends on what we get closed this year.

Then for the acquisitions charge, you guys sort of like focused more on the former JDI business in the US? Or [spaces] are pretty open to any good opportunities, worldwide?

Well, what we have always said is that we are looking for three fundamental areas -- new services, new technologies or global expansion of what we have. So those are the three areas that we will look for. We have identified Pest Elimination as a specific area. We have identified Health Care and Water Care as specific areas as well.

On the gross margin trends, I noticed that you guys guided probably flat margin (indiscernible) gross margin performance in third quarter 2006. Going forward, for the fourth quarter 2006, do you guys expect any raw materials relief on the horizon for that quarter, and then that can give you some actual benefit to drive the higher gross margin year over year?

No, we are still looking for cost of sales to be higher. We think that the rate of increase will be declining as we go through the year, but we still expect fourth-quarter raw materials to be higher than a year ago.

No, but I sort of --

But gross margins will be higher in the second half (multiple speakers) our pricing offsets those raw materials.

Michel Morin, Merrill Lynch.

Specifically on Europe and the margins there, are they up year on year in the second quarter?

Europe margins were flat in the second quarter.

They are flat? But your comment about the gold being a 50 basis points kind of per year -- that's still kind of -- the expectation is that there should still be some improvement on a full-year basis, probably?

Yes.

Even if it's not exactly that number?

Yes.

In terms of the guidance, how much M&A is baked into that?

Into M&A guidance for margins?

Well, no. In terms of your guidance for the full year, is there any M&A included in there? Are you assuming some acquisitions will be closed in the second half?

No, there isn't. But it really doesn't have much impact on EPS in the first few months or maybe first [few year] of an acquisition. So there's really none that's effectively baked into the number.

Laurence Alexander, Jefferies.

A question on the core institutional business. If you exclude any sort of investments in your new platforms or in new growth areas such as Pest Elimination or any new, nascent platforms, what levers do you have to pull to improve sales force productivity and returns on capital going forward? Or is it more a matter of growing just the number of sales people you have and then leveraging the incremental person as opposed to improving the productivity of the existing sales force?

Well, what we are looking at is more platforms, more innovation, leveraging the technology that we have. For example, the tablet PCs -- as you know, we have only scratched the surface on the productivity we can get out of that. Better penetration of customers is going to give us better productivity on the sales call through the 360 Degree program. So we see a lot of opportunity there for improvement in our sales force productivity, as well as the returns on capital that we're going to have.

Do you have any internal targets that are tied to sales force compensation that would help drive that?

To improving productivity?

No, to improving returns on capital in the core business rather than on the new platforms.

Yes, we do.

Can you discuss that in any detail?

Well, it's implicit, I think, in all of the compensation for our people, in the fact that all their bonus has not only a sales component but also an OI and EPS component. So as they improve OI, they are going to be improving return on capital.

The last thing is capital tends to be, for the field, driven at very close to the field level, the district manager level. For those guys, they are seeing very closely what the capital needs are in every account. Since that is part of their budget, they have got a tight rein on that as well.

(OPERATOR INSTRUCTIONS).

If there's no more questions, thank you very much for your time and have a great day.

This concludes today's conference. You may disconnect at this time.