Q2 2022 Ecolab Inc Earnings Call
Both great signs that the real value, we create for our customers and our margin growth potential.
We almost doubled our total pricing from 5% in the first quarter to 9% in the second as we further strengthen our structural pricing and executed our first ever global energy surcharge with customers around the world in all our businesses in 172 countries in extraordinary short period of time.
We're now exiting the quarter with double digit sales growth and pricing momentum that is now ahead of delivered product and product cost inflation. Most importantly, with gross margins that have now turned the corner in other words, we expect to see easing year over year margin pressure over the next few quarters.
We now are in a fortunate position, where our number one strategic priority over the past 12 months has been addressed getting ahead of inflation.
This will now help us fully recover our gross margin over time and expand them even further in the long run.
With margins getting on the right track. The time has now come to shift our primary focus to offense.
With an environment that keeps getting more complicated we do not expect the world economy to accelerate we therefore getting ready for that too.
Our new business is strong and innovation pipelines are at record levels. Our customer retention has remained largely unchanged still north of 90%.
The industry's largest and best trained sales force with the resources and the capabilities to get the job done and serve our customers better than ever.
We have a business model with over 90% consumable revenue with innovative technologies and services that are helping customers reduce their total operating costs when they needed. It most like right now.
And a growing 152 billion market opportunity that will remain a huge no matter what happens to the world economy.
We therefore entered the second half of the Europe in a position of strength.
With strong growth momentum and growing share across the board with inflation in energy cost that seem to keep getting higher, especially natural gas in Europe and in the U S. We have the right pricing momentum to stay ahead of inflation and the right mechanism, if I may say, which the energy surcharge to mitigate spikes of energy costs over time.
This shift from focusing primarily on pricing two major share gains will naturally take some time, but as we've demonstrated in the past. It will also lead to strong results down the road.
We therefore expect overall performance to improve sequentially in the quarters to come Q.
Q3 earnings will therefore continue to be driven by strong topline growth easing year over year margin pressure supported by solid pricing, but in the short term will also be impacted by unfavorable currency translation and potentially softer volume growth as the team shifted their focus to major share gain.
As a result, we expect Q3 to show a sequentially narrowing decline in year over year adjusted earnings per share, including the impact of at least 10 cents of FX headwinds.
That was the total pricing already at low double digit levels near.
New business generation to drive share gains breakthrough innovation and productivity benefits to drive margins, we expect fourth quarter to show accelerated adjusted earnings per share growth, resulting in modest growth in full year 2022 adjusted earnings per share now.
Now let me conclude my remarks on a more personal note.
Hello, Paul.
And I hate just as much as you do low earnings growth. This is not we are in.
Certainly not who I am.
When it's because we've done the right thing the right way for our future like keeping our global team and capabilities intact at the very high cost during the Covid lockdowns.
Managing pricing in a way that protected long term customer retention like maintaining growth investments in new products digital technologies, and new high growth businesses to gain market share and significantly increase our opportunities.
As intense as it is right now our near term momentum keeps building and our long term opportunities have never been greater that's why I've never been more bullish about the future of this company our 152 markets.
Our 152 billion market opportunity keeps getting bigger.
<unk> keeps rising we spend dynamics with hospital acquired infection in which food safety challenges like we've seen lately in baby food production, we hit to help our customers.
With water scarcity and a warming climate, that's hurting businesses and people we here to help our customers reduce their total water and carbon footprint, while reducing the total operating cost.
To deliver superior long term performance for them.
Our shareholders, which is why I firmly believe that we see collapse. The best is still yet to come and.
I look forward to your questions.
Thanks, Chris that concludes our formal remarks, operator would you. Please begin the question and answer period.
Thank you.
Definitely a question and answer session.
We ask you please limit yourself to one question and wouldn't be follow up question per caller, so that others will have a chance to participate.
If you'd like to ask a question today. Please press star one on your telephone keypad and a confirmation tone will indicate your line is in the question queue.
Can you refresh starts usually relate to remove your question from the queue.
For participants using speaker equipment may be necessary to pick up your handset before pressing the star keys.
One moment, please pull for questions once again Thats star one thank you.
Thank you.
Our first question is coming from the line of Tim Mulrooney with William Blair. Please proceed with your question.
Good afternoon, Christophe and Scott Thanks for taking my question.
Good afternoon, Tim.
So I'd love to ask you about your share gains and innovation and all that but I think I've got to stick to the basics at least starting out here. So my first question is about raw material costs not surprisingly in.
And then I've got a follow up on pricing.
No Chris that's the last time, we spoke with your expectation that delivered product costs would be up about.
25% in 2022 is that still your expectation and could you break.
Break that down between what you saw in the first half of the year versus what you expect in the second half.
Yeah, Great question, so talking about raw materials. So first I'd like just to step back. So one step last year. So in 'twenty, one we had 10%.
Delivered product cost inflation, which includes roles and Frank just to be clear as well on this one we entered the year 'twenty true expecting 15% then youre right, we talked about 25% and today, we're closer to 30% right now in the second quarter and we expect.
That level of inflation close to 30% to remain till the end of the year.
Okay got you. So it was a little less than 30% maybe in the first quarter, but then.
But 30% in the second quarter and for the remainder of the year. That's helpful. And then now if we layer on the pricing part of the conversation Christoph.
I guess net price cost to turn into a net positive in June can you talk about how you expect alright.
Or I guess, what you expect.
For the price cost spread how you expect that to play out through the second half of the year and what that implies for gross margins moving forward.
Yeah with pleasure, so the 30% as well so that we are experiencing so right now and going forward for the next few quarters as well just to put it in perspective. So represents a billion dollar of cost that our teams.
We'll have to overcome so during the years of 2022 and that's why it's been so remarkable that the team managed to get ahead of inflation during the last months of the quarter. When initially we thought that would happen in the first quarter of the Europe . The wall started.
Then in Ukraine and shifted unfortunately, one more quarter because energy cost went through the roof. We started with the energy surcharge, which worked out really well in the second quarter, we got structural pricing plus energy surcharge kind of well implemented during the last months of the quarter and that's how we got ahead.
