Ecolab Inc. Q3 2009 Earnings Call Transcript

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 |  About: Ecolab Inc. (ECL)
by: SA Transcripts

Operator

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

Michael Monahan

Thank you. Hello, everyone and welcome to Ecolab's third 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 website at ecolab.com/investor.

Please take a moment to read the cautionary statement on slide two. Stating this teleconference, 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 third quarter earnings release and in slide two. We also refer you to our earnings release, which includes supplemental diluted earnings per share information.

Starting with slide 3, in the third quarter, we delivered results at the top end of our forecast range, despite continued challenging market conditions and unfavorable currency trends as we aggressively drove new account gains, sales of new products that delivered effective cost savings for customers, cost reductions and pricing to recover margins.

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 4, reported third quarter 2009 earnings per share were up 20% to $0.60. On a pro forma basis, excluding special gains and charges and discreet tax items from both years, third quarter 2009 earnings per share were $0.61 compared with $0.55 last year, an increase of 11%.

The pro forma earnings per share growth was driven by new products and account gains, pricing, cost savings, which more than offset key investments in our strategic growth areas.

Operating margin showed good recovery as moderately favorable, delivered product cost and shares offset unfavorable foreign exchange impact and higher taxes.

To drive results in this challenging environment, we have continued to be aggressive focusing on top-line growth as we emphasize our innovative products that provide customers with labor, energy and water savings. We are using these products to help deliver new account acquisition among our national, regional and independent prospects. We have also focused on cost savings, emphasizing productivity and efficiency improvements to help increase margins, following a period of significant raw material cost increases.

Looking ahead, we have not yet seen an upturn in our major markets, and are not counting on recovery in the near term. 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 markets do pick up, we will clearly benefit from our extra effort.

We expect pro forma EPS for the fourth quarter to be quite strong, up 20% or more to the $0.54 to $0.57 range compared with pro forma EPS of $0.45 in the fourth 2008. We look for modest fixed currency sales growth in the fourth quarter with favorable delivered product costs and cost savings actions providing significant benefit to operating margins.

We also tightened the top and bottom ends of our forecast pro forma EPS range. We look for pro forma earnings of $0.98 to $2.01 per share representing a 6% to 8% over last year.

In summary, we expect 2009 to reflect yet another strong performance for Ecolab in a very challenging environment, and strong sales efforts to gain new accounts and achieve better sales penetration along with improved efficiency in cost savings will enable us to again deliver attractive growth and show the return while continuing to invest in future growth.

Turning to the details as shown in slide 5, Ecolab’s reported consolidated sales for the third quarter declined 5%. However, sales were flat at fixed currency rates. Looking at the components, volume and mix declined 3%, pricing was up 3% and currency reduced sales by 5%.

Slide 6 includes sales growth by segment and division. Sales for the U.S. cleaning and sanitizing operations were flat. Institutional sales were off 4% as new account gains, new products and pricing, once again, enabled us to outperform lower demand from lodging and food service customers. We have not yet seen improvement in institutional major end markets, and do not expect a significant pickup in the near term.

We remain focused on driving sales using innovative products like our Apex wear washing system, Wash and Walk and a new laundry program that 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 customers reduce total 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 flu has resulted in additional sales of infection prevention products such as disinfectants and personal hygiene hand care products. We are also 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, as well as, more sales tools to make them more productive.

These actions have resulted in good new account activity and we are continuing our efforts to drive more sales and margin gains. We expect these aggressive sales efforts, investments in our sales team and new account gains to help us to continue to outperform our markets in the fourth quarter and show a sales increase.

Kay's third quarter sales grew 4%, and compared to a very strong quarter last year, when sales grew by 21%, Kay offsets slower QSR growth through new product introductions, better penetration and growth in food retail. QSR sales grew moderately in the quarter benefiting from existing customer growth and pricing.

The food retail business continued to show strong growth with double digit gains as it benefited from new account growth. New products and programs like the introduction of 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 stronger gains in Kay's fourth quarter.

Textile care sales increased 5%. Customer gains along with pricing offset depressed industry conditions. Customers have shown increased interest in the operational savings textile care’s products and services can deliver in this tough economy. We look for modest growth in the fourth quarter as business gains and new products continue to offset lower industry volumes.

Healthcare sales rose 11%. Excluding acquisitions, sales increased to 8%. Continued solid growth in our infection barrier business and skin care products led the results. We also enjoyed good demand for H1N1 hand sanitizer products in the quarter. Looking ahead, fourth quarter sales should show continued good growth, again led by hand sanitizers in infection barrier sales.

Food and beverage reported sales rose 2%. Our core food and beverage business enjoyed good gains in the dairy, beverage and food markets as increased pricing, corporate account wins and new products offset soft results in agri and meat poultry. In the fourth quarter, food and beverage will continue to focus on new account acquisitions and new product sales. However, we will compare against a very strong quarter last year, and we expect weakening markets in agri and food -- and meat and poultry and softer pricing to impact revenues and yield a flattish sales performance.

EcoCare sales decreased 5%. The division is focused on pricing and new and more sustainable products, and operational cost efficiency programs to gain new accounts and drive sales. However, these efforts were more than offset by weak market demand due to the economy. We expect the fourth quarter will continue to be a challenging environment and we expect a modest sales increase. Sales for U.S. other services decreased 6% in the third quarter.

