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Edited Transcript of ECL earnings conference call or presentation 30-Apr-19 5:00pm GMT

Q1 2019 Ecolab Inc Earnings Call

ST. PAUL May 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Ecolab Inc earnings conference call or presentation Tuesday, April 30, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel J. Schmechel

Ecolab Inc. - CFO & Treasurer

* Douglas M. Baker

Ecolab Inc. - Chairman & CEO

* Michael J. Monahan

Ecolab Inc. - SVP of External Relations

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Conference Call Participants

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* Chip Moore

Canaccord Genuity Limited, Research Division - Senior Associate

* Christopher S. Parkinson

Crédit Suisse AG, Research Division - Director of Equity Research

* David Emerson Ridley-Lane

BofA Merrill Lynch, Research Division - VP

* David L. Begleiter

Deutsche Bank AG, Research Division - MD and Senior Research Analyst

* Eric B Petrie

Citigroup Inc, Research Division - Senior Associate

* Hamzah Mazari

Macquarie Research - Senior Analyst

* John Patrick McNulty

BMO Capital Markets Equity Research - Analyst

* Joshua David Spector

UBS Investment Bank, Research Division - Equity Research Associate - Chemicals

* Laurence Alexander

Jefferies LLC, Research Division - VP & Equity Research Analyst

* Manav Shiv Patnaik

Barclays Bank PLC, Research Division - Director & Lead Research Analyst

* Michael Joseph Harrison

Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst

* Rosemarie Jeanne Pitras-Morbelli

G. Research, LLC - Research Analyst

* Scott Andrew Schneeberger

Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst

* Timothy Michael Mulrooney

William Blair & Company L.L.C., Research Division - Analyst

* Vincent Stephen Andrews

Morgan Stanley, Research Division - MD

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Presentation

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Operator [1]

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Greetings, and welcome to Ecolab First Quarter 2019 Earnings Release Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce Michael Monahan. Thank you, Mr. Monahan. You may now begin your presentation.

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Michael J. Monahan, Ecolab Inc. - SVP of External Relations [2]

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Thank you. Hello, everyone, and welcome to Ecolab's first 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 the 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 in these materials stating that this teleconference and the associated supplemental materials 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 under the Risk Factors section in our most recent Form 10-K 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 results. Continued sales growth and margin expansion drove Ecolab's double-digit earnings per share growth in the first quarter. Pricing, new business gains and product innovation led to sales and operating income growth, which, along with cost efficiency actions, a reduced tax rate and lower interest expense, yielded the first quarter's 13% adjusted earnings per share increase.

Moving on to some highlights from the quarter and as discussed in our press release, acquisition-adjusted fixed-currency sales increased 3% as the Industrial and Other segments both showed strong sales gains and, along with modest growth in the Institutional segment, more than offset a slight sales decline in Energy.

Adjusted fixed currency operating margins increased 80 basis points, continuing the good acceleration shown throughout 2018. Growth was led by double-digit gains in the Industrial, Energy and Other segments.

Net operating income increase drove the 13% growth in adjusted diluted earnings per share to $1.03, representing another quarter of double-digit adjusted EPS growth. Currency translation was an unfavorable $0.04 per share in the quarter.

We continued to make progress on the spin-off of our Upstream business. We currently expect the spin-off to be completed by mid-2020. We continue to work aggressively to drive growth, winning new business through our innovative new products and sales and service expertise as well as driving pricing, productivity and cost efficiencies to grow our top and bottom lines at improved rates across all of our segments. Our digital investments are developing well, and we look for them to add an expanding range of new actionable insights for our customers to improve their operations, enhance their experience working with us and increase our sales force effectiveness.

We continue to expect consolidated 2019 adjusted diluted earnings per share to rise 10% to 14% to the $5.80 to $6 range as volume and price gains and cost efficiency benefits more than offset the impact of moderating delivered product cost increases and business investments. Currency translation is expected to be an unfavorable $0.11 per share in 2019.

Second quarter adjusted diluted earnings per share are expected to be in the $1.36 to $1.46 range, up 7% to 15%. Currency translation is expected to be an unfavorable $0.05 per share in that quarter.

In summary, we expect improving top line momentum in 2019, which should more than offset moderating delivered product cost increases and unfavorable currency exchange and, along with cost efficiency actions, yield a 10% to 14% adjusted diluted earnings per share growth. We continue to make the right investments in the key areas of differentiation, including product-innovation digital investments to develop superior growth for this year and for the future.

And now, here's Doug Baker with some comments.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [3]

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Thanks, Mike, and hello. So a quick overview. Look, we had a very solid start to the year and are in a good position to deliver 2019. On the plus side, industrial sales were very strong, so are margins, as pricing is overcoming the inflationary pressures that we've been feeling, and this is leading to margin recovery. Energy also had strong margin recovery, even with predicted soft sales of minus 2%.

Our Other segment and our other Specialty businesses, QSR and FRS, were strong also. The only disappointing news is Institutional, whose sales were weaker than expected. Their underlying sales were 4% in U.S. and 3% globally. This is better, clearly, than the 1% reported but still off expectations by a point or so as distribution inventories were reduced, this happens frequently, and the exited business we discussed last quarter converted quicker than we had forecast.

We expect the Institutional business to show improvement in reported and underlying sales through the year, particularly in the second half. So as we finish our first quarter and move into the balance of the year, we're well positioned, we believe.

The heaviest lifting of our U.S. SAP implementation is behind us, with our fourth and final supply chain wave completed in the first quarter of '19. Our processing, cost savings, innovation, digital and talent initiatives are all on track, and new business is tracking ahead of last year's record pace. As a result, we expect to deliver double-digit adjusted EPS for the year and in every quarter and, most importantly, leave the year with good momentum as well.

