Ecolab Inc (ECL) — Q1 2015 Earnings Call Transcript

Thank you. Hello everyone and welcome to Ecolab’s First Quarter Conference Call. With me today is Doug Baker, Ecolab’s Chairman and CEO. A copy of our earnings release and the accompanying slides are referenced in this teleconference and are available on Ecolab’s Website at ecolab.com/investor. Please take a moment to read the cautionary statements on Slide 2, stating that this teleconference and the slides include estimates of future performance. These are forward-looking statements, and actual results could differ materially from those projected. Factors that could cause actual results to differ are described in the section of our most recent Form 10-K under Item 1A, Risk Factors, in our first quarter earnings release and on Slide 2. We also refer you to the supplemental diluted earnings per share information in the release. Starting with an overview on Slide 3, strong new account growth and new product introductions drove a solid fixed currency sales increase in the first quarter. We leveraged that growth along with pricing, delivered product cost savings and our ongoing synergy and cost efficiency work to more than offset headwinds and increase our adjusted operating margins. These along with a lower tax rate and fewer shares outstanding drove an attractive adjusted earnings per share increase. Looking ahead, we expect 2015 to be another year of superior growth despite mixed macroeconomic and market trends, as well as substantially unfavorable currency exchange and pension costs. We’re seeing better sales growth in our institutional, other and industrial segments primarily resulting from internal work we’ve undertaken to improve our effectiveness. In addition North America restaurant trends are showing gradual improvement. Lower oil prices have yielded lower delivered product costs, while also slowing our energy segment. Net we continue to look for a strong profit growth in the mid to high-teens before currency and pension effects. The dollar has strengthened since the last call and we now expect currency exchange will be an unfavorable $0.30 per share. With pension and unfavorable $0.09 per share, currency and pension will represent a combined unfavorable impact of nearly $0.40 per share in 2015 or $0.09 of our EPS and 10 percentage points of EPS growth. We’ve adjusted our 2015 forecast to reflect the increased headwind from currency exchange in energy markets and now look for 6% to 10% EPS growth for the full year to the $4.45 per share to $4.60 per share range as continued good fixed currency sales growth, appropriate pricing, delivered product cost savings, innovation and synergies more than offset 2015’s increased challenges. We expect to show a 2% to 8% adjusted earnings gain in the second quarter as currency alone represents an estimated $0.08 per share which is $0.04 more than the first quarter impact. Moving to some highlights from the first quarter and as discussed on our press release, reported first quarter earnings per share were $0.77. On an adjusted basis excluding special gains and charges and discreet tax items from both years, first quarter 2015 earnings per share increased 8% to a record $0.80 despite a $0.06 headwind from the currencies and pension. The adjusted earnings per share growth was driven by volume, appropriate pricing, synergies, new products and the lower tax rate and share count. Our fixed currency acquisition adjusted sales growth was solid rising 4% and was led by our global institutional, other and industrial segments as each improved over its fourth quarter and 2014 growth rates. Latin America and Middle-East led the regional growth, while Europe growth also improved. Adjusted fixed currency operating income grew 7% and we expanded our operating margins by 30 basis points. We also continue to make key investments in the drivers for our future growth. We remain on plan to achieve our Nalco and Champion synergy targets and our Europe margins are on track for further strong expansion this year. In addition, we’re underway with our $1 billion share repurchase and bought nearly 3 million shares in the first quarter. Looking ahead, energy markets and some regional economies will present challenges in 2015 and the headwinds from currency exchange have only increased since we reported the last quarter. However, we also expect favorable tailwinds from lower oil cost to benefit our more consumer facing customers and we are realizing raw material savings that should improve in subsequent quarters. In this mixed environment, we will drive new business gains and lower costs as we maximize the benefits and minimize the challenges in 2015. We will once again use our product innovation and service strengths to help customers get better results and lower operating costs and through these drive new account gains across all of our segments. We expect the second quarter 2015 to show further solid fixed currency sales growth and margin improvement from our institutional, other and industrial segments as they more than offset lower energy results. Second quarter adjusted EPS is expected to increase 2% to 8% to the $1.05 to $1.11 range as the unfavorable currency impact increases by approximately $0.04 in the quarter and we compare against last year’s very strong second quarter when adjusted EPS grew 20% and was $1.03 per share. We look for the second half to show better gains as our institution, industrial and other segment sales continue to lead top-line growth. Delivered product cost savings should nearly double versus the first half and along with synergies and cost efficiencies lead to further margin expansion and yield the better EPS gains. We adjusted our forecast for the full year 2015 to reflect the increased headwinds from currency exchange in energy markets. We now look for 6% to 10% EPS growth to the $4.45 per share to $4.60 per share range with that wider than normal range reflecting the dynamic currency and commodity markets. In summary, we believe our first quarter performed very well despite very challenging conditions. We continue to expect 2015 to show strong operating performance for the company, despite the challenges in energy and to more than offset the increased drag on EPS growth from currencies and pension. 