Ecolab Inc.

Greetings and welcome to Ecolab's first quarter 2022 earnings release conference call. At this time, all participants are in listening mode. Any question and answer session will follow the formal presentation. If anyone today should require operator assistance during the call, please press star zero from your telephone keypad. As a reminder, this conference is being recorded. At this time, it is now my pleasure to introduce your host, Mike Monaghan, Senior Vice President, External Relations. Mr. Monaghan, you may begin.

Thank you. Hello, everyone, and welcome to Ecolab's first quarter conference call. With me today are Christoph Beck, Ecolab's CEO, and Scott Kirkland, our CFO. A discussion of our results along with our earnings release and the slides referencing the quarter's results are available on Ecolab's website at ecolab.com slash investor. Please take a moment to read the cautionary statements in these materials, which state that this teleconference and the associated supplemental materials 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 under the risk factors section in our most recent Form 10-K and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release. Starting with a brief overview, continued strong double-digit sales growth driven by accelerating pricing and further new business wins overcame substantially increased delivered product cost inflation and unfavorable currency translation to deliver the adjusted diluted earnings per share gain. Sales were led by double-digit gains in our institutional specialty, industrial, and other segments with attractive growth in all geographic regions. We drove the strong sales performance in a rapidly changing environment where the rise in new COVID infections early in the first quarter slowed the global recovery and further disrupted supply chains, While the war in Eastern Europe later in the quarter exacerbated the supply chain costs and geopolitical uncertainty. Our delivered product cost inflation soared an estimated 25% in the first quarter versus last year and added an estimated 55 cents per share of incremental costs to the first quarter alone. We reacted aggressively and continued accelerating our pricing, which reached 5% in the quarter up from 3% in the fourth quarter. We now look for our structural pricing to increase 6% to 7% for the balance of the year, and when adding in our previously announced energy surcharge of up to 12%, we expect very strong pricing to overcome the substantial delivered product cost inflation. Along with our new business wins, strengthened business portfolio, and improved productivity, we look to realize continued strong top-line momentum for the full year. We expect accelerating earnings growth through the second half, and expect to deliver low change growth in adjusted diluted earnings per share for the full year 2022, understanding there's uncertainty in the timing of the surcharge realization, which will become more clear as we exit the second quarter. This strong business momentum, along with our enhanced value proposition and favorable long-term macro trends, position us well to leverage the post-COVID environment and deliver further superior long-term shareholder returns. And now, here's Christoph Beck with his comments.

