Ecolab (ECL) Douglas M. Baker, Jr. on Q4 2015 Results - Earnings Call Transcript

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Ecolab, Inc. (NYSE:ECL)

Q4 2015 Earnings Call

February 23, 2016 1:00 pm ET

Executives

Michael J. Monahan - Senior Vice President External Relations

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Daniel J. Schmechel - Chief Financial Officer

Analysts

Gary Bisbee - RBC Capital Markets LLC

Nate Brochmann - William Blair & Company, L.L.C

David I. Begleiter - Deutsche Bank Securities, Inc.

David E. Ridley-Lane - Bank of America Merrill Lynch

John Quealy - Canaccord Genuity, Inc.

Dmitry Silversteyn - Longbow Research LLC

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Andrew John Wittmann - Robert W. Baird & Co., Inc. (Broker)

Michael Joseph Harrison - Seaport Global Securities LLC

Rosemarie Jeanne Morbelli - Gabelli & Company

Robert Andrew Koort - Goldman Sachs & Co.

Scott Schneeberger - Oppenheimer & Co., Inc. (Broker)

Operator

Greetings and welcome to the Ecolab Fourth Quarter 2015 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Michael Monahan, Senior Vice President of External Relations for Ecolab. Please go ahead sir.

Michael J. Monahan - Senior Vice President External Relations

Thank you. Hello, everyone, and welcome to Ecolab's fourth quarter conference call. With me today are Doug Baker, Ecolab's Chairman and CEO; and our CFO, Dan Schmechel.

A discussion of our results along with our earnings release and the slides referencing the quarter's results and our outlook are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statements on these materials stating that this teleconference, the discussion, 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 and Form 10-Q, under Item 1A, Risk Factors, and in our posted materials. We'd also refer you to the supplemental diluted earnings per share information in the release.

Starting with a brief overview of the quarter, continued strong new account gains and new product introductions drove good fixed currency sales growth in our Global Institutional, Industrial and Other segments during the fourth quarter, nearly offsetting a decline in Global Energy sales. Delivered product cost savings, ongoing cost efficiency work and synergies led the strong adjusted operating margin expansion, more than offsetting the impact of softening economies, weaker oil prices and increased currency headwinds. These, along with the lower tax rate and fewer shares outstanding, drove the adjusted earnings per share increase

While 2016 will present challenges, we are prepared to respond. Once again, we will focus on the fundamental Ecolab growth strategies that have proven successful through repeated economic cycles. The best products and service for our customers to give them the best results and lowest operating costs. We expect them to succeed again in 2016.

Looking to the first quarter, we expect our Global Institutional, Industrial and Other segments to continue to show solid fixed currency growth, outpacing their markets and softer international economies as they leverage investments we have made to further improve sales and service force effectiveness and profitability, and more than offset lower results from our Global Energy business.

We look for the first quarter earnings to show very attractive growth before currency, increasing 5% to 14%, as we continue to aggressively drive business growth. Adjusted earnings per share are expected to reflect about 14 percentage points of unfavorable currency impact, yielding adjusted EPS in the $0.73 per share to $0.80 per share range.

We look for comparative results to improve as 2016 progresses and show strong results for the full year with 9% to 13% adjusted earnings per share growth before the unfavorable impact of currency and the Venezuela deconsolidation. We expect currency and the Venezuela deconsolidation will penalize 2016 growth by approximately 9 percentage points. Net, we expect Ecolab to once again significantly outperform its markets and show a superior performance in 2016 while also investing in the key drivers for future sustainable above average earnings growth.

Moving to some highlights from the fourth quarter, and as discussed in our press release, reported fourth quarter earnings per share were $0.69. On an adjusted basis, excluding special gains and charges and discrete tax items from both years, fourth quarter 2015 adjusted earnings per share increased 2% to $1.22 despite a $0.13 or 11% currency headwind. The adjusted earnings per share growth was driven by delivered product and other cost savings, cost efficiencies, synergies, new products, and lower tax rate and share count.

Our fixed currency acquisition adjusted sales were modestly lower as our Institutional, Industrial and Other segments grew 4%, but were offset by a lower energy sales. Regional sales growth was led by Europe and Latin America excluding Venezuela. Adjusted fixed currency operating margins showed very strong growth, expanding 130 basis points.

In 2015's difficult environment, we focused on driving new business gains and lower costs. We used our industry-leading product innovation and service strengths to help customers achieve better results and lower operating costs. And through these, aggressively drove new account gains across all of our segments. Further, raw material cost savings along with our cost efficiency work, helped to offset these headwinds. Importantly, we also continued to make investments in our key growth drivers.

These actions delivered a strong fundamental business performance in 2015 with double-digit profit growth before currency. The fourth quarter represented another strong performance on this basis, growing 13% despite the further deterioration in Energy markets.

