藝康 (ECL) 2010 Q2 法說會逐字稿

Welcome to the Ecolab second quarter 2010 earnings release conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct the 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. You may begin.

Thank you. Hello everyone and welcome to Ecolab's second quarter conference call. With me today is Doug Baker, Ecolab's Chairman, President, and CEO. 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 that could cause actual results to differ 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. We also refer you to the supplemental diluted earnings per share information that is also in the release.

Starting with the slides three and four, we continued to deliver strong earnings results in the second quarter, despite mixed conditions in our end markets. Sales gain was fueled by aggressive actions to gain new accounts, using our innovative new products and industry leading service force. Margins improved on the better volume and benefited from favorable delivered product costs and cost reduction actions. Looking ahead, we expect to continue outperforming our gradually improving markets, and deliver superior growth once again in 2010.

Starting with some highlights from the quarter. Reported second quarter earnings per share were up 32% to $0.54. On an adjusted basis, excluding special gains and charges and discrete tax items from both years, second quarter 2010 earnings per share increased 12% to $0.56. The adjusted earnings per share growth was driven by better volume, new products, new account gains, pricing, favorable delivered product costs and cost savings, which more than offset higher operating costs and continued investments in our business.

Our US and European food service markets remained soft but are stabilizing. Lodging room demand has increased, and is showing good trends worldwide. The Food and Beverage and healthcare markets remain steady, and we continue to see good growth across all market segments in our Asia-Pacific and Latin America businesses.

We continue to be aggressive, focusing on top line growth as we emphasize our innovative products and service strengths to help drive market share growth in our core businesses, and deliver new account acquisition among our national, regional and independent prospects. We are also making significant investments in key growth businesses to build future growth. We also remain focused on cost savings, emphasizing productivity and efficiency improvements to help increase margins. Looking ahead, we expect third quarter adjusted EPS to increase 5% to 8%, to the $0.64 to $0.66 range, compared with adjusted EPS of $0.61 in the third quarter 2009, reflecting comparison against strong results last year, easing raw material cost benefits and unfavorable currency trends.

Despite the uncertain economy and fluctuating currency exchange rates, we continue to look for double-digit EPS growth with adjusted EPS of $2.21 to $2.26 per share, for the full year 2010, representing an 11% to 14% gain over last year. That would represent another year in our decades-long performance of fixed currency sales growth, our ninth consecutive year of adjusted EPS growth and the eighth double-digit EPS gain in the last ten years. In summary, we expect 2010 to reflect yet another strong performance by Ecolab, as we use aggressive sales efforts to gain new accounts and achieve better sales penetration, along with improved efficiency and cost savings to once again deliver attractive growth and shareholder returns. Turning to the details, as shown on slide five, Ecolab's reported consolidated sales for the second quarter increased 5%. Looking at the components, volume and mix increased 2%, pricing was up 1%, and currency benefited sales by 2%.

Slide six includes sales growth by segment and division. Sales for the US Cleaning and Sanitizing operations rose 3%. Institutional sales rose 2%. New account gains, new products, and the comparison to weaker distributor shipments last year benefited second quarter sales. We continue to outperform mixed market trends, with continued soft food service foot traffic and strengthening lodging room demand in the second quarter. We remain focused on driving sales growth, using innovative products in wear washing, laundry and housekeeping that provide superior performance while delivering water, energy and labor savings for our customers.

We're also targeting new accounts with additional and redeployed salespeople and programs. These actions have resulted in good new account gains, where we're continuing our efforts to drive more sales and margin growth. We expect these gains, investments in our sales team, and new accounts to help institutional continue to outperform its markets for the third quarter and the year. Kay second quarter sales grew 6%, led by strong growth from new account wins in food retail. We also enjoyed good demand from existing and new fast food chain accounts. New products and programs, like the introduction of Scrub-N-Go, the floor cleaner for QSR restaurants, benefited Kay's results. We expect these initiatives, along with continued good new account growth to help drive strong gains in Kay's third quarter.

Textile Care sales were up 3% as customer gains, new program launches, and the additional sales within existing customers offset continued challenging industry conditions. Ecolab has focused on innovative products and services, operational savings and service excellence to bolster results. With textile industry conditions remaining difficult, we look for sales to be flattish in the third quarter.

Healthcare sales increased 5% in the quarter. Gains in infection barriers and central sterile continued to more than offset the inventory work down of soaps and sanitizers from the prior year spike in demand due to H1N1 fears. Excluding the H1N1 impact, sales would have increased by approximately 7%. During the second quarter, we began installing the new OptiPro line of central sterile solid products. Looking ahead, third quarter sales are expected to continue to improve as H1N1-related product inventories appear to have stabilized.

Food and Beverage sales grew 3%. Sales increased in the beverage and food markets as corporate account wins and new products offset soft results in dairy, agri, and meat and poultry. Food and beverage will continue to focus on new account acquisitions and new product sales to offset slow end markets and softer pricing. We look for Food and Beverage sales to show similar growth in the third quarter. Vehicle care sales decreased 7%. The division remains focused on new, more sustainable products and gaining new accounts. However, these efforts were more than offset by weak market demand. We look for vehicle care to continue to outperform its market and show sales similar to last year in the third quarter.

Sales for US other services were flat in the second quarter. Pest elimination sales were off 1% as gains in fast food and food and beverage plants were offset by slow conditions in other major end markets. We continued to develop new product and program solutions to better serve customer needs in the current environment. Our new bedbug program, that reduces room down time for treatment cycles, and thereby helps lower customers' total costs, is doing well, as is our new EPA exempt pesticide, which poses a minimum risk to humans and the environment, yet still provides an average kill time for common cockroaches of less than five minutes compared with eight hours for other liquid applications. We continue to target specific growth markets like food retail, and food and beverage processing, to build contract growth. We are working on other programs to provide improved service, efficacy and efficiency for our customers. We expect these efforts to help offset the soft markets and yields to improve third quarter sales.

