Ecolab, Inc. Q4 2008 Earnings Call Transcript

Feb.12.09 | About: Ecolab Inc. (ECL)

Ecolab, Inc. (NYSE:ECL)

Q4 2008 Earnings Call

February 12, 2009 1:00 pm ET

Executives

Michael Monahan – VP External Relations

Douglas Baker – President & CEO

Analysts

Andrea Wirth - Robert W. Baird

Robert A. Koort - Goldman Sachs

Edward Yang – Oppenheimer

P.J. Juvekar - Citigroup

Laurence Alexander – Jefferies & Company

Mike Harrison - First Analysis

Nate Brochmann – William Blair

John Roberts - Buckingham Research

Gary Bisbee - Barclays Capital

[Richard Ong – Eagle Capital Management]

Jeff Zekauskas – JPMorgan

Dmitry Silverstein - Longbow Research

David Ridley Lane – Banc of America

James Sheehan – Deutsche Bank

Rosemarie Morbelli - Ingalls & Snyder

Robert Felice - Gabelli & Company

Operator

Welcome to the Ecolab fourth quarter 2008 earnings release conference call. Now, I would now like to turn the call over to Mr. Michael Monahan, Vice President, External Relations; sir, you may begin.

Michael Monahan

Hello everyone and welcome to the Ecolab's fourth quarter conference call. With me today is Doug Baker, Ecolab's Chairman, President, and CEO, who will join us for the Q&A session following the review of the quarter's results.

A copy of our earnings release and the slides referenced in this teleconference are available on Ecolab's website at www.ecolab.com/investor.

Please take a moment to read the cautionary statement on slide two, stating this teleconference and the slides include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected.

Factors that could cause actual results to differ are described in the section of our most recent Form 10-Q under Item 1A, Risk Factors, in our fourth quarter earnings release and on slide two.

Starting with slide three in the fourth quarter we delivered a strong performance despite increasingly challenging market conditions, unfavorable currency trends, and substantially higher delivered product costs as we aggressively drove new account gains, new product sales, pricing, and cost reductions to achieve double-digit pro forma earnings growth.

Looking ahead we expect to continue to outperform our markets, and deliver superior growth once again in 2009. Starting with some highlights from the quarter as we move on to slide four, reported fourth quarter 2008 EPS were $0.33. On a pro forma basis excluding special gains and charges and discrete tax items from both years, fourth quarter 2008 earnings per share rose 13% to $0.45.

We delivered good organic earnings growth. This organic growth more then offset higher delivered product costs. We also benefited as tax and shares more then offset unfavorable exchange. These helped fund our investments in Europe and acquisitions.

In the US we achieved double-digit sales growth from our Kay, food and beverage and healthcare businesses, with modest gains in most other US businesses as we worked hard to offset slowdowns in our full service restaurant and lodging markets.

International showed good sales gains as Latin America rose double-digits, Canada was strong, and Europe and Asia Pacific both reported moderate growth. To drive results in this more challenging environment we have continued our aggressive sales efforts emphasizing our innovative products that provide customers with labor, energy, and water savings, and using them to help deliver new account acquisitions among our national, regional, and independent prospects.

We have also focused on cost savings emphasizing productivity, and efficiency improvements and increased pricing to recover significantly increased raw material costs and offset unfavorable currency. We took more aggressive action on costs last month when we announced a significant restructuring to redeploy our resources toward our best growth bets in this tough economy.

We will add sales firepower to key areas like corporate accounts, healthcare, pest, Kay and Latin America while reductions were made in areas that have seen volume slowdowns or functions that did not align with our long-term strategic priorities.

We reduced G&A support and will also close some plants. Looking ahead we continue to expect our full service restaurant and lodging markets which represent about 30% of our sales to be weak in 2009. However we expect resilient trends to continue in 60% of our businesses including the quick service restaurant, food processing, healthcare, grocery, government, and educational markets where forecasts call for growth in 2009.

In 2009 we will also change the way in which we implement our distributor incentive promotions in the institutional division. This will have a negative impact of approximately $0.03 in the first quarter, be close to neutral in the second and third quarters, favorable in the fourth quarter, and be neutral to slightly favorable for the full year.

We expect pro forma EPS for the first quarter to be in the $0.30 to $0.34 range compared with pro forma EPS of $0.39 in the first quarter of 2008. As mentioned the quarter will approximately a $0.03 impact from the distributor promotion change. The quarter is also expected to see a $0.03 to $0.04 per share hit from currency.

Looking a little further ahead our forecast remains consistent with that given in January. We expect modest fixed currency sales growth over the remaining quarters of 2009. However easing delivered product costs and the impact of cost savings actions should provide significant benefit to operating margins.

This should yield improving pro forma earnings per share comparisons as the year progresses. We expect the remaining nine month period of 2009 to show double-digit pro forma earnings per share growth as these impacts benefit earnings.

We expect further earnings growth in 2009. We look for a full year pro forma diluted earnings per share which excludes special gains and charges and discrete tax items to be up 5% to 10% and be in the $1.95 to $2.05 range. In summary we continue to expect yet another superior performance for Ecolab in a very challenging 2009 environment as we leverage our markets with strong sales efforts to gain new accounts and better penetration.

We will also implement appropriate pricing and cost reductions to deliver steady growth and shareholder returns while continuing to build for future growth. Turning to the details as shown on slide five, Ecolab’s reported consolidated sales for the fourth quarter rose 3%. Looking at the components volume and mix were up 2%, pricing was up 3%, currency reduced sales by 4%, but acquisitions and divestitures added 2%.

Slide six includes sales growth by segment and division, sales for our US cleaning and sanitizing operations increased 10%. Excluding the Microtek and Ecovation acquisitions, sales rose 6%. Institutional sales rose 4%, our Apex [Solid] Warewashing line finished well ahead of plan and showed terrific momentum as heightened customer demand for cost savings and energy solutions drove interest.