Of delivered product cost inflation. So at the end of the second quarter. So when I think about the second half of the Europe .
Got the job done we ahead of inflation that will remain.
For the foreseeable future.
Mostly which means that the margin pressure is going to ease over the quarters to come this is going to be true in Q3, but it is going to be even more true in the fourth quarter of <unk>.
Pricing and energy surcharge together are going to keep accelerating I talked about saw low double digit levels in the second half and if we assume.
Easing after 30% rate of inflation.
The next two quarter is Q4, so should be.
Very nice margin play, which is why we expecting as well accelerated growth in terms of earnings per share in Q4.
Got it thank you.
Thank you Tim.
Our next question is from the line of Manav Patnaik with Barclays. Please proceed with your questions.
Hi, This is roni <unk> Kennedy on for Manav. Good afternoon, and thank you for taking my call Christoph May I ask if you could just recap the outlook I know you touched on.
Potentially unfavorable volume growth or growth not accelerating.
Initially anticipated can you just recap what the outlook is for the second half and into 'twenty three from a growth standpoint, and if you are starting to see obviously the inflationary pressures are immense but are you starting to see some macro pressures as well.
Well great question Ronan.
The overall picture for 2022.
We're expecting so from an economy perspective.
Seniors exploration so during the year over the past few months, obviously, so the environment has changed that being said our own trajectory as ecolab. So has remained so fairly stable so 13% organic growth in the first quarter of 13% in the second quarter and weeks.
Something similar in the quarters to come as well, but it's basically so having our own views focused on the potential risk of an economic slowdown all indicators are showing that direction in our own businesses. It's not all just yet.
But we're not immune obviously to whatever could happen in the world out there, which is why first we believe in our models are being great in that environment, which is very different than the lockdowns of Covid, which was just an industry. So stopping to operate when we talk of a slowdown this is some.
That would be very used to.
And we liked it because our model ultimately, 90% consumable revenues so that means recurring our promise to customers it's too.
With premium products to reduce their total operating costs.
<unk> when they need us even more in those moments so our model very well aligned.
With potentially.
Potentially slowing environment and ultimately.
It's why as I've mentioned as well in my earnings quarter.
The shift from primarily focusing on pricing, primarily focusing on new business will come at the right time, as well, which is a shift that we've done many times as well in the past. So overall, an environment that might be slowing down and with what we undertaking so expecting so kind of stable.
Momentum in the quarters to come with a potential downside risk that we can manage as well.
Thank you that's very helpful and with regard to that shift in focus I think you'd also referred to it as going from defense to offense.
What does that entail that shift to focus on new business wins, and then are there other elements to kind of a downturn playbook.
That may be different than the approach that was taken during the unprecedented height of the COVID-19 pandemic, where the focus was on protecting the company our employees and.
Customers.
Yes, I think that what we are heading towards two today is kind of something that the company has been used to.
Any so more difficult times over our history, we have sales organization, where we have a sales culture, we say, it's driven which means that half of our company saw is driven by two things. The first one is in your business. The second is price and since it's all about execution, it's important to.
Set for the organization, what's the clear primary priority is it price or is it new business. While you do both obviously at the same time well in the last 12 months with this high inflation that came.
On us like everybody else ultimately primary focus had to be pricing and the team got it done and now it's kind of shifting in saying you focus primarily on new business, while you keep driving pricing. So it's selling new accounts, it's expanding penetration.
Selling innovation, while you get price as well because we create more value as well so for them. So it's a shift between primary focus from priced new business.
We've done all the time.
In our history. It takes a few months, obviously, so to getting gear, but this is something that we're very familiar with so I'm not worried about that.
Thank you I appreciate it.
Thank you Ron.
Our next question is from the line of David Begleiter with Deutsche Bank. Please proceed with your question.
Okay.
Mr. Begleiter your line is the line for questions.
I'm sorry can you hear me.
Yes, we can hear you David I'm, sorry about that Christophe Beck.
Back to the Q4 guidance Christoph.
Guiding to about 20%.
Share growth EPS growth from Q3 to Q4, a pretty sharp ramp up.
Is it just the additional pricing or are there other drivers of that additional price increase.
Additional earnings growth from Q3 to Q4.
It's the combination of many factors when we think about the third quarter. So to begin with so it's mostly impacted by FX to 10.
That we've talked about.
Otherwise so the EPS would be growing in the third quarter and if you look at Q4, it's going to be the combination of business momentum driven by new business as mentioned before added two weeks of pricing that's going to keep strengthening together with the energy surcharge as mentioned so it will be in the low double digit <unk>.
As well our productivity work is going to keep working as well in our favor and we expect as well as <unk>.
Rising.
30% are delivered product cost inflation rate as mentioned before so the combination of all ultimately is playing to the ecolab model, where you see margins.
Enhancement.
During the fourth quarter, it's not going to be an improvement versus last year, but it is going to be a sequential improvement from Q2 to Q3 to Q4, which by the way David is really sore.
<unk> in our favor longer term as well as we rebuild our margins fully and then afterwards, even expand them.
Understood and just briefly of the energy surcharge, you announce of 8% to 12% how much do you actually realize.
It's hard to tell exactly the number it's a it's part of the 9% or the low double digits.
The second half we estimate that it's roughly two third is structural pricing and one third is the energy surcharge when we communicated in our press release it at all with directional that's a Max and then afterwards, you need to respect could drift through the agreements with customers you need to negotiate with customers.
Well and some customers have even chosen so do you have the energy surcharge being included in the structural pricing, which makes the line between the two.
Bit more fuzzy, but I think that.
Good guide might be.
Structural price and a third energy surcharge.
Great. Thank you very much thank you.
David.
The next question comes from the line of Seth Weber with Wells Fargo Securities. Please proceed with your questions.
Hi, good afternoon, everybody. Thanks for taking the question.
Yes, just another pricing question Christoph.
Talking about say six or 7% structural pricing.
Can you just give us your view on.
Ecolab is ability to retain that next year into 2023, not asking for guidance for next year, but just your confidence level in the company's ability to keep that type of pricing next year. Thanks.
Thank you says the structural pricing.
