藝康 (ECL) 2008 Q2 法說會逐字稿

Welcome to the Ecolab second quarter 2008 earnings release conference call. (OPERATOR INSTRUCTIONS) This conference is being recorded. If you have any objections you may disconnect at this time. I would now like to turn the call over to Mr. Michael Monahan, Vice President External Relations. Sir, you may begin.

Thank you. Hello, everyone. Welcome to Ecolab's second quarter conference call. With me today is Doug Baker, Ecolab's Chairman, President and CEO, who will join us for the Q&A section following our review of the quarter's results. A copy of our earnings release and the slides referenced in this teleconference are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statement on Slide Two stating this teleconference and the slides include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Factors are described in the section of our most recent Form 10-K under item 1A, risk factors, in our second quarter earnings release and in Slide Two.

Starting with Slide Three. In the second quarter we achieved a strong performance despite challenging conditions in certain end markets and sizable increases in delivered product costs. As we continued to aggressively drive sales, new account gains, cost reductions and pricing to deliver double-digit earnings growth while still making the key investments to continue our growth for the future. Our outlook remains strong for the third quarter, full-year 2008, and the foreseeable future.

Starting with some highlights from the quarter in Slide Four, reported second quarter 2008 EPS increased 25%, reaching $0.55. Pro forma earnings per share, which excludes special gains and charges and discrete tax events, rose 12% to $0.47, hitting the top end of our forecasted range. We also note that these second quarter earnings include dilution from the Microtek and Ecovation acquisitions of approximately $0.02 per share. We once again enjoyed strong organic earnings growth. Organic growth more than offset higher delivered product costs while exchange and tax also benefited earnings. This overall strength helped fund our investments in Europe and acquisitions.

In the US, we continue to show strong sales trends from our Kay, healthcare, food and beverage, and textile care businesses, while institutional reflected slower trends in the markets. International also showed good sales gains as Latin America rose double digits, Asia-Pacific showed a good increase, and Europe reported moderate growth. The US food service and hospitality markets, representing one-quarter of our business have softened, reflecting headwinds from the economic slow down. In response, we continue to focus on aggressive sales efforts, emphasizing innovative products that provide customers with labor, energy, and water savings.

In addition, we have undertaken productivity and efficiency improvements, cost-reduction actions, increased pricing, and fuel charges to recover the increased raw material costs and to continue to drive our bottom line performance. Despite the challenges, we are confident in our action plan and are, therefore, raising the bottom end of our forecast range by $0.01and now look for full-year pro forma diluted earnings per share which excludes special gains and charges and discrete tax items to be in the $1.85 to $1.88 range. These results will include about $0.04 of dilution from the Microtek and Ecovation acquisitions for the year, which is $0.02 per share higher than previously forecast. Pro forma earnings, excluding net dilution, are now expected to rise 14% to 16% to $1.89 to $1.92 per share, slightly above our previous forecast.

For the third quarter, we expect pro forma EPS to be in the $0.53 to $0.55 range. These results will include $0.02 of dilution from acquisitions. In summary, we continue to expect yet another superior performance for Ecolab in a challenging 2008 environment as we leverage our markets with aggressive sales, appropriate pricing, and cost efficiency actions to deliver very attractive growth and shelter returns while continuing to build for future growth.

Turning to the details, as shown in Slide Five. Ecolab's reported consolidated sales for the second quarter rose 15%. Looking at the components, volume and mix were up 3%, pricing was up 2%, currency added 7% and the impact of acquisitions and divestitures was 3%. Slide Six includes sales growth by segment and division. Sales for US cleaning and sanitizing operations increased 13%. Excluding the Microtek and Ecovation acquisitions, sales rose 5%. Institutional sales rose 3%. We saw heightened customer demand for energy and cost saving solutions like our new Apex solids warewashing line, which is running well ahead of plan.

New business gains also continue to be solid as we picked up market share against regional and local competitors. These gains were partially offset by lower consumption among our food service and hospitality customers as they experience a slowdown in their traffic trends. We also saw inventory reduction among distributors in the quarter as they tighten their operations which cost a percentage point of growth in the quarter.

In response to the tighter, market we are driving new product and program sales, focusing on the cost savings and performance improvement opportunities that our products offer customer and how well they tie in to the broader 360 degrees of protection program that is designed to maximize total operational savings for customers. We have accelerated the rollout of our new Apex Warewashing System which provides customers with new standards of performance and cost savings, and we are adding more new products and programs that deliver similar performance and value. We are also driving new account growth, utilizing improved prospecting tools and software and targeting independent accounts and regional chains with additional and redeployed salespeople and programs. We expect these aggressive sales efforts along with market share gains and pricing will deliver higher growth for institutional in the third quarter and the balance of 2008.

Kay's second quarter sales grew 17%, primarily reflecting new account gains and comparison to a weaker quarter last year which was due to lower than normal distributor shipments. The underlying sales business trend in quick-service restaurants is good with strong ongoing demand from major existing and new fast food chain accounts. The food retail business continued to show strong growth double-digit gain. New products and programs like the introduction of solids for QSR along with customer wins continue to bolster Kay's results. We expect these initiatives to help drive strong canes in Kay's third quarter.