GCS sales increased 1% in the quarter. Once again, profitability improved over last year in the first quarter. New account wins offset the impact of slow food service business conditions. GCS profitability continued to improve, as productivity and efficiency improvements were gained throughout the business. We remain focused on developing chain account relationships, and driving sales through their regional and franchisee organizations. We have used some of the improvement in profitability to invest in regional sales force additions to deliver current and future growth. Looking to the third quarter, we expect continued sales growth and further profitability improvement.

Measured in fixed currencies, international sales increased 5%. Europe, Middle East and Africa sales increased by 4% in the second quarter, at fixed currency rates. Results benefited in part from a weak first quarter and year-ago period. Europe's institutional sales increased as food service markets appear to have stabilized, and lodging trends improved in most European markets. Our sales teams targeted new business with regional and local customers. These efforts were leveraged by new products that offer customers superior results, cost savings and better efficiency.

Food and beverage sales improved. The business continues to focus on winning new customers by emphasizing the cost savings benefits of our leading products like DryExx and Water Care. Textile Care sales were off, reflecting reduced volumes from central laundries. Europe's healthcare sales were comparable to last year as strength in east Europe was offset by H1N1-related product inventory reductions by customers. Pest Europe sales were also comparable to last year as we continue to improve operations and drive profitability.

We are starting to work with Europe's new business information systems platform to unlock cost and complexity in our operations, to drive faster sales growth and higher March engines. We continue to expect significant improvement starting next year, as the range of growth and profitability actions we are able to implement begin to take effect. We look for a modest gain in Europe's third quarter, fixed currency sales, reflecting a less favorable comparison to last year. Asia-Pacific sales grew 9% in fixed currencies, as the region showed good recovery from last year's low levels of business travel and tourism. Institutional sales were strong, as occupancy levels improved and the economies recover.

Food and Beverage sales showed strong growth, both the beverage and brewing sectors continue to increase, benefiting from improved product penetration and account gains. Looking ahead, Asia-Pacific expects continued good sales growth in the third quarter, reflecting recent account wins and stabilization of the markets. Second quarter sales for Ecolab's Canadian operations were flat when compared to last year, at fixed currency rates. Food and Beverage, Textile Care and Vehicle Care all reported strong sales growth. However, institutional and healthcare were negatively affected by H1N1-related product inventory reductions. We look for our Canadian business to show better growth in the third quarter.

Latin America reported a strong sales gain, rising 9% in fixed currencies, and all divisions in that region increased. Institutional growth was driven by new accounts, increased product penetration and continued success with global and regional accounts. Food and Beverage sales reflected good demand in the beverage and brewing markets as well as the benefits of new accounts. Overall, we expect attractive growth trends to continue in Latin America with another solid gain in the third quarter.

Turning to margins on the income statement in slide seven of our presentation, second quarter gross margins continue their recovery, increasing 100 basis points to 50.7%. The increase was driven by volume gains, pricing and improved delivered product costs. SG&A expenses represented 37.2% of sales, 70 basis points above last year. The increase in SG&A ratio was due to continued investments in our business, people and systems, and other cost increases, which more than offset cost savings and leverage from the sales gains.

Operating income for Ecolab's US Cleaning and Sanitizing segment increased 10%. Margins expanded by 130 basis points. The increase was driven by volume gains and favorable delivered product costs. We also benefited from favorable cost comparisons against last year. Operating income for US other services grew 2%.

Margins expanded by 30 basis points over last year, driven by pricing, and cost saving actions, which more than offset higher service and other cost increases. International fixed currency operating income declined 5%. Volume gains, pricing and favorable delivered product costs were more than offset by additional investments, including European systems expense, and Asia-Pacific and Latin America investments in personnel. The corporate segment and tax rate are discussed in the press release. We repurchased 1.2 million shares during the second quarter. The net of this performance is that Ecolab's reported second quarter diluted earnings per share was $0.54, compared with $0.41 reported a year ago. When adjusted for special gains and charges and discrete tax items in both years, adjusted earnings increased 12% to $0.56, when compared with $0.50 earned a year ago.

Turning to slide eight, Ecolab's balance sheet and cash flow remains strong. Total debt to total capital was at 34% at June 30, compared with 37% reported a year ago. Our net debt at June 30 was 30%. Looking ahead, we expect a continued mixed performance in our end markets, but also look for gradually improving trends. Against that backdrop, we are taking appropriate actions to drive both our top and bottom lines.

As outlined in slide nine, we will continue to drive new account and market share growth, using our product and service strengths that combine to help customers reduce their costs and improve their efficiency. We will continue to focus on investment in growth businesses like healthcare, China, and Latin America, as well as new products and acquisitions to accelerate the top line. And we will expand our sales and service force and invest in their field technology to make them more productive. We expect fixed currency sales to rise in the low to mid single digit range in 2010 and look for gross margins to show continued good improvement.

SG&A will reflect the investments we are making in our sales force and systems. Corporate expense should moderate slightly. Interest expense is expected to be comparable to 2009, and the tax rate is forecast to be in the 30 to 31% range. As mentioned in our opening comments, we are cautious regarding the speed of the recovery and the impact of currency fluctuations on our second half results while we continue to look for double-digit EPS growth with adjusted EPS in the range of $2.21 to $2.26 per share for the full year 2010, representing an 11 to 14% gain over last year. The press release includes line item forecasts of our third quarter P&L. Net, we expect adjusted diluted earnings per share for the third quarter, excluding special gains and charges and discrete tax items to increase 5 to 8% to $0.64 to $0.66 range compared with adjusted earnings per share of $0.61 a year ago.