Pest elimination sales were up 4% in the quarter as gains in the fast food and food and beverages plant markets were offset by soft conditions in restaurant and lodging. We continue to focus on selling basic program to new accounts, as well as, regional and local chain accounts.

We are also targeting growth markets like QSR in food and beverage processing, and are working to build contract growth. However, we expect the continued soft economy will result in slightly lower sales in the fourth quarter.

QCS sales decreased 11% in the quarter. However, profitability once again, substantially improved over a year ago in the prior quarter. The service and part sales were weak, but appear to have stabilized. Sales pipeline in chain customer interest and the value proposition GCS offers remains good as we are able to demonstrate that our service program and reduced customer downtime and emergency repair. However, slower food service business conditions have resulted in longer decision timelines for new sales. As a result, new account wins were more than offset by general market weakness.

Despite the lower sales volumes, GCS’s profitability was substantially better compared with last year in the prior quarter as we continue to see productivity and efficiency improvements from the new system. The 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 fourth quarter, we expect the sales decline to narrow as we invest in sales force additions to drive growth, and we expect GCS will again report significantly improved profitability over the prior year period.

Measured in fixed currencies, international sales increased to 1%. Europe, Middle East and Africa sales declined 1% in the third quarter at fixed currency rates. Europe's institutional sales were up modestly. Food service and lodging trends appear to have bottom stabilized whereas in the U.S. we have not yet seen a return to growth. Focused sales efforts targeting new business with regional and local customers, and new products that offer customers cost savings helped to drive new account gains in a soft economy.

Food and beverage sales were slightly lower as gains in product sales and major accounts were offset by weak equipment sales. Textile care sales declined reflecting reduced lodging and uniform volumes.

Europe’s healthcare sales reported strong growth as H1N1 sanitizer demand and increased hand hygiene compliance benefited sales.

Pest Europe’s sales were lower as customers reduced ancillary product sales. Europe's business information systems platform work continues to move forward. We have successfully implemented the system in 30% of our European business including our largest country, which is Germany. We will continue the roll out to the remaining system locations over the next 18 months.

Asia-Pacific sales grew 2% fixed currencies reflecting the impact of economic uncertainty and low levels of business travel and tourism in the region. Institutional sales were flattish as the recession hurt hotel occupancy and slowed overall catering in the high end hotels. Food and beverage sales rose modestly. Both the beverage and brewing sectors continue to grow benefiting from increased product penetration and account gains.

Looking ahead Asia-Pacific expects better sales in the fourth quarter reflecting recent account wins and stabilization of the market.

Third quarter sales for Ecolab's Canadian operation increased 6% at fixed exchange rates. Food and beverage, healthcare, vehicle care and pest elimination all reported double-digit sales growth driven by new account gains, institutional sales growth also benefiting from new accounts. Latin American reported a solid sales gain rising 8% at fixed exchange rates as all divisions increased. Institutional growth was driven by new accounts, increased product penetration, as well as, continued success with global and regional accounts.

Food and beverage sales reflected good demand in the beverage and brewing markets as well as the benefits of new accounts. Pest elimination continued its excellent performance throughout Latin America. Overall, we expect healthy growth trends to continue in Latin America with another solid gain in the fourth quarter.

Turning to margins on the income statement in slide 7 of the presentation, third quarter gross margins increased to 190 basis points and were 50.6% compared with 58.7% last year. Gross margins are continuing their recovery towards levels that existed before the run up in raw material costs. The quarter's gain was driven by pricing, cost savings and improved delivered product cost.

SG&A expenses were 35.8 percent of sales, 20 basis points above last year. The higher SG&A ratio reflected savings from our January restructuring, price leverage, and closely managed spending which were more than offset by higher costs and increased investments in our business.

Operating income for Ecolab's U.S. cleaning and sanitizing segment increased 17%. Margins expanded by 310 basis points over last year. The increase was driven by pricing, favorable delivered product cost and cost savings.

Operating income for U.S. other service grew 3%. Margins expanded by 120 basis points over last year. Growth was driven by improved pricing, productivity and efficiency gains and cost reductions. International fixed currency operating income increased 6%; margins expanded by 50 basis points over last year.

Pricing gains and cost savings efforts more than offset easing delivered product cost comparison and continued investments in the business. Delivered product costs are expected to provide a favorable comparison in the fourth quarter.

The corporate segment includes special gains and charges which are reported as a separate line item on the income statement. Special gains and charges in the third quarter of 2009 of $7 million included a restructuring charge of $5 million. The corporate segment also includes $6 million of investments and the development of business system and other corporate investments we are making as part of our ongoing effort to improve our efficiency and returns in Europe. These investments are included in pro forma results.

Ecolab’s reported third quarter consolidated tax rate was 30.2% compared with last year’s reported 32.1%. Excluding discreet tax items and the tax impact of special gains and charges, the adjusted effective income tax rate for the third quarter 2009 was 32.0% and compared with 30.4% in the third quarter 2008.

The increase in adjusted third quarter 2009 effective tax rate was primarily due to lower tax benefits from our international operations which increased the third quarter 2009 adjusted tax rate, as well as, tax benefits in the prior year, which reduced the third quarter 2008 adjusted tax rate.