As noted earlier, the business environment has become more challenging in recent months as the dollar strengthened, Energy markets weakened, and global economies softened. Nonetheless, against that challenging backdrop, we look for 2016 earnings before currency and Venezuela deconsolidation effects to continue to show strong growth as we implement the same approach in 2016 as we did in 2015 and aggressively drive market share and new business gains.

We expect first quarter adjusted earnings per share from operations to rise 5% to 14% before currency and the Venezuela deconsolidation, with adjusted earnings per share in the $0.73 to $0.80 range, reflecting a currency drag of approximately 14% to earnings per share growth.

Results are expected to improve as the year progresses with the second half outperforming the first half. We look for full year adjusted earnings before currency and the Venezuela deconsolidation to increase 9% to 13%. We expect adjusted earnings per share in the $4.35 per share to $4.55 per share range with currency and Venezuela deconsolidation representing an approximate 9% drag to results.

In summary, despite a very challenging global economic and market environment, we expect our underlying business to continue to deliver very strong fundamental earnings in 2016. We remain confident in our business, our markets, and our people, as well as our capacities to meet our aggressive growth objectives over the coming years.

And now here's Doug Baker with some comments.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Thanks, Mike. First, I'll just offer some perspective on 2015 and then talk 2016 as well. So 2015, we had very solid business performance. It was clearly shrouded by FX. But if you take it net of translation FX, our EPS was 12% for the year and 13% in Q4.

And this includes the full impact of Energy in the year and in the quarter, full impact of transaction FX. It includes system investments of $0.10 for the year, which is $0.03 over last year. It also includes an increase in sales and service head count, i.e., we continue to invest in the business while driving double-digit results in obviously not the perfect environment.

Our major business drove this. All of them grew faster than their markets, including Energy. While Energy was hit clearly by the oil and gas market headwinds, it outperformed. So in a market with a 60% decline in U.S. rigs, 50% drop in oil prices, our Energy business declined 8% top line for the year, 14% in OI.

If you parse through Energy and look at the core of the business, the production or OFC and downstream collectively, they grew top line 1% and OI 8% for the year. So the core of that business managed very well.

The rest of our businesses, I'd say, also outperformed the markets and had a very, very strong year. So Institutional globally grew sales 6%, OI 12%. F&B grew sales 6%, OI 16%. Water grew sales 6%, OI 12%. Specialty services 7% and 16%. If you add in the rest, Paper, Healthcare, et cetera, the total of all those businesses was 5% growth and 12% OI.

We drove it the old fashioned way. We continued to take share. We're outgrowing our major competitors in the markets we compete in as our team continued to drive innovation and delivered new business. This is what drove the underlying 12% EPS performance.

So as you look at 2016, it's going to be much more of the same. It's going to be continued FX headwinds, see more of the same market conditions. We expect the economies globally to be choppy, but manageable. It's going to be continued tough oil and gas markets, offset, in part, by favorable raw material markets, which is the flip side of that coin. But most importantly, we're going to have continued strong underlying business execution.

So we expect to deliver double digit underlying EPS growth again in 2016. The range is 9% to 13%. We expect Energy to continue to be impacted by the tough market conditions, but our natural raw material price hedge will mitigate this negative impact.

Energy, we do not believe will be as negative as last year, but given our forecast position of no 2016 energy market turnaround, it will likely decline modestly year-on-year, but at a slower rate than last year. The balance of the business is poised to have another very good year; a bit stronger than 2015 on top-line and continued margin expansion.

Net, we feel good about the business. In 2016, as we continue to invest for the long term, we're going to continue to invest in R&D and systems field technology, sales fire power, talent development. We're very, very excited about the future and I think our investment belies (10:40) that. Our positioning and promise of clean water, safe food, abundant energy, healthy environments, we believe remains even more relevant or is more relevant as we go forward.

So, the business continues to do well. The underlying results, I believe, demonstrate our resilience as we continue to deliver double digit EPS, when you exclude translation FX, in far from perfect market conditions.

So with that, I'll turn it back to Mike and we can open it up for Q&A.

Michael J. Monahan - Senior Vice President External Relations

Thanks, Doug. A final note before we start the Q&A. We plan to hold our annual tour of our booth at the National Restaurant Association Show in Chicago on May 23. If you have any questions, please contact my office.

That concludes our formal remarks. Operator, would you please begin the question-and-answer period?

Question-and-Answer Session

Operator

Thank you. We'll now be conducting a question-and-answer session. Our first question is coming from Gary Bisbee from RBC Capital Markets. Please proceed with your question. Perhaps your line is on mute, Mr. Bisbee?

Gary Bisbee - RBC Capital Markets LLC

I'm sorry. Can you hear me?

Michael J. Monahan - Senior Vice President External Relations

Yeah, we can hear you, Gary.