So with that, I'm going to turn it back to Mike who will open up Q&A.

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Michael J. Monahan, Ecolab Inc. - SVP of External Relations [4]

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That concludes our formal remarks. As a final note, before we start Q&A, we plan to hold our annual tour of our booth at the National Restaurant Show in Chicago on Monday, May 20. Looking further ahead, we also plan to hold our 2019 Investor Day on Thursday, September 5. If you have any questions, please contact our office.

Operator, would you please begin the question-and-answer period?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is coming from the line of Gary Bisbee with Bank of America Merrill Lynch.

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David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [2]

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This is David Ridley-Lane filling in for Gary Bisbee. Can you discuss the revenue trends in Europe, particularly in your core segments, Institutional and Industrial?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [3]

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Yes. We had a stronger quarter in Industrial than Institutional. Industrial was organic 5%, and Institutional was down a point. QSR had a fairly strong quarter. So if you put them together, you end up with a little better answer. Institutional, Europe, I think, is an area where we feel like we're doing the right things to improve this. We put a new GM in Europe late last year. The new GM, [Martin Pulcher], started in Institutional. He was the GM who turned around Pest North America. We've added a sales field leadership position in Europe reporting to [Martin]. And collectively, that team's focusing on 3 things: localizing innovation, we got too global in much of our Institutional approach. And we want to make sure that we're doing the right things and making sure our innovation is tailored for a local approach. We're also enhancing field execution discipline, this is really the key role of the sales field leadership position. And we're also adding sales firepower by converting some field resources where we're a little heavy and converting them into corporate account selling resources. Obviously, it's not the same bodies in every case, but it's the same money.

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David Emerson Ridley-Lane, BofA Merrill Lynch, Research Division - VP [4]

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And then as a -- just a quick follow-up, I heard the comment on new business growth. Could you maybe quantify that a little bit or put that into context of your hiring -- aggregate hiring on the sales force? For instance, are you getting increased productivity out of sales force as well as just hiring more people?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [5]

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Yes. Over 2018, we added about 3% in sales and service resources last year. So we feel we're in a good position to take care of the growth that we're generating as we move forward.

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Operator [6]

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The next question comes from the line of Chip Moore with Canaccord Genuity.

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Chip Moore, Canaccord Genuity Limited, Research Division - Senior Associate [7]

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Wondering if you could touch on Life Sciences continuing to outperform the market very nicely there. Doug, maybe talk a little bit about the runway for growth. Any changes you're seeing in the competitive environment there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [8]

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Yes. No. The Life Sciences business continues to do well. And while it was performing decently before, we, if you will, have created a focused life science business, it clearly has kicked into a higher gear and we've averaged double-digits since that point in time. Look, we love that market. So the market is global. It's consolidated in many sense. If you think about the customer set, it's a fairly fragmented competitive set. That's a good environment for us. We continue to reach out and drive our advantage, which I would say is kind of 3 fronts.

We have very good clean room technology. We have world-class CIP technology. So the lessons that we've learned over the years in Food & Beverage and, increasingly, in other industrial applications perfectly applies here. And then, finally, the Water capabilities that we have are really well suited for this industry as well because it's a great -- it's a prime source for contamination, potentially, et cetera.

And so we're leveraging these advantages quite successfully, growing that business. We made an acquisition, as you'll recall, in U.K., Bioquell, just fourth quarter is when we closed. And so that's going to also give us additional technology and a new entry point, if you will, into this market. Finally, we've just added manufacturing capability in North America, where we have now registered products. So it's going to open up a much broader swath of the U.S. market than we've been able to compete against previously. That will, in a sense, change the competitive environment for us, I don't think for the worse, simply because we'll be able to go after a bigger part of the market.

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Chip Moore, Canaccord Genuity Limited, Research Division - Senior Associate [9]

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Got it. That's helpful. And just a follow-up. In terms of -- you mentioned the U.K. acquisition, is there a pipeline of potential targets in that space?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [10]

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Absolutely. And I would say, it's a relatively new space for us. And so it's not an area that we've probably mined as heavily as we have others in the past. So yes, there's a nice long list. Obviously, it's got to be at the right time, right price, et cetera.

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Operator [11]

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

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Manav Shiv Patnaik, Barclays Bank PLC, Research Division - Director & Lead Research Analyst [12]

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Just on the Institutional side, you talked about the distribution inventory issue. Could you just elaborate on that and maybe, in past quarters, where it might have happened, so that we can take a look back? And if that was the main reason why you were a point or 2 behind your expectations there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [13]

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Yes. Clearly, it was one of the issues. I would say, distributor inventories move up and down. And we have printouts from the distributors, so we know where every case moves to, meaning we have a very good understanding of consumption in the industry. And as a consequence, it's very easy for us to understand what's happening in terms of distributor inventories up or down based on ins and outs, if you will.

So this happens almost every year in a quarter, we have some conversation. Last year, in the first quarter, our conversation was the opposite. We had actually -- distributors had built inventory during that quarter, and we talked about how the reported number was a little stronger than the actual underlying sales at that time, and that don't expect that immediately in the second quarter, but we would expect to end the year at a 5% run rate. So this happens frequently.