We expect the full year 2009 tax rate to approximate 2008, 31.6% rate. The net of this performance is that Ecolab’s reported fourth quarter diluted net income per share was $0.60 compared with $0.50 reported a year-ago. When adjusted for special gains and charges and discrete tax items in both years pro forma earnings increased 11% to $0.61 when compared with $0.55 earned a year-ago.

Turning to slide 8 Ecolab's balance sheet and cash flow remains strong. Total debt to total capital was 33% at September 30 compared with 32% reported a year ago and 42% at year end 2008. Our net debt at September 30 was 29%. We also made a voluntary cash contribution to our pension plan of $75 million in September, bringing our total 2009 voluntary U.S. pension plan contributions to $125 million.

Slide 9 shows our forecast for the fourth quarter and full year 2009. The press release includes line item forecasts of our fourth quarter P&L.

As previously discussed, we look for continued slow market conditions 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 strength to capture market share and drive growth.

Further, margins are recovering and we are using them to continue to make investments in key areas like corporate account sales, R&D, healthcare, water and energy, and global pest eliminations to drive future growth.

In the fourth quarter, we look for our U.S. operations to show a modest sales increase as new account gains and the reversal of the first quarter distributor incentive program change more than offset continued challenging conditions. We will continue to emphasize products that provide unparallel performance and energy and cost savings for customers. We expect them to provide further differentiation and opportunity and help drive results.

We look for international sales to be similar to last year and fixed exchange rates as good growth from Canada, Latin America and Asia-Pacific are offset by soft trends in Europe.

Net we expect pro forma diluted earnings per share for the fourth quarter excluding special gains and charges and discrete tax items to increase 20% or more to the $0.54 to $0.57 range compared with pro forma earnings per share of $0.45 earned a year ago.

In summary, as noted on slide 10, we performed effectively in the third quarter against very tough conditions and delivered on our forecast as we also invested for our future and despite the expected challenges from weak markets, we continue to look for a strong fourth quarter gain and expect to deliver a very attractive performance for the full year 2009.

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

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

Question-and-Answer Session

Operator

(Operator instructions). Your first question comes from the line of Bob Koort with Goldman Sachs.

Bob Koort – Goldman Sachs

Good morning, Mike. Hello?

Operator

Bob, please go ahead with your question.

Bob Koort – Goldman Sachs

Can you hear me? Hello?

Doug Baker

Operator, it seems we have a problem.

Bob Koort – Goldman Sachs

Mike, can you hear me?

Michael Monahan

I can hear you now Bob. Can you hear us?

Bob Koort – Goldman Sachs

Absolutely. My question for you is on institutional business, early in the year you guys talked about changing a program with the distributor and that it should have a backend benefit, are we going to see that, did we see in the third quarter and are we going to see in the fourth?

Doug Baker

Yes, Bob, Doug Baker. We exactly did talk about first and fourth quarter, we have not seen it in the third quarter. We didn’t expect to. We will see it in the fourth quarter, and we anticipate institutional sales will be positive and part of that positive is clearly going to be the promotion impact.

Bob Koort – Goldman Sachs

And then the U.S. margins that you guys are delivering now, do you think there is upside to that as you go forward or is most of the upside going to be around demand, resuscitation and revenue growth?

Doug Baker

I think our conversation around margins has been -- we have got two sizable opportunities in front of us. Clearly, there is a top-line opportunity, we chase the big market and have a 10 to 11 share. And the others within the business we’ve got a number of opportunities in terms of driving improved margins by driving efficiency within the company. So, our expectation overtime is that we will continue to grow our margin, but a lot of it’s going to come through work within the company.

Bob Koort – Goldman Sachs

And then lastly, if I just might ask, the raw material outlook, I know it’s been somewhat volatile end of this year, what would be your expectation next year for that and the pricing response you might implement?

Doug Baker

Yes, I think our view on the raw material market at least our momentary view is, it’s going to, we expect the raw materials will be favorable next year versus this year, particularly in the first half. Simply because you got to remember the base they're going against.

Bob Koort – Goldman Sachs

Great, thank you.

Operator

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

PJ Juvekar – Citi

Yes. Hi, good afternoon. How big are your sales of disinfections and sanitary and washing products targeted towards H1NI, and what kind of growth are you seeing and where could the sales go?

Doug Baker

Yes, PJ, they aren't overall a huge percentage of our sales. Call it, the 4% range of total sales. And they're up -- what we've got certain categories that are up quite dramatically, hand sanitizer, etcetera as probably the most impacted, but overall that segment is up double digits in most markets.

PJ Juvekar – Citi

Okay. And then you cited pricing several times. Can you just quantify what kind of pricing did you put through recently, and what are the expectations for 2010?

Doug Baker

PJ, a lot of this pricing was pricing that we put in place over the last 12 months, and much of it was in response to the write -- the write-up on raw materials that we've seen over the years. As we've always said, we don't try to catch up in any one period. We do this and meet it out over a period of time, so that we eventually get there, but don't shock our customers as we go through.

I think our expectation is as we've said previously, in the next year, as you are not going to see the same level of pricing as we had had say in the back half of last year, nor throughout this year. It's going to be much more in the call it the 1% range or traditional range.

PJ Juvekar – Citi

And so how much or what kind of pricing did you get in the last 12 months? If 1% is your traditional?

