藝康 (ECL) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Ecolab Third Quarter 2017 Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mike Monahan, Senior Vice President of External Relations. Thank you. Mr. Monahan, you may now begin.

Thank you. Hello, everyone, and welcome to Ecolab's third quarter conference call. With me today is Doug Baker, Ecolab's Chairman and CEO; and Dan Schmechel, our CFO.

A discussion of our results, along with our earnings release and the slides referencing the quarter's results and our outlook, are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statements on these materials, stating that this teleconference, the discussion 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, and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release.

Starting with a brief overview of the quarter. Ecolab's underlying sales and profit fundamentals continued to improve through the third quarter, and we are building momentum as we finish 2017. Continued pricing and new business gains drove third quarter acquisition-adjusted fixed currency sales growth in all our business segments despite the unfavorable impact of hurricanes in North America.

The sales gains, along with product innovation and ongoing cost efficiency work, more than offset higher delivered product costs. These, along with our work to lower interest expense and our tax rate as well as fewer shares outstanding, yielded the third quarter 7% adjusted earnings per share increase.

Moving to some highlights from the quarter and as discussed in our press release. On an adjusted basis, excluding special gains and charges and discrete tax items from both years, third quarter 2017 adjusted diluted earnings per share were $1.37. Hurricane-related impacts on sales and costs were estimated to be a negative $0.04 per share in the third quarter, representing a 3 percentage point reduction in our EPS growth.

Consolidated acquisition-adjusted fixed currency sales rose for all of our business segments. Europe and Asia Pacific led the regional growth. Absent the impact of the hurricanes, acquisition-adjusted fixed currency operating margin declined an estimated 20 basis points as pricing volume increases were more than offset by the margin impact of higher delivered product costs in the quarter. Absent the impact of the hurricanes, acquisition-adjusted fixed currency operating income is estimated to have increased 3%.

The operating income gain, along with lower interest expense, the lower tax rate and fewer shares outstanding, yielded a 7% increase in third quarter 2017 adjusted diluted earnings per share.

We continue to aggressively work to drive our growth, winning new business through our innovative new products and sales and service expertise as well as driving pricing and cost efficiencies to grow our top and bottom lines at improved rates. We also continue to see underlying sales volume and pricing improve across most of our business segments and look to that to more than offset continued delivered product cost headwinds and yield stronger operating income growth.

We expect fourth quarter fixed currency sales to rise in the 5% to 6% range, with net income increasing more than 10% as improved sales momentum and stronger pricing drive results and more than offset higher delivered product costs.

Adjusted diluted earnings per share are expected to be in the $1.35 to $1.45 range, up 8% to 16%. Hurricane-related impacts are estimated to be a negative $0.04 per share in the fourth quarter, and the loss of Equipment Care income will reduce earnings per share by an estimated $0.01 per share. Together, these represent an estimated 4 percentage point headwind to fourth quarter EPS growth.

Reflecting the impact of the hurricanes and higher delivered product costs, we have tightened our full year adjusted diluted earnings per share forecast to the $4.65 to $4.75 per share range in 2017, rising 6% to 9%. We expect the impact of the hurricanes on full year sales and costs will be approximately a negative $0.08 per share and the Equipment Care sale to reduce income by $0.01 per share. We do not expect 2017 hurricanes to have a meaningful impact on 2018 results.

In summary, we see momentum improving in our business. We expect to deliver strong adjusted diluted EPS growth in 2017, and we look for our investments and actions to drive better growth ahead.

And now here's Doug Baker with some comments.

Thank you, Mike. As I look at Q3, I would highlight 3 key takeaways. Number one, our business fundamentals are improving. Our new business, innovation and pricing discipline are showing up in the numbers. Pricing is improving in all segments since we covered the absolute raw material increase in Q3 and expect to exceed in Q4, which will begin our margin rebuild. And our volume is also forecast to increase as it's regaining its natural path in Q4 as well.

Institutional is the exception, point number two. If you cut through the clutter, Institutional is growing at 3% globally and 3% to 4% in North America, which is better than it looks but still way under potential in our expectations.

In short, the U.S. environment in particular requires more offense. Unit growth and same-store sales in full and casual dining are weak. To increase offensive capability, we are adding additional sales positions, launching new platforms in warewashing and laundry to drive new unit sales and refocusing the field on large category penetration opportunities to help drive same-store sales.

We anticipate these steps, which are already starting to lead to improvements, will improve Q4 versus Q3 modestly but drive continued improvement throughout 2018.

Finally, the third takeaway is that overall results have been on a steady improvement path all year. The fundamentals are winning, and we expect to leave the year with very strong momentum. We have sales momentum. We forecast in Q4 organic sales to be 5%, fixed currency sales to be 5% to 6%, reported sales to be 6% to 7%. We have margin momentum. Pricing will continue to accelerate in all sectors, including energy, which we forecast to have positive pricing in Q4, too. We have earnings momentum. We forecast double-digit net income growth in Q4 as well as double-digit EPS with a 12% midpoint -- be 13% if you exclude the divestiture of our Equipment Care business.