If I were going to sum up Institutional, I would say this, we expected a downtick in Q1, part because of the previously announced exit of low margin business. However, it was worse than we expected, which we talked about in my opening remarks, and Mike referred to. So one, the business, the low margin business exited faster than we had forecast and expected. That's not going to result in any change long term. It's just a timing issue. The distributors did drop inventory in the quarter, which happens. Typically, we'll see a rebalancing and that come back in follow-on quarters. I can't predict if that's Q2 or Q3, probably one of those 2. And the final piece I would describe, for a lack of a better term, is the fog of war, and this is related to the SAP U.S. implementation. It's not -- this doesn't mean we lost consumption because of SAP. We didn't. But when you do these implementations, and I'll just remind you, we had 4 waves in the U.S. The last supply chain wave was just this February, a couple months ago. The first wave was the February before, and wave 3 was in quarter 4. And what happens during these waves is you pre-load, i.e., build inventory in your direct customers and in the trade. You do it in case you have a supply chain short circuit as part of a cutover.

Now we never saw a short circuit. We were able to get up and running very quickly in every one of our waves. But you still prepare as if that may happen, so that you don't end up shorting customers. But as a consequence, after these waves was all this rebalancing activity. And so it's noisy short term and hard to go figure out exactly what's happening.

In Q4, North America Institutional was up 6%, but that was driven by a 7% growth number in U.S. Institutional. And we said at the time that's higher than our run rate, don't use that as a terminal value. We knew it was a little inflated. We weren't exactly sure how or how much. And as we look at first quarter, obviously, we see a lower-than-expected number. And certainly, in that wash, there is this rebalancing and all the other stuff going on here.

Now when we look at March and April, we see much more normal activity in our North America and particularly U.S. Institutional business and see sales as we would have expected all along. So we think the noise, as we would expect from past experience is sort of moving out of the business, and what we're going to see is more normal behavior. So when we look at all the underlying things, pricing, new business, lost business other than the low margin stuff I've talked about, a lot of stuff is exactly on track. We know that if we continue to focus on these things, we'll show improvement. The key metrics to us are new business and pricing. If we drive these, and we expect to, the rest self-cures. The loss is annualized, the distributor inventory is rebalanced, and the SAP implementation costs, which are not insignificant, by the way, and 70% hit Institutional, are also recouped. So there's some natural like margin lift as we move through this, just as we start getting through this noisy period.

Net, we think we'll see an improvement in Q2, I'd say modest, but a more significant improvement as we get into the second half in Institutional. So we're -- I think we have a good understanding of what's going on. Business is doing what it needs to do to go drive value, and we expect Institutional to be a strong business, as it always is.

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Manav Shiv Patnaik, Barclays Bank PLC, Research Division - Director & Lead Research Analyst [14]

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That's super helpful with the color. Maybe just along the same lines on Industrial, like should we think of that 7% growth as sustainable? Or maybe is there some timing and it might sort of stabilize later?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [15]

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Yes. Look, our Industrial business is really led by Water and F&B, have obviously been strengthening sequentially for a number of quarters. It's driven by both pricing activity and by volume. Volume driven by a lot of new business, which we've been talking about, right, in almost every call, how we're having very good new business success. That's clearly in the Water and F&B business, in particular, also in Institutional, et cetera.

The Food & Beverage rate -- organic growth rate is 7%. I wouldn't say that's our terminal value, but F&B has really done a heck of a job partnering with Water to bring outsized value to customers, and this turned into big sales with big players.

Now annualized against some of these sales in quarters, so every quarter is not going to be a 7% organic, but with that said, we expect to have a very strong year in F&B and a very strong year in Water. So is 8% exactly sustainable? I'm not going to commit that to every quarter, but we expect mid- to high single-digit organic growth rates in these businesses. And we also are starting to see the margin leverage that we've talked about. We had significant raw material and logistic inflation impacting all of our businesses but, in particular, our Industrial businesses. And so they've been on pricing. And this pricing is now starting to overwhelm the inflation in that business, and we're starting to recoup the margin losses that we've seen. But this isn't going to be overnight either, right? This is going to take us some time to rebuild these margins, but you should expect to see positive margin build throughout this year. And it's going to need to continue into next year. So some of that's going to come from pricing, some from cost savings, some from doing a better job operating the supply chain now that over 80% of our volume is on SAP. So we just have better visibility and a better and a more easier, if you will, kind of foundation to run on. So those are the key things to look for and watch, particularly in the Industrial business.

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Operator [16]

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

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [17]

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Two questions. First, on the Institutional growth rates, as you think about the cadence of this year and the -- you have underway, should we see that business sort of exit the year at about a 4% to 5% kind of run rate? Is that a fair way to think about it? And secondly, can you give a little bit of flavor about Colloidal and how long you think that can sustain a double-digit growth rate?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [18]

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Yes. Well, I'll do the small one first, Colloidal. I would say Colloidal's an interesting technology. We have it. There's capacity constraints in the world and other areas, we'll continue to drive the growth there. But that business we're going to continue to manage, we think, very intelligently for cash and return and other things. We want to do the right thing for our customers, but we'll also do the right things for shareholders as we look at this business.

In Institutional, yes, I would say there's really not a caveat because if you want to say do we expect to be at a 4% to 5% run rate on December 31? The answer would be yes because by that time, we would have -- no longer be lapping the lost business, right? It would be pretty much out of our sales. So I think that would be a comfortable yes that we would exit the year at that run rate because of that.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [19]

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Okay. And can you give a bit of a flavor for how you're thinking about the sales force incentive programs? That is, are you comfortable with the current set? Or are we going to go through one of these periodic refresh and refocus cycles? Can you just give us a sense for where you're at on that?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [20]

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I would say, we really look at comp every year and make minor adjustments almost every year, and there are episodic times where we go through a major adjustment in a given business, meaning we went through one in Pest about 3 years ago, quite successfully I would add. You couldn't even see it in the business, but we changed the comp there dramatically. In Institutional, there's certainly areas of that business where we are going to revise comp programs, part to reflect new regulations or the way regulations are being enforced, and some because we think it's going to just -- and we'll do that in a way like we did with Pest, where I don't think it's going to be visible to anybody except those in the business.