New business gains continued to be solid and we had moderately favorable impact from distributor shipments. These gains were partially offset by the impact from the business decline among our food service and lodging customers. In response to the weaker market we continue to drive new product and program sales focusing on a cost savings and performance improvement opportunities that our products and service support offer to maximize total operational savings for our customers.

We expect another strong year in 2009 for our Apex Warewashing system which provides customers with new standards of performance and cost savings and we are adding more new products and programs that will help drive growth in 2009. We are also driving new account growth utilizing improved prospecting tools and software and targeting independent accounts and regional chains with additional and redeployed sales people and programs.

This includes additional sales people in corporate accounts, distributor sales, regional sales, and specialization of sales people in the field. We expect these aggressive sales efforts along with pricing and market share gains to deliver continued growth for institutional from end customers in the first quarter.

However as mentioned in the press release we will change the way we implement distributor incentive promotions in the US institutional division in the first quarter. This will have a significant negative impact on institutional sales and result in reported sales decline for the quarter. But that should be reversed in the fourth quarter and be neutral to slightly positive to the full year.

Kay’s fourth quarter sales grew a very strong 19% primarily reflecting new account gains and new product sales. Business trends remain strong in the quick service restaurants with very good ongoing demand from major existing and new fast food chain accounts. The quarter benefited slightly from the timing of some shipments. But even adjusting for this QSR was still up mid teens.

The food retail business continued to show strong growth with a double-digit gain. New products and programs like the introduction of solids for QSR along with customer wins continued to bolster Kay’s results. We expect these initiatives along with continued good end market trends to help drive solid gains in Kay’s first quarter of 2009.

Textile care sales increased 1%. New plan additions from new and existing customers offset softer volume from existing accounts. We expect somewhat better growth in the first quarter as recent new business gains and new markets offset lower customer volumes. Reported fourth quarter sales for the healthcare division rose 64% reflecting the impact of the Microtek acquisition in November last year.

Adjusted for the Microtek acquisition healthcare sales rose 11% even as it compared against the strong quarter a year ago. Growth reflected continued solid end market demand for our traditional healthcare business which we now call infection control products and expanded penetration within our existing base of group purchasing organizations and healthcare purchasing systems.

Microtek rose double-digits led by strong sales of infection barrier products across all channels. Looking ahead first quarter sales should show modest growth as we compare against another strong quarter last year. However we expect stronger reported growth in subsequent quarters as comparisons normalize.

Food and beverage delivered a strong fourth quarter, reported sales were up 15%, adjusted for acquisitions, sales rose 11%. The quarter was led by strong gains in the dairy, beverage, agri, food, and water care markets, as better pricing, corporate account wins and new products drove sales. Looking at the segments, dairy plant was up double-digits as pricing, customer penetration, and market share gains led the increase.

Beverage also saw strong growth in the quarter led by new product sales. The agri segment delivered another solid quarter reflecting new account sales, pricing and favorable agri market conditions. The food segment saw better growth boosted by new accounts and pricing gains. Meat and poultry saw mixed results with customer gains largely offsetting weak market conditions.

Water care sales experienced healthy growth in the quarter with continued focus on our corporate account opportunities particularly in food and beverage. As previously discussed the uncertain economy has caused a number of Ecovation projects to be delayed. Customers continue to be very interested as the need for Ecovation’s affluent management and energy systems remain strong. However customers are reluctant to commit to significant capital projects in the current economic turmoil.

While we expect slow results until the market confidence firms up, we remain excited about its potential and the four billion-market opportunity it addresses. In the first quarter of 2009 we expect continued good sales trends for the food and beverage business as we focus on new account acquisition, pricing and continued expansion of our water management platforms. We will also focus on account profitability and cull those that do not provide sufficient returns based on the new raw material cost realities.

Ecovation will compare against the strong quarter last year is likely to see lower sales. Vehicle care sales increased 17%. The market demand declined dramatically due to the recession which more then offset better pricing and new products including the car wash industry’s first comprehensive sustainability program.

Vehicle care continues to focus on new programs and new market opportunities to drive sales in what we expect will be a continued very challenging and likely lower sales environment in the first quarter. Sales for US other services decreased 1% in the fourth quarter. Test elimination sales rose 3% as gains in the fast food and food and beverage plant markets offset weak conditions in restaurants and lodging.

New account activity and add on business slowed in the quarter. Both were effected by increased customer caution in food service and hospitality where core services grew but customers reduced the purchase of ancillary programs. In response we are focused on selling the basic programs to new accounts as well as regional and local chain accounts.

We are also targeting growth markets like QSR and food and beverage processing. We are enhancing the field sales force effectiveness with new training and hires to more aggressively pursue contract business. We expect pest elimination to show a modest growth in the first quarter as it focuses on expanding market segments and emphasizes its high quality and reliable service results to drive new business.

GCS sales decreased 11%. Service sales were off as the economic downturn has resulted in customers showing continued caution and deferring kitchen equipment repair. Chain customer interest remains very good as we are able to demonstrate the value of service programs which reduce customer down time and emergency repairs.

However the weak economy has resulted in new customers being slow to commit and existing customers deferring repairs. These combined to yield lower fourth quarter revenues. GCS profitability improved as gross margins and SG&A ratios improved shrinking the operating loss over last despite the lower sales volume.

The new business systems are fully online and we are seeing the benefits of the new system through better business transparency, customer and market segment profitability, dispatching improvements, better tech utilization, and improved working capital management, all of which helped our business decision-making and operating efficiency and worked to improve profitability.

Looking to the first quarter we expect sales to be off due to the weak economy and decreased customer repair activity. Measuring fixed currencies, international sales increased 6%. Europe, Middle East and Africa sales rose 4% in the fourth quarter at fixed currency rates. Europe’s institutional sales showed good growth. New products and progress with the sales force were partially offset by slowing markets.