Textile Care sales increase 10%. New plant additions from existing customers more than offset softer volume from existing accounts. We expect solid growth in the third quarter as Textile Care brings on new business and uses new technology as well as leveraging customer needs for operational efficiency to drive growth. Reported second quarter sales for the healthcare division more than tripled, reflecting the impact of the Microtek acquisition. Excluding the impact of the acquisition, organic healthcare sales grew -- rose 8%. Organic sales growth reflected continued solid end-market demand for infection-control products and expanded penetration within our existing base of group purchasing organizations and healthcare purchasing systems. Our skin care products showed continued double-digit growth. Microtek also rose double digits led by strong sales of infection barrier products across all channels.

Looking ahead, third quarter organic healthcare sales should show continued good sales gains and be bolstered by Microtek growth. Food and beverage delivered a strong second quarter performance. Reported sales were up 13%. Adjusted for acquisitions, sales rose 7%. The quarter was lead by strong performances in nearly all markets. Looking at the segments, corporate account wins, better pricing, new products contributed to dairy plan sales growth. The meat and poultry business enjoyed a strong quarter driven by customer gains which more than offset weak market conditions. The agri segment also saw good growth reflecting new account sales and favorable agri market conditions. Beverage also increased. Water care sales grew nicely in the quarter as a focus on larger F&B processor accounts helped to offset account rationalization.

In certain economies caused a number of Ecovation projects to be delayed and will not reach the very aggressive sales targets for 2008 that were originally projected. However, Ecovation is still expected to enjoy substantial growth in 2008, and the need for its affluent management and energy systems and the resulting long-term growth prospects remain outstanding. We expect continued good sales trends for the food and beverage business in the third quarter of 2008 as we focus on new account acquisition, pricing, and continued expansion of our anti-microbial and water management platforms. Eco Care sales decreased 7%. Results continue to be influenced by higher gas prices and a softening economy, both of which more than offset better pricing and new products, including the car wash industry's first comprehensive sustainability program. Vehicle care expects new programs, investments in the sales force and new market opportunities to drive sales in a continuing challenging sales environment for the third quarter of 2008.

Sales for US other services increased 6% in the second quarter. Pest elimination sales rose 7%. New account activity was driven by corporate account gains while non-contract services for seasonal or periodic work experienced slow slower growth. Both were affected by increased customer caution in food service and hospitality towards spending on such additional ancillary services or new initiatives. In response, we are focusing on growth markets like QSR and food and beverage processing, and continue to develop programs to better target specific market needs like our bed bug program which is growing at double-digit rates. We have also increased sales force hires to more aggressively pursue contract business, and we are enhancing field sales force effectiveness with new training and hires.

We expect pest elimination to show higher growth from the third quarter as it leverages its high quality and reliable service results to drive new business. GCS increased 5%, showing continuing good progress in service sales. These were slightly offset by parts volume. The new business systems are fully on line and we are in the process of completing the system optimization phase of the implementation. We are seeing the benefits of the new system through better business transparency, customer and market segment profitability, dispatching improvements and better tech utilization, all of which have helped our business decision making and operating efficiency and worked to improve profitability from the first quarter.

Productivity is continuing to improve on the new systems, and we expect significant gains as our people build experience with the new tools. The sales pipeline continues to look attractive and while the softer economy has resulted in some customer hesitancy in closing new sales, we still expect continued good sales growth in the third quarter and the year with significant profitability improvement in the second half. Measured in fixed currencies, international sales increased 6%. Excluding acquisitions, fixed currency sales increased 5%. Europe, Middle East, and Africa sales rose 2% in the second quarter at fixed currency rates. However, excluding acquisitions and divestitures, fixed currency sales increased 4%. As expected, Europe's institutional sales showed modest growth. Sales benefited from gains in floor machine sales and product sales growth which offset slow markets.

New products, like the introduction of Wash and Walk, and the Max Floor care lines combined with continued gains from housekeeping also helped drive sales. Food and beverage sales showed a good gain benefiting from corporate and national account growth. Healthcare sales also showed good growth lead by skin care sales, while textile care had modest sales increase in the quarter. Adjusted further divestiture of property services business last year, pest Europe sales increased as programs to improve sales and profitability gained traction. Key metrics, including service deliver yin the UK, new contract sales growth in France, and overall customer retention continue to show good improvement and help to offset the elimination of a couple of larger but low-margin contracts in the UK.

As an update on our work to improve Europe's performance, the business information system's development work continues to move ahead and is completing the testing stage. A multi-phase rollout will begin in the next couple of months starting with two countries, and will then roll out to additional countries over the next 24 months. Obviously, it is still too early to see benefits, and while these improvements will take time to implement, they are critical to the fundamental development e need to make to achieve better growth and profitability in Europe. Sales force training is going well, and we're beginning to see improvement in the sales team performance. We have moved the bulk of our European management to our new regional headquarters as we build a pan-European operating structure. While these combined investments represent a significant cost to 2008, we remain confident that these actions, as they are implemented, will lead to higher sales and profit growth and a more effective business model. We look for Europe's third quarter fixed currency sales to show modest growth. However, with we look for better results ahead as the actions we are implementing take hold.

Asia-Pacific sales grew 6% in fixed currencies. Excluding acquisitions, sales increased 5%. From a divisional perspective, institutional strong sales gains were driven by new products including the launch of a new warewashing platform in Japan and by growth in the Market Guard program for retail stores. We achieved important account wins in casinos, catering, hotels and restaurants as well as food retail markets.