So clearly, Q4 is a notable improvement, but the most important news is the momentum driving Q4 results positions us well to deliver Ecolab-like results in 2018.

So with that, I'll hand it back to Mike.

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

(Operator Instructions) Our first question is from the line of Gary Bisbee with RBC Capital Markets.

Doug, I guess, the first question -- I appreciate the positive commentary on improvement in -- ex the hurricanes this quarter and more to show up next quarter. But I guess, I continue to struggle. It's been like 18 months now that you've been talking about improving bookings trends, and it's just been a stubbornly slow -- to work its way into revenue. What's going on there? And I guess, can you say anything other than what you've said so far to help our confidence that this is actually going to materialize going forward?

Yes. I don't know that I'm going to rehash all the stuff that we went through in '15, '16. I think, though, in '17, it's been pretty clear that we've had improvement on a going basis on fixed currency sales. I mean, they were 2% in Q1, 5% in Q2, 5% in Q3, and they're 5% to 6% forecast in Q4. And if you look at rounding, I mean, we are moving up in the right direction. It's a bigger business. This business always, it's very sticky once you sell it. It does not ramp up quickly in almost any environment, never has. And so we are starting to see traction take hold. The callout I made on Institutional was it's a place, honestly, where we haven't seen the same traction we would have expected. And I would call that mostly the results of a tougher-than-anticipated environment, which isn't an excuse because we have tons of share opportunity in U.S. as well, which is what we really have to get after and get on. So short of Institutional, I would say you're seeing, clearly, signs of improving business. In Institutional, we've been a little bit on a hold, but we think we've got the traction moving there too.

And I guess, just a follow-up on that point. Some of the things like the new warewashing and laundry platforms you talked about in September at the Investor Day. But this increase in headcount and some of the other things you mentioned about the focus on penetration, it sounds -- it seems to be new. So did something change in the last couple of months that made you acknowledge, hey, this isn't going the way we want? Or is this just not something you discussed there but that had already been underway?

No. I would say part of it was we were talking about it there but had not decided to go do some of these things. And the -- I mean, the fact is the institutional market in U.S. isn't giving as it used to. We used to naturally acquire new unit expansion as a result of having the chain business. They're not adding units. We used to have better same-store sales as a result of traffic. We don't have traffic. And so you got to acknowledge the market you're in, not the market you hope for. And so as a consequence, we know we got to up the offense, and we're doing it. Now we've been here before. I would say if you go back in the early 2000s, there's probably a 2-year period -- unfortunately, it was when I took over, where we were stagnant as well and growing at about the 1% and 2% in U.S. Institutional. And so we upped offense. We did a number of moves. I would say the things that we're launching now are digitally enabled and will allow us to capture a lot of the information that we're already securing but get it to the cloud, which will allow us to do more for customers, which I think ultimately leads to more business. Those are the new platforms we're launching. So I just think this is a little bit of a relook at how this market is actually performing and what do we need to do to succeed in the given market.

Our next question is from the line of John Quealy with Canaccord.

The first question. Can you talk about the impact on price across all segments and SKUs? Has everyone that can catch up at this point caught up? And then a part of that is, when did the delivered comps get easier on the price point? That's the first question.

Yes. I would say from pricing, I mean, in total, we are north of 1 in Q3. Expect that to expand by basis points going into Q4. But the expansion is across the board. As I mentioned, energy will be positive on pricing in Q4. It was nominally under last year in Q3. So we kind of crossed the threshold there as well, which is the last segment to cross it. In terms of raw materials, raw materials started moving against us last year fairly early, really at the very end of Q4, if you will, a year ago, and into first quarter. So as the year goes on, the base gets easier.

And my last question. On the Paper business, I think it's been, at least in the ROIs, a pretty good run, 36 months plus of growth there. And then maybe hurricane-excluded growth, maybe 1% or rounding up to 1% this quarter. Can you talk about big picture around cyclical versus secular in Paper?

Yes. I mean, the Paper business, frankly, is doing well everywhere but in China. And China, we -- I would say, we're starting to bottom out in Paper, but we've not performed as we should have in China. And that's really clouding the results in all other regions. China is not going to be a long story because we're getting to a point where it can't be. But we've retooled. We're putting a lot of emphasis on technical competency. We're launching new technology, which had been delayed there, and doing a number of other steps. I would call China more upside at this point than downside. So I think you're going to see Paper stabilize and start moving up or accelerating sales. I mean, it's growing; just not growing very quickly.

Our next question is from the line of David Ridley-Lane with Bank of America Merrill Lynch.