Food and beverage gained market share and introduced new programs and systems to offset slow markets and industry consolidation. Textile care showed modest sales growth in the quarter and healthcare sales showed strong growth led by skin care sales. Adjusted for the divestiture of a property services business last year, past Europe sales continue to improve. Europe’s business information systems development work continues to move forward.

We went live in two countries in September and it was successful. We continue to roll out with our remaining system locations over the next 24 months. The system will be critical in helping us achieve better growth and profitability in Europe and we remain confident regarding the value the systems will provide. Sales forces training is going well and we are beginning to see the improvement in the sales teams performance metrics.

Lastly our new regional headquarters in Zurich is up and running. We look for Europe’s first quarter fixed currency sales to be flattish. Asia Pacific sales grew 6% in fixed currencies. From a divisional perspective institutional solid sales gains were driven by account wins in casinos, catering, hotels, and restaurants as well as food retail markets. New products include the launch of a new warewashing platform in Japan and by growth in the market [guard] program for retail stores.

Food and beverage sales had moderate growth. Both the beverage and brewing sectors continued to show good growth in Asia due to increased product penetration and account gains. Looking Asia Pacific expects continued good sales growth in 2009. Fourth quarter sales for Ecolab’s Canadian operations were up 7% at fixed exchange rates. Institutional and pest elimination sales were strong benefiting from corporate account gains, accelerated [street] growth and the rollout of Apex.

Food and beverage sales also improved. Latin America reported yet another outstanding performance with sales rising a very strong 12% at fixed exchange rates. All divisions again rose double-digits. Institutional growth was driven by new account sales, increased product penetration, as well as continued success with global and regional accounts. Food and beverage sales reflected strong demand in the beverage and brewing markets as well as the benefits of new accounts.

Pest elimination continued its outstanding performance throughout Latin America. Overall we expect healthy growth trends to continue in Latin America with another double-digit gain in the first quarter. Turning to the margins on the income statement and slide seven of our presentation, as we expected fourth quarter gross margins decreased reaching 48.1% compared with 50.2% last year.

Higher delivered product costs along with the impact of acquisitions more then offset pricing and cost savings initiatives. SG&A expenses were 36.5% of sales, 220 basis points below last year. The SG&A ratio reflected stronger leverage from pricing, cost controls and lower variable compensation which included lower bonuses.

Operating income for Ecolab’s US cleaning and sanitizing segment increased 17%. Excluding dilution from recent acquisitions operating income grew 22% as adjusted margins excluding acquisitions expanded by 210 basis points over last year. The increase was driven by pricing gains, improved cost efficiencies, and variable compensation reductions which more then offset higher delivered product costs and investments in the business.

Operating income for US other services grew 88%. Continued pest profit growth again led the improvement. GCS profitability also improved compared to the year ago period. International fixed currency operating income decreased 11%. The moderate sales gain in pricing were more then offset by higher delivered product costs and investments in Europe.

The corporate segment includes special gains and charges which are reported as a separate line item on the income statement. Special gains and charges for the fourth quarter were $32 million. As previously announced $19 million was for the write-down of investments in an energy management business and the closure of two small non-strategic healthcare businesses.

The remaining $13 million was primarily from non-recurring costs that were part of our plans to optimize our business in Europe and included headcount reductions taken in 2008. Corporate segment also includes $7 million of investments primarily related to the development of business systems and other corporate investments we are making as part of our ongoing efforts to improve our efficiency and returns in Europe.

Ecolab’s reported fourth quarter consolidated tax rate was 35.6% up from last year’s reported 29.7%. Excluding discrete tax items the tax impact of special gains and charges, the adjusted effective income tax rate for the fourth quarter 2008 was 30.6% and compared with 34.3% in the fourth quarter 2007. The substantial decrease in the adjusted fourth quarter effective tax rate was primarily due to tax planning efforts involving optimization of our international tax structure, international rate reductions, and benefits associated with our European headquarters move to Zurich.

We repurchased 11.7 million shares during the fourth quarter. As previously disclosed 11.3 million shares were purchased during the Henkel secondary offering in November with the remainder purchased earlier in the quarter. The net of this performance is that reported diluted net income per share for the fourth quarter was $0.33 compared with $0.45 reported a year ago. Pro forma earnings when adjusted for special gains and charges and discrete tax items were up 13% to $0.45 compared with $0.40 reported a year ago.

As mentioned in our opening comments organic growth more then offset delivered product costs. We also benefited as tax and shares more then offset unfavorable exchange. These helped fund our investments in Europe and acquisitions. Turning to slide eight Ecolab’s balance sheet and cash flow remains strong, total debt to total capital was 42% at December 31 compared with 34% reported a year ago and reflected the purchase of shares as part of the Henkel secondary offering in November and the unfavorable impact of currency and reduced pension assets on equity.

Our net debt at December 31, 2008 was 40%. Slide nine shows our forecast for the first quarter and full year 2009 and the press release includes line item forecasts for our first quarter P&L. As previously discussed we look for slower markets in 2009 and are taking appropriate actions to drive both the top and bottom lines in these markets. Raw materials and currency present formidable headwinds in the first quarter as they compare against the prior year so we look for better comparisons for both in the second half.

We know this is an opportunity to use our products that help customers reduce their costs and improve their efficiency along with our customer service strengths to capture market share and drive growth.

In the first quarter we look for our US operations when adjusted for the distributor change to show sales gains in the face of challenging conditions. We will continue to emphasize products that provide unparalleled performance and energy and cost savings for customers. We expect them to provide further differentiation and opportunity to help drive results. We look for international sales to again be led by strong growth from Latin America and Canada as they enhance moderate gains from Europe and Asia Pacific.

We believe this will result in overall good fixed currency international sales growth. As mentioned earlier we are changing the way we implement our distributor incentive promotions in the institutional division during the first quarter, [will] have a negative impact of approximately $0.03 per share in the first quarter, that will be reversed in subsequent quarters and be slightly favorable for the full year.