We want great people. We want great people that -- incented to do the right thing and also incented enough where they want to continue to stay here and can make enough money to make a career out of it. And so we always have evolutionary change around here, and I wouldn't -- there's nothing on the horizon that I would say would be noteworthy.

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Laurence Alexander, Jefferies LLC, Research Division - VP & Equity Research Analyst [21]

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And maybe, if you wouldn't mind, just 1 last one on Healthcare. Is there a reason why the business model there hasn't flexed more in response to a sort of the disappointing growth rate. I mean, like why this hasn't evolved into like a partnership with an insurance company or some kind of other way to get an end run around the bottleneck that you've seen in terms of the purchasing managers?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [22]

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Yes. Well, look, we've certainly explored a bunch of different things. Here's what I would say. The Healthcare business, our program business, which is really what we're emphasizing, continues to do well. These are programs around room cleaning to reduce HAICs, around O.R. turnover and accelerating turnover, both time and efficacy, and also in central sterile, et cetera. These programs are doing quite well. The issue, which is principally in U.S., is just one of portfolio mix. These programs are still relatively small versus what I'd call the historic product approach. And as time goes on, obviously, since the programs are growing so much faster than the products, they're becoming a larger percent of the portfolio. And what you'll see is that sales will reflect that, but that just is going to take some time. And the team, I think, is doing exactly the right thinking and after that. But that is having good uptake.

In Europe, our mix is a little bit better. And in Europe, we expect to have mid-single-digit, low single-digit organic growth rate. Anios is doing well in Europe. They've got a very strong program mix in a number of areas. Some of those we're exporting to other parts of the world, including the U.S. once we get registrations. So I would say, underneath the covers, we think the Healthcare business is more right than wrong. Certainly, we would like to accelerate it. We would like to see faster, better results, too. But if you look underneath, good things are happening, and we want to make sure that we stay focused on what we think the long-term advantage is.

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Operator [23]

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

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [24]

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This is Josh Spector on for John. Just a question around Energy. Given some drivers that spin around customer buying patterns shifting and maybe moving a bit away from kind of the Ecolab heritage model and slower growth there in the quarter, do you see any risk of another shift going on that could impact the second half? Or do you have pretty good visibility into the sales growth there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [25]

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Yes. The Energy quarter, if you will, the soft sales of negative 2%, I mean, we expected it to be flattish coming into this quarter, plus/minus. And so the 2%, to us -- look, I'd rather have plus 2% than minus 2%, no doubt about it, but it was around where we expected it to be. It's not the easiest business to forecast. And really, we expected these types of top line results for 2 reasons. One, there's a dramatic reduction in just activity. A lot of this is occurring in Permian. I mean, if you look at others in this business, you're going to see, I would say, even lower sales rates than we had. And so we're not alone. Ours would probably be on the better side.

The second reason was we were going against a high base, i.e., first quarter last year was an 11% growth quarter. And even at the time, we said it was, in part, driven by one-timers, and we knew those one-timers weren't going to recur again in this quarter. Hence, the reason we were sort of bearish on the first quarter. So it's not a change in buying pattern. It's not a change in, all of a sudden, we're out of favor at all. We would expect that, as the year goes on, you're going to see stronger top line performance. And most importantly, even in the first quarter with negative 2%, we had double-digit OI growth in that business as we are recovering on the margin side handily due to the pricing work that we talked about every quarter last year and it's continuing. And now, it's being coupled with excellent cost savings efforts as well, impacting both gross profit and SG&A. So we expect mid-single digits in this business for the year, top line, and outstanding margin recovery driving even much better OI results for the year as well. So I'm not really worried. I think the stuff that the Energy business is doing is smart, right, and it's going to bear fruit for the year.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [26]

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Okay. And just a quick follow-up around the Energy spin. I don't know if it's too early to ask about any numbers around that, but I guess if I try to think about how much amortization stays with Ecolab and goes with the spin, do you have a rough cut there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [27]

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Yes, $170 million of amortization goes with the spin.

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Operator [28]

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The next question comes from the line of David Begleiter with Deutsche Bank.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [29]

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Doug, you have new competitors the last 6 to 9 months in Water and Institutional. How are they acting in the marketplace?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [30]

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Well, I guess our new competitor in Institutional would be a new owner.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [31]

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Oh, I'm sorry. New owner, yes. I'm sorry.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [32]

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Yes. And I would say, they're acting like they've always acted. So I don't -- we really don't see a significant difference. They can be really aggressive at times bidding on new business. This has been a pattern for years and years. There have been frequent times over the last -- I've been here 30 years, anytime during the 30 years, but over the last 15, 20, I have a better memory, where we've blinked and walked from business where we're not going to make money, and in some cases, not make cash, and we don't think that's smart to stay in those situations. And we've had some recently, but we've had them 2 years ago, 3 years ago, 5 years ago, 7 years ago, 10 years ago. In many instances, these businesses end up back with us, not 100%, but a fairly high percentage. And what we want to make sure that we do is maintain our ability to do a great job for customers. We're there for customers when they need us. And -- but we've got to be able to make money, so that we continue to invest in innovation and digital and all the like. And so we've got to be -- play a disciplined game as well, and that's the story there.