Gary Bisbee - RBC Capital Markets LLC

Okay. Sorry about that. Hey, so the first question just on the global macro, how much worse have things gotten? Is your message more that this is just a continuation of the weak-ish growth we had in 2015? Or do you feel like things really have gotten worse in the last quarter or two? Thanks.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Gary, I would say I think the base economy is a little worse. I don't think it's the driver. U.S., we expect U.S. to continue to slog along with positive GDP, but there are some positive impacts in U.S. for us, i.e. in the food service market and some of the others where frankly cheap oil price starts driving consumer behavior in our favor, at least in that part of the business. We think Western Europe's likely to be worse in 2016 than in 2015 as they've just a baseline economy. It was probably our big positive surprise last year. And we would expect it to be modestly off in terms of economic growth, but still growing this year, so we're not predicting recession. China is still more (13:15). Then you look at Latin America, clearly, Brazil is going to be not very healthy. So I'd call it a tick off, but I don't really believe that's what we're trying to forecast as a driver. As long as it doesn't turtle, we should be fine and able to grow. I think next year, I think our base sales are going to be better in 2016 than 2015.

Gary Bisbee - RBC Capital Markets LLC

Okay. Fair enough. And then the follow-up question, just on margins, I guess the midpoint of the margins within the guidance assumes a deceleration of the expansion. I guess, wondering if you could just talk about the puts and takes there from underlying trend, how the benefit from lower raws is flowing through or you think it will this year, and anything else, in particular, that you've got implied in that guidance. Thank you.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, well, I would say, this year, clearly, margin accelerated throughout the year, which is what we predicted. And that was that raw material savings increased as the year went on, which is how they manifest themselves. We also had the other side, which is the Energy business cost savings effects really built throughout the year too, as we had to take out heads and other things. And obviously you have more heads out of your business in Q4 than you did in Q1, if it's an initiative that you undertake at the beginning of the year.

In 2016, we would expect margins to continue to expand at a somewhat slower pace than they expanded in 2015. And really that's mainly driven by the fact that raw material delta isn't going to be a significant savings. It will be a savings, but not the same level in 2016 versus 2015 as 2015 was to 2014. But we would expect margins to continue to accelerate and improve.

Gary Bisbee - RBC Capital Markets LLC

Thank you.

Operator

Thank you. In the interest of time, we ask that you please limit yourselves to one question and one follow up. Our next question is coming from Nate Brochmann from William Blair. Please proceed with your question.

Nate Brochmann - William Blair & Company, L.L.C

Yeah. Good afternoon, everyone. Hey, Doug, just a little bit on the Energy business. Obviously, you've seen a lot of pressure in WellChem throughout the year, and we continue to see that a little bit. The rest of the business has held up, some way, okay.

Could you comment a little bit in terms of, obviously, I'm assuming that you're getting some pricing pressure across the board, but also ex-WellChem, kind of what you're seeing in terms of whether those trends remain stable or there you're seeing a little bit of an increasing pressure here and there? And what could be some of the puts and the takes as we move throughout 2016?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. Look, we expect there's going to be continued WellChem pressure throughout the year, but obviously, it's a smaller piece of the portfolio given its decline last year. In terms of the production piece of the business or OFC, there's pricing pressure there. We had very strong production volumes in 2015. I think production will be – it's going to be about even with last year for the year, so we don't think that's really going to be the big negative impact. But there may be some slight negative in our OFC production business, not material and not significant.

And then downstream, we would expect to be quite strong this year as it goes forward. I would say, net on balance, Energy, simply because the comparative period becomes much easier, is going to be at worse less of a drag than last year, at better maybe no drag in terms OI.

Nate Brochmann - William Blair & Company, L.L.C

Okay. And then just a quick kind of bookkeeping thing, but on the interest expense being up a little bit. Is there any structural changes going on there in terms of some permanent things or is that kind of a temporary kind of one year up mark?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

I'll let Dan answer this one.

Daniel J. Schmechel - Chief Financial Officer

Hi, Nate. This is Dan. Nothing structural going on. The increase in interest expense is really based on the continuity of how we're thinking about managing the capital structure, first of all. So a slight increase in the total amount of debt. We are also doing a fairly significant chunk of refinancing of term debt, and likewise anticipating, based on the current yield curve, slightly higher short-term interest rates during the year. So, I would say, it's a tiny bit of volume, but mostly it's a rate impact. Okay.

Nate Brochmann - William Blair & Company, L.L.C

Thank you.

Operator

Thank you. Our next question today is coming from David Begleiter from Deutsche Bank. Please proceed with your question.

David I. Begleiter - Deutsche Bank Securities, Inc.

Doug, just on the Water in Q4, it looks like that business did decelerate a little bit. Reasons why that happened and what's your expectations for 2016?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, you're right. The headline number on Water looked like it decelerated. If you strip out mining where we really had some significant pressure, Water was up 5% in the quarter year-on-year, so no real deceleration, continued strength. As we look for the year, I would say, we expect Water to accelerate through 2016. The headline number is going to be a little impaired again in the first quarter, mostly because of mining again, but that dissipates as you start annualizing against some of that pressure. And Water, for the year, we'd expect to be a pretty strong number in 2016.