As the Energy business recovers in 2018, what's the likely range of incremental margins that you're planning for? I know this year has had some compensation rebuild, the raw material pressures, et cetera. Just wondering, the underlying margin potential of that business?

David, I mean, we're not going to get into real specific details on '18 in the call. I would expect -- this year, we've said it was going to be plus-minus OI and low to mid-single-digit growth. And that's really what we're seeing for the year and forecasting for Energy. Next year, I would expect growth to be nominally better, and it would be on the plus side on income, so it'll be accretive. And we aren't really going into detail of how much. We'll do that in the call at the first quarter when we typically give our detailed 2018 forecast.

Okay. And then just a quick numbers question. On the Equipment Care divestiture, what is the estimated after-tax proceeds? And then the margins of the pest business on a stand-alone basis for modeling going forward?

No. Those -- neither of those we've disclosed nor plan to. I think as we move forward, pest margin is obviously certainly north of the equipment margin. So this is not dilutive to margins.

Our next question is from the line of Manav Patnaik with Barclays.

You touched on the pricing in an earlier question. I was wondering, looking ahead, like we saw this quarter, I guess, where your pricing offset your ROIs -- or your increases in the ROIs, should we continue to expect that going into '18? Or is there anything else you would call out, whether it lapses or anything as we think about sort of the cadence into the year?

Yes. We've historically talked about our pricing philosophy to be: try to recapture absolute increase in year 1 and recapture margin in year 2. Obviously, you got to recapture roughly double the increase in raw material absolute dollars in pricing to recapture margin. And we tend to do this over a period of time, call it 6 to 8 quarters. And I think that's exactly what you're seeing. So we're saying we sort of crossed the threshold. Even though we had a little spike in raw materials in Q3, we still were able to cover absolute dollar, I mean, like almost exactly. The -- what we saw from pricing in absolute dollars and paid out in raw material increases. Q4, as I've mentioned, we will have daylight where pricing exceeds raw material increase at that point in time. We were obviously below in Q1 and Q2. So what I would expect to see is that delta, the positive delta, continue to widen as we go on because, one, we got to kind of pay back what we invested in the first half; and two, that's how we recover margins. So I think that would be a steady increase in that delta over the next 3, 4 quarters.

Got it. And then just on tax reform. I understand you're dealing with 140 characters or less. But I think in the past, you talked about 28% maybe being the breakeven tax rate for you guys on corporate tax reform. I was just wondering if you had any updated views there.

Well, I mean, the simple answer right now, they seem to be very focused on 20%. And 20% almost assuming it's territorial and the like, which is what they've been contemplating, would be fine for us, would not be a negative.

Our next question is from the line of John Roberts with UBS.

Doug, on Equipment Care divestment, was the inability to wrap Equipment Care into the circle of the customer strategy the primary reason for moving on with that effort?

I guess, look, the Equipment Care was a good business. We didn't always run it that way, but obviously, we drove substantial improvement over the last 5 to 6 years. I would really say, at the heart of it, when we looked at: how we're going to drive food safety, how did we want to invest in digital, where do we really want to put our money and where was the upside for us? Equipment Care, as we looked at our portfolio, increasingly became the odd man out. And if we're not going to be fully on the gas at a business, then we'd probably be best not to own that business. So we thought to see if we could find an owner who we thought would be better for the business long term, and I think we found one. So that's the best explanation. I mean, we had sold it in circle bundles and other things successfully. But it's a bit of a different model, which I think the new wonder -- new owner understands. Leverage is tougher in that business than it is in our other businesses for us, and we want to focus on businesses that are more like our core model than not.

And then could you talk about the Specialty Paper chemical unit you acquired in the quarter. And I think there's a more commodity part of paper that's water chemicals that -- is that core long term? And now that you bought something else in paper, does it make it more core long term, the more commodity part?

Yes. I wouldn't overread or underread. I mean, it was, to us, a smart acquisition. It put us in -- it's really technology that's in the growing part of that industry. It's not a huge acquisition. I think sales were $40 million the prior -- in the base year. So it just, we thought, positioned us better to do what we're doing in Paper. We're going to invest in that business and continue to invest in it. We've substantially improved the business since we've been operating it. We plan to continue to do just that. And this particular acquisition increased our positioning in the fastest-growing piece of that market.

And our next question comes from P.J. Juvekar with Citi.

This is [Scott Goldsmith] on for P.J. So maybe going back to growth initiatives. Is your -- are you looking to add to your sales force to target any particular market segment? Or is it more broad-based? That's the first question.

Yes. No, we're, I would say in most businesses -- the exception right now, energy, we don't have significant adds in this year. But in almost all the other businesses, we've added, albeit not huge numbers. In particular, we've been adding corporate account resources in 3 of our major businesses because as we've looked at and analyzed opportunities, we felt we had too few people to get after new opportunities because the existing business base was commanding most of their time.