We also expect currency to be an unfavorable $0.03 to $0.04 per share in the quarter. Net including the $0.06 to $0.07 impact from the distributor change and unfavorable FX we expect pro forma diluted earnings per share for the first quarter excluding special gains and charges and discrete tax items to be in the $0.30 to $0.34 range compared with a pro forma earnings per share of $0.39 earned a year ago.

Slide 10 shows some detail on our 2009 outlook building from 2008 results. As shown the first quarter is heavily influenced by raws, freight and fuel, exchange and the distributor change. These penalize the quarter by $0.16 per share. Consistent with our prior comments regarding the year our raws and freight present a big challenge in the first quarter and first half which should benefit us in the second half. Currency exchange is expected to present a headwind most of the year with the fourth quarter showing a much easier comparison.

The distributor chains hurts the first quarter but because of the effect through the quarters, benefits the fourth quarter. Along with our business, pricing, growth, restructuring, and other cost savings and other actions we expect to continue to generate good growth in 2009 and lead to a 5% to 10% EPS gain.

Please note these are pro forma numbers which exclude special gains and charges and discrete tax items. In summary we are proud of our accomplishments in the fourth quarter as we delivered effectively against tough conditions and achieved double-digit pro forma EPS growth while building for the future and despite the increased challenges from the weakened full service restaurant and lodging markets, and increased raw material costs, we continue to expect an attractive performance in 2009.

And now here’s Douglas Baker with some closing comments.

Douglas Baker

Well good afternoon, I want to offer an overview and I’ll start with Q4 but I’m going to have very little to say about it because I think Michael covered in detail and I imagine that most of the emphasis needs to be on 2009. First of all we feel very good about the Q4 performance. The businesses held up well, our new growth initiatives performed well and the things that we aimed to get done got done.

As I talk about 2009 I really want to talk about three areas, market, our situation, and the outlook. First the market, the F&B, healthcare, food retail, QSR, government, and school markets are holding up quite well. They are continuing to grow to look at the underlying conditions, they continue to provide a very good platform for us to perform in line with I think almost historic growth patterns.

If you look at the food service and hospitality markets they are also performing as we expected however our expectations there was that the markets would be challenged and they are. So you are seeing declining foot traffic in restaurants and you are also seeing declining rooms sold in lodging.

The foot traffic issues in food service are principally a US issue. You don’t see the same types of declines globally but you didn’t have the same type of food service market development over the years in the rest of the world. Hospitality is more a global story. But with this, this is a manageable piece of the business we believe. In total when you add up the markets, and you sum it, we really have a flattish market situation for Ecolab in total for the year, plus or minus a point or two.

So we anticipate what I’ll call and characterize as lousy market conditions through all of 2009. We don’t anticipate a second half recovery in these markets and honestly we aren’t planning on a V shaped rebound even in out years. We think its going to be a different type of rebound. The implication here is that its very important that companies are able to manufacture their own growth under this type of a scenario.

The good news is this is a skill that Ecolab has, we’ve demonstrated it and I believe you’ll see that we’ll continue to demonstrate it as we go forward. To our situation, clearly better then most companies. We certainly have challenges, a number of them we share with everybody else but we have fewer challenges then other companies. We chase a $50 billion market. If you want to argue that that $50 billion is now $47 billion, so be it, its not going to determine our success.

It wasn’t the next $3 billion that evaporated, we have plenty of opportunity to get out and grow this business and its not lost on our team, they are after it. We’ve also taken difficult steps to react and reposition ourselves in this market situation. We announced in January that we are reducing our headcount by 1000 people. We’ve done that. We are watching every penny and we’re using if you will the money that we are conserving to continue to aggressively invest to make this company better.

So we are all over new account activity, our goal is to gain share in every business in every market. We are continuing to invest in growth. We have added corporate account positions in institutional, F&B, QSR, food retail, and pest. We continue to invest in our healthcare platforms which continues to perform quite well. We are all over water and energy technology investments, pest global expansion, China and India businesses.

We are also taking this time to retool our cost structure. This is getting after SKU simplification because it untaps our plant capabilities. We have a lot of under utilized facilities but we’ve got to simplify the product line to get after that capacity. We are also looking at our raw material cost streams and realigning them to benefit us in the coming years. We believe we know where the pressure is going to be on the raw material market and we want to make sure if you will, that we lower our exposure to what we think are going to be inflationary pressures in some of these raw material streams.

Finally we have a strong balance sheet and we are looking for M&A opportunities. We are going to be patient. I don’t think prices go up in this environment, I think they probably go down as people get real with what the new multiples are in the M&A world. And so we will be prepared to move on M&A when the opportunities arise.

So we have clear plans, the team is very energized, and the team is moving forward. So, outlook forecast, we’ve talked about $1.95, $2.05 range, it’s a forecast that we first communicated as part of our November secondary offering and we reiterated that forecast as part of our January restructure announcement.

This remains our best estimate of where the year is going to fall going forward. Also as we discussed in November and in January its going to be a tale of two halves in 2009. Its going to be a stronger second half then first half. Its going to be driven by several factors. Raw materials flipped from a big negative to a positive from first half to second. There is a sequential decline in the prices we’re paying for raw materials but the other big factor is the big comparison difference when you look at 2008 [inaudible] half to half.

The raw material run up last year was principally a second half phenomenon and we had peak raw material prices on average globally in the fourth quarter. FX headwind abates in Q4 simply because you had the big dollar move in Q4 of 2008. Restructure savings, growth throughout the year, as we start seeing the benefit from the actions taken you get full quarter benefit, and some of the actions that we identified in January, were going to be follow on activities in subsequent quarters.

Distributor promotion move flips $0.03 from one half to the other and finally if you take the cumulative sum of volume pricing etc. all remains fairly constant contributors quarter to quarter as our efforts and improvement offset continued market decline. So we do not have a market turnaround in our forecast. That’s not what drives the second half to first half change in performance.