David I. Begleiter - Deutsche Bank Securities, Inc.

Very good. And just on WellChem, Doug, how large is that business now as a percentage of the overall Energy business? Is it roughly 10% or a little bit more, a little bit less?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, it's about 10% of the Energy revenues.

David I. Begleiter - Deutsche Bank Securities, Inc.

Thank you very much.

Operator

Thank you. Our next question today is coming from David Ridley-Lane from Bank of America Merrill Lynch. Please proceed with your question.

David E. Ridley-Lane - Bank of America Merrill Lynch

Sure. Another question on Energy. Just roughly what percentage of your business today is related to U.S. shale production? And if you have a view as to what's embedded in your revenue outlook in terms of U.S. shale related revenue?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. In total, it would be around 15% of the Energy business.

David E. Ridley-Lane - Bank of America Merrill Lynch

Got it. And then the fourth quarter results show pretty significant cost savings in Energy. Are there other levers that you're planning to pull or are you just counting on anniversarying the cost reductions you've already done?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, there's a little more to come but most of the benefit in 2016 versus 2015 will be annualization of what you're seeing in Q4. There's a bit more that's coming, but that's the bulk of it.

David E. Ridley-Lane - Bank of America Merrill Lynch

Okay. Thank you very much.

Operator

Thank you. Our next question is coming from John Quealy from Canaccord Genuity. Please proceed with your question.

John Quealy - Canaccord Genuity, Inc.

Hi. Good afternoon, folks. So, in both Global Institutional and Global Industrial, specifically industrial food and beverage and institutional, the core institutional business, can you talk about the dynamics for 2016 price versus volume? They've held up still very well all-in in this market. So if you could just talk through some of the variables that play in 2016 for growth there on the top line.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I would say Global Institutional, the division not the sector, we would expect to have a very similar, strong 2016 as 2015, and maybe some dynamics as to where the growth is that are a little different. We would expect margins to continue to increase in 2016. And so, that's a bit of a benefit from raws, but not significant in institutional. Continued innovation driving margin, which has really been the play in institutional for a number of years, and we have a very good innovation pipeline.

In terms of F&B globally, I would say, we expect a better year in 2016 than 2015, and they had a good year last year. So there's been a bunch of new business, improved performance in North America, in particular, and continued margin expansion there. That business benefits a little more as a percent from raw material market benefit than institutional just by the mix of raw materials that they buy, but again, they're also doing a good job in innovation.

John Quealy - Canaccord Genuity, Inc.

And then last, on the M&A environment, given the slowdown in the macro, have prices come in at all? Does it make you want to change the total dollar amount that you talked about on the Analyst Day for deployment, et cetera? Thank you very much, folks.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

M&A, look, is kind of an ongoing interest. We don't really get interested and then lose interest. I would say, right now, we've got a very rich pipeline. We ended up closing deals last year that are going to deliver over $300 million in sales. I hope we do better than that this year. The wildcard is valuation. And I would say, the market is fairly richly valued at this point in time. And so, I think we're working to be very smart and choiceful. Ultimately, we want to do deals that we know we can get very good returns on long term. That's the main metric we pay attention to, not accretion, dilution, et cetera, but what is the ultimate return going to be. We've seen this cycle before. It does come and go, and we're going to be very, very careful while we're in a frothy environment.

Operator

Thank you. Our next question today's coming from Manav Patnaik from Barclays. Please proceed with your question.

Unknown Speaker

Hi. This is actually Greg (23:04) calling on for Manav. I was just wondering if you could give a bit more color on the inputs into your Energy forecast in terms of what you're thinking about for the oil price trajectory. And then during Investor Day, you kind of talked about a snap-back in 2017. Is that still your base case or are you guys kind of thinking about more of a U-shaped recovery as we look out into 2017?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I would say, for the year, we've been fairly consistent. We do not expect the Energy market, i.e., if you're measuring, say, oil price, to recover in 2016. It doesn't mean that we might not see increased oil prices in May and June as we move into the summer driving season, but we think that could be followed by a bit of a dip. We do believe in 2017 that the supply and demand lines start converging and that we will see a change in oil price over time. We're not predicting a snap, a U, a saucer or anything else. I think it's too early. We're probably not the best people to predict that. But ultimately, we do believe that the oil price will move north of $30. We don't believe that really happens for any extended period of time until 2017 and beyond.

Unknown Speaker

Okay. Fair enough. And I think you talked about the cheaper gas prices as a potential tailwind for your consumer businesses. We've seen a couple of reports that that tailwind hasn't played out as much as some people would've thought of. So I'd love to hear what you're seeing in your businesses and if you're actually seeing some marginal benefit there.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. Look, you can find all kinds of metrics. I would say, the food service business, traffic hasn't really turned around, but sales in many of the food service establishments have improved, not in all. And I would say we look at both lodging and food service as healthier than they were a few years ago. Lodging has been fairly consistent, but food service in particular. In our U.S. sales, where you see the singles biggest decline in gas price because you don't have currency neutralizing it as you do in other countries, we've seen pretty robust market conditions, better.