On the Water side, GE Water is now owned by SUEZ. I don't know that there's a dramatic difference day-to-day. We were -- we thought we were well positioned against GE Water, and I'm not -- we respected them. We respect them now that they're owned by SUEZ, but we remain, in our minds, quite well positioned as a competitor in this area. And you can see it in the strong results. So I don't think our competitive environment has really dramatically changed one way or another.

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David L. Begleiter, Deutsche Bank AG, Research Division - MD and Senior Research Analyst [33]

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Very good. And just on your delivered product costs, I know they will be moderating for the year. What were they up year-over-year in Q1, Doug? And what should it be up by the end of the year on a quarter -- or maybe on a Q4 over prior year basis?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [34]

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Yes. We're forecasting 3% to 4% inflation for the year. I'll be honest, for the first quarter, it was the most significant year-on-year, 5%-plus probably increase in the first quarter. But it abates for 2 reasons. I mean, mostly because we start running into an inflated base, if you will, i.e., raw materials got more expensive throughout the year last year. So the delta decreases as you move forward as long as you don't see dramatic inflation this year. We have some inflation forecast this year. We've held that forecast.

Last year, we got burned on raw materials. The indices we follow were completely wrong last year. If you looked at the indices this year, they would say that inflation's going to be less than we have forecast currently. We don't know if that turns into upside for us or not. We're being a little more conservative this year based on last year's experience, which means we'll be wrong 2 years in a row, I hope.

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Operator [35]

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

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Vincent Stephen Andrews, Morgan Stanley, Research Division - MD [36]

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If I could just ask a question on price. And you touched on this a bit earlier in the Institutional comments, but just want to know how price was across the segments, if there were any meaningful discrepancies or anywhere where you were -- still need to work a little bit harder. And then, just within Institutional, was there -- is price flatter at all by the exit of the low margin businesses in any meaningful way?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [37]

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No, but that would show up in -- for us, in more mix, and it would have an absolute price the way that we measure the margin stuff. And I would say 2 things. We continue to accelerate on price, if you will. It's 5 quarters in a row. And so it still is around the 3% rate. Industrial had the strongest price number. They need it because, one, they were probably the furthest behind and have been playing catch-up and doing a very good job doing it, but they've got a couple of years of big raw material inflation numbers in their business, and they're working to recover those, and obviously working with customers to do it in a way that works, et cetera.

Institutional always takes more a slow and steady approach on pricing. They don't get hit and rocked significantly with raw materials as some of our other businesses do. Part is the mix of the raw materials and part is solids and the other technology that they've deployed over the years. And so they've got a lower, more like a 2% price, if you will, year-on-year. And Energy was also 3% in the quarter as well. And Energy also obviously sees significant inflation. We expect to continue to get pricing throughout the year. We need to. We have margin recovery goals. Our plan isn't to expand margins during the cycle, but we certainly -- our goal isn't to lose margin either as a result of this. We'll expand margin through our own efforts internally, i.e., leveraging the SAP implementation and other work to help improve margin and/or innovation. But that's where we are on price. I would say the team is doing a very good job in a very -- and it's always hard.

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Vincent Stephen Andrews, Morgan Stanley, Research Division - MD [38]

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And just as a follow-up on the destocking, it sounds like from your comments earlier that this would be something that would take place within a quarter, that it wouldn't straddle 2 quarters based on your look at the printouts or the books and stuff and the conversations with the distributor customers. Is that correct?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [39]

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Yes. We don't expect -- I mean, look, we don't control it absolutely, obviously. If I went on history, and we go through this literally every year in a quarter, and obviously, when it helps us, nobody remembers it. And when it hurts us, they don't remember unless it bounces back. And I would say this is a very normal thing. We would expect it to bounce back. And as I said earlier, I don't know exactly if that's second quarter or third quarter. But it's probably 1 of the 2 most likely. That's typically the pattern we've seen in the past, and there's no reason to believe that, that won't be the pattern we see here.

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Operator [40]

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The next question comes from the line of Hamzah Mazari with Macquarie.

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Hamzah Mazari, Macquarie Research - Senior Analyst [41]

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My first question is any update you can provide as to your circling the customer initiative? Specifically, which verticals? It seems like Food & Beverage is one which maybe you sort of optimized in terms of selling your entire product suite to corporate clients. And where you think there's room to sort of improve that?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [42]

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Yes. Look, it's been a key part of our strategy and a key part of our success, particularly in Industrial. As we put Nalco -- and made Nalco a part of Ecolab, we came out of the gates and said one of the key areas we wanted to focus on was the F&B market. And if you look at what's occurred in F&B over the last 6 years, it's been really amazing. And if you look at the brewery business in particular, how we've been able to very successfully marry Water and our F&B cleaning-in-place, food safety technologies together to create outsized value for customers, it's driven share. And it's been a key part of how we went to market strategically, how we created value for customers and the reason that we've won.

Coupled with that is always Pest Elimination. It's also led us to understand other parts of the Pest business like fumigation, and it's then led Pest to start, one, buying and acquiring some fumigation business, which we've done recently and starting to build a larger business in that area because it's core to the F&B market. So that's a great example of how Circle the Customer drives value for customers, share for the company and also opens the door to new opportunities as well. There are other examples. I mean, I can do warewashing technology being leveraged in QSR and in some instances in our Food Retail business, coupling with the Institutional capabilities. I mean, there's plenty more. But I don't want to take up too much more time.