In summary, as noted on slide ten, we had a strong second quarter while still investing in our future. We look for a solid third quarter earnings gain and expect to deliver double-digit EPS growth for the full year 2010, representing our ninth consecutive year of adjusted EPS growth as we continue to outperform mix to the gradually improving end markets. And now here's Doug Baker with some comments on the quarter.

Good afternoon. Before we go into Q&A I just wanted to offer a brief overview. My take on the quarter is this. We had a solid quarter. We did exactly what we said we would do, and most importantly, we continue to build momentum in our business and we're doing this against a backdrop of a really mediocre economic environment, and I'd also remind everybody, it's against a real history, meaning last year our adjusted sales, OI, and EPS grew.

So where are we? Well, we're on the other side of a major SAP implementation, which is good news. It means it's all upside from here. The disruptions that accompany a change like this are mostly behind us and will soon be completely behind us. The service and productivity metrics in the region that impacted Europe are showing the right movement. And we're now able to get after savings that have been promised, and have been part of this whole initiative. Most importantly, and even more importantly, our collective growth and innovation investments are paying off.

We continue to add share in food service, food retail, F&B and our healthcare businesses. We've had significant corporate account wins the last 12 months. The last six months being the most productive. Our innovation in wear washing, Apex and laundry, low temperature and low water initiatives and F&B, DryExx and new anti-microbial. In QSR, our solids. In FRS, our formula foam. In healthcare, our Encompass, Protect, Opti solids and now new hand care system, all continue to show very good momentum.

And this year's innovation pipeline is the second biggest in history, and by far our most balanced, and also new initiatives with Sysco and others are just coming online as we speak. So finally, the market is stabilized but it is not yet our friend. We're improving the business without any market help and we expect the market to continue to slowly improve. So our focus in the second half is really more of the same. Leverage all of the above good deeds, to drive our top line acceleration and build sustainable OI momentum built on volume growth. Our forecast for the year is double-digit EPS. Our growth of 15% EPS remains our goal, and we believe the right goal.

So while the market growth is slow at best, we've had huge share upside, and we are getting after it. So the business is progressing. We have no real drama to report. We need to continue to focus on execution and deliver the year the right way.

Thanks, Doug. That concludes our formal remarks. Operator, please begin the question and answer period.

Thank you. (Operator Instructions). Our first question comes from Gary Bisbee from Barclays Capital. Your line is open.

Good afternoon. You talked recently about the pipeline being maybe more robust than it's been in a while and also a lot of new products. Given that you've historically brought these out at premium price and a premium margin for you, are you seeing any sort of difference in the uptake of new products based on the weaker economy than what you've seen in the past or is that something that over the next 12 to 18 months as you launch all these things you think will be another good avenue for margin gain?

Gary, I would say our experience right now is very positive on the new initiatives. They are higher margin. But I'd say even more importantly, they represent much better value for customers because they're really targeted at getting after water, energy and in some cases labor savings. So they've got a great economic benefit for customers, and this is exactly the right story to be taking to the market at this time. So you need to have the balance of those two, meaning it has got to make sense for customers and the initiatives we're launching.

Okay. And is there -- it sounds like there's a lot more. Maybe it's just that you guys are talking about them, than you have in a typical 12 month period or whatever. Is there any issue with getting it all out there, or is the sales force so targeted on their particular areas that you feel like you're well positioned to have uptake in all these new products at once?

Gary, there's a big pipeline but I guess the point is that it's a balanced pipeline so this isn't all falling at the feet of one sales force. So we've got initiatives that are going to our institutional team. We have initiatives at our F&B team. We have initiatives going out to our healthcare team, our QSR team, our food and retail team.

These are discrete sales teams and the number of initiatives per team is well managed. It's just that we have a number of initiatives across the teams, across the Company. And so this has been planned for a while. And we have been upping our R&D, upping our focus on what we call our anchor technologies, those that we think are the most important in terms of impacting customer satisfaction, so this is a result of several years of effort.

And just I guess one last question. On the margins, particularly in international, it sounds like you've increased the level of investments. Is that -- should we read into that a sign that you're feeling better about the macroeconomic progress that some of those markets are making or is it other reasons that you stepped it up and had margin turn a little lower this quarter? Thanks.

Yes, to answer your specific question, yes, I would say clearly in Asia-Pacific and L-A in particular, we certainly have found those and continue to believe that those are in better shape economically than say near term US and Europe. I don't think this is a unique view on our part. But certainly we are upping the investments, particularly in Asia-Pacific, where we've added several hundred heads year on year and done a number of other things to continue to drive growth.

Great. Thanks for the color.

Our next question comes from Nate Brochmann from William Blair & Company. Your line is open.

Good afternoon, gentlemen.

Hello, Nate.

Doug, just to follow up on that last question a little bit, just wanted to think a little bit more how you guys think about investment and kind of also balancing that with bottom line returns. And then also secondarily, if you could talk a little bit about underlying productivity, if we were able to strip out some of the higher investment spending.

Yes, you know, I don't know how philosophical you want to get. I mean, if you look at A-P and L-A OI growth was spectacular in the fourth quarter and just excellent in the second quarter. So it was in the 25% year on year range, and so we typically will continue to feed the business, and in A-P, and L-A in particular, we see very significant growth upside and very significant opportunity to capture increased share in a market we believe is going to grow faster than the balance of the world. So we want to seize this opportunity now.

So we are investing somewhat on the comp as we go through this. Right? We will add people and our people don't become productive immediately. We're making sure that we've got very smart infrastructure bets, not huge ones, and they're very limited. The ones that we need to make because by and large we've got the infrastructure built. We are rolling out field technology in these regions because we don't -- it does two things. It enables us to supply even better value to our customers by collecting data and it also allows us to drive productivity in the region as we build scale in that region. I don't know if that gives you any color.