I have a very high level of confidence that we're going to keep it. This is what we've done over the last 99 years.
Anthony So we.
Not cyclical in terms of pricing evolution. So structural price is going to is going to stick the way, we execute that with customers. The energy surcharge will be more of the question I don't think that the energy costs are going to come down anytime soon unfortunately.
I may almost say and maybe one piece of information for use US is also that our energy surcharge, which was anchored on oil price.
<unk>.
Everybody could read has been complemented.
By the natural gas prices as well, which is becoming a bigger issue in Europe and in the U S. For the same reasons as we know so it's going to be a combination of oil and natural gas, which is why initially we call it as well the energy surcharge how much are we going to keep all that whenever the market comes down.
I think we're going to keep part of it and some.
It might be given back but overall the discussion with customers is driven by how do we build margins.
On our side Thats, our internal discussion, but most importantly, with customers is making sure that the return that they get on the investment.
Dave made in our value, yes, a positive return which is ROI. So.
I feel good about the way, we can maintain our pricing that we've executed keira.
Some might get back, but it's going to be marginal.
That's helpful. Thank you and then maybe just a quick follow up on the health care life Science margin was a little bit light versus what we were thinking.
I saw some of the call outs in the slide deck and things like that but is there anything that would prevent.
The margins there.
Is there something thats going on there just structurally that.
Pure light margin is obviously very high.
We're assuming that margins there get a lot better.
Can you just talk about the ramp that we should expect in health care Health care life science margins going forward. Thanks.
Yes, it's really saw two different stories.
You saw life science and pure light.
Doing very well.
So no issue on that side and it's been very steady in the past and it's going to be steady in the future as well.
<unk>.
Is a different story, that's where.
Our challenge lies three things.
I would mentioned the first one is.
Pricing was <unk> it takes more time than with customers that has an impact on margin Secondly, North America elective surgeries took more time.
Expected initially that's been a non enough. So during COVID-19 as we know so quite a few times, that's where we make most of our money as well like hospitals do as well at the same time that has an impact on the healthcare margin and third in Europe. So we still compare to the so called Mega deals with governments.
<unk> co.
Covid activities related in 2020 one.
Which is also having an impact on the healthcare margins, but let me be very clear.
<unk> is not where it should be.
It's not been so for a long time, there have been some better and some less great times in that business, we focused on it we need to fix it and we will fix it.
Got it. Thank you very helpful. Thank you.
Thank you Sir.
The next question comes from the line of John Roberts with Credit Suisse. Please proceed with your question.
Thank you it sounds like based prices up 6% on its way to 7% what is the base cost inflation that you're seeing that is what our costs up excluding energy.
Yeah.
It's a difficult question.
David because when we talk about energy, we don't buy energy directly.
As you know, but the way we think about it.
A third of our.
Raw material cost is impacted by energy and again, when we talk about energy.
You have oil and then you have natural gas salt what we buy.
A third derivative.
That that's why it's it's a difficult question so to answer here, but I would say one way to think about it we were thinking 2022 do you have an inflation of.
15%, plus we are 30% right now to a great extent that DPC incremental inflation came through energy following the invasion.
End of February so that's maybe.
One way to think about it but hard for us to really split the two.
I'd, rather focus on the 30% delivered product cost inflation, which is the true number.
Okay, maybe a different way to ask about price, but when you started to implement a surcharge.
<unk> oil was about $120 barrel and now it's 95.
And back then Tcf gas was $25 a million Btu now at 60.
Can you help us understand like an average U S surcharge has gone down I assume because of the WCS drop.
And the average European surcharges going up because of the Tcf gas increase.
No.
So the brand is still north of 100, right now which is the same bracket is where we started.
In April so during the second quarter, So no change there and it's not a perfect science as well.
If customers were to pay straight math.
So you're in that bracket and you get a 10%.
Take what we had in the press release, well that'd be one situation, it's a negotiated.
Number which means that this one is not changing every months either on top of it as you mentioned and as I've mentioned as well earlier on that core natural gas.
The new game in town you have mentioned a number in the U S going up pretty rapidly and in Europe . So even more so basically where we are is that.
Surcharge in the U S.
Kind of.
Change to up because we are still executing more with customers that we haven't concluded yet and in Europe , we moving further up because of the natural gas price.
Increases that you've just mentioned.
Okay. Thank you.
Thank you John Thank.
Thank you.
Our next question is from the line of Josh Spector with UBS. Please proceed with your questions.
Thanks for taking my question and actually similar vein at the prior question.
Curious just Claire.
Clarify is the surcharge essentially in for all customers now or is there some percentage that's still being negotiated and windows.
Take effect during the third quarter and similar to the prior question to an extent if if energy prices go up 20%, 30% into the fourth quarter you have the surcharge in place or are we going to be talking about that there is a price cost catch up in the fourth quarter or do you feel relatively insulated that what you've done.
As immunize that risk now.
Yeah.
If there is not.
Major shock in the system, geopolitically, which could happen.
If you look at what's happening so we saw with Russia, and Ukraine today, we should be.
In a good shape.
Ahead of inflation as we exit the second quarter as mentioned and we will stay ahead with increased pricing in Q3 and Q4.
Further execution of the energy surcharge as well in the months to come so both together. It brings me in a reasonable place for Q3 and Q4 that we will stay ahead and expand as well so the margin leverage or margin impact that we have on our business second.
Something happens as well.
<unk>.
In the world.
In Western Europe , especially impacting natural gas as we just mentioned before.
With David as well with the energy surcharge, we Havent Mccann is as well that we can fairly short term.
Change in order to capture more pricing through your energy surcharge. So this is pretty handy, which was what we had in mind when we launched as well that was not just to react to what was happening back then following the invasion in February but also being able to react with whatever could happen as well in the <unk>.
In the quarter to come so bottom line I feel.
Quite good about staying ahead of inflation and rebuilding margins in the month and quarter to come to fully restore and expand even further and if something happens in the world. It might take some time to increase the energy surcharge, but we have the mechanism to address that as well.
Thanks, and just to clarify the inflation for the second half you talked about 30%.
Two year stack of that inflation that you guys are planning for it.
The two year stack that was your question Josh.
