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Ecolab, Inc. (NYSE:ECL)

Q2 2009 Earnings Call

July 28, 2009 1:00 pm ET

Executives

Michael Monahan – VP, External Relations

Doug Baker – Chairman, President, and Chief Executive Officer

Analysts

Andrea Wirth – Robert Baird

Amanda Seguin – Jefferies

Steve Schwartz – First Analysis

Bob Koort – Goldman Sachs

Ed Yang – Oppenheimer

Mark Gulley – Soleil Securities

Nate Brochman – William Blair and Company

Gary Bisbee – Barclays Capital

Rosemarie Morbelli – Ingalls & Snyder

John McNulty – Credit Suisse

David Ridley-Lane – Banc of America

PJ Juvekar – Citi

Jeff Zekauskas – J.P. Morgan

Dmitry Silversteyn – Longbow Research

John Roberts – Buckingham Research

Amy Johnson – Goldman Sachs

Operator

Welcome to the Ecolab second quarter 2009 earnings release conference call. (Operator instructions) Now, I’d like to turn the call over to Ecolab. Mr. Monahan, Vice President, External Relations.

Michael Monahan

Welcome to Ecolab's second 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 our review of the quarter's results. A copy of our earnings release and the slides referenced in this teleconference are available on Ecolab's web site at ecolab.com/investor.

Please take a moment to read the cautionary statement on slide two stating this teleconference and the slides include estimates of future performance. These are forward-looking statements, and actual results could differ materially from those projected. Factors that could cause actual results to differ are described in the section of our most recent Form 10-K under item 1A Risk Factors, in our first quarter earnings release, and in slide two. We also refer you to the earnings release which includes supplemental diluted earnings per share information.

Starting with slide 3, in the second quarter, we delivered results at the top end of our forecast, despite very challenging market conditions, unfavorable currency trends, and substantially higher year-over-year delivered product costs as we aggressively drove new account gains, new product sales, pricing, and cost reductions. 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 slides 4, reported second quarter 2009 EPS were $0.41. On a pro forma basis, excluding special gains and charges and discreet tax items from both years, second quarter 2009 earnings per share were $0.50 compared with $0.47 last year, an increase of 6%.

Pro forma earnings per share were driven by strong new account gains, pricing, and cost savings including about $0.04 from our restructuring and the impact of new production which more than offset about $0.05 from our higher delivered product costs and $0.05 of unfavorable foreign exchange impact. We also continued to make key investments in R&D, systems, and people that are important to sustain long-term success in our strategic growth areas.

In the U.S., we achieved double digit strong sales growth in our Kay and healthcare businesses and solid growth from our core food and beverage business. International showed strong sales gains in Latin America and Canada, while Asia-Pacific reported modest growth, and Europe, Middle East, and Africa declined.

To drive results in this more challenging environment, we have continued to be aggressive in developing topline growth as we emphasized our innovative products that provide customers with labor, energy, and water savings. We’re using these products 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 higher raw material costs.

Looking ahead, while it appears the economy may have stabilized, we’ve not seen enough turn in our major markets and are not counting on a recovery this year. We expect we will need to continue to work hard to drive sales and will closely manage our costs to deliver EPS growth this year, and if the markets do pick up, we will clearly benefit from our extra efforts.

We expect pro forma EPS for the third quarter to be in the $0.58 to $0.61 range compared with pro forma EPS of $0.55 in the third quarter 2008. We tightened the top and bottom ends of our forecasted EPS range to $1.96 to $2.02. We continue to expect modest fixed currency sales growth in the second half of 2009. However, favorable delivered product costs and the impact of cost savings should provide significant benefit to operating margins.

In summary, we expect another strong performance for Ecolab in a very challenging 2009 environment as strong sales efforts enable us to gain new accounts and better sales penetration. We will also continue to implement appropriate pricing and cost reductions to deliver steady growth and shelter returns while continuing to invest for future growth.

Turning to the details as shown in slide 5, Ecolab's reported consolidated sales for the second quarter declined 8%. However, sales were flat at fixed currency rates. Looking at the components, volume and mix declined 4%, pricing was up 4%, and currency reduced sales by 8%.

Slide 6 includes growth by segment and by division. Sales for the U.S. cleaning and sanitizing operations increased 1%. Institutional sales were off 3% as new account gains, new products, and pricing enabled us to outperform lower demand from lodging and food service customers. We have not seen improvement in institutional major end markets and do not expect a pickup this year. We remain focused on driving sales gains in 2001 using innovative products like our Apex wear washing program and Wash and Walk the provides superior performance while delivering demonstrable water, energy, and labor savings as customers look for cost savings and efficiency in this tight economy.

Our Apex wear washing system which enables us to help customer reduce dish room cost and lower their environmental impact continue to show strong growth and help lead sales for new accounts. Further, Ecolab’s customer support plan for H1N1 swine flu has resulted in additional sales of infection prevention products such as disinfectants and personal hygiene hand care products. We’re also targeting independent accounts and regional chains with additional and redeployed salespeople and programs. This includes additional sales people in corporate accounts, distributor sales, regional sales, and specialization of salespeople in the field.

In addition, we’re utilizing improved prospecting tools and software. These actions have resulted in good new account activity, and we’re continuing our efforts to drive more gains in the second half. We expect these aggressive sales efforts and new account gains to help us continue to outperform our markets in the second half.

Kay's second quarter sales grew 13%, primarily reflecting new account gains and new product sales. Business trends remain strong in quick service restaurants with continued good ongoing demand from major existing and new fast food chain accounts. The food retail business continued to show strong growth with a double-digit gain. New products and programs like Solids for QSR, along with customer wins continue to bolster Kay's results. We expect these initiatives along with continued good end-market trends to help drive strong gains in Kay's third quarter of 2009.