Doug Baker

I'd say about three. We left the year -- last year at a run rate around four, moving into this year, 4%. Probably for the year this year I think three is probably the right number.

PJ Juvekar – Citi

Okay. Thank you.

Operator

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

Mike Harrison – First Analysis

Hi, good afternoon.

Doug Baker

Hello.

Mike Harrison – First Analysis

Looking at the Kay business, I think there's a little bit of concern on the QSR side about the sustainability of customer traffic in a recovery, given what you guys posted here, just 4% growth year-over-year. Can you talk about what you're seeing in terms of customer order patterns here so far in the fourth quarter, and maybe share some of your expectations for growth rates going forward over the next few quarters in that business?

Doug Baker

Mike, I would say a couple of things. One, the key result this quarter was going against the 21% growth last year in the third quarter. So, it was a very high base number. I would say our confidence in Kay remains quite high as a growth vehicle. You got two main focus points underneath what we’ve reported for Kay. One is QSR, the other is retail. Both, if you will, are highly influenced by our ability to capture new chains, and we have done a good job there, and worked to have nearly double-digit again in the fourth quarter in this business.

Mike Harrison – First Analysis

And then, I was wondering if you could give us an update on our relationship with Cisco and increasing sales to some of their top-tier customers. Do you feel like that’s potential share gain has been mostly captured, or is there still little bit of room to go?

Doug Baker

We believe there is sizable room to go. I think we've been very pleased with Cisco as well with the progress we’ve made year-to-date. But, as with all of these initiatives you learn quite a bit as you go through it. Our team has just, in fact, re-launched an initiative with Cisco to go, if you will, double down on this effort within the last three weeks. So, we like the prospects going forward. We do not believe that we've fully mined that area.

Mike Harrison – First Analysis

And then a question on food and beverage, I was wondering if you could talk about the Ecovation business, how that performed during the quarter and whether you are starting to see some of the customers come back, try to give us an update there?

Doug Baker

Yes, I would say the water business is doing better. Ecovation, specifically, we have not seen, what I would say, the turnaround that we anticipate, because you've still got people watching their money, and any business tied to credit is still fundamentally impaired moving in year end. Ecovation is one of the few businesses that we have that depends on free flow of credit. But it’s a very small piece of our total business.

In long term, Ecovation is exactly the right opportunity. So, I would also point out that the conversation we're having with the large players, the push for finding ways to recycle water, use less water, consume less water, find ways to generate energy are only heightening, they're not going away. So, long-term, this is exactly the right technology to own. It's not exactly the best time to own it.

Mike Harrison – First Analysis

Would you say that in general you're seeing maybe an increase in the number of sales leads that’s just closing those sales that the customers are doing in as (inaudible).

Doug Baker

Yes, I would say, I mean, I think there are two things. One, if we look at the F&B and water space in total, I think we feel very bullish about that business over the near and midterm but precisely what you touch on. It will depend on the technology they need or where they want, but there is huge interest from our customer base in helping them maintain a high level of hygiene but do it and reduced in using less water and less energy and Ecovation plays into that.

So, I would say the lead list is long. There are other technologies that we’re deploying as well to go meet some of these needs. And I think as credit becomes more available, I think you will start seeing Ecovation sales pop [ph], too.

Mike Harrison – First Analysis

All right, thanks very much, guys.

Operator

Your next question comes from the line of Laurence Alexander with Jefferies.

Amanda Seguin – Jefferies

Hi, this is Amanda Seguin on for Laurence. I was wondering if on the healthcare side, you could you give us an update after doing the initial service protocol trials, how that's going there?

Doug Baker

Yes, to protect model continues to look extremely promising. I’d say all the work that we're doing in hospitals is proving the concept that is actually clean and reduced bacteria loads, new have an improvement long-term in infections. I don't know if you saw it today, the Wall Street Journal, in section R-6, there's 10 steps to prohibiting infection in hospitals were referenced to step one.

So, I think the word is getting out, and there's a lot of, I think, interest in this area, and we remain quite bullish on our healthcare initiative and protect.

Amanda Seguin – Jefferies

Okay, and then just a second on demand trends in Europe. Could you just expand a little bit about what you’re seeing there as far as competitor behavior?

Doug Baker

Yes, I don't know that we've seen any significant change in competitive behavior in Europe. What I would say about demand in general in Europe is, it’s stabilized, and I think we're pretty confident that we have seen the bottom in terms of demand destruction in Europe. So, if anything that business appears to be firming up.

Amanda Seguin – Jefferies

Thank you.

Operator

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

Gary Bisbee – Barclays Capital

Hi guys, good afternoon. I guess the first question, how much benefit do you think you are likely to get in 2010 from the cost action taken early this year? Obviously it seems like the benefit your margins this year are back loaded, there would be some flow-through in the first half of next year, but I guess I'm trying to get a sense if you think that you've done enough now to position yourself for without a big volume spike, it continued up year-over-year margin story next year?

Doug Baker

Yes, Gary, I guess when we -- so if you are talking about the activity that we undertook beginning in January, we talked about roughly $75 million annual benefit. We're going to realize roughly $55 million of that this year and another $20 million incremental next year as we go through.