Second half specifically, yes.
Last year, we had.
As mentioned, so we had 10% in Q3, we had 20%.
In Q4, and you add the 30% of this year or so that's how you get to Europe .
Is that two years.
Model.
So we have 33.
40% to 50%.
How we're thinking about it.
Directionally, that's right, yes over two years, Okay alright.
Alright, thank you.
The next question is from the line of Christopher Parkinson with Mizuho. Please proceed with your question great.
Alright, thank you so much christophe.
Of your platforms and services.
Ultimately pertained directly to your customers facing their own inflation, whether it's low temperature ware washing systems, and even some stuff around commercial and water treatment in terms of prevention, and obviously facing inevitably raising rising costs and their own side of things.
Can you just offer a little bit more color on your ability to kind of continuously push price just given the environment your own customers or I mean is the narrative really changed between the value added proposition of your products and services over the last year, new customers ultimately recognize that so just any color on that would be greatly appreciate it.
That's a great question, Chris Thank you.
Well it speaks to our model that you are really familiar with and.
Our promise that the company has always been best results at the lowest total operating cost, which we measure with <unk>, which is basically saw how much cost savings versus investment customers are making and our ambition is to be north of 25% return for the customer in here with pricing.
In here as well and we stick to that model the way, we operating with customers today, usually we north after 25%, which gives us as well some margin as well.
To get even further pricing so so far it's worked out pretty well.
Why I mentioned that our customer retention has remained very stable.
Over the past 12 to 18 months, but going forward focusing even more on <unk>.
Roy will be essential for two reasons first do really so keep executing pricing, but most importantly in times where.
Cannot make environment might evolve as well so to the downside if I may say without mentioning the word as well in Europe customers needed even more this is truly where Washington. This is true in laundry. This is true.
In water and it gets compounded as well that most of the customers. They have a hard time as well as the two fine staffing.
Get the job done well, our offering helps them get the same results or even better results with less people and less cost at the same time and Thats why our value proposition is pretty ideal in such an environment, where we help customers get better results with less people and lower costs that helps us execute module.
And drive more new business.
Got it and then in honor of Mr. Monahan I'll make sure I say this correctly as it pertains to your pest elimination business non control, but elimination I'll always remember that.
Give us a.
Quick update it.
It seems like things are kind of reengage in there you're getting a little bit more momentum and specifically in North America. It's been a huge focus of your enterprise kind of ongoing enterprise selling initiatives.
Can you just help us kind of offer the framework of the current environment and how we should think about that intermediate longer term now that it seems like youre getting a little bit more.
A little bit more traction in terms of the recovery. Thank you.
Yeah.
I love so the relation to Mike that's true it's pest elimination.
Competition, that's controlling you still have.
And writes running around but you have less than before with ecolab youll have none which is our promise.
So.
To the business.
Pest elimination as being an exceptional business for many many years, it's been strong during COVID-19 in 2020.
It was strong last year as well you may remember it was a double digit topline growth. It has been expanding its margins as well both gross profit and Oi ratio as well and when I look at 2022, well, it's kind of steady Eddie.
All in double digit territory as well in terms of top line growth as well with very strong margin as well that's why I don't talk much about pest elimination because the business is doing extremely well.
Done well during difficult times and he is doing well right now it's a great team very well led and I look forward to even more going forward a beautiful business.
Great. Thank you as always.
Thank you Chris.
The next question comes from the line of John Mcnulty with BMO capital markets. Please proceed with your question. Yes. Thanks for taking my question Christoph maybe we can speak to the end markets for institutional so I know youre kind of battening down the hatches it sounds like for a potential recession at the same.
Tom.
I guess I'd be curious to know where your institutional business is relative to pre COVID-19 and if there is still some uplift to go there even if we even if we do kind of stumble a little bit into recession, I guess, how would you characterize that.
Yes, great question John Institutionally.
In a good shape and evolving very nicely.
Honestly.
I had expected that the market recovery.
Would happen so way foster way border.
It happened that has nothing to do with us.
Obviously this is a market question, but when I think about our business.
Institutional well if you compare it to 2019 for instance, which is kind of the base. So pre COVID-19 we.
5% ahead of 2019, we were 2% ahead of 2019 in the first quarter. So that shows that the business is kind of in a good place and evolving very nicely as well.
Most interesting is that we're gaining shares as well the reason that we've done so many times as well so for the U S restaurants.
If you look at dine in traffic, which means people coming in dining rooms.
It's down 36%.
Versus 2019.
Our business in the same place is down only 3%.
Which means that we've gained huge share as well in the meantime, so at the end of today.
Ed up 19 in terms of sales in the in the second quarter.
In the quarters to come two or three quarters, we will recover the volume and.
In the second half of 'twenty three I believe we will recover as well the margins, which is the plan that we had all along so all in all in a pretty good place.
Got it.
That's helpful color and then I guess the second question would just be on the raw material front. So.
The industrial business in particular, if I have it right has a reasonable amount of exposure to like propylene derivatives things like that propylene is off at this point, it's off about 25% quarter over quarter.
I guess can you help us to think about.
That kind of basket and if youre starting to see any raw material relief, yet or if it's more just look these are derivatives. It takes time, but thats still on the comp as we kind of look to the back half of the year is there a way to think about maybe some relief coming for you.
It's clearly the ladder.
John So we don't buy anything so at spot prices or does that make <unk> probability, but generally no. It's also a contract based more longer term as you've mentioned, it's derivatives second or third.
Feedstock as well, which means that it takes time to get through the system for us as well, which means as well as the spikes are not that high but it goes higher and stays longer as well so for us, but when I think about.
Industrial they've done an exceptional job at pricing there ahead of the average they got most of the DPC delivered product cost impact since inflation started in second quarter last year, they've gotten on pricing on the energy surcharge extremely well they're ahead, obviously of <unk>.
<unk> as well as they exit the second quarter, they're going to have even a higher pricing versus the average of the company I think they are on an exception of trajectory doing really well in new business in momentum getting pricing getting productivity as well and if you think quarters down the road.
We like what we will see from the industrial business, which is half of our company and I'll just end on one thing it's been.