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, while also delivering attractive returns in 2015. Slide 4 shows our first quarter results both as reported and with adjustments for special gains and charges, while Slide 5 shows our sales growth detail. Ecolab’s consolidated fixed currency sales for the first quarter increased 4%. Acquisition adjusted fixed currency sales also rose 4%. Looking at the growth components, volume and mix increased 3% and pricing rose 1%. Currency was a negative 5% and acquisitions and divestitures were not significant. Reported fixed currency sales for the global industrial segment rose 5%. Adjusted for acquisitions and divestitures, sales increased 3%. First quarter fixed currency global food and beverage sales increased 6%. Adjusted for acquisitions, fixed currency sales grew 4%. Food and beverage growth was primarily driven by share gains and we used them to more than offset generally weak volumes. We enjoyed good growth in agri and food and beverage and modest sales gains in dairy and food. Regionally, we saw solid gains in Latin America, Middle-East Africa, Europe and Asia Pacific with modest growth in North America. Food and beverage continues to drive sales growth using its Total Plant Assurance approach to customers, in which we combine our industry-leading Cleaning & Sanitizing, Water Treatment and Pest Elimination capabilities to deliver improved food safety results, lower operating costs and better product quality assurance for our customers. This is enabled us to win business with key global customers and offset difficult conditions in our North America and Europe market, where lower volumes have impacted sales. Looking ahead, we expect improved organic sales growth in the second quarter. We look for further benefits from growth synergies, better customer penetration and new business capture, as well as leverage from our innovation pipeline, including 3D TRASAR for cleaning plate systems in food and beverage plants to more than offset continued tough industry conditions. Fixed-currency water sales grew 5%. Adjusted for acquisitions water sales grew 3%. Fixed-currency acquisition adjusted water sales excluding mining grew 4% as good gain in the power and light industries were partially offset year weak steel industry demand. Acquisition adjusted fixed-currency mining sales were flat. Regionally, we saw strong growth in Latin America and Middle East Africa, modest growth in Europe and North America and a modest decline in Asia-Pacific sales. The introduction of 3D TRASAR for hotel and other institutional cooling systems, utilizing solid chemistry and advanced dispensing is going well. We also continue to drive better penetration in our other water markets, using our innovative solutions to optimize water usage. We remain focused on building our corporate account and enterprise sales teams, delivering our growth synergies and improving product innovation to drive revenues. We expect to show improving growth through 2015 as market share gains drive our heavy and light businesses to outperform soft end-markets. First quarter fixed-currency paper sales grew 2%. Latin America recorded strong growth. Elsewhere we saw overall modest gains with slight improvement in North America and lower sales in Europe and Asia-Pacific resulting from continued low customer plan utilization and extended customer shutdowns and slowdowns. We expect paper to show to modest growth in 2015 as we drive new business and technology penetration to augment stabilizing paper market conditions. Fixed-currency sales for the Global Institutional segment rose 6%. Adjusted for divestitures sales grew 7%. Turning to the businesses that make up the segment, fixed-currency sales growth for the Institutional business grew 6%. Adjusted for small divestiture in your sales grew strong 7%. We saw further good growth in global lodging demand, but also positive signs in North America food service foot traffic. Another regional food service foot traffic trends remain steady. Looking at our regional sales, we continue to outperform our markets. We recorded strong sales growth in North America, North America, Asia-Pacific and Middle East Africa. Europe also improved reporting a moderate sales gain. Sales initiatives targeting new customers along with effective product and service programs appropriate pricing drive our results. We continue to globalize our leading technologies as we rollout our next generation laundry platform in Europe this year. Our work to standardize global competencies and initiative is going well and they’re helping to drive our sales improvements. We’re also focusing on strength in our execution and delivering increase customer value with solutions that reduce their water, energy and labor costs. With the work on our business fundamentals yielding good results and with end market study to improving, we look for further solid sales growth in the second quarter and for the full year. First quarter sales for specially grew 8% in fixed currencies. Quick service sales were solid as new account, increase service coverage and additional solutions leverage generally modest industry trends to drive growth. Regionally, Europe quick service sales grew double-digits benefiting from new accounts and additional customer solutions. While Asia-Pacific also shows strong gains building on good quick service foot traffic growth North America sales rose modestly. The food retail business posted solid double-digit sales growth benefiting from international customer additions, new products and increased penetration in North America. We look for good sales growth again in the second quarter, especially works to deliver another solid performance in 2015. Fixed currency global healthcare sales increased 5%. Sales gains were driven by new account growth, better penetration and new product introductions. We continued our work to strengthen our corporate accounts approach and our integrated value proposition, as well as better focused on product portfolio. We believe we are on the right track and look for core global healthcare sales to show moderate growth in the second quarter and the full year. First quarter fixed-currency Energy segment sales rose 1%. Looking at the components our upstream business rose modestly as the decline in North America results was offset by very strong international performance. The downstream business saw a good growth also led by strong international sales and share gains in North America. First quarter results reflected North American drilling and well completion activity that fell much faster than once than we expected while production gains were steady. Downstream growth stayed solid worldwide. Looking ahead, we now expect energy segment sales for the full year 2015 to show a low single digit decline primarily reflecting faster than expected