Food and beverage sales had moderate growth. Both the beverage and brewing sectors continue to show good growth in Asia. The food and beverage division benefited from increased product penetration and account gains. Looking ahead, Asia-Pacific expects continued good sales growth in the third quarter. Second quarter sales for Ecolab's Canadian operations were up 5% in fixed currency. Institutional and pest elimination sales were strong, benefiting from corporate account gains, accelerated street growth, and the role out of Apex. Food and beverage sales also improved.

Latin America reported an outstanding performance with sales rising a very strong 15% at fixed currency rates. Sales were excellent throughout the region as all divisions rose double digits. Institutional growth was driven by new account gains, increased product penetration, as well as continued success with global and regional accounts. Food and beverage sales reflected strong demand in the beverage and brewing markets as well as the benefits of new accounts. Pest elimination continued its outstanding performance throughout Latin America. Overall, we expect healthy growth trends to continue in Latin America with another double-digit gain in the third quarter.

Turning to the margins on the income statement and Slide Seven of our presentation, as we expected, second quarter gross margins decreased by 180 basis points to 49.1%. The impact of acquisitions, which by their business model operate at lower gross margins than our historic business, were 70 basis points of the margin decline and along with higher delivered product costs more than offset sales leverage, pricing and cost-saving initiatives from margin perspective. SG&A expenses were 36.9% of sales, 130 basis points below last year. The SG&A ratio reflected leverage from our healthy organic sales growth, cost controls, the impact of acquisitions which operate at lower SG&A ratios. These more than offset investments in the business systems and efficiency, R&D, and information technology.

Operating income for Ecolab's US cleaning and sanitizing segment increased 8%. Excluding dilution from the Microtek and Ecovation acquisitions, operating income grew 11% as adjusted margins expanded by 80 basis points. This increase was driven by the volume and pricing gains and improved cost efficiencies which more than offset higher delivered product costs and investments in the business. Operating income for US other services grew 19%, adjusted for a legal reserve last year, other services operating income increased 5%. GCS showed a better business performance which resulted in profit improvement over the first quarter and was flat compared to the year-ago period despite higher costs of the new system. Pest elimination income also rose.

International fixed currency operating income increased 2%. Adjusted for acquisitions and divestitures, operating income rose 3%. Latin America, Canada grew double digits while Europe and Asia-Pacific were off slightly as sales gains were more than offset by higher delivered product costs and continued investments in the regions. The corporate segment includes special gains and charges which are reported as a separate line item on the income statement. Special gains and charges for the second quarter include $24 million from the previously announced sale of a plant in Denmark which more than offset non-recurring costs to optimize our business structure, including the establishment of our European headquarters in Zurich, Switzerland. The corporate segment also includes $8 million of investments primarily related to the development of business systems and other corporate investments we are making as part of our ongoing efforts to improve our efficiencies and returns.

Ecolab's second quarter consolidated tax rate was 28.8%, down from last year's reported 30.9%. Excluding discrete tax benefits last year and the tax impact of special gains and charges in this year, the adjusted effective income tax rate for the second quarter 2008 was 32.8%. The second quarter 2007 tax rate adjusted for discrete tax items was 34.3%. The decrease in the adjusted second quarter 2008 effective tax rate was primarily due to tax planning efforts, international rate reductions, and US tax legislation. There were no shares repurchased in the second quarter. The net of this performance is that reported diluted net income per share for the second quarter was $0.55, up 25% over the $0.44 earned a year ago. Pro forma earnings are up 12% to $0.47 when adjusted for special gains and charges this year, and the discrete tax benefit last year.

Second quarter 2008 results included dilution of $0.02 per share for the Microtek and Ecovation acquisitions. As mentioned in our opening comments, organic growth more than offset higher delivered product costs while exchange in tax also benefited earnings. This overall strength helped fund our Europe investments and acquisitions.

Turning to Slide Eight, Ecolab's total debt to total capital was 36% at June 30 compared with 35% reported a year ago. Our net debt at June 30 was 30%. Depreciation, amortization for the quarter was $85 million and capital spending for the quarter was $89 million.

Slide Nine shows our forecast for the full year 2008 and the third quarter. We continue to expect another year of superior growth in 2008. We look for solid sales gains as continued strong sales efforts in pricing along with acquisitions that accelerate our top line are leveraged by productivity and efficiency increases and cost savings. We expect these actions to enable us to overcome much higher delivered product costs and yield another year of attractive earnings growth. We raised the bottom end of our pro forma forecast by $0.01. For the full year we now look for pro forma diluted earnings per share which excludes special gains and charges and discrete tax items to be in the $1.85 to $1.88 range. Including these expected pro forma earnings are approximately $0.04 of dilution from acquisitions. The higher dilution than previously forecast reflects the delay of some projects and revenues at Ecovation due to the uncertain economy. However, we also expect pro forma earnings, excluding dilution, to be up $0.02 higher than previously expected and be up 14% to 16% to $1.89 to $1.92 for the year, fully offsetting the additional dilution.

Please note these pro forma numbers, which exclude special gains and charges and discrete tax items. We presently expect the special gains and charges to net to a rage of zero to a positive $0.02 per share in 2008. This income statement includes the sale of a plant in Europe as well as certain costs associated with the establishment of our Europe headquarters and move to Zurich.