Thank you so much, Mike, and good afternoon, everyone. I'm very pleased with how the team continued to execute in Q1. In a rapidly changing environment, we remained focused on what we could control, like new business, pricing, innovation, and exceptional customer service, while we continued to manage extremely well what we could not totally control, like obviously inflation, COVID restrictions, and now the war in Eastern Europe. We started 22 actually with strong momentum as our fundamental business drivers continue to improve, which is most important to me. Fixed currency organic sales growth accelerated to 12%, with 7% of that led by volume gains from strong demand and new business generation. Institutional specialty, as you just heard, led the quarter with 19% organic growth, continuing its strong recovery when industrial further strengthened its already healthy momentum by delivering 12% organic growth, which is even better than what they delivered in Q4. Our margins were also trending very well for most of the first quarter, even ahead of our own expectations, as we were on a path to nicely overcome the significant delivered product cost inflation until the war in Eastern Europe started. As we all know, this had a major impact also on global energy costs, which impacted the last few weeks of the quarter. The spike in costs added an unexpected incremental $0.04 a share in the last months alone, resulting in a total unfavorable impact from delivered product cost inflation of $0.55 per share in the first quarter, close to 70% of our ultimate Q1 earnings. Importantly, we overcame this significant headwind thanks to accelerated pricing, which rose from 3% in the fourth quarter to 5% in the first quarter. And most importantly, we did all this while maintaining strong momentum in demand, new business, pricing, and productivity, the fundamentals of Ecolab. So based on what we see today and the actions we have already taken, I remain really confident in our ability to continue to deliver strong top-line growth and actually keep pricing in 2022 to get ahead of these new energy costs and to see our margins turn positive during the second half to deliver a strong full year 2022, even if the path to get there has now changed quite a bit once again. The unexpected rapid rise of oil and gas costs during the last months of the first quarter will now impact three full months of the second. We therefore had to react boldly, and we did. We decided to implement a global energy surcharge, the very first for Ecolab, which will now come on top of our increasing long-term structural pricing. And once fully implemented, the surcharge should then behave as an offset to what we expect to be short-term but incremental energy cost inflation. Now, we started the second quarter naturally with 100% of the incremental energy cost, but 0% of the energy surcharge as its implementation started on April 1st. Because of this, we now expect the second quarter to see the most acute squeeze in the year between price and delivered product cost inflation. Occurring at the same time, the surcharge is being implemented with customers around the world, but early progress is very encouraging. As the energy surcharge progressively rolls out, we should see the bulk of the surcharge primarily impact the second half of the year and somewhat the second quarter. And accordingly, this initial benefit from the surcharge, along with accelerating structural pricing, strong volume growth, and productivity gains, should help us drive our second quarter delivery with earnings that approach last year's 1.22. And finally, as it's been demonstrated over and over again at Ecolab, when challenging times strike, we make absolutely sure we protect what matters, our people, our customers, and our company. Over the past few years, when we could have reduced our workforce to manage short-term costs, we protected our global team. One of the key reasons why today our customer retention remains so high. We also protected our customers with major breakthrough innovation like Ecolab Science Certified, one of the key reasons why today our new business generation remains so strong. And we protected our company by investing in digital technology, one of the key reasons why today our productivity keeps improving. This approach has also demonstrated over and over again that our model starts generating significant margin leverage when cost inflation stabilizes and structural pricing sticks. So with continuing strong demand for unique solutions that prevent infection and protect natural resources when customers need them the most, we expect organic sales growth to remain in double-digit territory for the rest of the year. We structured pricing rising between 6% to 7% for the balance of the year and an energy surcharge that will progressively act as an offset for the spike in energy costs. We expect operating margin comparison to turn positive sometime during the second half of the year. This should then support our early expectations to deliver full-year earnings growth that reaches the low teens, understanding, as you've heard, that there is uncertainty in the timing of the realization of the surcharge and actually the pace of inflation. But this will become more clear as we exit the second quarter. And also, let's not forget that our full-year delivery includes $0.26 of pure light amortization of 5% of EPS. And as that momentum extends beyond 22, we expect to show Ecolab's hallmark of consistent, superior earnings growth for the many years to come. I look forward to your questions.

Thanks, Christophe. That concludes our formal remarks. As 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 Monday, May 23. If you have any questions, please contact our office. Operator, would you please begin the question and answer period?

Thank you. We'll now be conducting a question and answer session. We ask that you please limit yourself to one question, one brief follow-up question per caller so that others will have a chance to participate. If you'd like to ask a question, please press star 1 from your telephone keypad and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants that are using speaker equipment, It may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. Our first question is from Tim Mulroney with William Blair. Please proceed with your question.

Yes, good morning. Just one question from me today, Christoph, on the delivered product costs. I know you said they were up 25% in the first quarter. Can you just talk about how inflation trended through the first quarter and through April, and then how you're thinking about that progression through the second quarter?

Thank you, Tim. Great question. Actually, we've become experts at this, unfortunately, if I may say so. And it's important to step back, probably, because when we look at 2021, sorry, so last year, well, the first half of the year, there was almost no inflation. It was close to 1%. And then the third quarter, as we remember, so moved to 10% for us of this delivered product cost, which represents 25% of our sales, as you know. And then in Q4, so it doubled to 20%. And the full year was 10% of inflation for Ecolab, so for 2021. And now, so to your point, in Q1 2022, we're expecting kind of the same as in Q4, so the 20%. Well, it moved to 25% because of the war in Eastern Europe that started at the end of February. And we're expecting initially Q2 to be the same as Q1 or Q4, so 20%, 20%, 20%. And ultimately, we ended up with 20% in Q4, 25% in Q1, 30% expected in Q2. So when you're talking about April, so it's trending towards this full second quarter of 30%. which we expect that for the full year we should end up with 25% inflation for DPC. When we were thinking initially that it would be 15%, and to put it in perspective, Tim, just to conclude here, that will represent roughly a billion dollars over 18 months that we will have to overcome, which we have overcome. So the port of 21 last year and delivering 15%. EPS growth, the same in Q2 as well. And we'll do the same as well for the quarters to come in 2022.