Especially a part of our business, where every inflationary cycle they've done really good work in pricing and they helped improve the gross margin as well at each of those cycles as well going forward. So in a way as hard as it is right now it's going to be a good story in terms of margin for industrial going forward.
Got it thanks very much for the color.
Are you doing.
The next question is from the line of Ashish <unk> with RBC capital markets. Please proceed with your questions.
Yes. Thanks for taking my question just wanted to focus on two items that was discussed at the National Restaurant Association show one was on re igniting the Ecolab certified program I was wondering if you could talk about how that's coming along and then obviously there was a discussion also around the significant pull from customers for digital solutions.
<unk> products.
You could comment on that as well thanks.
Yes. Thank you so the two points situation hasnt changed much in Brazil since we met.
A few months ago.
<unk> science certified.
Mentioned, so it has been launched during COVID-19 to support our customers in order to protect their own guests and ultimately so having more people coming to the restaurants or their hotels, it's kept being a very good story.
We've become the leading program in the U S. Each become stronger as well in the meantime, we.
We're expecting.
To get in the next few quarters, so close to $100 million of incremental business close to 100 thousands of locations as well down the road. So it's becoming a major program for us for our customers and ultimately it's going to move beyond Covid and really making sure that.
Our customers' customers, so feel safe when they get to their own restaurants.
As we've talked all along now to digital solutions.
Interestingly enough with <unk>.
Most of our customers struggling.
With staffing conditions.
As we've seen when you go to restaurants, two hotels to airports or wherever you go.
Similarly, our automated solutions for customers, helping them get the same job done with less people as well well. This is not only helping them on the staffing side, it's helping them on the cost side as well, which is good now and even more important going forward. So thank god, we've kept investing.
Behind digital solutions, which by the way are helping ourselves.
As a company if you look at our SG&A productivity that has kept improving year over year and accelerate it as well. So during the past few years. This is almost directly related to the work that we've done with digital.
That's very helpful color and maybe if I can drill down further on the volume side of the industrial segment.
Can you just talk about how that busy.
Business, obviously as mark since the last JFC, both under Nalco friend, but also on the core side and also some of the growth drivers there.
Particularly animal health and data centers, how are those progressing so any color on those firms will be helpful. Thanks.
What's good in industrial is that its very broad based.
All the businesses.
Doing really well when I look at <unk>.
Water, which is the biggest had strong growth food and beverage downstream in paper.
The four big ones, obviously that we've had.
All doing so really well so it's not one business driving up the whole industrial is very broad based and it's very broad based geographically as well, which is why I feel confident about that business, especially.
As well going forward. So in terms of demand we haven't seen.
Much reduction if I compared to 2019 for instance, as well, which is the right base uptick as you remove all the noise of Covid as well so in between there.
Some noise some variation as waiting there, but otherwise so pretty steady.
Months after months.
We'll see what happens in the months to come.
With the economic environment, but ultimately very strong new business, that's going to help them.
Obviously mitigate any.
<unk> of demand.
Out there and second the pricing evolution is extremely strong as well as mentioned before so the combination of both.
Is driving a very steady and healthy story for industrial.
Thanks, a lot Christophe.
Thank you.
Our next question is coming from the line of Jeff Zekauskas with Jpmorgan. Please proceed with your question.
Thanks very much.
You expect the lower.
Earnings per share comparison in the third quarter versus the year ago.
Said that your raw materials are being offset now by price increases you've got a little bit of negative currency.
Does that mean that volumes are about flat in the third quarter year on year.
So the key points.
Jeff So youre right that Q3 2022 is going to be.
Lower than Q3, 2021 as mentioned mostly impacted by the FX <unk>.
That I've mentioned as well earlier, so without that so we would be in positive territory that being said I'd like to add two points. The first one is we compare.
Q3 last year, which was a strong recovery.
Institutional market. So ultimately the volume growth in Q3 will be lower than what we have in Q2, because we comparing <unk> reopening.
The third or fourth Covid wave that we experienced in institutional and the last point I'll mention is while there might be some conservatism as well in terms of volume from my side as well in here, but looking at what's happening around the world I want to be as well on the safe side. So you have all three.
The FX the <unk>.
There isn't to reopening in institutional due in 'twenty, one and there might be as well as some caution from our part in terms of economic development.
Okay.
Ecolab has maintained staffing levels since 2020.
With the idea that the global economy would recover in the restaurant industry. It would come back and that there would be no strong inflationary effects.
There has been inflationary effects has been a slower recovery for the restaurant industry and it looks like we may be going into recession.
Would you be thinking about restructuring our operations are having a lower cost structure and what you've got now.
We're not planning for restructuring.
At least nothing broad base, you will always have some pockets around the world where large organization operating in many countries around the world obviously, not everything is created equal and we keep improving our operations wherever we operate around the world Broadbased.
No nothing major as expected at least with everything we know.
Right now so from the environment, if you look at our SG&A.
As well so over the past few years, we've done some very good progress as well in terms of productivity and we're going to keep doing that as well going forward, mostly driven by digital automation, which means that with the same team we can serve more customers and do more.
We still estimate that we serving as well so directly driven by.
<unk> digital.
Automation, which means that if in the past our company was growing its team more or less at the same speed as the company was growing that's going to change in the years to come not because our model has changed but because our technology is helping our teams do more.
With less than last point.
I'd say in hindsight.
Jeff I would do again the same thing.
If we would have reduced our team in 2020, when most of our customers did ultimately well we would have lost all those relationship we would have lost all the capabilities and expertise that these team head. We've kept it. This is a huge advantage for us well with customers and going forward.
But that would productivity is going to keep improving in the years to come.
Great. Thank you so much thank you Jeff.
The next question is coming from the line of Vincent Andrews with Morgan Stanley . Please proceed with your questions.
Thank you and good afternoon, Chris.
Christophe could you talk a bit about Europe , and I guess I'm less focused on sort of consumer recession type angles and more just thinking about the energy situation over there and how ecolab would be impacted if there were natural gas or electricity shortages.
In the fourth quarter and potentially into the first quarter, what would that duty your own operations and ability to produce or procure raw materials and what might have due to some set of your subs. Some subset of your customer base and presumably you don't have anything baked in for these risks in the second half guidance.