In the third quarter we look for our US operations to show continued solid momentum. New products, like the ongoing roll out of Apex, our warewashing platform that provides unparallel performance and energy and cost savings for customers, as well as the first solids for QSR, new on-premise laundry products in the US and Europe, and the new floor care line will provide further differentiation and opportunity and will help drive results. We look for international sales to again be lead by strong growth from Latin America and Asia-Pacific as they enhance moderate gains from Europe. We believe this will result in overall good fixed currency international sales growth. The press release includes line item forecast for our third quarter P&L. As discussed in that release, we expect pro forma diluted earnings per share for the third quarter, excluding special gains and charges and discrete tax items, to be in the $0.53 to $0.55 range compared with the pro forma earnings per share of $0.49 earned a year ago. We expect third quarter 2008 pro forma results will include $0.02 per share of dilution from acquisitions.

We have nothing new to report regarding Henkel's stated intent to sell some or all of Ecolab's shares that they hold. You may recall, Henkel owns 73 million Ecolab shares. In February, Henkel said it would sell part of all of its interest in Ecolab. Earlier this month the directors designated by Henkel resigned from Ecolab's board saying that because of the uncertainty regarding when or how the sale would take place, it would be prudent for Henkel to forego representation on Ecolab's board at this time. Until Henkel discloses the size, timing, and method of this transaction, we have nothing on which to comment regarding Ecolab's potential interest in purchasing shares in any such transaction.

In summary, we are proud of our accomplishments in the second quarter as we delivered effectively against tough conditions and achieved double digit EPS growth while building for our future. And despite any increased challenges from both the US food service and hospitality markets and raw material costs, we continue to expect a solid performance in 2008 as we use our strong sales and service team to drive growth through aggressive selling, additional solutions per account, new services and appropriate pricing to drive our top line, and a constant focus on efficiency and effectiveness to leverage our bottom line while at the same time making key investments to assure growth for the future. That concludes our remarks. The conference call and associated slides will be available for replay on our website through August 8. Operator, please begin the question and answer period.

Thank you. (OPERATOR INSTRUCTIONS). Our first question comes from David Begleiter of Deutsche Bank.

Thank you. Good afternoon, Doug and Mike. Can you just comment on how much your raw material costs increased in the quarter? Can you quantify that?

Yes. I don't know what is going on.

Go ahead and answer the question.

Hello, Mike?

David.

Yes, hi, sorry about that. I was asking can you quantify how much your raw material costs increased in the quarter and if pricing fully offset that?

David, were you able to hear the answer?

I was not, no.

Okay. They were up about 6% in the quarter.

And did pricing fully offset that?

Yes.

And only a question -- Doug, you mentioned some moderation in food and hospitality. Can you quantify that moderation and is it continuing? I assume it is into the third quarter.

Yes, we track a number of metrics, but probably the one is foot traffic and there's clearly some moderation, but this isn't a highly cyclical market. So in a lot of ways it's flat. There's some trading between full service and QSR. You can see that in some of our results. I guess our expectation coming into the year was that it was going to be a soft market. You might argue it's a little softer than we thought. Our expectation for the balance of the year is that it's going to remain soft at this level. With that said, institutional, we believe Q2 is really their low water mark and feel pretty bullish about how they are going to respond in the second half as we move forward simply because we had a lot of, we think, very positive initiatives which are gaining traction as we go forward.

Thank you very much.

Our next question is from Mike Harrison of First Analysis.

Good afternoon.

Hi, Mike.

Now you've talked about getting more aggressive in going after market share in Kay in particular, but also on the institutional side. Do you have any metrics that you can point to that indicate how successful that push has been or barring that, do you have any anecdotal evidence of some share gains?

Yes, I -- Mike, this is Doug. I would point to a couple of things. On the Kay side, this will be their strongest new business year maybe since we have owned them. It's going to be certainly be in the upper one or two years and we have owned the business since '95. So we have had a couple of big wins there which is what is going to propel the business as well as there's some trade down to QSR. In institutional, we're also positioned to have a very strong new business result this year in the US. I would say Europe is doing much, much better in terms of gains and losses as we are in every region. So this is a big focus. We have recently gone back through, just to illustrate where the opportunity is for each of the business, and ask them to identify opportunity. We are still a very target-rich business and have a lot of share gain in front of us which is why we remain confident in our expectations for the business as we move forward.

What -- Doug, what about this new -- it's sounding like you have a new targeting software system for trying to find some of these new -- new customers. Can you talk about that a little bit?

Yes, and that's -- we're really running it right now in institutional North America and it's taking some purchased database and cleansing it with some of the data that we have and identify clearly by F&B dollar volume because that way we can start segmenting the markets most attractive to us where the business opportunities are. We recently in the last few years rolled out new technology to all of our field associates and we were able to really, if you will, send these leads out via the technology so they have them in hand, track and manage it in a much more efficient manner than in the past. We have got better clarity on the leads, better segmentation, i.e., we know where the volume is and where the most attractive targets are, and we have gotten them out to the people closest to the business, so that's why we are -- we're seeing traction there. It's working, and that's why we feel pretty good about the business.