Europe, we've also obviously had major investments, which is the other part of the international story for us and those investments are largely around EBS. So we have the last wave if you will of EBS, eight countries, it was by far our largest wave. So you've got increased amortization showing up in the second quarter. That will stick with us. But even larger than that, you've got the natural but unfortunate disruption costs that come with flipping from one ERP system to another. Things like back orders, when you're moving from one inventory to the other, which means double shipments to a customer per order.

Now, all these costs are starting to move in the right direction, but they are incurred when you go through one of these things and we're going to move out of this. So that's another big piece of the international OI piece. If I was going to give you a picture going forward, our expectation is that international acceleration on the top line is going to continue in Q3 and Q4. And we will start seeing significant OI momentum in our overall international segment, beginning in Q4.

No, that's very helpful. Thanks, Doug. Just to think about the Asia-Pacific business a little bit, I believe up until at least recently that a lot of that growth has been coming from moving along with US-based customers. Is that starting to expand a little bit beyond that base?

Yes, I would say it is. I mean, if you looked at our top 20 customers in China, the majority of them would be Chinese-based at this point in time. And so that's been kind of an evolution that's been occurring because that market has been growing, and obviously local Chinese players are becoming quite large players in the food and beverage space in particular.

Great. Very helpful. Thank you very much.

Our next question comes from Mark Gulley from Soleil Securities. Your line is open.

Hey, guys. Institutional growth behind let's say textile and Europe, and I know that a lot of it is market driven by perhaps you can give us some observations on the pace at which you think US institutional can recover here.

Yes, Mark. I will -- we may record that and send it to the institutional. They noticed that too. Look, institutional has clearly had the most significant market impact. We know that we are adding share when we look at customer counts in that marketplace but even when we go back, they've had three years of declining food service and so while it -- in terms of traffic comp.

While it's stabilizing, and certainly the -- if you will, the decline has stabilized, they're still looking for the rebuild which is coming in the future. I expect that business to continue to accelerate growth. They will rebuild at a fairly steady pace which is what we've seen following other significant dips in institutional growth rates. We're seeing that pattern and all the things that we ought to be doing in that business, we're doing. We're after new accounts. We're driving in new innovation. We're working on penetration.

All the stuff that we know is key to rebuilding the top line. And the team is doing a number of excellent things there. So I'm very confident that that business will rebuild to the type of sales growth we expect.

To make that happen, Doug, do you have to continue to add people, or kind of following on some previous questions, are you really differentially adding people to high growth areas which you talk about in the slide deck, and maybe not so much in some of these low growth areas?

I mean, it's not even. Meaning we are adding more significantly and investing more significantly in high growth areas than we are in areas that aren't high growth. I would also say the high growth areas are also subscale versus some of our other businesses. So those two things tilted in the high growth arena.

But with that said, in institutional, we will make and continue to make very select investments because there's still significant opportunities to grow that business in North America and in Europe as we move forward. So this isn't a case of that business doesn't get any investment. That business will get the right investment. There are a number of high potential share areas that we've identified that we're going after. We've increased the number of corporate account teams in those areas.

There's a pretty rich area in terms of regional accounts that we know we're going to get after. There's very critical initiatives with large distributors that are really just starting to unveil. So there's a lot going on there so they will get investment.

Finally, Michael, if you will, a sort of a housekeeping question. Built into your guidance, was what kind of FX impact might we expect in the second half of the year?

Looking for a negative $0.03.

That's for the whole second half?

Yes, in that we had a positive $0.03 in the first and we expect a negative three in the $0.03.

Got it. Thank you.

Our next question comes from David Ridley-Lane from Merrill Lynch. Your line is open.

Healthcare sales, the H1N1 are up 7%. What are the internal revenue growth goals for healthcare and how quickly can you get back up to double-digit growth in that vertical?

Well, you somewhat answered what the internal growth goals are for healthcare. Double-digit organically, right, and then on top of that we will continue to look for smart acquisition targets as we build that business. We would expect to be there on a reported basis early next year. I think if you look underneath, recall, in the second half we're going to still be going against a pretty inflated H1N1 purchase base last year. But the underlying metrics, the new initiatives that I highlighted in my opening comments are all making very good traction. That business continues to strengthen.

Okay. And maybe following on from your comment about certain geographies being subscale, what are the geographies where you would say you're the most subscale and would have the highest potential incremental operating margin from adding revenue?

Well, I'd say if you want a real broad comment, it would be AP and LA would be the Regions that have the most upscale but I would say China, India, there's still significant upside in our Latin America business and I would also say kind of other Asia ex-Australia, New Zealand and Japan.

Okay. And maybe just one last housekeeping. What was the raw material pricing change compared to last year? Thank you very much.

It was a couple cents.

$11 million year on year in Q2.

Okay. Thank you very much.

Our next question comes from Edward Yang from Oppenheimer. Your line is open.

Okay, thank you. Doug, following up on that last question, don't you have the most margin leverage in Europe?

Yes. But the question was about subscale. We aren't subscale in Europe. What we are is poor margin. And so Europe is really leveraging the scale that we've already built so yes, Europe has got the most upside margin but the question I was answering is where does volume growth have the most benefit. And I would say in the regions that I identified in Europe, the margin journey is really as we laid out in the past. Leveraging the EBS system, getting after the Pan-European supply chain system, which means there's huge money in transportation and warehousing. We know there's money in purchasing and we know operating if you will our plants more efficiently, there's big SG&A upside as we stop running 33 independent companies and start leveraging the scale of the business and move forward, which is all the plan to start moving from the nearly 4 to 5% OI margin that we're at today on an annualized basis up to the teens that we talked about.