Unknown Speaker

Perfect. Thank you.

Operator

Thank you. Our next question is coming from Dmitry Silversteyn from Longbow Research. Please proceed with your question.

Dmitry Silversteyn - Longbow Research LLC

Good afternoon, gentlemen. Couple of questions, if I may, first of all, you mentioned Latin America as a source of strength for your Industrial and Institutional businesses. That's a rare thing to hear these days. Can you talk about what you're doing to succeed in that region and how you look at it in 2016, obviously, with Venezuela being the deconsolidated operation now?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. So I'll give you numbers ex-Venezuela. For the year, we were double-digit in Latin America. This is on fixed currency. So that's not a small thing, given the real and everything else. What's driving it is just underlying success in securing new business. I mean there is no other – there's nothing fancy going on.

We've got a good team. Businesses are focused. This is more on the Industrial side of the business is where we're having the most success throughout Latin America. And we would expect to have continued success in 2016 in that market as well.

Dmitry Silversteyn - Longbow Research LLC

All right. So it's a question of not so much the economies or your sectors of the economies doing well, it's just getting new business and hopefully getting pricing to offset some of the FX headwind?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, Dmitry, I would say, look, the economy can get bad enough where it absolutely impacts us. So, we're not bulletproof and we've never pretended to be. But when I had that earlier question on the economy, if it's growing at, I don't know, 4% or 3% or 3% or 2%, we're not that sensitive where we're going to feel those types of changes. What we really focus on is driving share. And we have enough share upside in virtually every business, every market we compete in that we believe, in most situations, we control our destiny. And our teams are out there trying to go secure new business. And the headlines around Latin America being in the dumps are interesting, but we believe we can continue to be the exception to that rule as long as we keep focused on driving innovation and new business.

Dmitry Silversteyn - Longbow Research LLC

Got you. And then the follow-up question with respect to international operations and foreign exchange expectations, you highlighted about a $0.36 headwind for the year. That's about $0.10 above the midpoint of the range you gave a couple of months ago. So I guess the question is which currencies have gotten worse since then or is your outlook on the recovery in exchange rate changed for 2016?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I think the difference between the old forecast and the new is Venezuela. And a lot of the Venezuela impact we have in FX, because there is, in fact, a huge devaluation of their currency, which was sort of a reflection of the turmoil they have in their economy. So I think that dealt it, and if you have more questions on that, we'd be happy to address them.

In terms of expectations going forward, we've given the best forecast we can. We were way off in terms of our anticipated FX impact in 2015. If you looked at what we thought was going to happen in the first quarter versus what we ended up happening, I think it was $0.18 over plan for the year. We don't pretend to be great at forecasting this. We're trying to give clarity to you so you know what our underlying forecast is and you know what our FX forecast.

Obviously, if FX comes in a lot lighter than we've stated, then we are going to have better results. And conversely, if it's a lot worse than we stated, we're going to have worse results in terms of our adjusted EPS with FX. I think the FX we've got is realistic and makes sense given the environment we think we're in.

Dmitry Silversteyn - Longbow Research LLC

So I understand, I thought that the currency did not include the Venezuelan operations, but if they do, then I guess the guidance was about the same because I think the sum of the two impacts was about $0.40 and now you're guiding to $0.38. So that's pretty much in line. Okay. That's all. Thank you.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

You bet.

Operator

Thank you. Our next question today's coming from Shlomo Rosenbaum from Stifel. Please proceed with your question.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Hi. Thank you for taking my questions. Hey, Doug, I'm just going to kind of continue to kind of beat this Energy horse over here on, if you can just walk through some of the underlying assumptions, particularly if the WellChem should decline, you're assuming production is flat, but are we going to end up or are you anticipating a scenario where the production goes to kind of the cheaper-to-produce type of oil that just requires less chemicals?

In other words, I'm trying to get to what the assumptions are if we have kind of flat production revenue and (30:40) modestly lower top line, what's embedded in that? I assume there's a little bit of pricing, but are we in a situation where just the oil that they're going after is just cheaper to get oil right now?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I guess. I may even go a little higher on this for a few minutes. I think the big change year-on-year in terms of when we talk about oil's impact, the energy impact on our business, is the fact that we're going against an entirely different base. So when we're giving an EPS forecast and growth forecast, I mean, obviously, we're comparing it against 2015 not 2014, and that's not insignificant when you look at the Energy business. So, the really only negative comparison that we have ever talk is the first quarter. And that's when the market really started diving and our business started feeling the impact of the market.