Yes. This is a great question. So there is some I know we don't know.
So starting first.
We saw our business in Europe overall doing really well.
Growing double digit.
It's been very resilient during the Covid times as well so overall ecolab in Europe doing so really well now to your question.
Operational resilience, depending on what could happen.
Eastern front.
We have a very good.
<unk> chain team that has been tried year. After year is when you think about it so what we went through.
Over the past few years being so natural catastrophes in the U S like the Texas phrase or what happened in China as well. So we saw all the lockdowns that.
That we had to go through.
Managed to really supply customers in remarkable ways around the world in very difficult situations. So when I think about Europe . Our team worked there together as well over the last few weeks thinking about the extreme scenarios and ensuring supply during those times I feel.
Reasonably good.
Our ability to ensure supply in the case that natural gas would be stopped from Russia, which I guess is the core of few question the impact on our customers is way harder to answer because obviously, we don't operate for them. So depending on how they are going to do that's going to have an influence on us but.
This is something I can't obviously influenced the only thing we can do is ensure the supply and driving as well new business with existing and new customers as well to try to mitigate that as well as we can.
Okay, and then as a follow up you referenced in the back half guidance, you sort of let us know, maybe we're being a little conservative.
On the volume side of the equation.
Where do you think the biggest risks are to the back half forecast if.
If it doesn't come in where you think it is going to what are the one or two things that youre worried about in relation to the forecast.
Yeah.
It's hard to tell but the hotspots.
Starting with Europe , all of the reasons that you mentioned before geopolitically and not an easy situation, obviously, there and we have a great business doing really well with a very strong team, but okay. We can't create miracles as well either so I'm very cautious about what could happen in Europe .
The U S.
The economy is not going to accelerate we will see you saw what the print will be so for GDP as well in the second.
In the U S. While he's going to head towards more of a slowdown in the next generation.
That's the second area and the third one.
That was a bit of a question Mark at least a few months ago was China.
I've become a little bit more comfortable with the situation in China, our business is doing reasonably well all considered.
As well over there so first Europe .
Quite a bit behind the U S and wave out China, but overall, it's still remain cautious and to think about all that could happen to have as well contingency plan in place in case things would happen differently than what people would expect.
Thank you very much.
Thank you.
The next question is coming from the line of Steve Byrne with Bank of America. Please proceed with your question.
Yes. Thank you.
Within your water treatment business, our municipal water supply authorities currently customers of yours.
And if not is there something structural about that end market.
<unk> not of interest to you.
One would think that drinking water standards are only going to get more challenging for these municipalities and.
Just just curious to hear your your your outlook of interest for that end market.
Well, let me start.
By staying Steve.
We are literally not in the municipal.
Water business by by choice, we do maybe a few millions here and there, but it's totally irrelevant.
Our company because we do not want to be in the business. We have so much more to do.
On the industrial and institutional and healthcare end markets that we know extremely well.
As a company.
Think about what's the main reason for that well first.
Its choice of priorities, we want to really stay focused where we can truly win and second most importantly.
Way, we sell as mentioned before it's really so helping customers improve their total operating costs, while reducing debt.
The environmental impact this is a value proposition that resonates extremely well.
We skipped Denise municipal by definition our governments.
Governments do not think that way in terms of total operating cost it's much more what's my budget.
For the year. This is not the way we drive our business. So there is a mismatch as well here is it going to stay like that for the next 50 years I don't know, but for now no interest in entering the municipal market.
And with respect to innovation can you comment on on what areas of focus you're particularly excited about with respect to new products.
From innovation.
Yes, we have some some great stories.
It's been the case for many years, obviously, so in our company I would start with.
A few macro innovation. The first one is ecolab science certified as mentioned before this is a comprehensive program for institutional customers restaurants and hotels.
Protecting day guests.
A major innovation for us.
The industrial and feed.
About net zero water.
With a comprehensive set of programs that is helping our customers deliver on their sustainability commitments or ambition.
As well we are uniquely positioned to help customers. So get there. This is a major driver for the future think about pure light, it's an acquired obviously innovation.
It's growing fast very high margin. This is new to our portfolio in the last I'd mentioned is ecolab <unk>.
Probably one of the largest industrial clouds out there that we've been building over years.
We have thousands of clients that are connected that they can improve their performance in real time compares with that performance.
You need versus unit within the company across industry and across industries as well. So those are four key.
<unk> that I would qualify so as enterprise innovation as well, but then you can think about data centers as well we didn't have a program for data centers. It's a new business. We started that a few years ago extremely successful as well. So this is a good one as well think about lobster ink, which is also a.
Providing online real time training.
For institutional customers hotels, and restaurants with all of the staffing changes they have we have close to 3 million users.
Today's so working really well as well and I can maybe you mentioned just the last one which is during COVID-19, we've launched as well.
Our fastest kiln.
For Covid virus in 15 seconds program for institutional guesstimate as hotels and restaurants as well that had been used as well in healthcare those are just a little bit.
A list of innovations that are coming to mind.
To your question.
Thank you.
The next question is from the line of Scott Schneeberger with Oppenheimer. Please proceed with your questions.
Thanks, very much good afternoon.
Could you elaborate on.
Typically the healthcare segment Christoph.
Could we see that return to revenue growth in the third quarter and maybe some commentary on your view of electric procedures.
Procedure excuse me versus pre pandemic levels.
Yeah, I want to be careful on this one so as mentioned before so healthcare is a business that still needs work. Unlike the focus that we have on it it's going to take some time as much as I hate it and you hated as well.
So thinking about the fourth quarter, so to see growth in our health care Group Health care and life Science, Obviously life science isn't a great shape. It's clearly saw health care I think it's more looking at the fourth quarter growth.
Probably more realistic and if we can improve in Q3, while that's going to be even better, but I would really focus on Q4.
Thanks, I appreciate that and then.
Could you categorize just overall are summarized in the press release this quarter over last quarter investments in the business and last quarter was investments in the sales force could you just categorize broadly where that where the company is making investments and <unk>.
And just levels.