Textile care sales increased 1%. Good new account sales along with pricing offset depressed industry conditions. Customers have shown increased interest in the total cost operational savings textile care’s products and services can deliver in this tough economy. We look for continued modest growth in the third quarter as business gains and new markets continue to offset lower industry volumes.

Healthcare sales rose 13%. Acquisitions accounted for 2% of that growth. Continued solid growth for our surgical drape businesses from patient warming systems and flu-related hand sanitizer sales led the results. The new non-aerosol foaming sanitizer for skin care as well as Asepti-Wraps for surgical instruments also continued to generate good customer interest. Looking ahead, third quarter sales should show continued good growth led by the surgical business.

Food and beverage reported sales rose 3%. Our core food and beverage business enjoyed good gains in the dairy, beverage, agri, and food markets as better pricing, corporate account wins and new products drove a 6% sales increase. Water care sales were off slightly as shortfalls in the commercial markets where mostly offset by the focus on our corporate account opportunities, particularly in food and beverage.

As expected, Ecovation sales were down from last year on a comparable basis reflecting the weak economy and tight capital markets. Customer interest remains good as the need for Ecovation's affluent management and energy systems remain strong. The sales of the smaller solid separation treatment units are good, but customers are reluctant to commit to the larger plant treatments or make major capital commitments in the current uncertain economy. We expect good sales trends once again in the third quarter for the food and beverage business as we continue to focus on new account acquisition, new product sales, and expansion of our water management platform.

Vehicle care sales decreased 9%. Weak demand due to the recession more than offset better pricing and new more sustainable products and programs. Vehicle care is focused on new programs and new market opportunities to drive sales. The division continued the roll out of a recently introduced operational cost management program to help car wash operators critically analyze their operations and achieve cost savings through energy and water conservation. This should help boost future sales. We expect the Third quarter will continue to be a challenging environment.

Sales for U.S. other services decreased 5% in the second quarter. Pest elimination sales were flat in the quarter as gains in the fast food and food and beverage plant markets continued to offset weak conditions in restaurants and lodging. We continue to be focused on selling 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. These seem to be having a positive impact with customers starting to show interest in new contracts and ancillary services. These will take time to work through the sales, but is appears some stabilization is beginning to show. We expect pest elimination to show flattish trends in the second half.

GCS results decreased 15% for the quarter; however, profitability once again substantially improved over a year ago and the prior quarter. Service and part sales were weak. The sales pipeline and chain customer interest remained very good, and we are able to demonstrate the value of our service programs, which reduce customer downtime and emergency repairs. New account wins were more than offset by current uncertain economy which has resulted in reduced spending as customers delay repairs and in longer decision time lines for new sales. Despite the lower sales volume, GCS profitability was substantially better as gross margins and SG&A ratios improved, dramatically shrinking the operating loss over last year as we continued to productivity and efficiency improvements from the new systems.

The new ERP system is providing the operating information that has led to improved customer and market segment profitability, dispatching improvements, better tech utilization, supply chain improvements, and improved working capital management. All of these have helped our operating efficiency and improved overall division profitability. Looking to the third quarter, we expect sales to be off due to the weak economy and decreased customer repair activity, but we expect GCS will again report significantly improved profitability over the prior year period.

Measured in fixed currencies, international sales decreased 1%. Europe, Middle East and Africa sales declined 4% in the second quarter at fixed currency rates. Europe's institutional sales declined as food service and lodging trends were weak. In response, we have dedicated sales resources, targeting new business and emphasized new products and the cost savings we offer customers to drive market share.

Food and beverage sales declined reflecting lower consumption, reduced plant utilization and capacity as well as reduced equipment installations. F&B is focused on winning new customers by emphasizing the cost savings benefits of our leading products like DryExx and Exelerate as well as implementing appropriate pricing.

Textile care sales declined reflecting reduced tourism and uniform volumes. Europe healthcare sales reported solid growth. Increased sales of hand disinfection products helped by H1N1 concern along with customer gains in the pharmaceutical sector for hard surface disinfection products led results. New product launches in the second half should enable continued growth.

Pest Europe showed better core contract sales. However, these were offset by soft ancillary program revenues. Europe's business information systems platform work continues to move forward. We have successfully implemented the system in four countries, including our largest country, Germany, and the country with our largest plant, which is Belgium. We'll continue the roll out to the remaining system locations over the next 18 months. With continued weak markets, we look for Europe’s third quarter sales to be off from last year’s levels.

Asia-Pacific sales grew 4% in fixed currencies. Institutional's modest sales gains were driven by account wins in catering, mid-scale hotels, and restaurants as well as food retail markets. They continued to offset weak occupancy and lower overall catering in the high end hotels.

Food and beverage sales reported solid growth. Both the beverage and brewing sectors continue to show solid growth due to increased product penetration and account gains. Looking ahead, Asia Pacific expects continued sales growth for the third quarter and the remainder of 2009.

Second quarter sales for Ecolab's Canadian operations were up 10% over last year at fixed exchange rates. Food and beverage and institutional sales were strong driven by new account gains, product price increases, and institutional’s increased focus on distributor partnerships. Pest elimination, vehicle care, and healthcare sales were also strong driven by new account gains.

Latin America reported a solid sales gain rising 8% at fixed exchange rates as all divisions increased. Institutional growth was driven by new account gains, 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 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 solid gain in the third quarter.

Turning to margins on the income statement on slide 7 of our presentation, second quarter gross margins increased and were 49.7% compared with 49.1% last year. Pricing more than offset higher delivered product costs. SG&A expenses were 36.5% of sales, 40 basis points below last year. The lower SG&A ratio reflected savings from our recent restructuring, price leverage, and closely managed spending which more than offset higher costs and continued investments in our business.