So, the year-on-year delta will be about $20 million, and you're right. It's going to be principally in the first half that we'll recognize this. We have a number of other initiatives underway within the company that simply aren't part of, "the restructuring efforts" but they’re all designed to help drive efficiency or lift margin in both a up-sales cycle or a flat-sales cycle.

So, I think we're completely aware. My assumption next year is I don't think the economy is going to be nearly as rosy as some of the other predictions. So, our expectation is that it's going to be what I would call another difficult demand year. Not in all markets. Lodging probably gets marginally better. Foodservice, I think is going to be a difficult year. And I think healthcare and food and beverage government will remain fairly healthy like they were this year. But we aren't planning on any big boomerang effect next year or big spike up in demand from an economic turnaround.

Gary Bisbee – Barclays Capital

One of the things that I think was a key take away from your Investor Day was just to focus on all the margin opportunities you have. I guess, you said earlier some are volume driven, some are just efficiencies. Is that the right way for us to think about that this is more of an evolutionary process, where you'd love to get some number, well, say it's 50 basis points a year over the next five years or should we think about -- is that how we should think about that if not -- sort of how should we think about that 1,000 points of margin potentially you talked about?

Doug Baker

Yes, Gary, it will be more evolutionary, and so as we discussed in that Investor Day, this will come over a period of time and this year we maintained our significant investments in this area. So, EBS in Europe remains on track. We ended up spending exactly what we planned to spend on EBS.

We now have over 30% of the business, two more countries going on in the next few weeks. In that geography, we're doing a number of things in terms of' efficiency studies which is one-time spend in the second half so that we understand more clearly how to go capture a number of these opportunities.

We've invested in key talents in number of positions so that we could go capitalize on it at once when we understand the path. So, I think there has been a lot of work done this year, very beneficial work to enable us to capture that. It overall came at once. We frankly don't want fixed Ecolab to growth. We are a growth company first, but we are a growth company with terrific upside in terms of margin opportunity within the business within our control.

Gary Bisbee – Barclays Capital

Okay, and then just lastly, it’s probably too early to say, but do you expect any real change here in competitiveness or strategy due to the recap of JohnsonDiversey ,and as part of that is there any general update on share gains, that you – and how that trends over last quarter? Thanks a lot.

Doug Baker

Yes. While, look we have been – our focus has remained, which is at the end of the day, we're the leader in this business. Our focus or responsibilities for our customer and gaining new ones, and that’s exactly what we’re going to continue to do, which is a big market. We've got a relatively small share, and our focus is increasing that share.

In terms of how are we doing there, I would say we've talked earlier in the year that even in spite of a downturn we wanted to continue to up our investment in our corporate account selling talent. We've done exactly that. We've got, I think a great team, a stronger team. It's stronger in every region, much better I think, and we are very actively pursuing what I consider a great lift of customer opportunities around the world, probably the best list we've looked at in a long time. And with turndowns like this, you will have some unique opportunities that we're working to capitalize on.

We've already have gotten a number that have said yes. We don't announce who, and we have not installed them, but we are trying to get many more. It is the way we are going offset what we consider a soft demand cycle. We really want to grow our share and grow share of units aggressively.

Gary Bisbee – Barclays Capital

Thanks.

Operator

Your next question comes from the line of Chris Shaw with Ticonderoga Securities.

Chris Shaw – Ticonderoga Securities

Hi, guys. I belong to Ticonderoga. Will you just talk about the hand sanitizing opportunity, was it even an EPS impact or is it $0.1 or was it nothing?

Doug Baker

I think it's nonmaterial. We're glad we were able to help the communities that we served and the customers meet the challenge that H1N1 represents. It certainly helped sales during that period. You would not say H1N1 negated soft demand from the overall economy, by any stretch. And I think the team has done a very good job.

We got on supply back in May, and built it all through the summer, so that we were able to meet the demand, when many other people frankly are out at this point of time the hand sanitizer (inaudible). But I said earlier, I don't think this is a reason to go buy Ecolab. I think you got to look at the long-term sustainable macro trends. That's the reason to invest in this company.

Chris Shaw – Ticonderoga Securities

Right. Then in the Fast-Casual restaurant customers, what are you seeing there? Are they coming back with better ordering yet, or they are still sort of strapped?

Doug Baker

I would say the general view on North American Foodservice, and you are going to have to separate this somewhat, Europe foodservices is probably bottomed and moving in the right direction. I mean, it was never as big a business as North American.

Asia and Latin American continue, are starting to move forward as well. When you look at North American in a fast casual, mid casual, all those segments continue to be under real pressure. For them, it's going to be a share game, and I think that market has changed and probably changed for the future.

I think it's changed in a way that worked quite well for us, but our customers are going to need us to help them run their units more efficiently. And that’s going to be a key focus in that industry going forward. We do quite well in industries that are gone through this. So, we look forward to the challenge, but they're not going to be growing through just wild unit expansion anymore.

So they are changing their game. We're ready and understand it, and have changed ours and are already out there with things like Apex and other programs that helps them to minimize expense in operating the restaurants.

Chris Shaw – Ticonderoga Securities

Just quickly, in Europe is there any geography that's doing better than the others?

Doug Baker

Yes, I think Spain is having a spell of difficulty, obviously. I think our performance probably mirrors what you read broadly about the economy in Europe.

Chris Shaw – Ticonderoga Securities

Okay. Thanks.