Okay. That's very helpful. Thank you.

Thank you, Tim. The next question comes from David Badliner with Deutsche Bank. Please just use your question.

Thank you. Christoph, looking at Q2 guidance, we look at the various puts and takes of volume and pricing, etc., Can you discuss why we only approached last year's $1.22? And secondly, what drives a strong year earnings growth in the back half of the year?

That's a big question, David, but let me go one by one. So first, Q2, if I may. Well, the situation changed, obviously, so when the war started at the end of February, Because the first half of the first two months of Q1, we had a great start. We were trending really well, both in terms of top-line momentum. You've heard of this 12% organic growth driven by 7% volume and 5% price. Well, at the end of February, things changed. So we were ahead of our expectations. We were getting ahead of TPC inflation, and we were expecting so. to deliver a strong Q1 and really get in a very good position for a strong Q2 delivery. That was before the war started at the end of February. So when the war started, we obviously saw a good impact on the energy cost which triggered that surcharge that we've talked about where we had just a few days basically to decide that globally all businesses, all countries will move together in order to compensate for this additional energy cost. As you've heard before, this month of March added four cents to our delivery. And for the second quarter, well, you get three months of that, obviously, and training up, unfortunately. So it will all depend now, as mentioned in my opening remark, on the speed at which we can deliver the surcharge, which is going well, but it's a complicated exercise. It's 40 end markets. It's 170 countries around the world. We want to make sure that all customers are aligned with it as well in order to have the right, obviously, revenue recognition. We want to make sure we don't have collection issues as well. So it's hard to know exactly how the timing is going to be. So I'm having Q2 basically with 100% of the headwinds. and the surcharge that's progressing during the quarter, how to know exactly where we're going to end at the end of the quarter. But I think we're going to get down close to where we were last year. And honestly, if I get to 95% of where I was last year, I'd be happy with it. But we will do our utmost, obviously, to get as close as we can. That's the first part of your question. The second, so for the full year, with our ambition to get towards the low teens, which obviously requires a strong second half. Well, think about it. We have strong momentum, which always helps. Obviously, 12% driven by high demand. The price is really good. We have 5% that's been accelerating during the first quarter, moving towards 6% or 7%. without losses of customers or major losses. There's always onesies, twosies, but nothing major as well. We have productivity that keeps getting better as well. You've seen that in our results for Q1, over 100 basis points of improvement. So we have fundamentals that are in very good shape. Then we have the surcharge that's coming almost 100% for the second half. So if you get the fundamentals plus the surcharge realization, and also expecting that inflation will plateau and ease at some point as well. So during the second half, well, we should end up in a very good place from a margin leverage perspective. But that all depends on the timing. First, on the execution of the surcharge, which is hard to totally predict. And second, how inflation is going to evolve. But if things happen well, we'll end up in the right place with a very strong second half. That I'm sure about it. where we end up for the full year exactly, that's harder to tell, but it's just a matter of one month or two plus or minus at the end of the year that's going to bring us to the final result. But at the end of the day, David, what I'm truly trying to drive here is to have the right fundamentals that ultimately in 23 we end up in a place where we get the high margin leveraged that we're all looking for starting in the second half and then getting even better for 2023. So the two parts of your questions here, hopefully I could address them.

Very good. And just quickly on the surcharge, how quickly is it designed to roll off if and when oil prices do ease off as well?

It's a good question. That's something that we will have to discuss with customers. I don't think that it's going to happen overnight, but it's taking a few months to implement. It's probably going to take a few months to roll off as well whenever that's going to happen.

Thank you.

Thank you, David.

Our next question comes from Manav Patniak with Barclays. Please proceed with your questions.

Thank you. Good afternoon. Christophe, I just had a big picture question from you in terms of, you know, outside of, you know, obviously the inflation pressures you talked about, just curious if you're starting to see any macro pressures, maybe specifically in Europe, given, you know, all the press around it.