Operating income for Ecolab's U.S. cleaning and sanitizing segment increased 18%. Margins expanded by 260 basis points over last year. The increase was driven by pricing gains and cost savings which more than offset slowing delivered product cost increases.

Operating income for U.S. other services grew 40%. Growth was driven by pricing, productivity and efficiency gains, and cost reductions. International fixed currency operating income decreased 17%. The lag of higher delivered product cost increases internationally, primarily in Europe, impacted second quarter international operating income. Pricing gains and cost savings efforts were unable to offset lower sales volume, delivered product and other cost increases, and continued investment in the business. The impact of delivered product cost increases are expected to moderate in the third quarter and the balance of 2009.

The corporate segment includes special gains and charges which are reported as a separate line item on the income statement. The special gains and charges which are not included in pro forma results include a restructuring charge of $24 million for actions primarily taken to optimize our work force as well as other nonrecurring costs to optimize our business structure. Second quarter 2008 special gains and charges included a $24 million gain on the sale of a plant.

The corporate segment also includes $7 million of investments in 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. These investments are included in pro forma results.

Ecolab's reported second quarter consolidated tax rate was 33.6%, compared with last year's reported 28.8%. Excluding discreet tax items and the tax impact of special gains and charges, the adjusted effective income tax rate for the second quarter 2009 was 31.3% and compared with 32.8% in the second quarter of 2008. The decrease in the adjusted tax rate was primarily due to tax planning efforts involving optimization of our international tax structure and global rate reductions. The net of this performance is that Ecolab’s reported second quarter diluted net income per share was $0.41 compared with $0.55 reported a year ago.

When adjusted for special gains and charges and discreet tax items, pro forma earnings increased 6% to $0.50 when compared with $0.47 reported a year ago. As mentioned in our opening comments, pro forma earnings per share were driven by new accounts, pricing, and cost savings and the impact of new products which more than offset higher delivered product costs, unfavorable foreign exchange impact, and key investments in our business.

Turning to slide 8, Ecolab's balance sheet and cash flow remains strong. Total debt to total capital was 37% at June 30th, compared with 36% reported a year ago and 42% at year end 2008. Our net debt at June 30 was 35%.

Slide 9 shows our forecast for the third quarter and full year 2009. The press release includes line item forecasts of our third quarter P&L. As previously discussed, we look for continued slow market conditions through the balance of 2009 and are taking appropriate actions to drive both the top and bottom lines in these markets. We have been successful in using our new products that help customers reduce their costs and improve their efficiency along with our service stream to capture market share and drive growth. Further, as raw material cost comparisons ease in the second half from the extremely high levels of a year ago, we look to recover margins and continue investments in key areas like corporate account sales, R&D, healthcare, water and energy, and global pest elimination to drive future growth.

In the third quarter, we look for our U.S. operations to show sales similar to last year in the face of continued challenging conditions. We will continue to emphasize products that provide unparalleled performance and energy and cost savings for our customers. We expect them to provide further differentiation and opportunity and help drive results. We look for international sales to also be similar to last year at fixed exchange rates as good growth from Latin America, Canada, and Asia-Pacific are offset by Europe. Net including the estimated $0.03 impact from unfavorable foreign exchange, we expect pro forma diluted earnings per share for the third quarter excluding special gains and charges and discreet tax items to be in the $0.58 to $0.61 range compared with pro forma earnings per share of $0.55 earned a year ago.

Slide #11 shows some detail on our 2009 outlook building from 2008's results. The outlook is consistent with our original forecast. Raw materials, freight and fuel, while generally lower than fourth quarter 2008 levels remain a significant combined headwind on a year-over-year basis in the second quarter before turning favorable in the second half.

In summary, as noted on slide 10, we are performed effectively in the second quarter against very tough conditions and delivered on our forecast as we also invested in our future. And despite the expected challenges from the week markets and unfavorable foreign exchange, we continue to look for an attractive performance once again in 2009 and use the strength and momentum to set up 2010 and beyond.

As a final note, we are planning to hold our biennial investor meeting on September 10th. A limited number of seats remain available. Please let us know before August 21 if you plan to attend, or if you have any questions by contacting me or Nicole Grochow in my office.

That concludes our remarks. This conference call and the associated slides will be available for replay on our web site.

Operator, please begin the question-and-answer period.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Andrea Wirth – Robert Baird.

Andrea Wirth – Robert Baird

I was wondering if you guys could just first talk a little bit about raw material costs in the quarter. How were they versus your expectations, and have we now reached the high point in costs and have they now come down sequentially? I’m just trying to get a sense of where we are at there.

Doug Baker

They did come down from Q1 as we anticipated. I would say they came down in line with what we forecasted, so obviously less than we hoped. Our view that we shared in the first quarter that they would continue to fall sequentially is still our view. They were down in the second quarter. We believe they will be down again in the third quarter versus Q2, and they’ll switch to favorable, if you will, in the second half.

Andrea Wirth – Robert Baird

They’d be favorable overall for the second half?

Doug Baker

In the second half, they will be favorable versus second half of ’08.

Andrea Wirth – Robert Baird

In Q3, you still expect them to be a headwind, correct?

Doug Baker

They’ll be a help in Q3.

Andrea Wirth – Robert Baird

How should we think about pricing going forward? You saw 4% again this quarter. Should we assume that that pricing probably moderates a little bit, or how should we think about that going forward just given that raw material costs are subsiding a bit?

Doug Baker

I think what we discussed on pricing is that we believe we will successfully hold the pricing that we’ve achieved, but we do not believe we will be gaining new pricing agreements at the same rate we were last year; therefore, I think you’ll see slow moderation year over year as you go through the year.