So, in terms of WellChem, we think WellChem is going to be negative for year, but nowhere near the types of numbers we saw last year. It's going to be mitigated by the fact that it's going against last year. We've gained share in a couple of key segments and we feel a lot of the rig count decline is in the base as we move forward. U.S. is down 62%, so even a 20% decline isn't all that material given that you've already taken 60% of the market.

You have OFC is going to be flattish for the year. We have pricing pressure there. We'll continue to have fairly solid volume. We've got some new business coming on. I mean we have secured some new business. Some fields came on during the year that were basically CapEx that was spent prior years and/or platforms that went out to sea, etcetera, that's going to be net new business.

In total, we look at that flat to modestly down, but very modest. And in the downstream, we expect to have a stronger year this year on the top line than last year. So net, I think it's a very modest decline in the top line to something resembling this year's decline, which is 8%. I think it's going to be less than that would be the downside case.

When you look at OI, there's mitigating. We've got cost savings going this year, started really seeing full effect in Q4. They're going to annualize. The head count moves have been taken. There are not a lot more anticipated or any really anticipated going forward, but we're going to be very judicious about heads that we add as we move forward. So cost savings are going to be a bigger positive. And the raw material markets are going to continue to benefit the Energy business.

Now part of that is given back in the form of cost-plus arrangements, but not all of it. And so last year, we had some margin decline. Fourth quarter margin was up. Some of that was one-time benefits but it was probably up, if you neutralize for that, about 90 basis points in the fourth quarter. We don't expect it to be that strong throughout the whole year, but we do have steps in place now that we think mitigate margin decline. And we think volume is going to be not a significant story this year. So that's the Energy story.

In net, this natural hedge we have of energy pain offset by raw material gain in the balance of the business is going to be true next year too. Those are almost a net neutral in 2015. We would expect they're going to be close to a net neutral in 2016. And so, then it's back to the Industrial, Institutional, and other businesses, which we think are going to have another strong year. I mean that's the fundamental equation.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Okay. Thank you very much for that color. We didn't hear anything about pension. Last year, we talked a lot about pension. Is there a plus or a minus going on in pension underlying, Dan?

Daniel J. Schmechel - Chief Financial Officer

Hi. So, this is Dan. Thank you. We'll see a favorable year-on-year pension expense, okay, driven by – primarily by the lower rate environment. We are changing our accounting in the calculation of the pension expense, but we will see a year-on-year benefit. Look, I'd say this, it's largely all offset within the compensation line. You think on the back of a year like this, there's pretty significant variable compensation rebuild that has to go on in the businesses, in the corporation, which offsets most of that. Any remaining piece is essentially offset by less year-on-year benefit in the raw material markets.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

So, is there any way to quantify that or way that we should be thinking about that. So when we model our 2017 numbers, we don't assume a similar type of gain?

Daniel J. Schmechel - Chief Financial Officer

It's about $0.14 and $0.14 I think, plus and minus. The pension benefit year-on-year is like a pickup of $0.14, and that's about the offset.

Shlomo Rosenbaum - Stifel, Nicolaus & Co., Inc.

Okay. Thank you.

Operator

Thank you. Our next question is coming from Andy Wittmann from Robert W. Baird. Please proceed with your question.

Andrew John Wittmann - Robert W. Baird & Co., Inc. (Broker)

Thanks. I wanted to maybe get a little bit more detail on the margin and kind of break it down. Looks like the SG&A guidance for the year suggest that SG&A will be roughly flat as a percentage of revenue. Gross margin at least the range brackets the 2015 reported number. So I guess the question is, you said that there'd be some margin expansion in 2016. Where does it come from? And do you see it as a result of identifiable cost reductions? I guess you mentioned a little bit in the last question, Doug, or is it more as a result of just operating leverage from the business?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. I would say on the margin improvement in 2016 is pricing, still favorable raw markets, and innovation, and it's a little different by each business. Those are the inputs, mostly it's going to be in gross profit. You're right, SG&A, any pick up we would see from growth and/or volume benefit is going to be offset by investments.

Andrew John Wittmann - Robert W. Baird & Co., Inc. (Broker)

Got it. And then a question on cash flow and the balance sheet. I guess in the part of the script that wasn't highlighted on the call, you mentioned that there's a $700 million buyback assumed. Cash flow, I guess, don't know exactly what it's going to be, but it should be well over $1 billion, probably $1.4 billion, $1.5 billion, I would imagine. So are you expecting to deleverage the balance sheet? Or should we assume that that might be – that other capital that's not considered in the $700 million buyback is maybe the M&A budget for the year that you hope to deploy?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah. Since Dan is not at the mike, I'll handle it and he can walk over and correct. So, yeah, free cash this year was $1.2 billion. It was up 15% in 2015 versus 2014, which we considered a strong performance. Cash will be a little beneficial to that next year, but not nearly as dramatic an increase. Uses of cash are going to be nearly identical in 2016 as in 2015, i.e. you saw the share buyback. It's virtually the same number in dollars as last year. And you can go and do your implied M&A, right?