All right. And last question I had was you noted some delays related to the higher integration costs for Ecovation. Can you give us more details on that front and also how that's impacting your plan to roll out the Ecovation offering across some of your Food & Beverage customers?

Yes, what is really going on on Ecovation is two things. The -- one, there is a portfolio of business in hand when we bought the business. We have chosen really not to pursue several of those deals because of our assessment of the credit risk, and really walked away very late in the process on a couple of them. And additionally it has taken longer, which is normal in this environment for people to get to yes. With that said, if you go further back in the portfolio, we are gaining a lot of momentum, have a lot of interest in Ecovation, have a number of strong trials. So we're bullish and remain as bullish in the long-term aspects of this business as we were when we bought it. This year is not going to be as strong as we thought when we bought it basically because we chose not to pursue some business and we have got a few delayed yeses.

All right. Thanks very much.

Our next question comes from John McNulty of Credit Suisse.

Yes, good afternoon, just a few quick questions. First of all, can you give us an update in terms of what your actual European margins were for the quarter?

Hey, John --

Yes.

-- Europe margins are about 8%.

Great. The 4% growth in Europe excluding acquisitions and divestitures, can you give us some color as to how that stands up relative to the past few quarters. It sounds like it actually is a maybe a little bit higher than what you have been doing and maybe indicating there is some traction there.

Yes, John, in Europe last year, '07 was -- our organic sales growth was 80 basis points higher than '06. Our first half is stronger than last year's first half in terms of organic sales growth, and we expect to end '08 several basis points better than '07. I don't want to get -- but we -- we expect to be accelerating again for the balance of the year and in total for the year. It is better.

Okay. And then the last question. With regard to the distributors, I believe you had indicated there were some inventory clearing-out issues, and that hurt your growth a little bit. To the best of your knowledge, is that done or should we expect some of that to linger in to the third quarter as well?

Our guess is the bulk of it is behind us, particularly in US institutional. But we don't have absolute transparency in to where they are going with inventory. But our guess is the bulk of it is behind us.

Okay. Great. Thanks a lot.

Our next question is from Dmitry Silversteyn of Longbow Research.

Good morning -- or good afternoon, I should say. Time flies. Couple of questions. First to follow up on the GCS. Not sure I heard you correctly in that business. Did you say what was going on with the losses in that business? Is it getting close to break even or did you say the losses were the same as last year?

Yes, Dmitry, this is Doug. We lost $4 million in Q2. We -- and that's following a 6 million loss in Q4, another 6 million in Q1, so it's sequentially better. It was marginally improved versus Q2 of last year. Importantly, I think is more of the trend, and clearly the business has a very good handle on the money flow and how it's going, and we expect continued improvement in Q3, Q4. I mean I think GCS performed about, how about met our expectations in Q2, and we usually have high expectations. They are moving in the right direction.

So to extrapolate that further, you do expect to be break even or better by the end of the year in that business?

Yes, I think what we have said is we would end the year at a break-even run rate. I have tried and generally been successful at also saying that doesn't mean we expect to make money in the fourth quarter.

Okay.

With that -- yes, I would say we're more on track than not. What GCS is dealing with, which we didn't plan when we said that. Honestly, I'm not sure it is going to change the outcome dramatically. Clearly the economy is softer than we thought. What I would say is I think GCS's progress on the margin is probably faster than we thought, which is offsetting a little bit of slowness on the top line due to the economy.

Got you. Doug, thank for the color. Question on sales force headcount increases, I hope. Did you have any data that you are willing to share with us on that?

I think for the year we're up 2 -- about 2 points so far this year.

Yes, are there plans to to accelerate hiring into the second half of the year to kind of deal with the weaker North American market?

Yes, where we're going in the second half -- I would say we're probably going to end the year between 3% and 4% increase in sales force. And some of this is we are going to clearly continue to aggressively feed our growth businesses. And we're going to aggressively feed where we have got great growth opportunities. But we're also working to redeploy headcount from businesses that aren't growing quite as fast as those that are growing fast.

Okay. And then final question just on Europe and the progress you're making there. You talked about having 8% operating margin in that business, which I think is kind of as low as it has been. So can you give us some, I don't know, milestones or markers of what you are looking for as incremental improvement in Europe until we start seeing it in the numbers?

We have tried to talk and this isn't always that easy to see in the reported numbers, is clearly we're making a number of investments in Europe to get after a couple of things. First, to accelerate organic sales growth, which we're doing. Second, to drive improved margins in the business, which will translate and improve the Y margin. And third, improve our cash flow and tax rate. And the way we said they would come is we would expect to see ongoing improvements immediate, which we have been seeing in organic sales growth. Second area you are going to see is tax improvement because frankly we had to make investments in SG&A to realize some of the tax savings. That's just the way it flows, and then we will see the third stage will be improved margin as well.

Okay.

Al of these things together, we are very excited about our prospects in Europe and our ability to generate more income and better cash flow.

Okay. Thank you, Doug.

Our next question is from Gary Bisbee of Lehman Brothers.

Hi, good afternoon. Let's start out with just a macro question. It seems like every data point we see these days from Europe indicates that things are really beginning to slow there pretty aggressively. I guess wanted to know how you think that impacts the turn around you're trying to do there. Secondly, maybe you could give us a sense as to what type of a plan have you built in to your guidance in terms of weakness in Europe and how much you actually think it will impact the business?