Operator

Your next question comes from the line of Amanda Seguin – Jefferies.

Amanda Seguin – Jefferies

For the quarter, you guys came in at the top end of your range for Q2, but you’re narrowing the top end of the range for the full year. I was just wondering if you could walk us through what your thinking is there.

Doug Baker

The $1.95 to $2.05 which was our prior range for the year is a much wider range than we normally have. To recall, it’s a range that we established in early November when we were in the secondary moving the Henkel shares, and I think our feeling was as we moved through here that we wanted to give a better idea of how the year was developing and so narrowing it seemed like the wise course of action. Here is what I would say. We see our business improving. We are not counting on any material improvement from the economy. We hope we’re wrong. We haven’t been so far. We also believe that we’re going to continue to use the second half to invest in our business to assure that we have a very successful 2010 and beyond. We like the position that we’ve put ourselves in, and we want to continue to make sure that we optimize and take advantage of the market conditions that we’re seeing, which means competitors are stressed, we have a number of important investments we want to make that are going to get us both share and leverage, and we want to make sure we make them in the second half as well.

Michael Monahan

The thing I’d add is that we’re looking pretty strong. Earnings growth in the second half, I think, as you look at the range, it’s 13-19% EPS growth, so clearly we’re going to enjoy a period that has some very good earnings in the second half of the year.

Amanda Seguin – Jefferies

As far M&A opportunities, what’s the landscape looking like in Asia and Latin America in particular?

Doug Baker

My feeling on M&A is we’ve got what I’d consider a robust pipeline, but until they’re done, you can’t count them because they move in funny ways. I would say our emphasis is in probably areas versus region. Areas like healthcare, expanding pest globally, water and energy technology that makes sense for institutional and F&B markets. We’ve got properties on the list in both Asia and Latin America, but they’re probably proportionate to market.

Operator

Your next question comes from the line of Steven Schwartz – First Analysis.

Steve Schwartz – First Analysis

In international, your operating margins were down, and you mentioned it was operating cost increases. I’m wondering if that’s just the employment market frictions and so forth that are in Europe that are holding your restructuring, or what’s behind that?

Doug Baker

The major reason is Europe saw raw material increases really flow through a quarter later than the balance of the world, and it had a material impact on Europe’s earnings in the first quarter. The raw material costs are subsiding in Europe, but to us it’s a quarter behind everywhere else, and so they were much in the second quarter than in the first. We know they’ll be much lower in the third than the second, so really it’s raw material. It’s the bubble moving through at a slower pace or a delayed pace in Europe. As I said in the last call, we still expect Europe margin to be back in the normal 8ish range by the end of the year.

Steve Schwartz – First Analysis

The FIFO effect then, is that included in the commentary in your press release about operating cost increases then?

Michael Monahan

I’m not sure what you meant by that question, Steve. Could you repeat it?

Steve Schwartz – First Analysis

It sounds like, Doug, you were talking about the FIFO effect in Europe in raw material costs, but in the release you talk operating cost increases outpacing pricing particularly in Europe. I wondered if there was something other than the FIFO effect.

Doug Baker

It’s not really FIFO per se. We don’t have that much inventory. It’s really the timing of the raw material price increases and how the high-priced raw materials are flowing through our P&L, and they probably hit peak pricing for the company at January 1st, but they were delayed a quarter, if you will, in Europe, and it’s just a follow-through impact, but they’re coming down. We are buying raws at much lower prices, and we know it’ll positively impact the P&L as we through the year.

Steve Schwartz – First Analysis

Your guidance for the third quarter is 50-51% gross margin. You had nice gross margin in the second quarter. It sounds like you’re going to continue to have the raw material tailwind in the second half, so would you expect that your gross margin stays north of 50% beyond the next quarter or two?

Doug Baker

Historically, we’ve been north of 50%. We go through periods where we’ve got what I would call very difficult raw material markets where it can knock us down. We tend to price over a period of time and not try to recoup it any one year, so our plan would be to rebuild that and sustain it there.

Operator

Your next question comes from the line of Bob Koort – Goldman Sachs.

Bob Koort – Goldman Sachs

I’m wondering if you guys have given any consideration or thought to what your incremental margin in the recovery might look like if any differently than say the early 90s or early part of this decade. Is there a reason to expect your structural cost work is going to give you a little bit more juice when things recover or do you think you would just increase your expense load as things get better as well?

Doug Baker

I would expect that the work that we’ve undertaken and we’ve tried to leverage this period to give us leverage that’s sustainable, so we would expect that we will have a better business and a better line margin post this period than we did pre this period.

Operator

Your next question comes from the line of Ed Yang – Oppenheimer.

Ed Yang – Oppenheimer

Regarding your market share gains, are there any specific accounts that are noteworthy or you’d like to share? These account gains, are they more new accounts to Ecolab or are they part of the circle of customer and cross selling opportunities?

Doug Baker

Most of our emphasis right now has been on what I’ll call new accounts to Ecolab, and we’ve been working hard to increase the number of accounts that we serve in our markets. We find that the recessionary periods at the best time to go and increase share of units, and that’s what our emphasis is. We typically don’t share account gains and losses by name, so I will stick to that policy. Occasionally people start figuring out who they are if they’re large and meaningful, and there have been several significant wins around the globe, and we anticipate more.

Ed Yang – Oppenheimer

Doug, isn’t it an easier share take if you already have the existing relationship with the customer though? Would it be picking low-handing fruit if you go after accounts where you already have the relationship?

Doug Baker

We circle the customers that are, to use the term in other industries, cross selling. What we have found over time is typically people get in these recessionary periods they start pushing hard on internal spending. Certainly we continue to go push and try to go build our services, but we have found is leveraging anchor technologies and seeking new customers is probably even a better path in these periods. That’s what our experience was in the early ‘90s and early 2000s, and that’s what our experience is today. We will aggressively start adding on and circle the customer opportunities as the recovery unfolds.