Okay. And to follow up is, can you maybe give more details around the penetration optimization program that you're using to stimulate same-store sales?

Yes. I mean, what happens in Institutional is -- I would say there's rhythms over time or rhythm. And we've introduced a number of categories to extend our line, which is a time-tested and honored way that we grow our business. But over a period of time, it can also lead to a little lack of focus on the largest categories. And so what we want to make sure we're doing is focusing everybody's attention on the most important categories, in this case, in a restaurant and that we make sure we drive penetration in those areas. Our penetration hasn't declined, but it hasn't been increasing as we would expect it to over a period. So we need to reemphasize it. And I would say importantly, in Institutional, our challenge is really accelerating growth. We do not have a defensive challenge. Our account losses are at historic lows. So it's not that we're losing business. It's not that we're losing penetration. It's just that we aren't having the same offensive impact that's required to grow that business, in part because the market is not giving what it used to. So we're going to have to do it ourselves.

Our next question is from the line of Laurence Alexander with Jefferies.

This is Dan Rizzo on for Laurence. You mentioned technology as a part of the most recent acquisition. I was just wondering if -- will technology be -- or improving technology, will that be a growing part of your focus when you're thinking about doing future M&A?

Yes. I would say it's historically been one of the focus areas. So when we buy a business or a company, we're looking to create some advantage for the company. Meaning, we just don't want to get bigger; we want to get better at the same time. And so that either comes from adding talent, adding a fast-growing portfolio to your current portfolio and/or adding technology. In the case of the recent Paper acquisition, we're adding technology, which we believe strengthens our portfolio and does it, most importantly, in the fastest-growth part of that industry.

Our next question is from the line of David Begleiter with Deutsche Bank.

Doug, on 2018, you mentioned Ecolab-like results. Does that mean double digits? Does that mean 15%? I know it's early for 2018 guidance, but what are your thoughts there?

I would say it certainly implied double-digit EPS growth, and I'm not trying to hedge on any number at this point in time. I just don't want to get in front of our normal cadence. And we will give explicit guidance coming up in February. But clearly, work to imply that the momentum you see in the fourth quarter we expect to carry forward through 2018.

Understand. Doug, just on Institutional U.S. If the growth isn't there, how do you assess the impact of spending too much money for some limited growth as opposed to spending money in other areas of the company here?

Well, one, I guess, I'll deal with it when we get there, but I don't believe we're going to get there. So I mean, we're quite confident there's plenty of growth opportunity in the U.S. food service business. And we've done a lot of work trying to understand exactly what's happening, where is it. And that's why I -- we can say with certainty where it's not. So this isn't a defend problem. This is just making up for what the market used to give us and no longer is giving us. If it comes back, hallelujah, but we're not planning on it. So I'm quite confident that the investments we're making, which aren't huge in any absolute term, are smart investments and will pay back handily. If we prove wrong, we're a company chasing $120 billion plus market and we're $14 billion. So it's not like we're short on growth opportunities, and we'll get after the most appropriate ones. But I'm quite confident U.S. food service happens to be in there.

Our next question is from the line of Christopher Parkinson with Credit Suisse.

Real quick. In Food & Beverage, you guys are fairly comfortable. You're outgrowing the market by a few hundred basis points. Given this area was a focus in 2017, can you just comment on where you'd expect account wins, pricing share gains, all of that kind of even out through the balance of the year? And any just even preliminary comment on '18? And then also, what percent of this would you attribute to enterprise selling?

Yes. I would say the F&B business has had a very good year because it's done a very good job setting itself up for 2018. And so you mentioned enterprise selling. They have latched up with our water business very successfully. Together, they bring superior value to our customers. They're driving it. It's driving new business in both water and F&B. F&B was, what, 5% in the third and going to accelerate, we believe, in the fourth. And we believe that's going to be running at a sustainable rate in 2018. So they've done a great job driving new business, leveraging new technology to do it. And so all the emphasis that we put in that business is paying off.

Great. And then just a quick follow-up on just within heavy water. You've -- actually did some businesses in China, and obviously, there's a little bit of some hurricane effects. Can you just walk through some of the key end markets, geographies, et cetera, just very broadly? And anything that you see at present which gives you the confidence for more of a material rebound in '18 and '19?

Yes. Our light business continues to do very well. It's growing at mid-single digits, pops up into upper single digits. And that business, which includes the F&B market that we just talked about, we think, is growing at a very sustained and strong rate. So we feel good about that. Heavy has been impacted most notably by what's been going on in China. That business is now starting to bottom and show signs of improvement. So I think what you'll see is global heavy numbers improve as well because in other regions, heavy has done quite well. If you look at our core water, we expect at the end of the year growing at 4-plus-percent, and we would expect that to accelerate throughout 2018 as we move into the year. What's not included in core water is mining, in particular, would be the largest business unit. Mining has recovered as you -- as I think we've talked about, positive in the third and expect it to be positive going forward.