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Hamzah Mazari, Macquarie Research - Senior Analyst [43]

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No. That's helpful. And just to follow up, on Healthcare and you may have touched on this earlier in a question, but specifically, does your go-to-market strategy in that segment need to change? Specifically, more of a C-suite type sale? Are you just talking to the wrong people in Healthcare? I'm just curious around go-to-market, if that's a drag at all on growth. So you may have touched on this, but any color there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [44]

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We talked Healthcare earlier. So I'll just -- I'll sum it this way. No, I think the way -- we've really focused strategically on program selling there. And the programs that we have out in the market are growing, and we're having success selling them. And those are programs around room cleaning and HAIC reduction, operating theater, if you will, changeover and also better efficacy and then also in the central sterile. And those programs are working and growing. Now the issue, which is principally U.S., is they're just -- they're still a relatively small piece of the total portfolio, so that sales is sort of masked, if you will, by the product sales that represent the balance of the portfolio, where you don't have the same strategic advantages that we have in program selling. So our nose is to the grindstone, sell programs, keep focusing. The portfolio will shift over time because it's growing at 3, 4x faster than the other. We know what will happen, and then you'll start seeing the sales come through, but that's our strategic focus. And there, we are clearly calling on the right people. We're not flying the white flag on the product side, but it's just a different competitive environment and equation, which is why we're -- our efforts are going towards programs.

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Operator [45]

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The next question comes from the line of John McNulty with BMO Capital Markets. Moving on to Tim Mulrooney with William Blair.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [46]

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So first, Doug, your Industrial business, can you just give us an update on the Industrial business in China? It's hard to know what's going on over there sometimes, but your Water numbers are so strong. So just curious if the market's getting better or worse or about the same.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [47]

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Yes. Look, our China business overall was mid-singles growth -- mid-single-digit growth in the first quarter. Decent profit. I would say, it was really driven by the Institutional side. So I'm getting to the point you'd like me to talk about, and the Institutional collectively was double digits, doing quite well. The Industrial side of the business was flat to down modestly in total, really driven by Paper, which was down more dramatically. They're not making as much corrugated for export shipments in the meantime as we go through this. So certainly, we're impacted somewhat with the trade discussions there. We don't see this ultimately turtling our China business for the year by any means. We think it will probably, one, if we get the trade agreement figured out, it'll open the door. But even barring that, as we look at the progression and everything else, we think we've got more good than bad in that business, and we're going to have a good year either way.

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Timothy Michael Mulrooney, William Blair & Company L.L.C., Research Division - Analyst [48]

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Okay. My follow-up is on SG&A. SG&A adjusted for one-timers was actually lower than last year despite revenue growth. Is that primarily the result of your cost savings initiative? And do you expect a similar dynamic through the remainder of the year?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [49]

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Yes. I would say, SG&A, certainly, we have strong cost-savings initiatives in place. We would have said, in the first quarter, it probably delivered about $20 million, which is on pace to the $80 million that we've talked about. If I were going to handicap the year, we'd probably have upside on the cost savings side of the initiative pile in terms of you need some upside because you never know what's going to happen in other things like death, tax, et cetera. So yes, those are driving it. We're also leveraging technology in a number parts of our business as we go forward, and this is also enabling us to do more via each person. So it's a combination of things, but cost savings certainly is a driver.

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Operator [50]

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The next question then comes from the line of John McNulty with BMO Capital Markets.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [51]

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A quick one or 2 of them. One, on the raw material front, where are the buckets that you're actually seeing the inflation? Because it does seem a little bit counterintuitive given oil coming off the way it has that you're forecasting something in kind of the low to mid-single digits for the year. So maybe help us understand where you're seeing some of those pressures.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [52]

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Yes. Well, oil year-on-year is up nearly 50%. So we've got to go compare back to Q1 of last year. That's when our comparison is here. But beyond, if you will, sort of oil-derivative raw materials, certainly, cost, it goes up for us. Transportation costs grew double digit last year, particularly in the U.S., but we had inflation also in other markets, Europe in particular. So our 2 biggest markets, if you will. So there are number of areas where there's been inflation in raw materials. And I would say last year was significant. It followed a fairly significant year the year before. So it's been kind of a 2-year run. We are forecasting moderation in the inflation rate, but not deflation this year. We still think that's the right forecast, and we hope we're wrong.

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John Patrick McNulty, BMO Capital Markets Equity Research - Analyst [53]

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Got it. And then, it's been a couple of months since you announced the split -- or potential -- or the upcoming split of the Upstream Energy business. Can you speak to whether or not you've seen interest from potential buyers in that business at this point?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [54]

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Yes. That's not something we would comment on publicly one way or another.

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Operator [55]

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The next question comes from the line of Christopher Parkinson with Crédit Suisse.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [56]

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So when you look at your various platforms, what are the largest opportunities to improve margins over the long term outside of simply price/cost? Is it perhaps shifting more -- even more, I'd say, to a service model? And just I know Institutional in Europe has clearly been a longer-term opportunity, but where are the other ones that, long term, guys should be thinking about?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [57]

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Yes. Look, I think there are number of areas. I mean, you started in Europe, and we had a 3% OI margin in Europe, and they're now 9% and knocking on double digit. We've done that over a 7-, 8-year period of time. And I would say the opportunities that existed there still exist, and they exist everywhere else.