Okay. And what was the Apex growth in the quarter and penetration rates in the US and would you look to introduce Apex Into Europe any time?

Yes, ultimately we'll expand Apex Technology globally and we have-- are finalizing frankly great manufacturing technology which will allow us to do this very efficiently from a capital standpoint. And first we're going to go to a different market, but Europe will get that technology in the near term. The growth rate was double-digit in Q2. Apex now represents over 25% of wear wash sales, machine wear wash sales in North America, continues to progress very well.

Maybe a final modeling question for Mike. Interest expense has been pretty stable, around $15 million a quarter, but your net debt is down sequentially, was down year-over-year as well. Any opportunities to get some interest expense leverage?

What do you mean by interest expense leverage, Ed?

Well, your net debt is down but the interest expense is remaining pretty stable. So is there any opportunities to get the effective rate of interest expense lower?

We just had $150 million of debt go short-term and it is due in February. So we'll be paying that down and we've also been doing share repurchase as well.

Okay. Thank you.

Next question comes from John McNulty, Credit Suisse. Your line is open.

Good afternoon. Just a couple of quick questions. Mike, I think in your original comments on F&B you had talked about maybe some pricing being a little bit weak there. Can you go through what's actually driving that?

Well, pricing was very strong if you remember through 2008 and 2009 and it was just saying relative to those periods, pricing is flattish compared to the very strong pricing that we had in those two years.

So it's not down, it's just not the usual robust pricing?

Just off a little bit. But it's flattish, off slightly.

Is there any competitive reason as to why that's the case or is it just tougher times or -- ?

I would say it's principally because caustic went on a monster ride up and then down quite dramatically. So it's more to caustic. We're talking about down less than 1% and we had substantial increases for two years prior to that. So over the period of time, we have held on to 90% of the pricing.

Okay. Okay. Fair enough. And then with regard to cash use, I know you've been looking and you said even as late last year, you were looking to put capital to work in M&A and we really haven't seen much yet. What should we be thinking about in terms of the second half of the year? Is it going to be kind of continued share repurchases or are the M&A opportunities going to open up, do you think?

Well, the plan is that the M&A activity will be better in the second half than the first half which is a pretty low bar. So I would say our expectation remains that we will have a successful year in M&A this year.

Okay. Thanks a lot.

Our next question comes from Steve McNeil from Jennison. Your line is open.

Good afternoon.

Hey, Steve.

Hi. Doug, thank goodness you had no drama to report. Thank you for pointing that out. But I wanted to talk a little bit about Europe and the investments you've made there. Kind of seems like we're rounding the bases, so to speak, and running towards home plate here, and I'm just wondering as you indicated, you expect the EBIT momentum to develop here, I'm just wondering as a Company, I mean, Ecolab has traditionally delivered earnings growth around the 15% level call it. Are we potentially entering a period here where we could see earnings growth tick up to the 20% range, plus, as this momentum develops in Europe?

Well, look, I would say this. Our goal of 15% remains our goal. It's not a governor from that standpoint. However, I would say that's the target that I think we are comfortable talking about as we go forward. I would agree with you that we have reached a very important milestone in Europe in terms of having the roll-out waves behind us so that all the work now moving forward in Europe isn't about preparing new countries, isn't about worrying about what's next in terms of how do you prepare for the next roll-out. It's about how do you capitalize on all the work that's already been done.

Just from a mental standpoint, it is a huge milestone there. So we're excited about what that's going to bring. Last call, we said that our expectation is we would start seeing margin lift in Europe beginning in the fourth quarter. That remains our view. That is when we will start seeing year on year margin lift as a result of this work, and then obviously continued margin lift for many years to come.

And can you just remind us, the size of that business I think is, what, it's $800 million?

Europe?

Yes.

No, $1.8 billion --

I'm sorry?

It's $1.8 billion.

So you basically have --

If you put Europe specifically, it's in the $1.6 billion range.

I just want to frame it, make sure I have I'm framed out correctly. So we're talking about a $1.6 billion business that today has 4 or 5% EBIT margin that you think gets to the teens over a period of time?

Yes, absolutely.

We said our goal is 13%, 14%.

Okay. All right. Thank you.

Yes, you bet.

Our next question comes from Robert Koort, Goldman Sachs. Your line is open.

Thanks, guys. Just curious what do you think it would take to get back to that environment we had for several years there where you were generating 5 or 6% volume growth?

Well, I will tell you, that's exactly what's going on right now is that we have good positive volume growth, following a year where we didn't have positive volume growth. So I think what we're doing is exactly what it takes to rebuild that kind of volume growth. Because we have said our goal for organic remains 6% to 8%. We expect the pricing environment going forward to be more like our historical pricing environment, which is one point, so it's going to take 5% to 6% to get into that range. So it's new customers, penetration, leveraging the other tools that we leverage as we go forward. But we are starting to see positive movement in terms of volume.

And Doug, I think I know the answer you'll give me but I want to ask anyway. Do you believe in institutional you're continuing to sustain or gain market share?

Absolutely. We know we are.

And I hear from folks that look at the lodging industry, just seeing that the trends there -- I recognize they're off coming from the abyss, but seeing some momentum. Why aren't we seeing a greater follow-through, or is that similar to your comment to the first question that you're cranking up the fly wheel and that's on the horizon.

I think the lodging, one, you already did -- lodging is moving in the right direction. We like the room demand. It's up. It's been business travel-led. It looks like RevPAR, which is important to our customers, revenue per occupied room, is going to be moving in the right direction as well which is good news for us. But I think if you looked at room demand, we're back at like 2005 levels right now. In spite of that, we've grown this business this year, and are moving in the right direction but I would expect, typically we lag, and I would expect that we will see continued improvement in lodging as the recovery unfolds.