Our next question is from the line of Tim Mulrooney with William Blair.

My first question is on the Healthcare business. There's a slowdown to the organic rate of -- I think organic growth was 1%. Can you just talk about what's happening there? It's quite different than what we saw in the first half of the year.

Yes. Without trying to -- I mean, here's -- I would say the way to think about the Healthcare business, it's still growing in the 4% to 5% range. So we bought Anios, and we moved our international expansion effort largely to Anios. So Anios organic sales have moved up dramatically. I mean, I -- the organic sales were 9% in Q3. Now we don't have that as our terminal value, but one of the big drivers was international growth in Anios, which was 15%. And really, what we've done is taken a lot of our international expansion work, and we're running out of Anios versus out of the other business or the legacy business. And so you sort of have to look at both of those. When we strip out acquisitions, we strip out all of it. So it's taking away some of the growth efforts, which have just been shifted from one brand to another, which probably isn't the best way to portray the business and what's happening there. So the 2 big emphases -- growth emphases are continue to drive HAIC programs. That's going to be lumpy, a lot like we see in Kay and others, but we're having success there and continue to expect to have success. And we're expanding in international principally through Anios. When you put those together, you end up in the mid-4s. Life Sciences, which historically was in Healthcare up until this year, is now growing at high single digits as well. So all in all, that portfolio, I think, is doing fine with significant opportunity to accelerate.

Okay. I think that makes sense, Doug. So should I expect then after you lap the anniversary of the acquisition of Anios, we would expect to see the organic growth rate accelerate back to historical rates?

Yes. I think we expect it to be better in Q4 even the reported number we give you versus Q3. But yes, we would expect this to be, as we talked, mid-single digits heading up to upper single digits. That remains our ambition. We think it's quite realistic, and you'll see those things put together in early next year.

That makes sense. And then my second question is on the Institutional division. When do you lap the exit of the low margin business, is that in the fourth quarter? Or is that sometime in 2018?

Yes. Its impact has diminished considerably second half versus first half. I think it's -- there's a little bit of an overlap in Q4, but it's very small, and it will be all gone by 2018.

Our next question is from the line of Vincent Andrews with Morgan Stanley.

Just a couple of quick ones. In Global Industrial, the results are referenced to lower shipments to distributors. How material is that? And is that ongoing? Or is it just sort of a onetime issue?

Yes. No, that was Institutional, the distributor reference, not Industrial.

Okay. Yes. Well, either way, the question was just, is it a onetime issue or how material was it.

Yes. It was -- in North America, Institutional is about 200 basis points, and globally, it was about 150.

And will it just be housed in this quarter? Or is that something that you have to face until you lap it?

No, I -- you know what, these are always hard to predict. And what I would say traditionally, we've seen this movie before, and it happens episodically. There's a disconnect. So we get all the outdata, meaning the distributors that sell for us in the United States provide us where every case goes by end user. So we have very specifics about what consumption is. And occasionally, you get into a mismatch between ins and outs, if you will, in a distributor. And that's really what happened in the third quarter, that distributor purchases were well below distributor outs. So inventories, obviously, shrunk in distributors. Traditionally, we find these coming back. It's hard to predict if it's going to be excellent the next quarter. Our forecast assumes that there is no rebuild of the inventories in fourth quarter. So we'll see what happens as it goes. Traditionally, they find their way back. It's sort of like water seeking its level.

Our next question is from the line of Hamzah Mazari with Macquarie.

Doug, you had mentioned the market not giving what it used to in Institutional. Just curious, if you're seeing any structural changes in that market with either consumer behavior shifting from casual dining to home delivery or what have you. Just any sense of whether there's any structural change whereby you have to invest more to seek out more share gain and the market is just going through some sort of a change that the investor base maybe cannot have visibility to just yet.

Yes. I would say the change we're seeing in this market right now is there's clearly -- and this has happened many times, there is a move by the consumer. I mean, QSRs are doing relatively well. Fast casual is even under some pressure because QSR is probably the fastest-growing segment right now. But you get into casual dining or even full-service restaurants, they're just a little out of -- temporarily out of vogue. So you're not seeing the same kind of traffic and/or increase in those restaurants that you saw historically. Now this isn't the first episode, and we're going through many of the same things that we've gone through when you see this trade. For us, as a company, we're obviously strongly -- we have strong presence in the fast casual, in the casual, the QSR and all segments. So there's just trades up and down. We do not see a big structural change in terms of home delivery of food. We might see that down the road. I would say I was just in China where this is a significant burgeoning business, and they don't have any of the headaches of legacy technology. So they're moving quite quickly, and we -- and I met with one of the leaders there where, frankly, we've got a very interesting food safety proposal and program that we're using with them because, by God, when you deliver food, food safety matters, too. So I just look at it right now, this is just a classic trade up and down among the category. And we know we've got to get after it, so we have major exposure. They're not adding units because they don't see the growth, and you don't see same-store sales growth because you don't have the traffic. And that's what we've got to overcome, and we've done it in the past, and I'm pretty confident we'll do it right now.