And so as we now have SAP implemented through our supply chain and our finance backbone in North America, we now have visibility and different visibility into the U.S. markets than we've had ever via ERP. I mean, it's replacing a system called [Colonet], which we think is 40 years old, but we can't find any marker on the box. So let me just say our visibility is enhanced significantly. So we would expect there's significant savings in supply chain. The, if you will, kind of freight channels throughout North America, the pricing on those channels has changed dramatically over the last 2 years. We know that we've got to recognize that in the way that we shift supply or manufacturing in plants. And where do we supply what customer from where. And how do we do that. There's significant money there. We know that there's a number of policy issues that we're getting after that didn't reflect the current reality and now do, so that's going to reduce the number of shipments it takes to ship the volume we're shipping today. So we know we've got to get better standards there. Formulation reductions, not just SKU. The most important part of SKU is formulas. If you reduce formulas, you reduce raw materials, and you end up with more scale in buying, and so there's a lot of work around that area right now in Energy but, increasingly, in our Water business and in other areas as well.

If you look at just relative margins by business, we know there's significant upside still in Water and some of the other businesses that came over with the Nalco acquisition. Their margins have been enhanced significantly since they've come over, but the team does not believe we're at the edge there or at the end by any means, and we'll want to keep driving that.

So we've talked about 50 to 75 basis points is sort of your typical run rate. Clearly, with the announcement of the Accelerate initiative and the cost savings there and also that we're in a margin recovery zone time because of the recent run-ups, we expect to run significantly over that range for a period of time, we need to, to recover and get back on track on margin build.

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Christopher S. Parkinson, Crédit Suisse AG, Research Division - Director of Equity Research [58]

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And yes, I apologize for the stereotypical simple sell-side question, but can you just comment on the overall M&A landscape, particularly in Asia and Europe?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [59]

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Well, Europe's probably as good as it gets in the U.S. right now, simply because a lot of people are unsettled. And with that often comes opportunity, certainly in the U.K., but I would also say on the continent. In terms of Asia, I mean, the challenge in Asia is scale and culture, i.e., can you buy a company that's meaningful enough in size to be worth the risk and the effort to bring it on and integrate it? And then, culturally, and this isn't the Asian culture, just make sure it's a company -- what's the company's culture and how has it been built in terms of how it sells and creates value, et cetera.

So there, we've got to be -- make sure that it's a company that we would have a right to own and run as we go forward. Generally, I guess -- I think we're going to enter a period where acquisitions of even size are going to make sense again. It'll happen. I don't know exactly when it's going to happen. But being smart about the price you pay is always a good idea, and it proves out over time. We believe that value is created through return on invested capital and our ability to generate cash. And those are the things that we look very carefully at when we make acquisitions that can we do those things over a period of time. If the answer's yes, we're all in. And if the answer's no, we're quite careful unless it's got some seminal strategic value beyond just cash creation, which is hard to find often.

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Operator [60]

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

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [61]

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Was wondering, Doug, if you can talk a little bit about what kind of trends you're seeing in restaurant foot traffic, and if you could maybe talk about that by region. Sounds like North -- really, outside of Latin America, nothing's really much to write home about.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [62]

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Yes. Mike, I would say, kind of agree. I think the -- I would say this, I don't think the foot traffic anywhere is going to impact our business. It's neither dramatically -- I mean, the places where you've got fast, fast growth in foodservice is Asia. And we're all about scaling, getting after share. We've made a number of key moves in the last 12 months in China, which we think put us in a much better position to get after that business on a faster basis. I mean, it's a business that's already growing in the teens, but it should do better. And we're looking to do that. In the U.S., foot traffic seems to have been soft my whole career, and yet, every time I walk into a restaurant, it seems to be full. So I can't quite get over these 2 problems. And -- but by and large, throughout that period, we've had very good growth. There are a zillion restaurants we don't sell yet. We would like to sell them. So until we have 100 share, we're not going to talk about foot traffic is our problem.

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Michael Joseph Harrison, Seaport Global Securities LLC, Research Division - MD & Senior Chemicals Analyst [63]

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All right. And then, I wanted to also ask about the strength that you're seeing in Food & Beverage. Are we seeing any improvement at all in the underlying market there? Or is it really just share gain that we're still capturing?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [64]

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Yes, it's principally driven by share gain. I mean, people are still eating, obviously, but you've got some markets that are still fighting through some challenges. But the team's done a very good job for all the reasons I discussed earlier, partnering with Water and Pest, et cetera, driving outsized value, which is leading to some very significant wins.

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Operator [65]

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Our next question is from the line of Rosemarie Morbelli with G. Research.

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Rosemarie Jeanne Pitras-Morbelli, G. Research, LLC - Research Analyst [66]

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Doug, I was wondering if you could give us a little more detail on how -- the changes you have made in order to grow faster in China. You said double-digit is good, but you can do a lot better. So what changes have you made?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [67]

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Well, I think in a couple areas. So if you want to talk Institutional, we've organized a bit differently simply because that foodservice market is developing differently than markets have in the past. Part, they get to learn from U.S. history and European history. They have concepts which don't fit neatly in boxes, and we've got to go be prepared to offer what those concepts need around service custom designed for those concepts, not maybe the same exact service package that we've had in other markets, so designed for China. So we've invested more, if you will, on innovation resources in China, on digital for China, resources in China, organize our construct of businesses a bit differently to allow a better blurring of lines and have somebody overseeing it, so that they can make smart choices for customers first and by doing that for the company.

So there have been a number of steps and, most notably, increased resources. And so for all those reasons, we think we're just better positioned. We've learned a lot over the last few years. We've done decently, but as we look at it, we just thought the way we were structured and the way we were resourced was a hindrance, if you will, not an offensive weapon, and we wanted to change that.