Okay. Thanks.

Our next question comes from Rosemarie Morbelli from Ingalls & Snyder. Your line is open.

Thank you. Can you hear me?

Yes.

Oh, okay. Something went on with my phone. Could you touch a little bit on pest which has really been slowing down quite a bit this quarter, worse than any others. Could you give us a better feel as to why and has the competitive arena changed and is that one of the reasons?

Yes, Rosemarie, Doug. Clearly, pest has been impacted by the market situation, probably more severely than some other businesses. I would say two things. One, we are a premium product, sometimes we're the victim of our own success in that if you're successful with pest elimination, people start forgetting that there are cockroaches and rodents still there to pester them in the coming months. We have seen business that has fallen off come back. We track our underlying metrics in that business, things like account retention, new contract growth, et cetera. All those things have started to swing to the positive. Our expectation is that we will start seeing sales growth in the second half this year and that we will start rebuilding the sales line on this business as well.

Any change on the competitive -- in the competitive arena? Do you have to lower your price and not be as much of a premium product in order to regain some of that share?

Yes, I would say I don't think the competitive arena has changed, meaning there aren't new people doing new things or old people doing new things. I think people have had their positions staked out. From a price standpoint, we are certainly recrafting some programs and service level commitments and using those to gain new business. But I wouldn't say that's really a repricing phenomenon. We still plan to maintain our premium promise and premium price, because frankly, it's the best value in the market.

Okay. And then Doug, you mentioned that you were still working on additional cost savings. Could you give us a better feel as to what you are doing now that you haven't been doing for the past two years? And where you stand in terms of reducing the number of SKUs?

Yes, SKUs, I'm going to have somebody dig up the exact number where we are. We have made huge progress in SKUs globally and by key region. In terms of initiatives, look, we introduced Lean Six Sigma several years ago, so certainly they focus on unique initiatives, simply as we move down the [Perino] chart of opportunities, you end up focusing in different areas. If you want the big buckets for us, I mean, clearly the things that we staked out in Europe are huge opportunities, so we also know in US have major shared service opportunities and we also have similar opportunities in A-P and L-A. The focus is going to be Europe first, North America second on these opportunities and then we will start moving into A-P and L-A. The best way to drive margin in A-P and L-A right now is through volume and through sales growth.

One last question, if I may. That was very helpful. Could you give us the losses for GCS?

Yes, GCS lost $1.2 million in the quarter and continues to show annual and sequential improvement.

And are you still expecting to break even by the first quarter of next year?

The only thing between us and breaking even is more volume. So I'd say the most important metric to watch on GCS right now is how are we doing on the top line. We were down, I don't know, 3.5%, 4% in the first quarter and we're up positive 1% in the second quarter. So we made directionally the right move in terms of generating sales growth. This is -- the business runs well, operates well. We've got the efficiency we were looking for. Now we've got to get the volume to go drive the OI performance.

Okay. Thanks a lot.

Our next question comes from Laurence Alexander from Jefferies. Your line is open.

Good afternoon.

Good afternoon .

I guess first question I wanted to ask was bouts sort of sales force compensation. A lot of the benefits that you've outlined in the past, more to do with the SKUs and the logistics in the back office. Are you -- is there a chance over the next few years that you start looking at the sales force training and compensation schemes and look at ways to better align those with your growth targets?

Yes, I would say there's been a couple of things happening simultaneously. We've been investing and moving bodies, if you will, into what we call key sales positions. We've built corporate account teams in F&B and institutional where we had virtually done. We're doing similar things in terms of identifying the right corporate account teams to have in our healthcare business as well there. We are looking at ways that we can reshape compensation.

We're probably doing -- we're further along in the healthcare business but certainly the system will give us the transparency you need to drive the types of sales schemes that we run in the balance of the world effectively, i.e. paying comp per product, understanding what goes through our distributors, trace sales all the way through the system. We do not have those capabilities. We didn't have those capabilities until rolling out the system. Now we do have them. So that opens the door to many of the initiatives that we've already undertaken, say in North America and other parts of the world.

And separately in healthcare, as you've evaluated the path to market for the new business, I mean, are you looking at separating the consultative sales from the product sales?

I mean, I guess the simple answer is no, but it's probably somewhat nuanced. I guess in healthcare, importantly, what we're working on is making sure that we do the right job of flipping our sales team with the information they need to effectively sell the programs that we put together. This is not unique to healthcare. The work that we do in institutional, in F&B, in food retail, QSR, we're also undertaking it in healthcare.

We have a number of great initiatives in healthcare. They are moving the right direction. We are gaining traction. We are getting yeses. We are installing these things. So all the trends and the movement's in the right direction. If you get down to where we're separating the consultative part and the other part, I guess we are going to have a specific team that's going to handle some of the maintenance in hospital that will be different from the team that is representing and doing the consultative service part of the growth. That's not completely unique to things that we do in other businesses but that is going to happen in healthcare.

Thank you.

Our next question comes from PJ Juvekar from Citi. Your line he's open.

Yes, hi. Doug, can you explain how much investment did you make in installing these new European systems? What was the impact on the quarter?

Well, in the quarter, overall this system over several years was in the range of $200 million. Now, that includes obviously all of our internal people, travel associated with it, but it's a sizable investment from a Company standpoint. For the quarter, Q2, we had a step up from Q1 and $5 million in amortization. But probably the bigger piece of the expense was what I would call the resultant inefficiencies that happen as you roll eight countries. That stuff dissipates fairly quickly. Obviously the amortization's there until it runs out.

How much of those inefficiencies, just sort of ballpark number, what percent impact?

It's north of $5 million bucks in the quarter.

Okay.