Great. And just a follow-up question. With the new accounting rules, you mentioned disclosing product versus service components of your revenue. And I'm just curious, is that something you're comfortable with from a competitive standpoint? It definitely creates more online transparency on pricing around the product category. So just curious, do you intend to disclose that at a segment level? Or is that just very high level and you're comfortable there?

Yes. I mean, we're going to meet all the requirements. I mean, FASB has been busy, and so now we are, too. And I would say we're going to do this and meet the spirit and letter of what's been required, but we're really going to do it at a consolidated level. Importantly, it's not going to have any impact on OI. It's not going to have any impact on EPS. We'll have us -- have additional charts and show the business in a little different light. We don't believe it's going to create any undue competitive challenges and/or challenges anywhere else. It does create work. I hope it creates some helpfulness for the financial community.

Our next question is from the line of Mike Harrison with Seaport Global.

Doug, you talked a little bit about the Institutional business, and we talked about penetration and the desire to get some of the same-store sales moving a little bit better. But wondering what penetration looks like on the new accounts. When you get new accounts, do they kind of just dip their toe in the water and maybe take up just a very small number of products to start such that it weighs on your overall penetration rate? Or is the uptake actually pretty good as you look and compare it to existing institutional accounts?

Well, I mean, undoubtedly, we tend to grow penetration within existing accounts over time. I would say we usually go in with at least enough products to have a comprehensive kitchen hygiene program, which is really what we're representing and presenting. But from there, we build that out. Importantly, over time where you don't capture it all there's significant upside in all of our categories. I mean, if we look at warewash anchor accounts and look at pot and pan penetration or floor care or degreaser or presoak, sanitizer, I can go onto hand soap, on, on and on. There is dramatic room in every one of those categories to increase penetration, which makes a lot of money and, just as importantly, we think helps the restaurant save money and helps our field team make more money. So I mean, it's sort of a win on all levels. We need to go, and we are reemphasizing, refocusing and getting after it, and it will bear fruit.

And then on the energy business, I noticed that you mentioned in there that you had some weaker performance in the production side of that business. Was wondering if you could talk about how much of that weakness in production might have been related to the hurricanes. And then can you walk around the globe and the key production regions and talk about the trends that you're seeing on the production side of your business?

I think it's more kind of a temporary story. So production, I mean, we're talking about 2%, and production in the world is up 1%. So it's not a huge mismatch, and it's a quarter deal, not an ongoing long-term issue. So I don't think that's going to be an ongoing story in that business as we move forward.

And was it hurricane related, Doug?

No. The production side was very modestly impacted by a few platforms. But no, that really wasn't the issue.

Our next question is from the line of Scott Schneeberger with Oppenheimer.

Staying on energy. Doug, with oil prices certainly, they've moved up recently. How are you thinking about them looking into next year and how that would influence segment results?

Yes. I think what we believe to be true and what we're planning is that the energy prices are going to be roughly around the $50 range even through 2018. We do believe that they will move up, but we don't think the real sustained move is probably until later into '19, '20. So our focus and the numbers I spoke about earlier when I was asked about energy is really predicated on, call it, plus, minus $50, $55 a barrel.

And then going to something more of an upstart. Life Sciences, could you just talk about the customer conversations you're having there? How pharma and personal care are looking as an industry? And then just -- you spoke -- you speak in the release today to the lumpiness of new contract wins. Just progress you're seeing with a little more detail.

Yes. I mean, Life Sciences is a several-billion-dollar opportunity for us, and the market makeup is ideal. So you've got huge multinationals and a very fragmented -- so a consolidated customer set and a very fragmented competitive set, which works well to our advantage, i.e., that we can do world-class technology consistently around the globe. This market has big needs, and we think we're the perfect people to fulfill them. So our expertise in F&B and Healthcare sort of coupled together, with the CIP know-how we have from F&B and the sterile environment experience that we have from Healthcare, are the 2 areas that these customers are most in need of, coupled with water management and Legionella capabilities. So as we go out, I think there's been an understanding of the benefits we can bring. In many cases, you have had plant-level decision-making. This is what we went through in F&B years ago. It's what we went through with Kay when we entered the food retail market. Traditionally, they were local-level decisions that we worked hard to centralize and make the company understand the benefits of centralizing in terms of consistency, in terms of cost-saving capability, and ultimately, throughput improvement. And all those things exist. So our conversations have been quite positive, but we're talking about changes in big organizations that take some time. And what we're seeing is exactly what we would expect to see. If I take you back to food retail, which is not new news anymore, it's 20-some years old. We had no business in the top 10, and today, we sell 9 out of the top 10 globally. I mean, we've built a great position in that business, but it wasn't done overnight. It takes a few years, and we expect to see the same type of results in Life Sciences.