reduction in North American drilling activity and customer spending reductions. We expect that second quarter and second half energy segment sales to decline in the mid-single digit range as good international growth, ongoing share gains and solid downstream sales are more than offset by lower North American upstream activity and price decreases. We expect a very challenging year particularly in the North American upstream industry. We are very experienced team in place. They have remained aggressive using our industry leading product innovation and outstanding sales and service team to drive sales and share growth and they will use this period to strengthen our position. We continue to remain confident in our energy segment and its long term growth prospects. Sales for the other segment increased 6%. Fixed-currency Global Pest sales increased 7% in the first quarter. Adjusted for acquisitions, fixed currency sales grew 6%. Sales to Food & Beverage customers and restaurants once again led the growth. We enjoyed sales gain in all regions. We continue to drive market penetration using innovative service offerings and technologies. We also showed further progress in globalizing our market focus capabilities and field technologies. We expect Global Pest sales to show further good growth in the second quarter led by gains in all markets. Equipment Care sales grew 7% in the first quarter. New customer additions continued at a solid rate and productivity improvements from our technology investments and strengthened execution work continue to pay off. With solid underlying business growth trends expected to continue, we look for Equipment Care to show upper single digit growth in the second quarter and expect a strong second half. Slide 6 of our presentation shows selected income statement items. First quarter gross margins were 46.5%. On adjusted for special charges first quarter 2015 gross margins were also 46.5% and rose 80 basis points above last year. The improvement resulted from volume and pricing gains, lower raw material cost, merger synergies and cost efficiencies. SG&A expenses represented 34.5% of our first quarter sales. The SG&A ratio increased 40 basis points versus last year. The increase primarily reflected the impact of higher pension expense investments in the business. Consolidated operating income margins were 11.8% adjusted for special charges fixed currency operating income margins with 12% raising 30 basis points over the last year’s comparable margins. Sales volume appropriate pricing, cost savings and efficiency improvements as well as merger synergies more than offset higher pension cost and investments in the field sales force and the business. Fixed Currency operating income for global industry increased 5%. Acquisition adjusted operating income grew 4% and margins rose 10 basis points, pricing, volume gains, lower delivered product cost and cost efficiencies more than offset paper business exchanges. Fixed Currency operating income for Global Industrial increased 12% and margin expanded 80 basis points. Results benefited from volume gains pricing and cost efficiencies which more than offset business investments. Fixed currency global energy operating income increased 1% and margins were steady. Flattish volume, lower pricing and business investments were offset by lower delivered product cost synergies and cost savings. Fixed Currency operating income for the other segment increased 9% and margins expanded 40 basis points. Improved operating results more than offset business investments and higher cost. The corporate segment and tax rates are discussed in the press release. We repurchased approximately 2.9 million shares during the first quarter. The net of this performance is that Ecolab reported first quarter diluted earnings per share of $0.77 compared with $0.62 reported a year ago. When adjusted for special gains and charges and discrete tax items in both years, adjusted earnings increased 8% to $0.80 when compared with $0.74 earned a year ago. Turning to Slide 7 and looking at Ecolab’s balance sheet, net debt to total capital is 50% with net debt to adjusted EBITDA at 2.4 times. Slight increase in the net debt to adjusted EBITDA ratio from year end 2014 primarily reflects the first quarter share repurchase. First quarter cash flow from operations reflects the normal seasonal pattern of our business where in we typically see low income and smaller cash flow in the first half with both of them stronger in the second half. Looking ahead, and as outlined in Slide 8 we will take aggressive actions in 2015 to drive both our top and bottom lines. We will work to leverage the benefits and offset the challenges of lower oil prices as we capture the lower raw material cost, leverage the expected consumer spending tailwind and gain share in the Energy markets. We will also continue to drive organic growth through further cooperate account wins, stepped up innovation work and improve field productivity. We still expect a very strong operating performance in 2015 showing our business balance that more than offset substantial headwinds from currency in pension. We expect our second quarter to show good Fixed Currency sales growth with currency negative impacting reported sales by about 6 percentage points. We look forward second quarter earnings to increase 2% to 8% to the $1.05 to $1.11 as currency becomes increasingly unfavorable with currency pension combining for a negative impact of $0.10 or approximately 10% of second quarter earnings growth. Further the second quarter will also compare against a very strong period last year when adjusted earnings per share rose 20% to $1.03. As mentioned earlier, we adjusted our full year outlook while we continue to expect high teens earnings growth before currency and pension. We now look for 6% to 10% EPS growth for the full year in the $4.45 to $4.60 per share range as continued good fixed currency sales growth appropriate pricing delivered product cost savings, innovations and synergies more than offset the increased headwinds from currencies pension and energy. In summary, once again we delivered on our forecast in the first quarter with a solid fixed currency sales gain and continued margin improvement while offsetting market and currency challenges and investing in our future. We have our work cut out for us in 2015, but we are well positioned and well prepared to outperform once again and deliver another superior performance for shareholders this year and for the years ahead. And now here is Doug Baker with some comments.