It's a step that Doug referred to earlier, PJ, about back orders having to make two shipments to a customer rather than one, things like that, just part of the --

Sure. Doug, you mentioned that room demand is back to 2005 levels. Over that time, if you look at US margins, the US margins are higher than what they were back in 2005. In European margins are almost half of what they were in '05. Europe has been lagging for a couple of years. So can you talk about that sort of margin progression in the two continents?

Yes, I would say there's two key things driving Europe margin. One is what I will call a planned initiative called EBS. And we knew that while you're building this and laying on a second system on top of the historic or legacy system, that you were going to have margin erosion as a result of this. Because you can't turn off the old system until the new system's running. Right. So that is obviously been a significant impact.

Coupled with that, right, we also did a number of things which we talked about which we said would have an impact on OI margin but a benefit in NI margin, which was increased costs associated with putting together a principal Company model. That also if you will had margin impact. And then the other is we have a different competitive environment, and we had raw materials rising and taking us longer to recoup if you will raw material price increases in Europe than it did in North America and some of our other Regions, given just some market dynamics that go on. Those are the same market dynamics which lead us to guide you to say while there's significant upside in our margin in Europe, say at a 13, 14% range, it is still going to have a significant delta versus North American markets. So it's both factors. But we're quite confident at our ability to start driving this margin up.

All right. I mean, the 13 to 14% margin growth, is that realistic? I mean, you've never been consistently that high for any period of time in Europe.

I guess I wouldn't give you that number if I didn't think it was realistic. So we believe it's realistic. We have very clear plans. We've run that business. Look, we run A-P and L-A in double-digit. They've got absolutely no scale in those regions at this point in time versus what we have in North America and Europe. So I think we've got a very clear path. A big hunk of this is frankly money that we spend inefficiently by running a bunch of discrete product supply systems versus leveraging them efficiently.

PJ, part of the reason they weren't that high before is just the reasons we did this, because we had very complex system that did not allow you to see transparency and operate that business with a $1.6 million, $1.8 billion worth of scale. Instead, you were operating basically with 27 different entities and so again, part of the reason you never got it before is just the reason that we did it. That's why we see the opportunity to get margins like that. As we look across the rest of the world, we can see what the margin potential is, so we can hypothecate to what we think we should be able to get out of Europe.

You're saying that during the system change you got hit with the recession which is what crushed the margins?

Well, I would say I think the margins dropped for several reasons. Yes, certainly the economic crisis wasn't planned for and didn't help. But I would say you would have seen margin erosion during this period, even if the economy had maintained its same pace. Simply because you had, we're layering on this duplicate system. You've got to put on system do before you can take out system one. That's extra cost. There's no way around it. Second as I said, we did see raw material inflation, quite dramatic over the whole Company and it impacts us differently by region and Europe it takes longer for us to recover that margin loss than it does in other regions because of competitive environment. We are recovering it.

Thank you.

Our next question comes from Dmitry Silversteyn from Longbow Research. Your line is open.

Couple of questions. If you look at the sequential margins in the international business, they've improved quite a bit. Was that the result of the ERP going live and some of the duplicate costs beginning to come out or was it just sequential volume improvement or pricing versus raw material?

Dmitry, looking at first quarter to second quarter?

Yes. There was better than a 2 point improvement in sequential margin. I thought there were enough headwinds to keep it a little bit more subdued this time around.

It's principally volume driven.

Okay. But you really didn't see any costs starting to come out of ERP. That's all going to be in the second half?

Yes, because as I said it's really starting fourth quarter and then next year is when you're going to start seeing those benefits. So no, that's not in that. In fact, what I would say is there's extra cost in the second quarter as a result of the ERP, not cost out yet.

Got you. Okay. You talked about the GCS profitability or loss improving to $1.2 million on the operating profit line. You're starting to see sporadic volume growth there. You talked about needing to see revenues to leverage, the cost investments that you've made in that business. As you look out towards the second half of the year, and I know we've been through this I think going back to 2008 when you were first supposed to turn profitable or at least break even in this business. Given the last couple of years, as we were at this point, how confident are you that you're going to be in fact being able to get this business to at least a breakeven by the end of the year?

I don't know Dmitry that we aren't saying that this business will be breakeven by the end of this year. I would make a couple of comments, though. One, this business is not losing cash. It's been generating positive cash for us the last several years and continues to. And as we move forward, what we've got is a one front war which is as you pointed out a volume issue. Right?

As we grow this business, I mean, the thing that's standing in the way is we've got to get the appropriate level of sales on top of this infrastructure to make money. That's what it's going to take. And we don't believe we're going to have enough volume by year end to get us to breakeven. However, the path is very clear. It's not sucking up resources corporately. I mean, right now, I'd say we've got an upside chip to play that doesn't cost us any money to play it.

Okay. Do you get a sense in the market that there's some momentum building up behind that business in terms of customers asking for it, or how receptive they are to getting bids and actually following through and signing contracts with you, and have you reached out to the manufacturers? I remember at one point there was a possibility as well of becoming kind of a registered rep for the manufacturers as well.

I guess I would say this way. We're happy that we have seen a quarter to quarter improvement in the sales growth trend. I guess I don't want to overplay a 1% growth. Right? It's better than a 3 or 4% decline but it's not the level of growth that we expect or need from this business long term. We expect this to continue to move forward. But right now I would call the environment better than last year, but not quite at good, right, in terms of the food service environment it's playing in. But we expect the environment to also steadily improve, which has been a consistent forecast from us for a while now.

And Dmitry, we're selling a different way of doing kitchen equipment repair to our customers. So it's obviously you have to do some missionary selling on that and in this environment, as you can imagine, it's not the most ideal environment. So we think we're making good progress there as we've seen with the sales and the operating profitability for the business over the last few quarters. We think that's going to continue as we go forward, continue to make more progress. As the environment gets better, it should continue to also get better.