Ed Yang – Oppenheimer

Regarding raw materials, you’re very diversified with your raw materials basket, but I do notice on the spot basis, there have been a tremendous amount of price volatility. For example, chlorine which has gone up a lot recently and caustic which has declined, could you just remind us what are some of your key raw materials?

Doug Baker

I think the raw materials that have probably most influenced the delta in the past are going to be caustic, phosphates broadly, plastics, and surfactants, and plastics and surfactants are going to be more related to oil than the other two, but not directly.

Operator

Your next question comes from the line of Mark Gulley – Soleil Securities.

Mark Gulley – Soleil Securities

Doug, can you update us a little on what seems to be the state of play with respect to the large competitor based in Wisconsin?

Doug Baker

What we’ve seen out of that competitor is, I guess, more of the same which is clearly they’ve got some of the same market pressures that we’ve had in terms of raw materials and now from end-user market declines. They continue to do the stuff. They are reducing head counts. They continue to play in the market as they have in the past. So I wouldn’t say that we’ve seen material change out of them, but they’ve been under pressure for a while, and they continue to play like they are under pressure.

Mark Gulley – Soleil Securities

Switching to vehicle care if I can, I would think that maybe now might be a good time to try to talk to national chains about adopting that program because things are slow, and if there’s going to be any disruption and the risk of that disruption being a problem, the cost to them would be less. Is that a reasonable sales proposition to the customer or is that just a little bit too cute?

Michael Monahan

Mark, are you talking about vehicle care?

Mark Gulley – Soleil Securities

I meant GCS, I’m sorry.

Doug Baker

We are continuing to pursue new business in GCS actively. GCS has been under pretty significant pressure. From what we know of other people in this industry, we’re outperforming on the topline as bad as it is versus what others are going through, and we also expect the top line not to heal itself in the second half, but to show improvement, i.e., the rate of decline for sure would slow as we go through this because we have had some recent new business, and so I agree with your thesis.

Mark Gulley – Soleil Securities

The analysts’ day is in about six weeks. Can you give us any kind of sneak preview as to some of the themes you’ll be talking about there?

Doug Baker

Our themes are fairly consistent. I guess what we want to do is try to help dimensionalize the continued upside in terms of sales and share, and I think we’ve got a very rich target list, how we’re looking at going after it. I think during that day, we can give you more specifics about what we plan to do. We’ve got a very robust R&D portfolio which we’re excited about that we’ll also share parts of, and then finally leverage. The company we still feel has a lot of leverage in front of us, and we plan to build a very strong sustainable earnings machine, and there is a lot of work to be done, but there’s still a lot of leverage to be harvested.

Operator

Your next question comes from the line of Nate Brochman – William Blair and Company.

Nate Brochman – William Blair and Company

I wanted to talk a little bit about the topline in Europe. While down, it looks a little bit better than it might have been maybe over the last couple of year, and I was just wanted to see if you could talk a little bit about some of the incremental sales efforts there in terms of stemming the tide a little bit.

Doug Baker

Nate, we’ve invested in Europe in increased resources in our corporate account teams—the two big businesses there, and it’s had an impact. I would say we watch very closely net gains to net losses, things that we absolutely control. We can’t control how many units close, and we can’t necessarily always control consumption within a restaurant or another facility, but those we can control and we’ve been successful outpacing losses with net gains for quite a while. We’re also gaining on pricing, and Europe is going to have a much better pricing year. They’re delayed a year. We wish it was earlier, but they are getting it, which is important, given the raw material run-up they’ve had, so I think those are the big impacts.

Nate Brochman – William Blair and Company

I was wondering if you could talk a little bit what the benefit was for increased product sales for H1N1 in terms of what the outlook for that specific issue is in terms of sustainability.

Doug Baker

This is always very hard for us to estimate. We can try to look at a bug trend. We know health care had a couple of million dollars in increased sales in the quarter that we think would be directly related to H1N1. We think there is probably an equal amount in other divisions from that. I would tell you we’re preparing for a possible fall event because we think it’s a wise course of action, and we follow this quite closely. Don’t know if it’ll transpire, it it’ll occur, but we want to be prepared to help our customers if it does come out in a much larger way.

Operator

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

Gary Bisbee – Barclays Capital

Can you give us any color on how Canada is doing so well? It seems to me the economy there is struggling in many ways like the US. Is it more just success with new customers or pushing more products than you’ve offered there in the past? What’s driving it?

Doug Baker

I think we had several things going in Canada. We had very strong momentum going in. We’ve got more share upside in Canada than say in other markets. We’ve got a very good team, and they’re continuing to execute, so I don’t know if it’s a secret. They nailed a couple of large pieces of businesses moving into this and rolling them out.

Gary Bisbee – Barclays Capital

Any update on the Apex campaign with Sysco?

Doug Baker

Apex is a broad campaign. I’ll separate the two. In the second quarter, if you took the average placements last year, our placements in the second quarter was about 10% above, so we continue to have very strong success gaining new Apex accounts which is important, and for perspective, that’ll be close to about 1% share gain net-net, but that’s the kind gain given there’s about a half million restaurants in the US where this thing is fixed, so Apex is doing quite well. Our work with Sysco, we’d say the first half netted 10,000 new accounts. It’s probably 30 plus percent above normal pace with Sysco, so it’s significant. It’s been gaining momentum. We have an agreement that we’re going to both continue this program into the second half of the year because it’s resulting in good net new gains for both of us.

Gary Bisbee – Barclays Capital

Mike, I didn’t hear what you said that Asia-Pacific revenue growth on a constant currency basis was.