Thanks Mike and hello to everybody. So, my headline for the quarter in the year would be our underlying business performance was very good and it’s getting better. So all segments are growing share, all segments are executing very well, we had record new business in the quarter and that follows a huge year last year, we’ve got excellent innovation programming in almost every business; all segments have strengthened their teams that are doing the things they need to do built the culture. In all segments we’re accelerating from Q1 versus Q4 with the exception of energy. So, what’s new in the forecast, I guess I would point out three things. Number one; the energy markets are clearly more challenging than previously anticipated. Rigs in North America have declined further and faster, we’re not expecting energy to show a modest decrease on the top line and a flat to modest increase on the bottom line for the year. Offsetting the energy news, now it’s equally or more important to note that the balance of our business will do better than originally forecasted. We’re capturing the raw materials savings driven by lower oil with benefiting from improved institutional markets driven by cheaper gasoline, and we’re also seeing business acceleration in emerging markets that were up double digits; Europe top line accelerated to up 5%, 3% without energy. There is a lot of good news in our businesses around the globe. Our EPS delivery for our businesses at a fixed rate remains at 15% which is exactly what our forecast was last call. The major optic impact piece of news is really FX. And so this certainly colors a result, but I don’t believe this is a strategic issue for our business because most of our costs are incurred in the selling currency, but this does not dictate our competitiveness when we compete around the world. I also believe based on history it’s almost certainly going to reverse itself someday. We’ll probably all enjoy that. The perspective in our forecast FX is a $0.30 hit for the year or 7% that is $0.04 worse than the last call. This is 40 times worse than our 10 year average move, so this is truly outsize; it is 3x worse than our next highest impact over the last 10 years. So I think it’s hard to wrap our minds around this. We’ve been dealing with this for a while and it certainly has a big impact on how results look. The important thing is that we want to continue to focus on what we need to do to drive our business, drive value and drive returns. And as our FX forecast implies, I think the team is doing a lot of good things. At constant FX, our new forecast is to expect 14% to 17% adjusted EPS that compares to the last forecast of 14% to 19%, we trim the top reflecting the belief that we aren’t going to see any material improvement in our markets in time to impact this year. So we do anticipate the mid to upper-teen performance excluding FX. Clearly I think the team is doing the right stuff to focus on the things to drive value and returns. They will renew business. They will renew innovation. We know these are the two drivers of organic sales acceleration and that’s a primary driver of improved returns. We’re doing a great job on team and talent building. We’ll continue to invest in both and we continue to make sizable investments in process and system improvements which we know are key to our long term health. So we continue to be well positioned. We continue to build market position. I feel great about our ability to deliver another strong year, while improving the ability of the business to perform over the long haul. So with that, I’m going to turn it back to Mike and then we’ll go to Q&A.