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Rosemarie Jeanne Pitras-Morbelli, G. Research, LLC - Research Analyst [68]

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Okay. And then, looking at -- now you have your SAP more or less internationally installed. So now that you have this, can you see the potential benefit from your restructuring to be above the $325 million that you have initially estimated?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [69]

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Yes, I wouldn't -- I mean, look, we would agree with you as long as it's positive for the business, i.e., it doesn't hinder our ability to deliver for customers, more would be better. And not lost on us, but we're not in a position right now to increase our estimate of those. I mean, we just took it up $125 million from $200 million to $325 million when we announced the spin, which will enable us, as we all recall, to both cover the $70 million of estimated stranded costs and still deliver $200 million in, if you will, Ecolab ex spin, and so I think it positions us well. And on the spin side, they'll be more than able to cover their costs of building the kind of public company infrastructure that they need to build, which they estimate at $35 million. So I think we're in good shape there. If we can do more, we will. It behooves us and the shareholders, and that's what we're paid to do.

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Rosemarie Jeanne Pitras-Morbelli, G. Research, LLC - Research Analyst [70]

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And if I may squeeze one in. You said that you were expecting to close the Bioquell acquisition by the end of the year, by the fourth quarter. Are there some issues regarding the competitive environment? Are you dealing with anything that you may have to change?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [71]

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So Bioquell, we did close. Holchem, I mean, we've closed, but we're going through a competitive review. And I would say, right now, we're working with the authorities in the appropriate way, and that's the path we'll follow.

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Operator [72]

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

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [73]

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Doug, Specialty has been a real bright spot in Global Institutional, another good quarter. And you cited, I believe, some business wins. I saw also that second quarter may slow down a bit on new customer rollouts but still a solid year. Can you just elaborate a little bit on the subsegment? What is going on with the new business wins and some of these initiatives that you'd highlighted in the release there?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [74]

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Yes. I would say both the QSR teams and the Food Retail teams are doing a really good job of, one, driving new business. They're leveraging innovation to do it. They have a strong pipeline. They've been at the forefront on Institutional and digital food safety technology, which is already making a difference, and we think going to make increasingly a difference in their ability to secure new wins going forward. That's been significant development costs, which has really been born principally in the Institutional side of the equation. And so as that starts bearing fruit, I think you're going to see enhanced margin as well as we go forward.

So there are a number of large opportunities that exist both in QSR and FRS, U.S. and around the world that I think our team is doing a good job targeting and getting after. There are occasions, so we give you a heads up on Q2 that they may have slower than current run rate sales for a quarter. That's when they lap an unusual quarter the year before, where you might have had a pipeline lowered for a new customer, i.e., you've got to build their distribution network and their stores simultaneously, which just means you get 4 months in 3. And when you lap that, it's tough to replicate it. So we just try to give fair warning. That occurs in many of our businesses occasionally through quarters throughout a year.

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Scott Andrew Schneeberger, Oppenheimer & Co. Inc., Research Division - MD and Senior Analyst [75]

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Great. And one more if I could. The CapEx and free cash flow, a little lower this year in the first quarter than last year. I guess, last year, a bit of a unique comp year. But just any thoughts, I know it's early in the year, about what we should expect from these 2 going forward for the full year?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [76]

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Yes. Dan can have that one.

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Daniel J. Schmechel, Ecolab Inc. - CFO & Treasurer [77]

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Yes. Thank you. Sure. Absolutely. So yes, you're right. It was annualizing, first of all, in the first quarter of '19 against a very strong performance last year in which we grew the business but consumed almost nothing in the way of incremental cash flow. So part of the year-on-year comparison is what you're seeing. Look, we still feel great, both about our longer-term record of delivering great cash flow generation from the company and think that 2019 will be another great example of that. So sitting here today, I expect that our free cash flow conversion, which is the metric that I track most closely, will then be in the mid-90% range. So feel good about cash flow and how it's developing for the year.

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Operator [78]

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The next question is from the line of P.J. Juvekar with Citi.

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Eric B Petrie, Citigroup Inc, Research Division - Senior Associate [79]

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This is Eric Petrie on for P.J. In Water, could you just discuss the growth profiles underlying in light industry versus heavy industry and, perhaps, provide an update on 3D TRASAR penetration?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [80]

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Yes. They were very close, in fact, not a big differentiation in growth rates between heavy and light. So both performed quite well, and we expect both to perform well for the year. In terms of 3D TRASAR unit penetration at this point in time, I mean, we're nearing 40,000 units outstanding. If -- we can give you an exact number if it's important, if you want to call Mike or Andy.

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Eric B Petrie, Citigroup Inc, Research Division - Senior Associate [81]

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Okay. And then, secondly, your first quarter volume growth of 1% is kind of lagging the overall fiscal year '18 of 4%. How do you see that going forward? And do you expect price to make up the delta?

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [82]

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I'm trying to -- the 1% for the company?

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Eric B Petrie, Citigroup Inc, Research Division - Senior Associate [83]

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Yes, 1% in the first quarter versus 4% for full year '18.

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Douglas M. Baker, Ecolab Inc. - Chairman & CEO [84]

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Oh, yes. I mean, the 1% was clearly impacted also by FX. And FX is going to be a particular challenge in the first quarter and second quarter. But at current rates and forecast, not a significant challenge in the second half. So some of it's just that. The other, we talked Institutional, which we expect to improve, and Energy, which we expect to improve.

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Operator [85]

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Mr. Monahan, there are no further questions at this time. I would like to turn the floor back over to you for closing comments.

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Michael J. Monahan, Ecolab Inc. - SVP of External Relations [86]

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Thank you. That wraps up our first 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 our best wishes for the rest of the day.

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Operator [87]

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Thank you for your participation. Today's conference has concluded. You may now disconnect your lines at this time, and have a wonderful day.