Daniel J. Schmechel - Chief Financial Officer

That's right.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Same number.

Daniel J. Schmechel - Chief Financial Officer

Yeah. I think a good assumption would be that M&A will be directly in line with this year's. Of course what the actual number will be depends on where individual conversations progress.

Andrew John Wittmann - Robert W. Baird & Co., Inc. (Broker)

Thank you.

Daniel J. Schmechel - Chief Financial Officer

But certainly no leveraging is anticipated. We'll be slightly up in debt, but the increase year-on-year in interest expense is really a rate conversation as I indicated earlier.

Andrew John Wittmann - Robert W. Baird & Co., Inc. (Broker)

Yeah. Okay. Thank you.

Operator

Thank you. Our next question is coming from Mike Harrison from Seaport Global Securities. Please proceed with your questions.

Michael Joseph Harrison - Seaport Global Securities LLC

Hi. Good afternoon.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Hi, Mike.

Michael Joseph Harrison - Seaport Global Securities LLC

Doug, just looking at the organic sales number in Water, you called out the mining piece. I think that's about 15% of sales in Water. So was that down 25% or 30% year-on-year? And can you talk about what the growth rates look like on the light side of Water and heavy side?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, it was down. Mining was down double digits in the quarter. It went down 20% or 25%, but we got 15%, and you need a point and a half, I mean, that's what we're talking. And I'm talking on the core Water. There's other parts of the Water business. In terms of heavy, heavy was up 4% in the quarter, and light was up little north of 5%.

Michael Joseph Harrison - Seaport Global Securities LLC

And then looking at the impact of the Venezuela deconsolidation, you called out that it's $200 million in revenues. How much of that revenue is in the Energy segment? And I guess I'm under the impression that that was relatively high-margin business. So what's the revenue and operating income impact of that deconsolidation on Energy?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

I can't read that number. Energy ought to have been off by 8% (40:45). Energy was $158 million of the $200 million in sales. And I think we gave a total operating income impact number, didn't we?

Daniel J. Schmechel - Chief Financial Officer

No. EPS is $0.17.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Oh. Okay. EPS is $0.17. You got our share count.

Michael Joseph Harrison - Seaport Global Securities LLC

All right. I can do the math there. Thank you.

Operator

Thank you. Our next question today is coming from Rosemarie Morbelli from Gabelli & Company. Please proceed with your question.

Rosemarie Jeanne Morbelli - Gabelli & Company

Thank you. Good morning – good afternoon, rather, everyone. Looking at the Paper side, you talked about a decline in Asia-Pacific and then an improvement in North America and Europe, yet paper mills or machines or paper machines are still closing in North America and Europe, and the paper demand is expanding in Asia-Pacific and China especially. So I was just wondering where Ecolab is doing so well and why your result seems to be in opposite direction as to that of the paper industry?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Well, our Paper business was, what, 3% ex-Venezuela in the fourth quarter, which is probably good in the Paper business and we'd still like to see 5%. So look, tissue, towel and cardboard continue to grow. You're right. We've had to go work through and I think everybody's timing on when they have plants that are being shut down or shuttered is different.

Our business in China is not healthy, and that's obviously in the 3% number. And that's a business that we're working on making sure we get positioned right moving forward, because we do believe it represents a good opportunity long term. And I would just say we've worked hard and this team has worked hard over the years to continue to improve the position, i.e., make sure your pointed to where the growth is both regionally and within the Paper segment.

Rosemarie Jeanne Morbelli - Gabelli & Company

And then on the Healthcare, Doug, it is the first time, at least that I remember, where we actually see a little growth. So what are you doing there that is totally different from what you have done in the past? Is it a new marketing team? Have you figured out whom to talk to in order to convince them that they should be cleaning up those hospitals? Could you give us a better feel?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I would say two things. I mean, our Healthcare still is not performing where we want it to, but it did clearly improve. It was 1% growth in 2014. You adjust for the recalls, 3% to 4% in 2015, pick whatever number. It was improved, but not meeting our expectation. We expect it to be stronger this year.

The reason we believe we're accelerating is that we continue to do an improved job convincing healthcare systems that our program makes sense in light of the EHAIC challenge (43:56). And the team has improved the program, improved the story and improved the sales focus. I think what the team has in store, we feel very good about. I think we anticipate that we will continue to accelerate that business. I think that's one of the businesses that has significant upside in our portfolio, outsized upside, if you will, and we aim to get after it. But I would say we are continuing to improve there. Got a good team on it and I think we'll see better things even in 2016 versus 2015.

Rosemarie Jeanne Morbelli - Gabelli & Company

Thank you. And if I may ask one last question, on the M&A, any particular areas where you are focusing more where the opportunities are more attractive than in others?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

We've said we have our strategic priorities. With that said, we're open to smart bolt-ons, i.e., think Swisher in virtually every business. But we always figured there was probably going to be significant low-hanging fruit in Water, simply because prior to our acquisition, they were a bit capital-starved, et cetera. So, yeah, Water is a priority. Healthcare is a priority. But if we see good technology and/or bolt-on opportunities in any of our businesses, we are very willing and able to move forward. So right now, I would say, it's much more what the market is going to offer in terms of what can we buy at a price where we're confident we can deliver good returns for shareholders long-term.