Yes, we're usually pretty conservative on economic improvements and generally assume the worst as we go through this. So I can't say we have got great hope for economic turn arounds or improvements and, in fact, I think our forecast counts on the same type of situation we're in or minor worsening. Now, how is it going to effect Europe? We would rather compete in robust economies than weak economies, but with that said, there's enough share gain and that's why we figure we're responsible for creating our own wind in all conditions, and we're out there aggressively investing in new sales fire power, man power, putting them in the street, getting after business, our one loss ratio, if you will, has improved, and that's the type of metric we got to stay on because it is what drives your business regardless of the economic situation. So I don't know if that answers it. Our forecast isn't predicated on perfect economies.

Okay. You said in the prepared remarks and earlier in the Q&A that you thought the second quarter would be the bottom of institutional and that pest US-based pest business would also reaccelerate in the third quarter. Can you give any more color exactly how you are confident in it? Is it pipeline of sales calls that you have made and you are trying to close deals? Is it the new product rollouts or what give you comfort in that statement?

Yes, that's a fair question. I think it's a couple of things, institutional. Sometimes businesses are worse than they are. And there are times when they look better than they are. I think institutional second quarter makes it look worse than it is. And so the -- the underlying thing going on with institutional is they have got great new business activity per the earlier question. The targeted new account activity that we have got going. Apex, the new dish wash platform, is ahead of a revised more aggressive plan. We have got a number of units already on and like what we're seeing on Apex, that's going quite well. We're also on SKU reduction, which we're using to do a somebody of things, including enhanced margin, and we're on pricing, and so as we track these initiatives and look at the traction, you can start getting a good idea of how this is going to translate in to business performance. So we aren't just saying it to say it. It's going to be we are very confident third and fourth quarter will be better than second.

Okay. Then just last question, is -- are you seeing any real change in terms of the pipeline or what your sales force is hearing in the healthcare business related to the expected reimbursement changes this fall around infections people get while in the hospital for something else or is that really more of an '09 opportunity for you guys? I guess I'm trying to understand are the health systems trying to get prepared ahead of that and is that a real positive in the near term or is it more of an opportunity you are tackling for the future? Thanks a lot.

Yes. What I would say about our healthcare business is it is performing quite well. Microtek, our new acquisition, has accelerated since we bought it, and is growing at double-digit rates on a organic basis if you compare to their year on year performance and our, will if you will, historic healthcare business is also doing quite well and we expect it to accelerate, too. To your specific question about the reimbursement change, it's very hard to fare it out exactly what drives purchase decision. What I believe is customers are going to probably be in a more reactive mode than proactive mode on this, given the history in healthcare, and I would expect that this is even a more potent driver post change than it is prechange.

Okay. Thanks for all of the color.

Our next question comes from PJ Juvekar of Citi.

Good afternoon.

Hey, PJ.

Your Kay growth was really robust at 17% and you mentioned share gains. Are there any particular changes where you want the business? What is driving that?

I mean, PJ, I guess our historic stance is we don't get in to naming gains and losses, but, yes, they picked up some very good business for the year, so it's driven from a couple of factors. I mean their first quarter, I think as I told you first quarter they are doing better than it looked also because we had some inventory shift going on in that business between quarters. With that said, and so some of that is why the second quarter looks as strong as it does. But really we expect a very strong second half as Kay starts realizing the benefits of the share gain, particularly in the second half. So they picked up some nice change.

Okay. And since you bought Microtek, have you started negotiating with large national hospital chains for your one-stop shop? And have you had any success? Can you talk about that?

Yes, often the way chains buy -- or hospitals buy is through group purchasing organizations and we have certainly had some success, if you will, bringing Microtek in to relationships that were previously Ecolab and quite candidly going to the other way, and I would say the sales synergy, which we really don't generally count on immediately, has come faster than we thought.

And then finally, you talked about inventory draw down by distributors. You have this alliance with Cisco. Do you believe the distributors are drawing down inventory because they see a slow down in end market?

Well, yes, I think there's a couple of things going on. Cisco has made a number of large investments in technology, in distribution systems all designed to improve working capital, which for distributor reads inventory.

Right.

And -- and so some of this is just the natural outcome, I think of investments that they have been making over the years as they deploy. I mean, you get down to X. They need some inventory, and I think that's the larger reason, but actually if there's a slowdown, they adjust down and when there's a pickup, they adjust up.

Okay. Thank you.

Our next question is from Edward Yang of Oppenheimer.

Hi, good afternoon.

Hi.

Doug, you were pretty pressured in expecting some head winds this year. I know it's early, but could you share your preliminary thoughts on expectations for '09 and historically you have grown earnings in the low to mid-teens. If the current environment persists, is that something that's achievable?

'09 the -- our only assumption right now is it's lousy because -- I mean not for us but for the markets. And I think that's a safe assumption, those are the assumptions we need to make because we want to hold ourselves accountable for driving new business, driving share gain, making sure we are getting after the things that we need to get after to -- to ensure we are positioned to deliver no matter what the environment, and we would always rather be surprised on the upside. All right? That's how we generally view the world until the world proves us wrong. With that said, do we -- we have no plan to change our objective of 15% EPS growth, and we work to drive sustainable growth this year. You X acquisition dilution which we're going to have time to time, and you look at our forecast, it's clearly in our range in what I'll call a difficult environment, and we're doing it while making key investments in the business for the long term which will benefit us in '09, '10, and '11. And that's the type of ribbon we have worked hard to achieve and we're going to work hard to sustain.