Now we’ve got a larger [inaudible] then normal. Now this reflects a difficult forecasting environment however we’re confident we are going to grow, the question is how much, things are fluid, and our commitment is we’ll keep responding and we’ll keep you updated as things move forward throughout the year.

So I can’t tell you exactly to the penny what the year will be, I can tell you this, our team is responding remarkably well. The market is tough, tough on everyone, but they are taking exactly the steps that I hope they would and that you would hope they would be taking. They are out aggressively prospecting for new customers, we’re getting them. We are putting pressure on competition and competition is under tremendous pressure right now.

We are all over costs and we are still taking care of our customers. So our goal for 2009 is the same as it was in 2008, 2007, 2006, 2005, its to grow and improve the business. And I’m very confident we’re going to deliver against both of those objectives.

Those are my comments and I will hand it back to Michael.

Michael Monahan

Thanks Douglas, a final note regarding some upcoming Ecolab events, we plan to hold a tour of our booth at the National Restaurant Association show in Chicago on May 19. We’ll have more details as we get closer, in the meantime if you have any questions please contact me or Nicole in my office.

That concludes our remarks. We are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Andrea Wirth - Robert W. Baird

Andrea Wirth - Robert W. Baird

On your institutional segment in terms of the promotion impact, are you expecting, because of the change that your institutional business will actually, revenue will be down in the first quarter.

Michael Monahan

Including the impact of the promotional reduction yes. We would look for it to be flat to up slightly adjusted for that change.

Andrea Wirth - Robert W. Baird

Including that change you mean.

Michael Monahan

No excluding the change we would look for it to be flat to up, including the change we’ll look for it to be down.

Andrea Wirth - Robert W. Baird

You say in your press release you’re expecting moderate growth in the first quarter, I’m assuming that excludes the promotion then because with the promotion having your institutional business down, I think it would be tough to still see moderate growth for your overall business.

Douglas Baker

I think we still expect to have modest growth and we’re taking this at its most literal point but we expect to have, at management rates or at fixed rates, to have growth in the first quarter even including the impact.

Andrea Wirth - Robert W. Baird

Can you try to quantify what kind of revenue impact is built into that $0.03 a share EPS impact.

Douglas Baker

Its about $18 million in sales and fundamentally what we’re doing here is we have had a pattern and been promoting in advance of what I’ll call peak season for a number of years and this is we increase distributor inventories through promotion dollars through to the very end of Q1, we continue to carry those or have distributors carry those higher inventories and then we let the inventories decline in Q4. And this is a pattern that we’ve had for a while. The rationale for the pattern historically was a number of them, the different competitive environment, high pile moves faster, you wanted to make sure that you were dominating the slots at a number of things.

A lot of these strategies were very, were right for a number of years. I would just say fundamentally we think the calculus has changed. And as we look at the amount of money that we invest in this versus the benefits that we get we don’t believe that this is the right business move anymore. We spent 2008 studying this. We understand it very deeply. We have all the out information from all the distributors. We know precisely where our products go and so we can track quite clearly the results of these promotions for those distributors that take part and those that don’t.

And we know, I think to the dollar how this is going to translate and fundamentally what we are going to do is more normalize the sales shipments as we don’t think the money invested to increase these inventory levels makes any sense anymore given the change in the market environment. So that’s why the change and we know we will see this money back in the fourth quarter.

Andrea Wirth - Robert W. Baird

In your press release that you had last month talking about the restructuring and the reiterating the guidance you had mentioned that you expected earnings during the first half of 2009 to essentially approximate the first half of 2008, do you still view that to be the case especially in light of these promotional activities.

Douglas Baker

Maybe excluding the promotional activities, that may skew it a bit more now second half to first half. But aside from that, that’s largely right.

Operator

Your next question comes from the line of Robert A. Koort - Goldman Sachs

Robert A. Koort - Goldman Sachs

On Kay, I think you talked about some new accounts it looks like you might lap those so have one more big quarter in the first quarter and then back towards a more moderate run rate, is that fair?

Michael Monahan

No our new account activity continues so I think that we’ll have some not only additional new accounts but also the underlying run rate for QSR remains quite strong. Our food retail business is looking good so I don’t think you’re going to see a sharp fall off in the growth rates of Kay. And clearly 19% is not [substantial] but we’ve always run, or lately run in the low double-digits and so I think that’s kind of a good base line.

Douglas Baker

They’ve got a very strong innovation pipeline. We’re rolling out new programs to several of their largest customers right now which also is anticipated to generate growth and they’ve got other innovation that we plan to launch mid year that I think is a home run.

Robert A. Koort - Goldman Sachs

Could you give me a little sense on what the residence time is between your procurement guidance and St. Paul putting in an order for raw material and it actually showing up on the cost of goods line in a financial statement.

Douglas Baker

Its probably not the order but let’s say price change takes months to flow through the system which I think is fundamentally getting at the root of your question. So [inaudible] decline in price it takes several months to flow through simply because you’ve got inventory, raw material inventory, finished goods inventory and in some countries you’ve got balance sheet stuff to work on.

Operator

Your next question comes from the line of Edward Yang – Oppenheimer

Edward Yang – Oppenheimer

You mentioned that looking longer term that its going to be a different type of rebound, and no V shaped recovery in the outer years, what does that mean for your historical growth rate of 15% and 20% plus ROE targets, are those types of metrics achievable at the new base.

Douglas Baker

I would say I don’t think we relied on underlying market growth to determine our performance in the past. We got $6 billion of $50 billion and I just don’t think market growth is key determinate of our success of growing or not. I think all the evidence supports that. So we have not changed our outlook but this is a business, it can sustainably generate 15% EPS. We got huge share, you are seeing the resilience in our markets right now. You got some markets that are halving and in our markets are softer but we’re talking points at this point in time.

Fourth quarter we generated, I think if you break the whole thing down, 5% type growth if you take out acquisitions and FX and all the rest of the stuff, and while that’s not the number we look for on a continuing basis, its lower then we want, its still the resilience of the business in an economic meltdown. We still like the 15%. We got the right growth businesses in the right areas and we’ve got plenty of leverage in this business to unleash as well.