Thanks Doug. A final note before we start Q&A. We plan to hold our annual tour of our booth at the National Restaurant Association Show in Chicago on May 18th. Looking further ahead, we also plan to hold our 2015 Investor Day in Saint Paul on September 10. If you have any questions, please contact my office. That concludes our formal remarks. Operator, please begin the question and answer period.

Doug, just wanted to drill a little bit more into the new business wins on the sustained good growth within institutional. Is there a way to parse out things like new product launches and account wins versus end market health? From your prepared comments, it seems like 2015 is setting up for a healthy pace of account wins after a very productive 2014.

Yes, in our institutional business in the segment there are other businesses besides institutional that grew 7% in the quarter. Clearly I would say, like a point of the acceleration is probably just market improvement as a consequence of lower gasoline particularly in the U.S. where it’s fully reflected because currency hasn’t eroded simultaneously. And I would say though the other acceleration, and you’ve seen steady acceleration quarter by quarter for the last five plus quarters, is really a consequence of continued driving new business performance. Last year I think we talked about when we looked at net new business gains when you look at annualized contribution, we were up 45% versus the prior year. I mean we blew out the water; institutional is one of the real leaders in that whole area. We’re up another 10% cumulatively in the first quarter versus last, that’s netting our losses, so we’ve really done a very good job there, but clearly we are gaining share. I think it’d be hard to argue that the food service and hospitality businesses are growing at 7%. So we are I think outperforming. Europe grew an institutional roughly 3% when it controlled for divestitures almost in every market we see real strength.

Okay. That’s helpful. And then on energy, if the business slows faster than expected would that not also mean that potentially a recovery in growth to mid-single-digit growth could happen faster as well? So we can look at the potential for that business into 2016, obviously with a stable energy price environment?

Yeah, I mean I guess, you would certainly argue that the first quarter was a little easier than we forecasted previously. So I think I would speak to, if you think oil is going to stay in the same range as it is now through ’16, which is what our assumption is. And we think energy next year recovers in this call it mid-single-digit growth and that’s going to be accelerating throughout the year.

Hello everyone. Just a follow-up on the last question. In terms of the new business wins and obviously again great performance there. But you guys have always been great at going after business wins and the new product introductions et cetera and obviously Europe is doing well on that front as well. Is there any tricks or any differences in terms of what’s going on today versus what you’ve done in terms of great performance over the last X number of years? In terms of why this could be a permanent inflection point or why this is accelerating at such a rate is it changing customer behavior, is it a better understanding of the value proposition or is it internal tricks that you’ve made in the selling approach?