Yeah, good question, Manav. So generally so far, so good, but we're all reading the newspaper and looking at the news, obviously. So when I think in terms of demand for what we do, it's very strong. All companies have made sustainability commitments, as you know, and they need always more of our services in order ultimately to deliver. on the sustainability commitment. On the other hand, as well, from an infection prevention as well, food safety, COVID or whatever else that can be as well, our customers ask always more so from what we're doing. So we don't have a demand issue. We're really on strong trends, which is really good. So, so far, we haven't seen or perceived any slowdown with two exceptions. The first one is institutional, the restaurants and the hotels, but especially the restaurants. So we thought that it would open up quicker during the first quarter and continue on that trend during the second quarter. Well, it's been slower from a market perspective than what we were expecting. So is that as an outcome? as well of the economic pressure at the beginning of the year it was related to omicron obviously but now is it um because of uh interest rate and price of oil and so on um we'll see that so that's uh that's one uh small indication the second one is china um because of the lockdowns uh over there that are more extreme uh than everyone so was expecting it's four percent of our company so Anyway, it's a good news, bad news. Sometimes I would wish it would be much bigger. Today, I'm happy it's only 4%, but that's probably there that we might have as well, so some darkening clouds. Hopefully not, but that could happen. Otherwise, so far, so good. The last thing I would mention, Manav, is probably currency. As you know, the dollar is strengthening today. we're expecting roughly $0.10 for the full year, and it's doubled as we speak right now. So I would imagine that that's going to strengthen as well, so it might become as well a further headwind.

Got it. And maybe just ask another way, like maybe near-term, medium-term, longer-term, like if demand is not an issue, do you plan on changing your sales force growth strategy at all?

I want to make sure I understand right what you're saying. What did you say, Salesforce growth?

I think we'll be hiring more people. Will your pace of hiring increase given all this demand out there?

Yeah, great question. Okay, got it, Manav. So yes and no. In the past, I would say pre-digital times, Our growth was almost directly correlated to our growth of our field, Salesforce. That's changing now over time. It will still keep growing, but not at the same pace as it used to over the last 98 years, up to 99 years that we've been in business. because digital automation is obviously helping us automate a lot of transactional work that our team is doing today, like driving. A bunch of stuff you can do so with remote monitoring, preparation as well of sales calls. You can do much more so on the computers now, and we've implemented all that over the past few years, as you know. That requires less homework as well to get ready for customers, fixing equipment, As well, we can do that remotely. So there's a bunch of stuff that we can automate through digital technology, which will disconnect to a certain extent the growth of other companies and the growth of the field force, which drives, as well, SG&E productivity.

Got it. Thank you.

Thank you, Manav.

Our next question comes from the line of Steve Byrne with Bank of America. Please just share your questions.

Yes, thank you. I'd like to better understand this energy surcharge. Is it defined by oil, natural gas, or electricity, or does that depend on your customer? I just want to make sure I understood you correctly about the inflation you're expecting in the second quarter. If I understood you correctly, you're looking at a 30% inflation maybe 20% from raw materials and 10% from energy. Did I hear you right? If so, are you getting any pushback on this energy surcharge given it's roughly twice the magnitude of your structural price increases?

Good question, Steve. Two parts. The first one, we've announced that to customers around the world. It's a global surcharge for the whole company, all customers, all industries, all countries around the world. It gets implemented Slightly differently, business by business, then afterwards, think about pest elimination is very different than a heavy industrial business like paper, for instance. But the general principle is, yes, it's related to the price of oil. And what we've said is that the surcharge will be between 8% and 12%. It can go higher than 12% if the oil price gets higher. But 8%, 10%, and 12% are related to oil pegs that we've defined as well with customers. So if the oil price goes further up, the energy surcharge will go further up. We wanted to have it temporary, mechanical, formulaic as well that customers know how it works, when they get it, how much it is, when it gets off as well. That's the theory. The practice is obviously a little bit different. As mentioned before, so pest elimination might be different than a heavy industrial business. But generally, we discuss with all customers to get it right, making sure that it's an offset to the energy increase or energy cost increase that we have in our P&L. And so far, it's gone quite well with customers around the world. It's early. We've been three weeks at that, so it started April 1st. But so far, so good. It's going to take a few months to finalize as well. I'm quite happy with the progress we're making right now, but there's still some work that remains in order to get to the right place. I might pause here just to make sure that I'm addressing your question.