Operator

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

John McNulty – Credit Suisse

Yes, good afternoon. Just two quick questions. You had mentioned you have a pretty big new account list in Europe that you're really going after and targeting and it looks like new accounts have definitely been helping you this year. Have you gained more accounts than you have lost, over the last, say six to nine months? And in terms of the ones that you are losing, whether they're going broke or maybe looking for cheaper alternatives, have you seen that decline there slow at all?

Doug Baker

Yes, I'd yes to both questions. So, if I focus on probably the most impacted, one of the most impacted areas U.S. institutional, we closed the quarter with more accounts than we started the quarter and the situation is the same for the year.

Now, we also had, I think, to your point, as we talked about earlier in the year, quite a few accounts who went out of business that were closed. And we always go through these cycles. We have seen, I guess, a slowdown of the, what we call declining business or lost business line in the institutional business, which is what we would expect and what we’ve predicted. So, that's acting as it's acted in past recessions.

John McNulty – Credit Suisse

Okay that's helpful. And then just one last question. I know, recently you just made I guess a small acquisition in pest in the UK. Your balance sheet is in pretty solid shape. Can you just kind of give us an update in terms of what you're seeing in terms of acquisition opportunities out there, if there's more coming down the pike and what we should be thinking about going forward?

Doug Baker

Yes, John, the list has been pretty long for a while. I would say our point on remaining disciplined I think continues to be the headline. We want to – what we think we will be able to leverage this balance sheet. I think these opportunities will pop but we aren't going to go chase them with dollars to accelerate both process. We still believe time remains on our side and we pursue a more active, and there's a number of whom [ph] we very much like to add to the company. But we want to do it in a way that makes sense for shareholders.

John McNulty – Credit Suisse

Are you seeing price starting -- prices out there starting to get to maybe more appropriate levels, on ones that you would be more interested in?

Doug Baker

I guess there are some signs but the ultimate sign is closing the deal. And until we close them, I have to say I've seen signs but not the only sign that matters. But yes, we always had some people that we’ve both walked away from a discussion and we have started talking again, but until we close it, it’s not, there's nothing really to comment on. I'll be disappointed if in the next 15 months we noted have some successes under our belt there.

John McNulty – Credit Suisse

Great. Thanks for taking my question.

Operator

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

Ed Yang – Oppenheimer & Co.

Hi, Doug. Just to expand on the earlier questions in terms of getting efficiencies from your business, your CapEx spending in the quarter was down about 27% year-over-year, and it was down over 30% in the first half of the year. So, short-term, first question, how are you doing that?

And from a longer term perspective, 15 years ago, if I look back, you were spending like 8% of your revenue on CapEx. That came down to more like 6% in recent years and now you are down to 4% of revenue on CapEx. Is this basically a long-term secular trend in terms of spending less CapEx relative to revenue growth?

Doug Baker

Yes, I think when we were heading into this, we clearly took a hard look at how we’re spending capital and what were the areas that we could get after that would be a positive from a cash generation. And so we made some shifts during the year where we ended up spending more money on refurbing dish machines versus buying new ones, which clearly has a very positive effect on your capital spend.

We’ve got somewhat a negative effect on your immediate P&L but it was the smart move to make from the business standpoint. I just think the crisis caused us to re-look at some of the patterns that we have on spending. I would say if you want from a model standpoint, we think 6% is more the right number than 4% over the long haul. But with that said, we have our ROIC focus. We want to make sure we're doing the right thing with capital.

We have reorganized how we manage our merchandising equipment, procurement and manufacturing growth with the specific goal in mind of helping drive down the cost of each unit, which is only going to further improved capital spend and return on invested capital. So, that's one of the areas we believe we have got opportunity in as well.

So, I just think its part of the overall focus. I'm not ready to declare four as the new run-rate. I think that's premature. But I do believe that we're going to improve in this area over the long haul.

Ed Yang – Oppenheimer & Co.

Okay, that's helpful. On the pest side of the business, revenues declined year-over-year, and they had been kind of hanging in there, especially relative to what you were seeing in the institutional side of that business. Does that business lag or when do you expect pest elimination to return to growth?

Doug Baker

I think pest typically lags in terms of -- it moves a little later in some of our direct consumption businesses. And as customers experience longer periods of economic challenges they start going after different areas. Pest is one of those businesses where if you do a good job you don't have a problem in unit.

So there's an assumption that all of a sudden nature has changed and cockroaches have vacated, but they tend to come back. So, typically we go through this period where we see people go away then we will see people start migration back. I would expect pest with our expectation for pest to grow next year. I don’t think it will be a double-digit business next year but we expect it to be growing.

Ed Yang – Oppenheimer & Co.

Thank you very much.

Operator

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

Rosemarie Morbelli – Ingalls & Snyder

Good afternoon, guys. On the margin, the 20.4% of operating margin on your U.S. cleaning and sanitizing business is really at its highest point even for a third quarter. Were there anything special in that particular number meaning that the 20.4 is kind of the high end, or can you reasonably get it higher than that?