Operator

Thank you. Our next question is coming from Bob Koort from Goldman Sachs. Please proceed with your question.

Robert Andrew Koort - Goldman Sachs & Co.

Thanks. Doug, I was wondering if you could characterize what was different in your Industrial versus your Institutional business in terms of the margin expansion you delivered in 2015.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Well, if you look at the segment, you'd have to pull out the recall out of Institutional, but even if you do that, you'll see more significant margin expansion in Industrial. And that's just they've got more exposure to the types of raw materials that lowered as a consequence of oil lowering. And it's a mix of raw materials. So that's the single biggest impact and it built throughout the year.

Look, raws go up, go down, we typically work to sell in both our Institutional and Industrial markets based on value delivered. And our equation needs to bring benefits to our customers that are financial in nature as well as, say, safety and/or risk reduction. And as a consequence, we work hard to do that ongoing so raw materials can benefit us. We tend not to give them back long-term as long as we continue to have a great value story to our customers.

Robert Andrew Koort - Goldman Sachs & Co.

Makes sense. And then can you talk about what you anticipate on sales head count and how that's changed over the last few years? And I think most folks expect GDP to grow in Europe. So is there something more sinister or something about your particular end market exposure that leads you to think Europe could actually decline as a region?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Oh. Well, one, I'm sorry if I – I don't think Europe's going to decline as a region.

Robert Andrew Koort - Goldman Sachs & Co.

Sorry, decelerate.

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, well – yeah, so this year, our European business, all in, grew by 5%. That's pretty good performance in Europe and we felt pretty good about that. It also had very good OI leverage. It was 100 basis points, 110 basis points, consistent with our Renaissance program that we talked about. So all told, we've added 550 basis points to our Europe margin over the last five years.

Our view on Europe is just that the economy is not going to be as robust in 2016 as 2015. It's not going to go upside down, so we'd expect growth maybe more in the 3% range than in the 5% range, but I don't think that's all the drama. It's 20% of our sales.

Robert Andrew Koort - Goldman Sachs & Co.

Great. Thanks.

Operator

Thank you. Our next question today is coming from Scott Schneeberger from Oppenheimer. Please proceed with your question.

Scott Schneeberger - Oppenheimer & Co., Inc. (Broker)

Thank you. Good afternoon. I guess just kind of high level, looking at the 2016 EPS guidance range, what would be the major, I imagine we could guess at the top one or two, but maybe the top three or four swing factors that would put you at the extremes or outside that range?

Douglas M. Baker, Jr. - Chairman & Chief Executive Officer

Yeah, I would say, the number one plus minus is going to have to be FX. The second would be change in the Energy market. I would say, there's probably going to be more impact if it goes up than if it goes down from here. But it could go down bad enough or could have a material impact I imagine too. But it's starting to get squeezed on the downside. And then overall economy, but typically, that doesn't impact us immediately. So, I would say, that's probably a distant third as we look at it.

And then it's just other exogenous events, right, that none of us can predict, but would affect any company dealing in a global basis, be it terrorism or major economic calamity in a market. I would say this, I think our business has proven pretty resilient. If you look at our underlying forecast, we have a midpoint of 11% for EPS ex-FX in 2016. And that's really driven by business performance. It's neutral when you look at shares, interest and tax. And last year, they brought a benefit. So it is indicating that we expect our business performance to be even a bigger contributor in 2016 than in 2015. And the reason we believe that is we have the underlying trends. We know what we've sold. We know where the innovation pipeline is. And we know what's happening on pricing. And so we feel like we're well-positioned to continue to do well even in this environment.

Scott Schneeberger - Oppenheimer & Co., Inc. (Broker)

Great. Thanks. And then as a follow up just for modeling purposes, Dan, I think you said $0.11 ForEx impact in the first quarter and ballpark a range surrounding $0.20 for the year. How should we think about the cadence for the year just on the way you're looking at it? Thanks.

Daniel J. Schmechel - Chief Financial Officer

Yeah, well, sort of as the first quarter and the full year numbers would progress, right. I mean we think that this will drop off a little bit by quarter as you go through the year just based on how the currencies weakened throughout – continued to weaken throughout 2015.

Scott Schneeberger - Oppenheimer & Co., Inc. (Broker)

Thanks.

Operator

Thank you. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to Mr. Monahan for any further closing comments.

Michael J. Monahan - Senior Vice President External Relations

Well, that wraps up our fourth quarter conference call. This call, the associated discussion slides will be available for replay on our website. Thanks for your time and participation today, and our best wishes for the rest of the day to you.

Operator

Thank you. And that does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.

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