Of magnitude do you anticipate amplifying that or if it's.
If the economy takes it takes a turn for the worst how discretionary on your ability to pull back you had mentioned just a few questions ago that digital is something that sets a very consistent spending wisely. So, but if you could just categorize that broad base of investments that'd be appreciated. Thanks.
So macro picture investments stable they've been stable over the past few years theyre going to stay stable.
In the years to come.
As well so if you think about Capex for instance, 6% of OSA, that's been steady Eddie for a very long time and it is.
Going to stay as well like that second <unk>.
Our SG&A you've seen productivity is always improving as well every single year, and we will keep doing that as well. So it's investing in our team, but driving SG&A productivity as well at the same time, if I think about incremental investment it's going to be mostly on two areas or three area.
Sorry, the first one our growth businesses.
Like life Science like Peel light like data centers like Animaux House stores high growth high margin businesses, we will obviously keep over investing.
In those ones, because we want to build our leadership position as well going forward second is in digital for the reasons that you mentioned before it's adding value for our customers is driving a better experience for our customers and it's driving productivity. So all good reasons as well to do it the right way included in that you have some.
<unk> security as well the more digital you do the more cyber risk you get the more you need to protect yourself, we need to obviously make sure that we will protect it and I like where we are and third is behind innovation the products all the programs I mentioned before as well.
To the previous question, we will keep over investing as well, but overall very steady in terms of overall envelope of.
Of investment both Capex and Opex.
Great. Thanks, Jay.
Thank you Scott.
The next question is from the line of Laurence Alexander with Jefferies. Please proceed with your questions. Hi. This is Dan Rizzo on for Laurence. Thanks for fitting me in just one quick one if we think about the <unk> FX headwind in Q3 and 34 four for 2022, what are the assumptions for where the euro and pound are going to be.
Trading over.
Over the next six months or so or next five months or so.
Hey, that's a great question, then let me pass it through.
Scott, our CFO , who has more details on that.
Yeah. Thanks for the question Dan, Yes, as you might expect we're expecting continued rate hikes through the end of the year, probably in the range of eight and so as you see that FX, it's ramped up to the second quarter and were expected to double basically in the second half relative to the first half so about the 30 <unk> as you said.
Alright, Thank you very much.
Our next question coming from the line of Andy Wittmann with Baird. Please proceed with your questions.
Yes. Thanks for taking my question Scott I was hoping to keep you going here I guess and talk about free cash flow year to date, the free cash flow of the businesses I guess I'm calculating just under $200 million.
Which I think is probably a little behind pace, it looks like inventory and.
Accounts receivable is consumed a decent amount of.
Capital I suppose given the revenue line, that's somewhat explainable, but could you just talk about your forecast for the year, what we should be thinking about what free cash flow generation could potentially look like and if there's anything else going on in some of these key working capital accounts that we should know about besides fact.
Effects from the top line.
Thanks for the question Andy No you're spot on with that is the free cash flow really for the first half of the year is as we expected and as you're seeing the increases in sales the investments in working capital as well as Capex, which as a reminder, about half of our Capex is customer related equipment. So as we see new business and growth in the.
Business, we invest in Capex, but expect that to be in line as Christophe said that 5% to 6% of sales historically, so but as you think about the full year. We continue to expect as we talked after Q1 to have our free cash flow conversion in that mid 90% consistent with historical.
Yeah.
Thank you.
Our next question is from the line of Eric Petrie with Citi. Please proceed with your question.
Hi, good afternoon Christoph.
Good afternoon, Eric.
It's my understanding to get the Ecolab science certified scale you have to buy the majority of products from Ecolab, how does that compare to your existing customer base in terms of supplier diversity.
I want to make sure I get your question right when you say supplier diversity.
In terms of.
Ethnic Monterrey is it what you're talking about.
Yes, yes, how much your existing customer base buys from you versus others.
Okay.
Well in terms of customers.
This is a good question I don't have the exact answer.
For that so.
We can work on that and come back obviously to you. We are extremely driven abuse you saw by both.
<unk> inside and outside our company.
This is true forward customers and we have good progress there, but I want to make sure we get the right facts and Andy is going to come back to you.
And when I think about supplier diversity so for the company.
We've delivered on our commitments.
We've improved dramatically as well so our.
Our purchases from minority is as well and diverse suppliers in the country in the U S. As well we are perfectly on track versus what we had expected so far.
Okay.
A follow up how does your volume mix fair by month in the quarter and Directionally how did it.
Trends in July with the surcharge in place.
We usually don't give so that granularity so within the quarter.
It's also not the straight line so within the quarter as well so we have some seasonality.
As well that's coming as well.
Into play, but we usually don't have big spikes.
Within the quarter as well so what we've communicated for the quarter is a good proxy.
And what we've seen in the second quarter and third quarter pricing is going to be an even bigger share versus volume, which.
Which is not surprising since pricing is going up total organic growth is going to remain strong which means that.
Volume is going to remain so stable.
Stable slash down in the meantime going forward.
Thank you Christoph.
You.
Our next question is from the line of Kevin Mccarthy with vertical research. Please proceed with your questions.
Yes. Good afternoon. Thanks for taking my question Christa.
Christophe with regard to your global institutional and specialty segment do you have new structural price increases on the table are set to flow through in the back half outside of the realm of surcharges.
Absolutely.
Kevin first and foremost our pricing and our company is happening in every business every single year and that's been true. So for a very long time, maybe since the company started as well. So this is really a muscle that we keep.
Practicing every single year and pricing is something that sticks as well in our model because it is driven with the value of the return to E on ROI that we're providing.
To our customers, so we're going to keep driving structural pricing in all businesses, including institutional obviously.
In the months quarters and years to come on top of it.
Is coming the energy surcharge, which is related to the energy oil and gas markets as.
As mentioned as well before but the beauty of this structural price is really that it's driven by the value that.
That we create for our customers, which is D. C. ROI, how much savings do we help them create in their own operations versus the investment that they're making and we're really making sure that that return so stays as strong as it can be so pricing is true for every business and it's going to continue to be the case in the years to come.
I see that's helpful and then as a follow up sticking with the global institutional segment, if I look pre pandemic.