When you say lousy environmental rural for next year, does that mean things get worse from here?

I don't think we believe it is going to get dramatically worse. So we're not predicting economic meltdowns but we're also not predicting economic recovery in '09, particularly in North America. Europe may soften somewhat and some of the other markets. We just -- I guess we just aren't willing to believe, given our share position, our opportunity, that that's going to dictate our future.

And you mentioned with regards to Ecovation you walked away from some projects due to credit quality. Are you doing this in any other parts of your business. Are you being more watchful, and what has your bad debt experience been lately?

Yes, I think Ecovation is somewhat unique in the capital investment made up front, so we're going to be particularly sensitive in a business where you are putting a bunch of capital in. However, any of the businesses where you have that, I would say clearly in these environments we become even more vigilant on payables and receivables -- excuse me, receivables. We have been. I think we have got a very good handle on it as we go forward. I think that's exactly what you would expect us to do.

Thank you.

Our next question is from Michel Morin of Merrill Lynch.

Hi, good afternoon, guys. Couple of quick ones. The extra $0.02 that you now expect to get from the core business, I guess because you are saying you going to get $0.02 additional dilution, so the base business is giving you a little bit more than you had anticipated, where is that coming from?

Yes, it's coming from a couple of places. I mean we clearly accepted on the gas on cost savings and we are -- continue to be on the gas on organic growth and pricing.

Okay. And just going back -- that's very helpful. Thank you. And on the earlier question about our sales force, it's good to see you are not cutting back there. What are you seeing your competitors do? It looks like you are picking up some share. Is that facilitated by some of your competitors perhaps pulling back a bit on their sales force. Are you seeing any of that in the field?

Yes, I think there has been a trend of a number of our competitors reducing their field sales man power over time. We have seen a continuation of that trend. I don't know that it has been a big change in trend recently. But we figure -- look, generally in these tough environments I would rather be us than anybody else, and we figure this is going to give us advantage versus competition, and we want to make sure that we're in position to capitalize. I don't -- so we will go aggressively, work to build share, and the only way you do that is have a great offer for customers.

That's great. Thank you. And just finally on GCS, Mike, could you break out the growth that you had from service relative to the parts portion of the business?

Yes, service is up about 8%.

So parts was negative?

Yes, parts was down a few percent.

Great. Thanks very much.

Our next question is from Bob Koort of Goldman Sachs.

Thanks, good afternoon, guys.

Hey, Bob.

Couple of questions. One, Mike can you remind us when you guys bought the JV in Europe how high your debt-to-cap ratio went then?

It got up to 47% of capital.

Doug, is there any reason you wouldn't push those limits again?

Bob, I knew that was the second question.

I didn't ask anything about Henkel though.

You are very clever. Look, I think we have always said our debt-to-cap ratio we talk about is a range, and if there are unique situations, be the acquisitions or others, that we aren't afraid to extend beyond our range.

Let me ask a couple of different questions. I think, Mike, you said in Europe and Asia-Pacific your profitability was down year on year. Is that primarily because of logistical costs or what is it been the business models in those environments that aren't providing the earning leverage that you get any the US market?

Bob, this is Doug. In AP we have accelerated investments in corporate account heads, right? In a couple of what we thought were key investments to give us a bigger platform to grow on, right? Operations, we added a plant in China. We have done a number of things and in those businesses you kind of go through some step function changes. They were investments that we proactively made, and we feel good about the investments.

Okay. My last one on the health of the US institutional market it seems like that growth is about as low as we have seen it for several years. I think, Doug, you alluded to that being somewhat misrepresentative of the underlying business. What can we expect in the second half or maybe even looking further out? Is this going to be as long as the economy is a little sketchy 3% to 5% revenue business or can you ramp it back up to the mid-single digits?

We haven't -- we talked about institutionals range in the 6% to 8% piece. We believe we'll be close, not in the range.

Great. Thanks very much.

Our next question is from Jeff Zekauskas of J.P. Morgan.

This is [Ben Richardson] filling in for Jeff. Just had a question concerning your sensitivity to fuel costs and how you might manage that.

Well, whereas fuel cost is not one of our major raw materials, it is definitely down the list. In terms of how we are managing it, we instituted some fuel charges in some divisions and we'll continue to look at that and react to fuel costs as we go forward.

All right. That's all I have.

Our net question is from John Roberts of Buckingham Research.

Good afternoon, guys.

Hey, John.

The corporate line when you back out the 26 million gain was a 14 million expense. Does that stay at that rate the next couple of quarters or when did it drop back down towards a mid-single-digit number?

I'm sorry, John, I couldn't hear you. Could you repeat that?

The corporate expense line when you back out the one-time gain was I think about a $14 million expense in the quarter. Again, higher than normal because of the activity in Europe. Does that stay at that level the next couple of quarters or when does it come back down in to the more normal historical mid single digit -- ?