Our next question is from the line of Dmitry Silversteyn with Longbow Research.

I just wanted to follow up with a couple of follow-ups if I may. First of all, you talked about Europe and Asia Pacific sort of as the 2 regions that were leading your growth in the quarter. I kind of get the APAC portion of it. But what was it about Europe that made that region outperform, I would imagine, North America as well as Latin America in the quarter? And are those dynamics sustainable into the fourth quarter and to 2018?

Yes. I mean, Europe in the second half is going to grow 4% to 5% in total, which is pretty good. I think we called out early this year that Europe was probably the surprise in terms of economic activity. A lot of the Europe benefit was really driven by industrial. Water, in particular, was upper single digits and has done a very good job driving new business through an increased focus on both the heavy and light side.

It sounds like it's both sort of market growth as well as better execution. Is one -- was one more impactful than the other?

Well, in Europe, you have to put it more on execution than overall market growth. I mean, I would just say the market is better in Europe than we expected, but we had low expectations. But the water and the industrial business there certainly isn't growing in high single digits. So we know we're capturing share.

Got it. And then just a follow-up on the paper discussion, the paper chemicals discussion you had where you kind of called out China as a problem region. Is that for you and your Paper business specifically and the products that you've got going into that geography? Or was that a more general comment on the Chinese paper-producing and pulp and paper market?

No, unfortunately, I would say that's us. So I don't have any insights that the paper business in China is a problem overall. I would say, my guess is it's not. This is our own execution and our -- I'd say the mistakes reside here. So we're dealing with them and getting after it. But no, it's not an overall comment on that market.

Okay. So the good news is that it's going to be fixed quickly.

The next question is from the line of Justin Hauke with Robert W. Baird.

So just one more quick one on Institutional, not to beat a dead horse. But is there any difference in what you're seeing between the big, established chains that I kind of think as more legacy Ecolab versus the street business that you put more emphasis on in the last couple of years? Is there any difference in the trends, one growing faster than the other? Or are they doing about the same?

Yes. And I don't think this is an independent versus chain deal. This is much more a segment deal that's going on. So the segments that are doing well, i.e., QSR, it's the chains that are in particular doing well. So no, I don't think it's a mix in between independent and street at all.

Okay. And then we hadn't really talked about capital allocation on this call. The buyback activity slowed a little bit. Is it still your expectation to do about $700 million this year? And where are you on the M&A pipeline? Any comments there?

Sure. So let me start with the share repurchase. So you've noted in the release and the materials, we've done north of $550 million year-to-date. My expectation is that we'll finish the year south of $700 million, which is the number that we did last year. But of course, that does depend on the M&A pipeline, which I would describe as typically robust, like lots of good ideas in the hopper. And so we're watching it closely, but I would expect share repurchase to end south of $700 million for the year.

Our next question is from the line of Rosemarie Morbelli with Gabelli & Company.

Doug, I was wondering, Industrial seems to be improving as far as you are concerned. So could you separate what was the improvement that was market-driven versus Ecolab process due to -- progress due to new products or new accounts gained?

Yes. I mean, look I -- the best we would have is where is GDP and where is our acceleration, I guess, would be close. I -- we don't spend a ton of time trying to understand every nuance of plus and minus on the market in terms of what consumption is of, let's say, water chemicals in the existing accounts. By and large, I would say this: we know we're gaining share. We've got very good traction now in heavy, the exception being China, as I mentioned earlier, but that, we believe, is bottoming. We have very solid traction in light industry across the board, particularly in F&B, where we've put a lot of emphasis on the cross-selling. Our Food & Beverage food safety business is doing very well and accelerating as we look and go through. Paper, we talked, is really a story of China and everywhere else. And I would just say the quick story, as I just mentioned, in China is we're not executing as we should. It's not a market problem; it's an execution problem, and we own it. But we don't have a lot of those, and we have one there, and we'll address it and fix it as we go forward, and we're already working to do it. So I would say the Industrial, I think across the board, we've got good movement. We're confident we're gaining share, and most importantly, I think we're gaining momentum above and beyond what the market is giving us.

And then as you expect price increases to more than offset raw material incessions, do you think you can go back to -- and I'm talking about the gross margin for the company overall. Do you think you can go back to 2016 margins? And again, I am also talking about on a public currency rate basis, not once you have adjusted everything. So if I look at 2016, for example, the first quarter gross margin was 47.3%, then it went down to 46.5% in the first quarter of '17. On that basis, can we go back to 2016 numbers in 2018?