No, no, that was helpful. I wanted to also ask you about the PureLight acquisition. You've got four months under your belt now. Is anything surprising you? Anything going slower than you expected or anything that's a positive surprise?

Well, all of the above is progressing well with all the usual challenges of M&A, of integration. It was a family company. I would call it a big startup as well. So then suddenly you end up in a larger corporation with processes, with practices, with organization and all that. Obviously, there's some friction that needs to be aligned, but we're in a very good place in terms of team. You probably know that our leader for PureLight is a general manager who comes from Ecolab since the two brothers retired. They were all 80 years old or quite, so that was very natural. So we have a team combined from former ecolab or former pure light people and um people coming uh from ecolab as well from a performance perspective you know that business was growing double digit um uh as we took it over uh in 21 it'll be growing double digit in 22. what's important to keep in mind is that the first half of the year we are capacity constrained so the demand is higher than the supply we can provide which is the reason why we are building a new plant um in um Pennsylvania and extending another one in the UK as well. And that's going to come online in the second half of the year. We're going to have kind of this pattern of double-digit last year, kind of slower growth in the first half this year, much higher growth in the second half of this year, and then after races by 23 since capacity has been such a big driver that we had to open in order to grow further. But last but not least, the more we look at it, the more we like it. It's an unbelievable industry. It's huge. It's growing really fast. It's something we can address. There's very few competitors that can do what we can do as well. We have really saw technology that no one else has in some cases as well, and what I like the most is that we can build a lot of things around it to really build that growth platform like we did 20 years ago with pest elimination and all the businesses that we have in the company. Then 10 years ago, water that came as well. So around food safety and hygiene at Ecolab. And now we have Pure Light that can serve the life science business, but also the industrial businesses to which we can add as well some M&A down the road, which makes it even more interesting. So all in all, I would do it again. Thank you.

Our next question comes from the line of Ashish Subhadra with RBC Capital Markets. Please proceed with your question.

Thanks for taking my question. I just wanted to focus on the industrial segment. We saw some pretty broad-based acceleration there across water, food, and beverage and downstream. I was wondering if you could talk about what kind of momentum do you see going forward and how much of it was volume versus pricing driven? Thanks.

Great. Thank you, Ashish. Industrial is in a great shape. It's half our company, as you know. They've been growing 12% organic in the first quarter of this year versus 7% in Q4, by the way. 5% was volume, 7% was price. And what I like the most is that we have acceleration on all fronts. Water moved from Q4 to Q1, so 8% accelerated to 11%. F&B was at 4%, is now at 10%. Paper was at 15%, remained strong at 16%. And downstream, which has been stuck for two years, ended up the year at 8% and 16% in this first quarter as well. And what's really interesting is that there are some new engines as well in there, as we call them. like global high tech with data centers growing fast as well, chemical industry as well, which is a new business that we've created, and animal health as well, which are kind of those future growth businesses that are adding to the momentum of that group, which is doing really well, broad-based, all businesses, most countries around the world. In China, a little bit more tricky for the reasons I mentioned as well before, but otherwise in a very good shape. I'll just end up on margins as well for that in industrial, which is always a question. Well, margins were down 10% in Q1, but it's important to keep in mind they were up 19% versus 2019. So before COVID struck as well. Well, industrial has really shown ultimately how do they behave during inflationary time that was pre-WZD cycle, that was 17-18 cycle, ended up great margin improvement in 2020. And that cycle with very good pricing as well will end up into margin leverage down the road as well as it did in the past and gets up in terms of margin ratio as well as we go through each of those cycles.

That's a very helpful color. And maybe if I can just ask a question at the high level on the volume side. Obviously, very strong momentum in volume. But as we go through the rest of the year, the comps get a bit tougher, maybe on the institutional side, easier on the healthcare side. But you should start to see some of the benefit from, better benefit from reopening. So how should we think about the volume trend at a high level across the company? Thanks.

Overall, roughly the same for the reasons you mentioned. Actually, some are going to turn more positive and some are going to slow down for comp question. as you mentioned, but generally, so top line is going to remain in double-digit territory, and the volumes will kind of remain, for the most part, similar. That's assuming there's no recession or big, obviously, event happening out there. But otherwise, I think it's a pretty steady momentum that we have across the company.