<unk> earned pretty consistently between $930 million of EBIT to about 1 billion back in 2018, and so if I compare those sorts of levels to where you're tracking this year. It seems as though you've got maybe $300 million.
Or more of price cost to makeup do you agree with that math and if so what kind of time might be required to.
To restore the profitability too to the older levels.
Yes, as I mentioned before so to take the Big picture I think from a margin perspective.
In institutional.
It would be probably the second half of 'twenty three.
We're going to get there in terms of ratio in terms of volume Im expecting that soft first half of next year in terms of sales. We are ahead of us.
You already know.
We're working as hard as we can so to get as quick as we can towards those milestones that I just mentioned, but macro.
That's a good proxy.
That being said, it's important to keep in mind as well that institution like most of our businesses in the company.
Post this cycle are going to be in a stronger place than they were before.
Driven by by by three things first we've gained share.
You have bigger businesses second.
We have a pricing driven by the value that we create that takes time to get to the right place, but it's driving margin leverage and third we have this digital automation, that's going to keep helping so the SG&A ratio, which is going to be a good story. So taking time I wanted to do that the right way it takes more time.
It's kind of short term pain for long term gain but I feel really good about where we're going with institution loss point institution was mostly driven by North America as you know so from an it person.
<unk> like the fact that the regions around the world are improving as well in the meantime, especially.
Europe as well so it's a business that's getting stronger as well from a geographic perspective, which is also good in terms of stability going forward.
Okay. Thank you very much.
Thank you.
The next question is from the line of Rosemarie <unk> with Gabelli funds. Please proceed with your questions.
Thank you and good afternoon, everyone.
Those are all of them.
Yes.
If we look at scale for a minute I mean that.
It's been kind of a problem child.
A while do you have any.
Yes.
The path to get there.
The margin the profitability of that business.
The operation.
Yes, it's a great question and you're right that it has been a problem child for quite a while that that's one way to put it the way I am expressing it so within the organization is to say well, it's a dream that hasnt come true yet.
The promise of reducing hospital acquired infection in hospital, well makes human sense people hurting less profitable.
Profitability.
For hospitals, because it's less work.
Since people are not readmitted when you're infections that they get so I'd like to promise.
Like the journey that we've been on each taken way too long for us to get to the right place and we're not at the right place yet now back to your question. So.
Main driver.
Is really so to focus on those programs as.
As I mentioned during the Investor day as well.
Is central steroid for instance, which is kind of like a big kitchen.
Our healthcare team doesn't like when I compare that that way, our restaurants or to a hospital, but do you have a dish machine in <unk>.
Interest arrived with old instruments coming.
Coming in this is where we can play this is where we know how to win this is how we know where to make money as well and that's a core program that I want to strengthen and build around it our programs are doing really well then fortunately only 40% of the total business today.
As that will grow the business will improve its taking time too much time, but we will get there as well.
Alright, Thank you and and then if I look at the pro forma gross margin in 2019. It was 44% what is the likelihood that you can get back to that before 2025, even if we have a mild recession.
I feel really good.
Getting back there.
Obviously some of the work that we've done on structural pricing on energy surcharge is.
B domain driver for us to get there on top of it you have the productivity improvements.
Driven by digital automation in.
SG&A and in our operations as well so getting back to the 44%.
Step one step two is to build.
Even beyond.
The 44% the question will be the timing and the timing is related obviously to the shape of inflation.
In the quarters and years to come the trajectory.
I have zero doubt that we're going to get to the right place. The only question is how fast we're going to get there and thats, depending mostly on external factors.
Okay.
Yes.
Final question is from the line of Mike Harrison with Seaport Research. Please proceed with your questions.
Hey, good afternoon.
A couple of quick ones hopefully.
<unk> light.
Capacity addition, I guess I thought that some of those we're going to start to trickle in in Q3, but it sounds like Youre still sold out through Q3 is there going to be some additional commercial volume in Q4.
And are you at a point right now where youre able to base load that additional capacity with customer commitments.
Yes, we're in a great place.
It is an interesting problem to have where demand is really strong.
The innovation, we're bringing to the market even stronger when we combine so what we're doing in life science in water as well so for our customers, we Max didn't capacity as you mentioned.
We hope to bring that capacity online during the third quarter, knowing exactly when that's going to happen.
I don't know, yet and Thats why im assuming thats, probably going to take till the end of the third quarter. We wanted to do that extremely well quality it needs to be absolutely secured those all former products as you know as well and we want to do it as well so the ecolab way, which means that it is going to be unleashed in Q4.
In 2023.
Taking a bit bolt time than what I would have wished to build that capacity.
I will like to trade of getting very solid quality, even if it's taking a little bit more time and building for the future here. If the future is in Q4 instead of Q3.
Find with that the trajectory is going to be a really nice and the more I look at that business to more like it.
Alright, then the paper business continues to be very strong can you give a crystal some.
Some additional color are you, taking some market share and if so is that.
More of a new customer or new mill, a win or is it expanding share of wallet with existing customers.
It's all of the above.
It's a fascinating business.
Per an especially since we've evolved over time from all graphic paper paper Youre right on.
Two more consumer products, which are key issues.
The boxes.
For the most part.
As a market.
Thats.
That strong that requires a lot of technology that we can provide as well that is much less cyclical than.
Printing paper.
Timothy here so the portfolio shift that we've made in paper towards consumer products has been extremely successful both.
From a sales perspective, the attractiveness of what we're doing and margins as well because we had those consumer good company is operating at a lower total cost while reducing their environmental impact they use a lot of water as you probably know as well and create a lot of waste, while what we offer to them helps them reduce environmental.
In fact, we used to total cost and improve the quality.
As well of the of the finished product.
A good story and this team has been great at executing pricing as well, which on top of it makes it an even better business.
Alright, thanks very much.
Yes.
Thank you.
We've reached end of our question and answer session I'll hand, the floor to Mr. Hedberg for further remarks.
Thank you that wraps up our second quarter Conference call. This conference call and the associated discussion slides will be available for replay on our website. Thank you for your time and participation and hope everyone has a great rest of the day.
Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you.