Michael Monahan

4%.

Gary Bisbee – Barclays Capital

Can you tell us what the GCS loss in the quarter was?

Michael Monahan

They lose a couple of million bucks.

Operator

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

Rosemarie Morbelli – Ingalls & Snyder

Doug, looking at Europe, it continues to be an issue. You have had several managers. You have taken many steps and actions since you acquired the share from Henkel. Can you remind us what you are doing differently now versus the previous steps, and when do you expect to see the benefit either on the topline or the bottomline or both actually?

Doug Baker

Rosemarie, what we said is we’re going after topline by investing more in corporate account resources which we’ve done. We had organic sales growth momentum improvement each year. Obviously, this year is going to be an exception. We also said that we have to get after structural changes. We had taken advantage of a lot of low-hanging fruit, but we’ve got a disjointed supply system in Europe, so we went out and undertook an SAP implementation, so we’d have transparency across the manufacturing and warehouse platform across Europe. It would allow us to move to shared services and a number of other fairly standard processes that we just can’t deploy today in Europe. Where are we on the SAP? We’ve got over a third of the volume on it. We’ll have over about 60% by fall. We’ll be at the 85% a year from now, so largely done. That continues to progress well, meaning we’ve put on major countries without major hiccups which is what you hope for, and it’s starting to give us currency. The big news in Europe right now is a huge spike in raw materials moving through the P&L. It doesn’t mean we think we are executing perfectly well, doesn’t mean we are satisfied with every part of business, but that’s the big impact, and I think as that settles out, you’re going to see more normal margins in Europe quite quickly, and we’re working on moving those from 9 to 13-14, and I still see a path to do that, but we’ve got to get through the SAP implementations, so that we can take advantage of the inconsistencies.

Rosemarie Morbelli – Ingalls & Snyder

So we should really see a big marching improvement in let’s say 2011 giving you time by the middle of next year to be done with the SAP and figure out where you can make additional changes. Is that the game plan?

Doug Baker

Yes. I think in 2011, you’ll start seeing significant margin increases. As you recall, we have already gained substantial what I’ll call net income advantages as a result of how we structured and established a principal company in Europe. You’ll start seeing in addition whole margin increases in ‘11, ‘12, and ‘13.

Rosemarie Morbelli – Ingalls & Snyder

Could you also bring us up to date on your SKU rationalization? Where do you stand in the US and elsewhere in the world?

Doug Baker

All the US divisions have completed their upfront work which is really designing the product line that we to go compete. It’s a significant, over 50% reduction in SKUs in our North American business. We’re going to start implementing in third quarter in some divisions. We’re going to stage this. You don’t want to do it all at once. It would be a huge disruption in our product supply system. We’re already undertaking some of these eliminations and rationalizations as we move forward. It’ll take us a couple of years to fully implement. I don’t think it will take us a couple of years to start to come back.

Rosemarie Morbelli – Ingalls & Snyder

The margin in the US cleaning and sanitation was extraordinarily high. Was there anything special and is that a number that is sustainable?

Doug Baker

There is no one-timer or unique event in the business that you’d point to that you would say is unsustainable. I think it gets to the point that we feel like we have had leverage in these businesses, and so often when we get asked can you bring the European margin to the US, our answer is we hope not because we believe there is margin expansion in all of our regions. I think as we said as we moved into this year, because of the nature of the year, we’re going to focus more emphasis on margin expansion and getting after leverage opportunities because of the topline pressure, and we’re doing it the way that we believe is sustainable.

Operator

The next question comes from the line of John McNulty with Credit Suisse.

John Mcnulty – Credit Suisse

When you talk about the raw materials that are impacting Europe right now and that you expect to see pricing similar to the way the US, we saw some pretty robust pricing over the last 12 months and you expect to start getting pricing in Europe, is it going to be roughly the same magnitude? Is that what we should be thinking about in terms low to mid single digits?

Doug Baker

John, what I would say is that these things are always this way. Europe really got on this a little later than I would say North America, but they are on it in a material way in the second half, and you’re starting to see fairly good pricing in Europe right now as we speak. It will play through the balance of the year and hold at a fairly good level. We’ll see declining raw materials in Europe, and that’s pretty much a certainty because we know what the contract of price is as we move forward.

John McNulty – Credit Suisse

In terms of margins, I believe you said the target for Europe was 8% by the end of the year. Did you give what you did this quarter?

Doug Baker

I think it would have been threeish quarter. I’ve got guys with a calculator, so you know how wrong I am. It’s four.

John McNulty – Credit Suisse

So there is definitely a pickup coming, and it does sound like the raws and the pricing are going to get you there. With regard to the $7 million or so that you spent in terms of fixed investment in Europe, in terms of 2010, how should we think about that? I know you are going to be spending at least for a while in the first half of 2010, but when you look at 2010 versus 2009, how does the cost to fix Europe change?

Doug Baker

I think as you move forward, we’re going to continue to have investments, but they are not going to be at the same rate in Europe in 2010 as they were in 2009.

Michael Monahan

Yes. We are completing the ERP rollout, John, so you’ll start to see cost starting to come down because of that later this year and in 2010.

Operator

The next question comes from the line of David Ridley-Lane with Banc of America.

David Ridley-Lane – Banc of America

Can you provide a little bit more detail on some of the gross initiatives? It looks like you pulled forward into 2009.

Doug Baker

I’d say if we’ve pulled initiatives forward into 2009, there were more leverage initiatives, those that we shifted in foreseen timing, but from a growth standpoint, I would say there are several larger initiatives. One is continue to build our core institutional F&B and Kay position. There, we are very much focusing on the largest cooperate accountant players. We know these guys do best in these environments and tend to come out with outside momentum, and so we would have increase our share there, and we’re doing so successfully. We’re also all over the healthcare opportunities that we talked about, specifically around helping hospitals with infections acquired on premises. That work is going quite well. Our healthcare business is growing organically at high single digits. We’re working to introduce new technology and plan to accelerate that as we go through. We’ve got a number of fundamental core R&D investments which we also believe will continue to fuel our growth in our core businesses as we go forward.