Doug Baker

Yeas I would say third quarter in that business is always a seasonal high from a volume standpoint. So, you will naturally see some margin lift from the high -- the peak volume quarter, but I wouldn't say there was nothing unusual, i.e. one-timer that improved it or anything like that. It was more, I think, a recognition of a lot of the work that has been done in that area to recoup margin, quite candidly, that had been lost over the number of years that we've seen raw material inflation. Is there a -- yes, there's a natural governor on margin probably in all business. I don't feel like you've seen it in our businesses, simply because we know of the inefficiency within the businesses at this point in time. And so I don't think we're here to declare that we've seen the peak in U.S. cleaning and sanitizing.

Rosemarie Morbelli – Ingalls & Snyder

However, in that number, if you don't mind my pursuing this, excuse me, in that number, there is a certain amount of maybe incentives that you are not paying and other temporarily eliminated costs that will come back when volume will come back. So when this does occur, can we still look at a strong third quarter in around those levels?

Doug Baker

Rosemarie, you are talking about -- let's be clear on these incentives or -- can you be clear, what incentives do you think we're avoiding this quarter?

Rosemarie Morbelli – Ingalls & Snyder

Well, I am assuming that given while you have done very well throughout the year, given the environment, maybe some bonuses that have been reduced, that sort of thing, which -- travel may have been cut, which eventually will have to come back, those kinds of expenses which may come back when demand actually picks up again?

Doug Baker

I think there are -- I think in fairness, there are some puts and takes in terms of, I guess, a normal operating environment. Certainly, we've been down on travel and a number of other areas, but that's not an overwhelming number. From an incentive standpoint, and a pay standpoint, we've got bonuses that are in place, but we've got other bonuses. Frankly, bonuses for this year are likely going to be up over last year, particularly in the second half because last year we started ripping them down, because we had this very unforeseen crisis hit the business as we go…

So I think if you start putting these puts and takes together, it's more normal than you might imagine.

Rosemarie Morbelli – Ingalls & Snyder

Okay, that is very helpful. Thanks. And then on the international margin, have you made as much progress as you were anticipating, or you’ll expect to do much better in the fourth quarter even though the demand will not have picked up yet?

Doug Baker

I think the margin rebound in international and Europe as the main driver of that segment, was pretty much, as we I think played out in the last call where I think there was a lot of questions given what happened in the first and second quarter. But Europe rebounded as we said, and we said I think it was going to be 8%, 9%. It was a little on the north end of that for the quarter. And I think for the half, we stick with that forecast, even with a little lighter demand in the fourth quarter, which is natural.

Rosemarie Morbelli – Ingalls & Snyder

So, you are sticking with the 8% to 9%? I am sorry, Doug. You mean you are sticking with the 8% to 9% for the second half, or are we raising it actually to the third quarter margin level for international?

Doug Baker

No, I would stick with the second half number.

Rosemarie Morbelli – Ingalls & Snyder

Okay. And then lastly, meat and poultry were actually hurting in the last few quarters. What do we expect to see in 2010? Is it a question on the big animals of the size of the herds and the cost of feeding all of those animals and so on and therefore people raising fewer of them? And can you go -- I want to know over what is going on the poultry side, and whether you see an improvement or a pickup in 2010 in both categories?

Doug Baker

I think the only thing we know for certain is long-term beef is going to go up, rise considerably just because of how people are managing their herds at this point in time. I think poultry is going to be a big issue and a lot of it its going to depend on what happens from an export standpoint and how the U.S. is going to manage through some of the bearers that were temporarily put in place or threatened in place.

I think, our outlook we’ve competed in all these segments. There is always switching between protein sources. We would expect that to continue. I think our outlook for the food and beverage space in general, you don't want to get too specific about which protein is fairly positive through 2010 really in almost all regions.

And I think it probably strengthens throughout the year as things settle down, just fundamentally there are still going to be more people on earth, and they are going to eat.

Rosemarie Morbelli – Ingalls & Snyder

All right, thank you very much.

Operator

Your next question comes from the line of David Ridley-Lane with Banc of America Merrill Lynch.

David Ridley-Lane – Banc of America Merrill Lynch

Yes, can you rank the items you're spending discretionary SG&A dollars on right now? Is the ERP system the number one use of cash or is it more sales force increases? Just sort of go through your top three or four spending items. Thanks.

Doug Baker

Our focus is on second half, if that's helpful.

David Ridley-Lane – Banc of America Merrill Lynch

Yes, that's very helpful.

Doug Baker

Absolutely. I mean, EBS would be one of the major spend areas and probably the largest in terms of dollars, because as we roll out things from the balance sheet start flowing through the P&L.

Michael Monahan

And David, that's Europe systems…

Doug Baker

The ERP system in Europe, SAP, however you want to refer to it. We've got a number of what I will call R&D, technical acceleration projects that are also occurring in the second half. We have got a number of technologies, some that we're licensing, and the way the licenses are structured they have one-time impact in the second half that we're taking on because we like the technology and feel confident it's going to help us moving forward in 2010.

Healthcare remains one of the large investment areas for the company. We talked to protect model earlier. There’s a number of other technology bets that we've made and put into this business, so I think that team is managing that area quite well.

R&D is up in the second half and refer to the R&D acceleration that I’ve discussed. Then we've got a number of one-off efficiency studies, which are really one-timers that we've also put in place to help build the road map to get after some of the margin opportunities that we know exist.

And so there's a series of those that we've also conducted in the second half. So, all in all I think we went into this year protecting investments. If anything we've increased the investments as we moved throughout the year with 2010 and '11 in mind, not just 2009.