Edward Yang – Oppenheimer

Are you seeing any bad debt issues and if you have any data by end markets that would be great.

Douglas Baker

You watch bad debt very carefully, and certainly we expect to see, you’re going to have more bad debt concerns in this market. I think we are all over it. We don’t have any significant trends right now that alarm us but I will tell you we are watching payment patterns, we’re making sure we understand the customers, and we’re doing all the things that I think you would hopefully be doing in this environment.

Operator

Your next question comes from the line of P.J. Juvekar - Citigroup

P.J. Juvekar - Citigroup

As raw material costs decline, do you think you can hold onto pricing or even get your typical 2% price increases.

Douglas Baker

I think we have, a lot of it is because we had, we needed to and went after pricing very aggressively in the second half because there was such a wild run up on raw material costs. So we have that carry over effect this year because we didn’t realize it all in 2008. Here’s what I would say, the pricing environment right now is clearly not as good as it was say a year ago or even in 2007. With that said we don’t anticipate going backwards on price which I think is consistent with what we said in the past.

We haven’t completely linked it to raw materials in any fashion. But we’re not going to be seeing the 3.5, 4 points of pricing for the foreseeable future. Will we get backed out of the 1% to 2% I think that’s probably the right range for your model.

P.J. Juvekar - Citigroup

Can you provide more detail on your under utilized facilities, what are they and can you quantify how much cost savings you would expect in 2009—

Douglas Baker

Its really not a facility by facility comment, its simply this, we’ve got roughly 50 manufacturing facilities and probably 150 warehouse facilities around the world and if you look at that infrastructure it could hold 2x at least volume. But to go get after to unlock that, we’re going to have to simplify the line which we know and the line complications that we have today aren’t driven by market need, some of them are just driven that we, I don’t think have done a good job optimizing our product lines as we need to. So that’s the work that we’re doing. So its really unlocking the capacity that exists out there but that we somewhat choke off because of our overly complex product line.

Operator

Your next question comes from the line of Laurence Alexander – Jefferies & Company

Laurence Alexander – Jefferies & Company

On the end market trends, can you walk us through how you’re thinking about the education and government markets, particularly education in the US given what’s happening at the state budget level.

Douglas Baker

We haven’t spent a bunch of time on it, I can give you, its probably a couple of percentage points of sales in total, its not a huge driver for us in total. And education for us certainly does include some [inaudible], but probably more importantly its university feeding and some of that area. Its also feeding that we do out of the US in some of those markets. So I imagine there’s going to be some pressure there but honestly I have kids in public school, they got a credit card, they seem to ring it up fairly regularly and I don’t think this is funded by schools as much as it used to be in the past.

You’ve got a lot of the large contract feeders doing this work now in school and a smaller percentage of that is the old $0.45, its more like $6.00 a meal.

Laurence Alexander – Jefferies & Company

Has this environment effected your time line for the restructuring targets in Europe.

Douglas Baker

I wouldn’t say we’ve got a crystal clear answer on that, certainly volume, I think as we’ve stated, we expect to grow on a fixed currency basis but we don’t expect our growth rates to be as robust as they were last year so I expect that to start growing again as we move forward, move out of this say in 2010 and 2011. So I think you’re going to still see, it may be delayed six to 12 months. We really haven’t gone out and recalculated it at this point.

Laurence Alexander – Jefferies & Company

With the all other category, the various tailwinds that you have for Q2 to Q4, the run rate appears to drop off versus the Q1 run rate, and are there any factors in there besides just volume comps that you had in mind. Are there any issues with operating leverage at this point.

Douglas Baker

The drop off in the tailwind was principally tax consulting expense.

Operator

Your next question comes from the line of Mike Harrison - First Analysis

Mike Harrison - First Analysis

In the F&B business you mentioned that poultry was weak, obviously we’ve seen some bankruptcies there but how big of a piece of the F&B business is poultry and was wondering how long you would expect that weakness to persist.

Douglas Baker

I’ll get back on exactly what percentage of F&B business is poultry, I don’t know offhand. I think poultry has been a cyclical industry forever and we’ve gone through these ups and downs, I guess what I would say more broadly is this, we feel very good about the F&B business in total including the impact of the poultry. The market is fairly strong. We’ve got great innovation, we’re growing. Poultry represents 10% of our F&B business so I don’t think its going to be the driver of our F&B performance.

Mike Harrison - First Analysis

In terms of the pricing versus raw material gap, obviously you’re still working on pricing at least during the first half, any confidence interval around seeing you get back to the 50% gross margin level as the year progresses.

Douglas Baker

We expect margins to start recovering as the year progresses. We’re probably going to get half way back there this year. We would expect this to probably take a couple of years to get back to the full 50%.

Mike Harrison - First Analysis

On the M&A front, obviously you commented on your happy with where you are on the balance sheet some of your competitors are struggling right now, can you comment about whether you’re talking to any of those competitors about potentially acquiring them and then overall on the acquisition environment what kind of opportunities you might be pursuing out there.

Douglas Baker

We don’t comment about M&A targets specifically and I’m sure you can understand why. I will say this, we purposely I think we’re conservative on our share buyback in the secondary market. As we stated then we wanted to leave room on the balance sheet to take advantage of what we felt would be an attractive M&A market. We are happy we did that. We still believe the M&A market is coming our way and I guess we’ll make a smart move if it comes up. We aren’t going to do it just to do it. My guess is there are going to be some good opportunities this year.

Mike Harrison - First Analysis

On SG&A you said there were some lower bonuses, can you quantify that impact in the fourth quarter.

Douglas Baker

The bonuses were lower, they were fairly material. Its not something that we’ve publically announced. Its probably about $6 million.

Operator

Your next question comes from the line of Nate Brochmann – William Blair

Nate Brochmann – William Blair

Are you starting to see any more aggressive pricing from some of your competitors who may be struggling a bit more to stay in business and are you seeing that show up anywhere.