David Ridley-Lane – Banc of America

On the leverage initiatives that you pulled into 2009, absent of those discretionary initiatives, would you have had to lower the high end of your 2009 EPS guidance range?

Doug Baker

This is like the age old question. Somebody said you’re going to die unless you do almost any number, we’ll find a way to do the number. I guess what we’re trying to is be very wise in what we call a very unique period. Recall that we are going to be delivering EPS growth in a very depressed market situation while continuing to invest record amounts in our business, so if you’re asking me, I guess if we ripped down investments, would we deliver more. Yes. Do I think that’s a smart answer? No.

Michael Monahan

David, once again for the second half, we will be showing 13-19% EPS growth, so we’re taking advantage of the improvement in raw materials and at the same time making the investments and delivering pretty good earnings growth.

Operator

The next question comes from the line of PJ Juvekar with Citi.

PJ Juvekar – Citi

One of the key drivers of your institutional business is business travel and T&E. I know T&Es were slashed this year by corporations. What’s your outlook for next year? Do you see a big rebound next year in business travel?

Doug Baker

The only real answer is I don’t know. We certainly aren’t forecasting any big rebound in T&E travel for the balance of the year. Will it come back some day? I think it certainly comes back off these very low levels. Does it bounce back to where it was? I don’t know, but what I see, PJ, is we plan and we are taking things into our own hand. We know by selling more new accounts, continuing to leverage a new technology, ultimately getting back very aggressively on CTC, we believe we can continue to push the topline ourselves. I think we’ve proven we could do it in the past, and we’re in a very good situation as we move forward.

Michael Monahan

And if the economy recovers, PJ, that’s just a nice tailwind behind us because we’ll try to drive our own growth and that will be just another tailwind.

PJ Juvekar – Citi

Mike, how many sales associates do you have now, during this tough environment and your recent headcount reduction? Do you anticipate any change in that?

Michael Monahan

Right now, we’re at about 14,200. We think for the year we’ll probably be a little bit higher than that, but relative to last year, similar, maybe a little bit less. So, it’ll be probably similar to last year on a total basis for year end.

Operator

The next question comes from the line of Jeff Zekauskas wth J.P. Morgan.

Jeff Zekauskas – J.P. Morgan

If you look over your business to the lodging industry overall and to the restaurant industry overall for the first half, on a constant currency basis, what were the growth rates of those two sectors?

Michael Monahan

Do you mean globally or in Europe?

Jeff Zekauskas – J.P. Morgan

I mean globally for lodging and for restaurants.

Michael Monahan

We don’t have numbers that really track it globally Jeff.

Jeff Zekauskas – J.P. Morgan

Then I guess in the primary regions in which you do track it, what have the numbers been like, and are they better than you thought or worse than you thought at the beginning of the year?

Doug Baker

We anticipated a pretty difficult year fairly early. I would say that hotels probably have been impacted more significantly than we thought probably in November or December. Restaurants, in the range. QSRs probably fared a little better than we might have hoped, and I would say full service restaurants, particularly the top end, have probably been hit harder than we expected, so there is a mix there, but I wouldn’t say it was completely outside of what we laid out as possibilities moving into the year. Our QSR business is doing quite well as we go through this. Our restaurant business in total given the demand decline is doing quite well also.

Jeff Zekauskas – J.P. Morgan

Secondly, in the $24 million of restructuring charges you took in the quarter, if you had to apportion that geographically, how would you do it? Where did you spend the money?

Doug Baker

Let me give you the numbers for the whole $75 million. Really the amount of flow-through on a quarter is almost dictated by accounting rules versus strategically how we’re laying out the opportunities. We’re looking for a regional split. Why don’t you give me a minute, and I’ll come back to you with those numbers. Of the 75, Europe is going to be 27, APLA is going to around 8, and the balance is going to be in the US, which means 40.

Jeff Zekauskas – J.P. Morgan

Lastly, in 2010, all things being equal, is that a year were you would expect positive pricing for the consolidated entity or negative pricing or flat pricing, or do you not have visibility yet as to what 2010 might be like from a pricing standpoint?

Doug Baker

We aren’t in a position where we are going to be forecasting 2010. What I will say is we don’t have a history of having pricing go negative, and we don’t anticipate that scenario going forward.

Operator

The next question comes from the line of Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn – Longbow Research

When you look at the performance of pest elimination and the comments that you made about the geography outside of the US, it looks like pest elimination was a positive contributing factor to performance in international markets, but it was a flattish business in the US. Is that due to different market dynamics or to different sizes of businesses and where you are in terms of gaining share and how differentiated you are in international markets versus US? Can you give us an idea why the international parts of pest elimination did so much better than domestic?

Doug Baker

I think you answered the question. The US business is much larger and has a much larger share than the businesses we have internationally which are much newer. They also have I guess more striking advantages as we have gone over, and the competitors haven’t reacted. With that said, I think there is plenty of upside in our pest business going forward. Pest usually has a very difficult patch in early parts of recessions because we if we are doing our job, it means that there are no bugs or rodents, and when people are trying to cut, they will eliminate and they will ask us to leave for a period of time. We’re now being called back into accounts that we lost early in the cycle in a number of instances, and it’s a pattern that we have seen before. We don’t love the pattern, but it’s a pattern that we have to deal with, and we expect pest will ultimately rebound to the type of growth rates that we saw in the past.