David Ridley-Lane – Banc of America Merrill Lynch

Great. Thank you very much. That was very helpful.

Operator

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

Dmitry Silversteyn – Longbow Research

Good morning or good afternoon, I should say. Just wanted to follow-up on the top line impact of H1N1 that PJ asked about, I understand it was a much of the bottom-line impact. But do you expect that to carry over and perhaps you didn’t get stronger into the fourth quarter and have some carryover into the first month or two of 2010 first quarter?

Doug Baker

Yes, I don't know how far out we can see on H1N1. It's roughly, probably 10 million incremental sales in the third quarter. We would expect it to be maybe up to 20 million incremental in the fourth quarter.

Dmitry Silversteyn – Longbow Research

Okay.

Doug Baker

These are year-on-year. What happens in the first quarter, I don’t know, really depends how fast the governments are able to get the vaccinations in place and how successful we are controlling right the virus spread, and that's not an easy thing to predict.

I won't pretend that we can do it. The governments are behind where they had hoped to be in terms of getting this out, and you can see a fairly significant acceleration in the virus spread.

Dmitry Silversteyn – Longbow Research

Right.

Doug Baker

Perhaps this gets out. So, we give you our picture through the fourth quarter.

Dmitry Silversteyn – Longbow Research

Okay. That's helpful, thank you. Excuse me. We've seen a pretty meaningful improvement in margins of the international business to double-digit levels here. Was that driven more by regions outside of Europe or have European margins improved as well?

Michael Monahan

No, there is definite improvement in Europe in the quarter, Dmitry. So, it was a leader in driving the quarter.

Dmitry Silversteyn – Longbow Research

And that’s coming from reduced European sponsors relatively speaking to the levels previously or is that function of the initiatives that you took over the past 12 to 18 months to improve the profitability in the business, or is it just mix happened to be richer this quarter?

Doug Baker

Yes, I would say its a couple things. Actually, the ERP implementation costs move up as you move throughout the year, because they go up as you expand and you roll out.

I would say what's happening is, we took a number of pricing actions, a mix actions, efficiency actions to respond to the DPC or the product cost run up that we talk about that peaked in the first quarter. Then we’ve also seen as we expected a reduction in on raw material costs in Europe from the peak.

Dmitry Silversteyn – Longbow Research

Got you. And then to follow-up on the question on pricing, you talked about having an expectation of about 1% price component, average [ph] price component in 2010. We've seen basic raw material costs or basic costs start to move up fairly aggressively in the second half of the year.

It remains to be seen what they do in 2010. Europe, raw material pricing is delayed by several months or quarters. So you would expect the raw materials to be still positive in 2010 versus 2009, and so the profitability should be augmented by that 1% pricing rather than having to fight through a high raw material cost? Is that the way to think about that?

Doug Baker

I think what we said earlier as we expect 2010 to be favorable, i.e. we will spend nominally less on raw materials in 2010 for the year versus 2009. So, I guess the answer then is yes. I would also point out that the way we go after margin is two-fold. Traditionally, and we are going to be much more in the traditional model, we bring out new technology, which adds meaningful benefit to customers, and within that technology rollout we also try to have expanded margin. And that's traditionally how we drive margin improvement, not through what I call naked price increases.

Dmitry Silversteyn – Longbow Research

Right.

Doug Baker

The real move to naked price increases was a result of really runaway raw material costs during a period of time where technology waves, alone wasn't going to enable to us maintain margin, given the raw material increases. So, I think what are seeing is we are going to be going back to more traditional model at Ecolab, which is driving margin enhancements through new technology.

Dmitry Silversteyn – Longbow Research

I understand. Okay. Thank you very much. That's all the questions I had.

Operator

Your final question comes from the line of John Roberts with Buckingham Research.

John Roberts – Buckingham Research

Can you hear me?

Doug Baker

Yes.

John Roberts – Buckingham Research

On GCS, are there any metrics you can cite that would show progress there, obviously it's not on a gross numbers, but I'm thinking about number of pieces of equipment maybe including contracts, even if the customer doesn't need service on them, are you at least broadening the scope with the existing customers, maybe, some of you’ve had more than 12 months, adding more equipment under the contract?

Doug Baker

Yes, John, this is Doug. What we almost made it through a whole call without a question on GCS. So it's appropriate. Here's what I would tell you. I need to look, the first metric is in the quarter our loss was around $1.5 million. So, we continue to bring down to the loss. We've talked that if it’s cash flow positive at this point in time, that remained true. So, we've continued to see, I think, much improved profit performance.

GCS is shifting gears to start getting after how do we go expand the customer base, now that we know incremental customers need incrementally positive dollars and that's exactly the phase that they're in at this point in time. So, I think in a tough economy that team has done a very good job, leveraging the investments we’ve made to improve the profitability, which are obviously masked by the impairment on the top line due to the economy. But we like the work that's going on there.

John Roberts – Buckingham Research

Thank you.

Operator

And we have no further questions. I will turn the call back to management for closing remarks.

Michael Monahan

Thanks, everyone. That wraps up our third quarter conference call. As mentioned, this call will be posted on our website along with the associated slides. So, thank you for your participation and our best wishes for a great day to all of you.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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