Douglas Baker

I would say that has been with us as long as I have been in the business and I’ve been here almost 20 years. I don’t think its dramatically different in this environment. I think what probably is muting it is two factors, one their raws are even higher then ours and so they’ve just gone through a period where their whole cost structure is changing. What we see more from competition is that they are changing their service patterns, they’re letting service people go, they’re saying we only service three days a week, there are a number of those types of moves out there. They try to mitigate or lower costs because they’re having a hard time getting pricing in the environment.

We see more of that. Competition still exists. Its going to be a challenge as long as we are in business but I wouldn’t say its been materially different. They are under pressure and feel it.

Nate Brochmann – William Blair

Are you seeing that as you look to hire some more experienced sales people, are you seeing that opportunity out there as some of those sales people are let go from other competitors.

Douglas Baker

That opportunity exists. Traditionally we would prefer to hire and train our own is more our pattern. And that’s going to be more our pattern going forward.

Nate Brochmann – William Blair

I would assume that maybe some of your smaller competitors are customers might be going out of business here and there either in the lodging or restaurant side, are you seeing some of your larger customers gain some share from that and would that actually be a net positive for you as you already have an established position with some of those larger customers.

Douglas Baker

Food service traffic, there’s a lot of changes in food service patterns but habits and practices of consumers are hard so yes, I think people are continuing to eat out, they’re doing it in a different fashion, they’re trading down in many instances. So if these guys move into our customer base I wouldn’t, I don’t think that’s the trend you bet on our company.

Operator

Your next question comes from the line of John Roberts - Buckingham Research

John Roberts - Buckingham Research

Qualitatively would you say almost all of your growth is coming from share gain, it seems to me even hospital operations and so forth are flat or down and so most of the markets don’t seem likes there’s any end market growth and basically this is all share gain related.

Douglas Baker

The top line gain is clearly pricing and all volume that we’re manufacturing we share.

Operator

Your next question comes from the line of Gary Bisbee - Barclays Capital

Gary Bisbee - Barclays Capital

Wondering about the margins in the other services, US other services business and obviously you had a huge gain this quarter and you’ve been talking about GCS losses falling, is that something that can continue to happen with the negative revenue environment or is that going to be some place that in 2009 would be more realistic to not expect continued margin gains until we get towards the end of the year and some of the cost savings works its way through.

Douglas Baker

We expect to have smaller losses certainly in the early part of the year, its going to be important that we starting getting volume moving in the right direction to have sustained improvement in bottom line performance in the second half which we’re on but that’s probably the best answer. I would say this the work we’ve done to lower the water line in GCS has been quite effective and we didn’t anticipate running into this economic environment and clearly that type of repair business is more adversely impacted then other of our businesses.

And the fact that we are still having improvement in OI in spite of the top line pressure I think really goes to a lot of the work that the team did to improve the fundamental business model of that business.

Gary Bisbee - Barclays Capital

Do you have a lot of the big chain customers that you have in your core business or are there still a lot of opportunity to sell this into the existing base.

Douglas Baker

We’ve sold a few, we have a lot to go.

Operator

Your next question comes from the line of [Richard Ong – Eagle Capital Management]

[Richard Ong – Eagle Capital Management]

On GCS you mentioned profitability in the fourth quarter do you expect profitability for the rest of the year into 2009.

Douglas Baker

No I think we went out and said when we started seeing the top line pressure at the end of last year that what really the GCS equation is quite simple right now, its volume. As we put volume you’re going to see pretty direct correlation to OI improvement, that’s what’s going to need to happen. I don’t think this is going to be a market where we’re going to see the type of volume increases we need to get there but I do anticipate that we’re going to start seeing improvement in the top line as the year progresses.

[Richard Ong – Eagle Capital Management]

But for the full year do you expect to at least break even or expect to—

Douglas Baker

No it will be a loss for the year, it will just be a much lower loss then last year.

Operator

Your next question comes from the line of Jeff Zekauskas – JPMorgan

Jeff Zekauskas – JPMorgan

When you look at Ecolab historically your first quarter is usually stronger then your fourth quarter and on a pro forma basis you earn $0.45, what is you said is then the first quarter there’s a $0.03 hit from the distributor change incrementally from currency comparing the two negatives maybe there’s another penny or two, which gets you to something like $0.40 so how do you go from $0.40 to a range of $0.30 to $0.34. In your slides you talk about this raw material hit but your prices are up 3% which more then offsets a 10% raw material hit, so what’s the difference between the fourth quarter and the first such that your earnings drop so much.

Michael Monahan

First off first quarter is always our lightest quarter, fourth quarter is better then the first historically. And in terms of going from fourth quarter to first quarter you’ve got a big FX hit, raw materials continue to a strong impact and last thing is we’ve got greater pressure on our end markets as we’ve talked about all along that we’re facing in the full service restaurant and the lodging industry.

Jeff Zekauskas – JPMorgan

So basically the difference is volume then.

Douglas Baker

Q4 is a higher volume quarter then the first quarter and I think has always been seasonally when you look at it. And I think if you look at the moves I think there’s one of our charts in the webcast presentation tries to show the first quarter impact and the remaining nine months impact and these things are principally driven by the direct product costs are going to declining sequentially. You’ve got our restructure benefits are going to grow as time goes on simply the way that we structured the deal.

So really the math isn’t that complicated, I think if you get down to it I think what you worry about, what I worry about when I see what people call hockey stick plans is if you’re hoping for some miraculous turnaround our plan is not based on that. In fact its based that we have fundamentally about the same contribution from volume and pricing even though we do think we’re going to probably get more effective in terms of turning up new business as the year goes on.

But we haven’t really weighted that in our forecast. Its simply direct product cost, restructure benefits as they increase over time and the fact that you’ve got a very unfavorable first half comparison and a much more favorable second half comparison period in your base. Those are the issues.