Well, I think is a couple of things, a lot to touch on. But I guess, I would highlight one of the things that we said we want to drive when we bought the WPS business was really leveraging Ecolab’s know-how on enterprise selling in that market. That business and team has done a lot of really solid things, we’ve obviously stole a lot of their processes and apply them our businesses, but one of the things that we wanted to transfer, if you will, from WPS was the enterprise selling, view, skills and focus that we have in F&B institutional. And I think we’re doing a very good job of doing that, we’ve taken a number of their top sales people, we’re taking them through the same skill development that we’ve taken Ecolab through the years, but we have a broader base. So that’s one, and I would say we’ve done better on training and better on fundamentals. Second is innovation and so a lot of the things that we’ve been working on over the last five to seven years that are now really getting innovation with a very sharp point and that point is we will give you world class results but we’re doing it while reducing energy and water footprint. And that resonates, I’d say in good and bad times, I’d say every business has got pretty aggressive sustainability goals, we can help meet those while delivering cost savings and continued their food safety and/or efficacy performance objectives and that’s become I think even more relevant particularly the new types of environment where we’ve got water scarcity and energy concerns around the world.

And just, I mean what that mean that like with California going through the drought issues, has that been an extra area of growth for you to kind of reinforce that point?

Yes, without a doubt, we’ve got a team of over a thousand California focus right now and delivering our world-class water technology solutions throughout the industries that we serve. I don't care if it’s light industry like hospitality or light manufacturing all the way to heavy industries. We are all over the situation there. The edit from the governor regarding the 25% savings, it’s really focused on 25% of the water users, because so far agreeing it’s been sort of off on the sidelines, but that 25% is at the heart of what we do. So we’re all over trying to help them meet that target and probably going to have to do better than that long-term to make sure that they can get the water if they need to operate. Well, I guess I would say, let me enter a little broader perspective. Our operating model, I think it’s proven its resilience, so our forecasted delivery from our combined institutional, industrial, energy and other segments hasn’t changed one iota. So our energy softened, the other businesses strengthened, some of its exact mirror reflection of the same issue, and so we basically said while we have a bias towards higher oil prices, it is not a huge bias and we will perform well in the low oil environment or a high oil environment. For this year, we anticipate operating delivery EPS to be around 15%, which is exactly what we forecasted in the last call.

Mike, you mentioned that you expect the second half of the year to perform better in terms of earnings growth compared to the first half. I understand that the increases in raw material costs are a major factor in that expectation. Is that the main reason for your statement, or are you also anticipating that the revenue growth acceleration observed in the last couple of quarters on a constant currency basis, especially in non-energy sectors, will continue in the latter half of the year?

Yes, I think you got it Gary; it’s continued strong sales performance from the non-energy segments. The energy, as we already forecasted, and you’re right about the raw material savings growing as the year goes

Thank you. Doug, just back on energy, you mentioned pricing pressure, where are you seeing the pricing pressure and how do you think that reverses or how do you think it reverses going forward?

We’re seeing pricing pressure fairly broadly. It was anticipated because it’s not that similar from pricing pressure that has been realized by that business in other downturns. Right now I would say that pricing pressure which we would love to have none is close to forecast. And so the closer you are well head the higher the pressure in the business simply because that’s where it’s more acutely felt in that industry, but this pressure is throughout.

Hi, good afternoon. First question, can we go back to your view on lower oil for your outlook the sales. Can you comment by segment, have you been capturing those savings yet, when should we expect to see the full benefit of the oil on the cost side and I have a follow-up?

Well, I would say we gave, our forecast on raw material benefit for the year remains the same it was last call. And when we gave the chart last time I think we dictated how it’s going to show up first quarter and second half and obviously it was remaining of the year waited as I discussed in the previous question. We have not broken it out by segment nor do we plan to do that, so in the first quarter it was roughly a nickel. We anticipate it to be $0.32 for the balance of the year, so $0.37 in total.

Thanks Doug. A final note before we start Q&A. We plan to hold our annual tour of our booth at the National Restaurant Association Show in Chicago on May 18th.

As we believe the move in Mexico is favorable and will be positive for our energy business.

Thanks everyone for your time today. We appreciate this, and have a great day. Thank you.