Hey, John, that corporate line includes two things, the special gains and charges which are like the one-time things we talked about that I included that gain, which you are correct in backing out. Since we don't forecast special gains and charges, the only thing we can look to is what we call the corporate side which would be the cost of the European systems and the cost of the move to Zurich which we think over the second half it will be different by quarter, but will be around $13 million.

Okay. And then secondly, back to the question about your debt-to-cap ratio and so forth. We're obviously in a different credit environment right now than you were when you last had your peak debt-to-cap ratio. How do does factor in to your thinking? How important it is to maintain certain level of credit rating?

I'm sorry I missed the first part of that, John. The phone broke up.

The last time you had a very high debt-to-cap ratio when you caught out the joint venture, that was a different credit environment than now. Today it is pretty scarce to have the kind of balance sheet you guys have out there. And I don't know how concerned you are about your credit rating and as you would lever up possibly.

It's a -- you are right, the credit environment is very different. We do value -- we have always valued our strong balance sheet. And now we're not alone in valuing it, and we don't plan on doing anything to cream our balance sheet. I don't know if that -- that would be not a move we would view as wise.

Okay. Thank you.

Our next question is from Rosemarie Morbelli of Ingalls & Snyder.

Good afternoon all, and congratulations on a very good quarter.

Thank you, Rosemarie. It is nice of you to say that.

Looking at Asia Pacific. A 6% growth rate excluding currency is really not that big for this small size business compared to some of your other areas. Could you give us a feel as to what is going on there and why with all of the investments you have been talking about it is not growing at a rate that is a little closer to Latin America, for example?

Rosemarie, this is Doug. You are right. We don't like 6% either but really it's principally driven by Japan and Australia, which are outside businesses for us in that market. We had very slow growth. We had very strong growth, if you will, in Northeast Asia, and frankly the balance of Asia, as you would expect.

Okay. So we should see as time goes buy and the balance of Asia becomes a little larger, we should see that rate pick up to a level of 10% to 15%?

Yes, I won't argue with you there.

Okay. And then looking at other services, I mean the operating margin has improved substantially to 10.8%. Is that a new base level going forward, or was there something special in the second quarter and then we go back down a little in the second half of the year?

Yes, we expect that should continue to improve as GCS's margin continues to improve.

There was nothing special that bumped it so much between the first and the second quarter?

GCS --

Principally GCS. Yes.

Okay. And pes, while it is not growing as much, you are not doing anything there in terms of major investment that would lower the overall margin if GCS stayed at the same level?

No. No, I think -- past -- the past business is a stable business. We invest it in on a continual basis. We'll continue to, but that's at its base. And we don't have any planned outside investment up or down for that business.

I would say for continued improve in that Rosemarie going forward.

Yes, principally because of GCS.

Okay. Lastly, if I may. The gross margin Q4 versus Q3 historically is a little lower, but considering what you are doing in terms of price increases and new products, which I am assuming as Ecolab usually does have higher margins, should we expect the growth margin to improve sequentially Q4 versus Q3?

I don't -- I don't think so, Rosemarie. At this point, I would think maybe flattish.

Okay. So nevertheless a little better than the historical pattern?

Yes, and I think you have got the reasons why. Okay. All right. Thanks a lot. Okay. Thank you.

Thank you.

Our next question is from Chris Shaw of UBS.

Hey, guys, how are you doing?

Hey, Chris.

Where did the other $0.02 of dilution from those deals come from? Was that a new deal included in there or was that just you redid the numbers?

Chris, it's principally Ecovation and it goes back to the earlier conversation. The pipeline that we acquired changed when we ended up walking from frankly a very sizable deal because of the credit concerns that we had, and some of the other pieces of the pipeline have been somewhat delayed by the economic situation. With that said, we view this as a year phenomena.

Okay. That's reasonable. And then on pricing, you guys said pricing was up 2% for the quarter. Now, to me that seems kind of low. I would think that's the kind of pricing you do in a sort of flat raw material year. I would think that just from your new products and the value of bringing the customers that you could get 2% easily in a given year. So -- so should it be higher?

Yes. A couple of things. One, it will be -- we expect it to increase in the second half as we go, given the environment change and everything else we are out there getting pricing. This is a global number. Doesn't include pricing benefit that we realize when we change out products, i.e., mix-driven margin moves and that light.

The other thing, Chris, is remember we're giving a rounded number so you are actually seeing improvement from a little bit below to a little bit better to -- going forward.

It's moving up.

It doesn't include mix it doesn't capture when you introduce a new higher-value product?

Right.

Okay. Great. Thanks.

Your next question from Laurence Alexander of Jefferies.

Hi, there, just two quick ones. Are you still looking for mid-single digit raw material inflation for the year or is that creeping higher?

This is Doug. It is -- it has increased and our forecast -- if you want to include -- without freight and fuel to deliver product, it is going to be closer to 8%. If you include freight and fuel that we used to move product, it's going to be around 10% for the year, the number that we have historically given you is X freight and fuel.

Right. And then can you briefly discuss the volume trends in institutional in both the US and Europe? Because I guess given the pricing it looks as if -- I mean it is still positive in both regions or is there --

Yes, it's still, we have positive volume growth in both North America, US, Canada, Europe.

Okay. Perfect. Thank you.

And we continue to have positive volume.

Is that it, Laurence? Great. Okay. I guess that's the last question, so thank you all for your participation, and have a terrific day.