Dmitry Silversteyn – Longbow Research

Second question is sticking with the other services. In GCS, you’ve narrowed the loss significantly in that business both sequentially and year over year despite lower revenues. I think Mike talked about the third quarter being even better than the second. Is your expectation to get this business even in this environment to a breakeven point by the end of the year or do you think that’s too ambitious and you’re still going to be losing money heading into 2010?

Doug Baker

Yes. I think that would be too ambitious given the topline pressure. I think the only thing this business needs now is some topline wind to start getting to breakeven and better. I think all the work that we have done to bring down, if you will, lower the line at which we got to go cross to make money and we’ve lowered it substantially has been very effective. Unfortunately, it’s all been masked by pretty significant challenges in the topline, so we don’t expect the type of turnaround in the topline that you would need to get to breakeven by second half, so we’ll be losing money moving into next year, but obviously at a much slower rate than it was moving into this year.

Dmitry Silversteyn – Longbow Research

So if I asked the question differently, if you get to the level of revenues that you had in 2008, this should be a positive operating margin business?

Doug Baker

It would be a lot better from a profit standpoint. I would say the profit line on sales is achievable over 4 to 6 quarters, if you get some real movement in the marketplace.

Dmitry Silversteyn – Longbow Research

On healthcare, you talked about the initiatives in the US, obviously driven by hospital infections and the reimbursement for that from insurance and Medicare as well as some other drivers. Do you see similar drivers in Europe or is your healthcare business in Europe relying on different end-market and secular dynamics to achieve its growth?

Doug Baker

There is not one single answer for Europe because the markets are fairly distinct by country; however, the HAIs or the health acquired infection is a huge issue and a huge topic in UK. It’s also been a topic in many other countries in Europe. It’s an issue everywhere candidly. It’s just recognized and discussed in certain countries and not in others, so it’s an opportunity, but in the UK, I would say it’s probably been a longer topic than it has been in the US. There are other drivers in Europe, and there is new technology that we are bringing over from the US. Likewise, we’re taking some technology from Europe and bring it over here. We like healthcare and frankly have been very pleased with the progress we made this year and the position that we’re building for future.

Dmitry Silversteyn – Longbow Research

What’s the size of your healthcare business outside of the US?

Doug Baker

About equal in size.

Dmitry Silversteyn – Longbow Research

Was it about 250 to 150 in the US?

Doug Baker

It’s like 230 in US and about equal in Europe.

Operator

The next question comes from the line of John Roberts with Buckingham Research.

John Roberts – Buckingham Research

Do you think GCS has kind of a same effect like pest has? Initially people don’t buy equipment, they run stuff longer, maybe not service it as well, but it’s got to start breaking down. The same way the bugs come back and pest, there is going to be a maintenance issue to come back and bite the customers on GCS?

Doug Baker

Absolutely. I think there is. You can postpone repairs so long and then you need to go repair them. To put this in perspective, people have multiple fryers so if they had three, if things are rocking and one goes down, you fix it immediately. If things are slow and one goes down, you wait for the second to go down or if you are really pushing the envelope, you wait for the third to go down, so there is going to be some built-in pent-up demand, not significant, but we think you’ll start getting a normalization, and you can only postpone this stuff so far.

John Roberts – Buckingham Research

You are already starting to see the inflection in pest, you said. You don’t really see any sign in GCS yet?

Doug Baker

I think what we said is we believe the second half growth rates, for sure the rate of decline will be improving in GCS in the second half versus the first half, but that’s not exactly an inflection point. I think we’ll call it when we see it in GCS.

Operator

The final question comes from the line of Amy Johnson with Goldman Sachs.

Amy Johnson – Goldman Sachs

I think, Doug, you mentioned raw materials cost spiked in Europe in the second quarter. You do expect in the raw material cost to drop in that region. Going forward, I’m wondering, in other offshore markets like Asia and Latin America, have you seen very similar raw material cost trend, that means the raw materials cost goes up in those regions and you expect this cost to fall going forward?

Doug Baker

Amy, what we’ve seen is actually the peak prices hit North America and the frankly the other regions in Q4 of last year. Europe peaked prices in Q1, and all have been coming down sequentially from there. It’s just that Europe’s peak, if you will, and its resultant improvement is a quarter delayed from everybody else’s.

Amy Johnson – Goldman Sachs

I just want to clarify, in the second quarter, raw materials trends in a year over year basis, except for North America, all other regions are still higher?

Doug Baker

They were higher than last year everywhere but in North America.

Amy Johnson – Goldman Sachs

Going forward, the third quarter of this year, shall we expect all the regions including everywhere the raw materials cost should be lower on a year over year basis?

Doug Baker

That’s probably the best assumption you can have. There may be some exceptions, but we’re talking single digits here and there, but by and large raw materials will be favorable year over year in third quarter and then even marginally more favorable in the fourth quarter.

Amy Johnson – Goldman Sachs

My last question is on your FX guidance. Is that still $0.07 negative impact in the second half of this year?

Michael Monahan

No. We said it would be $0.03 in the third quarter, and we didn’t give a forecast for the fourth quarter.

Amy Johnson – Goldman Sachs

Based on the currency trends of US Dollar versus Euro and the current level, in the next quarter why do you expect something pretty similar? The negative impact of the currency is pretty similar to the second quarter. Wouldn’t that be a little bit more favorable? The negative impact should be less than $0.03?

Doug Baker

Amy, I don’t have my FX chart in front of me, but the FX really moved in the fourth quarter. It’s where the big move was. It’s really just looking at a year over year comparison and working with the currency mix that we have.

Michael Monahan

It appears there are no further questions, so that wraps up our second quarter conference call. As mentioned, this call will be posted on our website along with the associated slides. Thank you for your participation.

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