Yes. I -- you know what, we will get -- well, here is the history. So we really saw no raw material increase as a company from, call it, mid-'80s until mid-2000s. And then we've had a steady -- well, how about a march from 2004 onwards, it comes like every 3, 4 years in waves. And we're in the midst of another wave. If you go back to 2004 and you look at our margin in businesses we've owned since then, all of them have steadily increased in spite of raw material inflation. I know no reason that, that pattern is not going to continue. So we complain a lot about inflation. But by and large, it's been our friend, and we've executed well. So my expectation is yes, ultimately, we will recover our margins that have been eroded as a consequence of raw materials, but it's predicated on 2 things. Yes, we have to get pricing, but we also have new innovation and drive new innovation that makes a lot of sense for our customers. And that's the other piece of this play that's being played out right now as well. So both of those are important. We typically don't just do it through raw pricing. Innovation plays a very important role.

Our next question is from the line of [James Dolan] with Nomura Instinet.

Dan Dolev. Two questions. One is, what was the benefit you got in the energy segment from that legal cost recovery? And then is that included in your non-GAAP EPS?

Yes. It was a legal settlement benefit that we got, and it was in the segment because all the costs of prosecuting it were also in that segment and incurred. So we try to match cost and benefit wherever it shows up on the P&L, so they match.

And is it included in that non-GAAP EPS number? Or is it excluded from non-GAAP?

It's included in non-GAAP.

Got it. And then...

And so were the costs.

Right. Right. No, understood. And then my second question is, if you could take a step back and you think about sort of where you started the year at $4.70 to $4.90. You were expecting $0.07 of EPS headwind. Now it's neutral. Obviously, you had -- you add back the hurricane, it's about $0.08; and equipment, it's about $0.01. But you also have, like, $0.04 of lower interest and lower taxes. So I mean, net-net, I'm coming up with, say, like, $4.60 at the midpoint versus $4.80. Like, where is the weakness coming from most in terms of just the apples-to-apples comparison?

Good rack. I would say I have the same rack in front of me. And the only missing part, raw materials were a $0.16 hurt versus our expectation going into the year. And that was probably the big wildcard. Because you're right, FX is about $0.07 better than we expected when we started the year. We got hurricanes. So you're basically -- you go through this. The base business more or less performed as expected as we have our natural adjustments in there. So that really wasn't the big surprise. It would have been raw materials.

Got it. And you did a little better on the SG&A. Is that cost cutting? Or just more...

Well, I mean, look, you adjust to the market you have and to what you're going to go do. So certainly, there's efficiency drives. We continue to take our back office and centralize it in certain parts of the world and do all those other things that you need to do to stay cost-competitive.

Our next question is from the line of Bob Koort with Goldman Sachs.

Doug, I was wondering, as you guys went through in Institutional, the low margin stuff, was there a commonality through that in terms of the products that you moved away from? Was it you weren't getting enough price? Was there too much cost involved? Was it a market that was going the wrong way? And then what did you learn there that can make that sort of a continuous process across your portfolio? Or is this sort of more of an episodic event that we'll see from time to time?

Well, I'd say this one is sort of unique. But when we bought Swisher, it was losing cash. And the way you lose cash is you underprice. And they were underpricing in a whole host of accounts via what they were delivering and how they were delivering it. And so we worked with those accounts to basically say, "Look, we'd love to continue to serve you. We just can't do it at a negative cash basis." So we either bring up the price or we have to discontinue the service. And those are the exercises that we went through. So it's basically repairing what was a broken business. And as you recall, I mean, Swisher at one time was heralded as maybe the thing that was going to take us out. And you can't really sustain this on a going basis. So I would say Swisher is somewhat unique. We had to go exit. We weren't really -- we don't believe in losing money for strategic reasons and accounts. It's never proven to be very strategic to me over any period of time. So we wanted to clean it up and get after it. And so with that, there's some pain associated with it, but we acquired Swisher at a very attractive price. So it's a business that's going to end up giving us returns, but those returns need to be netted out once we see what our stable base is.

And so no Swisher-like issues across other segments? Or is that something that you routinely search for?

Much more routinely. We're always looking at our bottom contracts in terms of profitability and understanding how we can improve them organically over time. We rarely get into situations -- I mean, I don't know of any right now, where we're -- we don't like to be cash negative.

We have reached the end of our allotted time for today's call. I will turn the call back to Mike Monahan for closing remarks.

Thanks. That wraps up our third quarter conference call. This conference call and associated discussion and slides will be available for replay on our website. Thanks for your time and participation today, and our best wishes for the rest of the day.

Thank you. Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may now disconnect your lines, and have a wonderful day.