Operator

Your next question comes from the line of Dmitry Silverstein - Longbow Research

Dmitry Silverstein - Longbow Research

I was a bit surprised at the magnitude of foreign exchange impact on the operating profit line since I was under the impression that a lot of your international operations are more or less self hedging in the sense that you produce where you sell particularly in Europe which seems to be the largest unit within international, obviously that’s not the case. Can you give us an idea of how much your asset base is dislocated versus where you’re selling your product so that foreign exchange does have an impact of $0.03 to $0.04 on earnings.

Douglas Baker

Your basis assumption going in is correct that we do really procure and manufacture locally. What the FX impact is is really a translation of operating income or of income from outside the US back in US dollars. Its not a issue of we’re manufacturing in dollars, it is simply a translation issue on foreign earnings.

Dmitry Silverstein - Longbow Research

On the raw material costs, can you give us an idea of what are the top however many raws that are giving you the most grief in the second half of 2008 and that we should be paying attention to in 2009 as far as pricing is concerned.

Douglas Baker

The biggest guys are plastics in general because almost every one of our products has a plastic packaging component. Its [surfactints] which are probably going to move more in line with fuel, their oil derivative. Its caustic and its phosphates.

Operator

Your next question comes from the line of David Ridley Lane – Banc of America

David Ridley Lane – Banc of America

The cost savings your going to get in Europe those would typically since a lot of them are labor and European laws and everything, those would typically lag the benefit to cost savings and [assets] you’ll see in US.

Douglas Baker

The raw material moves in Europe lagged in the US and so its about a quarter behind in terms of when we see peak raws in Europe versus the US and so when you’re going to see recovery there as well. The cost savings, the only other, are you talking about the work we’re doing around restructure or—

David Ridley Lane – Banc of America

Yes, the restructuring as well.

Douglas Baker

What we said on the restructure is that really in 2008 and 2009 the benefit you’re going to see is principally on tax, its not going to be that easily attributable to Europe because of the way we report but you are seeing an improvement in our tax line, you’ll see late 2009, 2010 and 2011 you’ll start seeing improvements in SG&A and cost of goods. It wasn’t anticipated that we’d see that in 2009.

Operator

Your next question comes from the line of James Sheehan – Deutsche Bank

James Sheehan – Deutsche Bank

Can you give us your updated thoughts on what pension expense might look like in 2009.

Michael Monahan

Pension expense will be up in 2009, we think it will be a manageable number but it will increase somewhat.

James Sheehan – Deutsche Bank

What was the GCS loss for the quarter.

Michael Monahan

It was $5 million.

Operator

Your next question comes from the line of Rosemarie Morbelli - Ingalls & Snyder

Rosemarie Morbelli - Ingalls & Snyder

You have 50 plants and 100 warehouses, and you have announced some restructuring, am I correct in guessing that there is much more restructuring coming down our way with additional charges and future benefits or do you think that you are happy with those two numbers.

Douglas Baker

That’s not a plan as we said here, the restructuring announcement that we made in January was really designed to position us for this environment and so no I wouldn’t say that our plans are to have a bunch of follow on restructuring events.

Rosemarie Morbelli - Ingalls & Snyder

Many companies have already announced restructuring and then suddenly everything is falling off a cliff in terms of the demand for their markets, while you do have a certain amount, you have more resilient markets you could still see the environment for your products hurt some more as people not only postpone [killing a few bugs] they will postpone cleaning, they will keep the unoccupied rooms totally locked, and keeping them waiting for the potential new customers, do you think that you have done enough in order to face adequately a market demand going down another 20%.

Douglas Baker

We don’t forecast our market declines to reach 20% negative levels. So we haven’t done enough for that scenario but I honestly don’t believe that scenario is a realistic one to contemplate. What I think we did do was be very proactive and go after it in a way that puts it in a position to do this the one and done. That’s the goal. Recall fourth quarter we had 5% sales growth, if you take out acquisitions. We had 12% underlying earnings growth. The business is performing quite well while we were planning this. We really took this, a proactive stance to get after this so that we could be more in charge of how we did this and weren’t just in a reactionary mode to market moves.

I think the market that we have today is the one that we thought we would have, its not the one we wanted but it’s the one that we thought we would have as early as third quarter announcement when we were fairly dark on our 2009 underlying economic outlook and I think honestly some people thought we were too dark. So right now I think we are in good position, the plan isn’t to come with move after move, its not healthy for the organization and I don’t think its necessarily healthy for the confidence in the company.

Operator

Your next question comes from the line of Robert Felice - Gabelli & Company

Robert Felice - Gabelli & Company

On the pension, your healthcare pension liability increased quite a bit both sequentially and year over year not much of a surprise given the financial markets, but could you discuss whether you’ll have to step up your cash contribution, if so to what extent and will that occur in 2009 or 2010.

Michael Monahan

We’re not required to make a cash contribution until 2010. We may make a voluntary contribution but there’s none required in 2009.

Robert Felice - Gabelli & Company

Given the increase in the liability what’s the magnitude of that contribution.

Michael Monahan

We haven’t announced that. Its going to be in the $50 million, $75 million range.

Operator

Your next question is a follow-up from the line of John Roberts - Buckingham Research

John Roberts - Buckingham Research

on the distributor situation if you have a distributor that’s carrying say floor care cleaning products from you and JD and Proctor and Gamble and 3M, are they rationalizing consolidating and maybe that’s occurring across multiple products or are they continuing to carry everyone.

Douglas Baker

I’ve seen a lot of that. I wouldn’t mind seeing more of it because that would clearly benefit us in almost every circumstance. I would say there are conversations but I haven’t seen any move there yet.

John Roberts - Buckingham Research

Do you most of your distributors carry multiple supplier products in similar categories or are there a lot of exclusive distributor arrangements.

Douglas Baker

No I’d say principally they carry multiple.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Michael Monahan

Thank you for your time today and have a terrific day.

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