Question on raw material and pricing. There was a little bit of a pricing downdraft in this quarter. I think Doug you said there was -- you were giving up some pricing as plastic prices come down. Where are you in terms of kind of the trend curves with respect to pricing and raw materials? Have you basically anniversaried the price increases that you've gotten in 2009, and now you're looking at giving up maybe a percentage or two of pricing, and what are raw materials doing to you in the second half of the year?

So first on price, we were specifically talking about F&B and it was a global conversation. Food and beverage. In total, our price for Ecolab was positive in Q2.

Right.

Would round up to a point.

Right.

Okay? About what we've been talking about. But obviously, if you go into sub-businesses, you're going to have different answers and different businesses. But in total we were up about 1%. We expect that that's going to be the answer for the foreseeable future. That's probably the best thing to model.

Okay.

In terms of raw materials, they were favorable year on year but basically this is an annualization impact. Raw materials have really been relatively flat for the year, if you will, about the price coming in this year, about what we're paying now, and what we expect to pay for the balance of the year. So really, the deltas that we're talking about are because last year was a very different story quarter to quarter. This year it's fairly benign story quarter to quarter.

Final question on vehicle care. This business has been struggling going back to I think 2007 was the last time you guys had a positive revenue number there. What's the future of the business? I mean, we're seeing miles driven higher year-over-year in the first half of this year and anything that seems to be associated with or in some way related to miles driven within other companies businesses seem to be doing well. What is it about vehicle care that is causing this business to continue to lose revenues and see revenues decline going into the fourth year now?

I would say fundamentally car washes are down quite dramatically in total. Right across the industry. And so one of the places that people have chosen to economize is that they're either not washing their car or they're choosing to do it in their driveway with a garden hose. They're not driving through traditional car washes. Those counts are down double-digit. And have been for a while. So this is one of the consumer areas that have been impacted quite dramatically. I mean, that's what's going on in that business right now.

But Dmitry, that business is still making money. It's got a good profit margin. So it's not like this is a big drag on the bottom line.

I understand that, Mike. But Ecolab has not become the Company that it's become by investing in subset businesses or investing in businesses that have long-term negative growth trends. So I'm just wondering strategically or philosophically, how this business fits with what you guys are doing.

Yes, well, I don't know what to say, Dmitry. It's a business under pressure right now on the top line, principally market-driven. We're not going to offset that. That's the plan. The plan is to go fix the business as it is right now and that's it.

All right. Thank you, guys.

Our next question comes from John Roberts from Buckingham Research. Your line is open.

Good afternoon, guys.

Hi, John.

The National Restaurant Association meeting you had a private showing for some what looked like significant new products. Did any of them make it out into commercialization in the last couple months. I know it's kind of early. Some of them were nearer term compared to others.

Yes, no, several of them are in what I would call a quiet launch, and some of it is because we're building capacity capability. But I would say that they have done quite well and we're using them with some very strategic customers in terms of building what I would say is long-term capability.

Then secondly, and this may be a stretch, but here in Manhattan we've had some bedbug outbreaks at retailers, clothing retailers. We've had it at some office buildings. These are not your traditional markets. Pest elimination, you don't serve the power retailers very often, but is this a tip of the iceberg? Do your epidemiologists or your guys in insect control area think that they live in clothes and things like that and there's something more to this?

Well, you'll have to ask them specifically, but I would say if bedbugs are absolutely resurgent, they're going to become much wider spread throughout society. That's the nature of the little beast. That's the way it was in the 1930s and frankly throughout human history. They went away for a period of time. Most people point to DDT as the thing that unintentionally, it was for a different purpose, knocked down the bed bug population. DDT's been banned to save the eagle and fish and the rest and we have bedbugs back. This is a theory. They're going to be widespread. We aren't going to be chasing the retail business but people are going to find them in homes and other places. I would say we have a very good competency and a unique competency in bedbugs. Plenty of other people promise they can take care of them too.

It's one of the growing areas of pest, John, as we mentioned, we've got new technology which is highly effective and substantially cuts down the amount of time customers need to clean them out, so it's a good area of growth for us, unfortunately.

Think of them as mosquitoes without wings. It will make you feel better.

Our next question comes from Mike Harrison from First Analysis. Your line is open.

Hi, good afternoon. Thanks for squeezing me in. On the F&B business, can you give us some more details on dairy, agri, and meat and poultry. You mentioned they were soft right now. When are you expecting to see improvement and what kind of drivers or metrics do you look at?

Yes, a lot of these segments, and obviously it's somewhat different by region of the world but they're fairly flat right now. I would say long-term, F&B, the macro trends, that business globally is performing exceedingly well. And this business shifts around. I think our F&B business, what that team is doing, how we're moving in terms of innovation, I'm very bullish on the F&B business and so while we're going to go through these trends, long-term there's going to be more mouths to feed. They're shifting to protein which means they're going to need even more calories than they do today per mouth as we go forward. We like the macro trends of this business and we like our position. We're going to go through dairy's hot, dairy's cold, people are going to shift protein sources but I don't think that's going to be the big story long-term.

And just in terms of Canada, I know there was a tough prior year comp but any further detail on what happened there this quarter and what's going to get things going better in the second half?

Mainly it was the last year comp on H1N1 and this year the Canadian government basically put a freeze on all hand sanitizer. They run the healthcare system because they had a large inventory stockpile so it's really kind of a quota story. Not a big deal.

All right. Thanks very much.

Now I will turn the call back to Mr. Monahan for closing remarks.

Well, that's the end of our call, so thanks everyone for participating today, and have a good day and rest of the week. Thank you very much.

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