That's very helpful, Chris. Thank you.

Thank you, Ashish.

Next question comes from the line of Chris Parkinson with Mizuho. Pleasure to hear your questions.

Great. Thank you so much. Chris, would you just take a step back over the last few years? Obviously, there have been a lot of ebbs and flows during the COVID situation or whatever you want to call it. You have launched a bunch of new, I would say, products, but more likely programs in food safety, sanitization, among many other verticals. When you sit back and think with the management team about share game potential, kind of where you are and where you could be, is there any difference in how you would peg your growth I'll go for the institutional portfolio or pieces of industrial versus the market and peers versus, let's say, a few years ago. Just how has that thought process evolved? Thank you.

Yeah, great question, Chris. Well, generally, we're definitely gaining shares. We compare, obviously, so always our shares. growth with competitions growth, and I guess you do the same, so we're way ahead. So most of them, we have some weaknesses sometimes that we recognize and deal with, obviously, but I feel good in terms of shares that we're gaining across the key businesses, across the key countries. If you take institutional, as you mentioned, for instance, as well, it's interesting to take one fact, since you know institutional in the U.S. is so big, We'll take our restaurant business in institutional sales in Q1 at the same level as they were in 2019, so pre-COVID, while the dining traffic in restaurants is 35% down versus 2019 for all the reasons we know of staffing and all the staff that are bugging restaurants ultimately. But we're back to 19 when the traffic in restaurants is a third down versus 19. Well, that's showing how much share we've gained as well in that specific example of institutional, and I could cover other businesses as well.

Got it. Very quick follow-up on health care. You mentioned the supplemental, some momentum with elective surgeries in the U.S., you know, offset by a slower recovery in Europe. But, you know, the competitive dynamic kind of evolved there also during the COVID situation. Some of the HPCs got a little bit more aggressive. Can you just talk about your strategy there a little bit more, once again, where you stand today and how you believe your position for growth and just comment on, you know, how the street should be thinking about modeling that over the next, let's say, two years? Thank you so much.

Yeah, thank you, Chris. Well, interestingly enough, before COVID, the major convergence of focus in healthcare was towards surgical. So operating rooms, central sterile, patient rooms, so really sort of centered around the operating room. which I believe was a very small strategy, and it didn't come from me. So I take no credit about this one, but I think the company did it really well. Except that during COVID, well, surgeries got shut down, postponed, and it happened a lot of times, so on and off, which drove everybody nuts, obviously, in the industry. And that happened again over the last six months with Omicron. So it's the right long-term strategy, Chris. I have zero doubt about that because it's ultimately making sure you protect patients from hospital-acquired infection, which is good for patients. It's good for the hospital because they reduce their total cost, and they can operate as well so more often, which helps because they don't need to repeat operations that they've done as well in the past. Strategy was right. It's still right for the future. It just got a lot of stops and go over the last two years, which was related to those elective surgeries that have been so kind of shut down and restarted.

Thank you, as always.

Thank you, Chris.

Next question comes from the line of Josh Spector with UBS. Please shoot your question.

Yeah, thanks for taking my question. I just wanted to follow up on the volume question. outlook kind of for the rest of this year and specifically in institutional. I just wanted to think about if business travel improvement is something that becomes a meaningful kind of flex point for your outlook. So lodging rooms sold has recovered, but arguably that's more leisure versus business travel. I think your exposure hotel and regional wise will be more skewed to the business side. So do you think that improves and is that baked into the second half outlook at all? or is that a source of upside versus your current thinking?

So business travel is a small part of our business, but it's impacting obviously our lodging business, which is roughly 6% of our company, as you probably know. But we're taking obviously any help in the market out there. I think for the full year, We're going to have a lot of puts and takes. There's going to be some upside with travel. As you mentioned, leisure is getting better. We feel it in our end markets. Business travel is going to ramp up as well in the months to come. But on the other hand, I think that there will be some economic pressure as well on most people in the U.S. and in Europe as well, driven by the price of oil, interest rate, subsidies, you name it, obviously, that we had during COVID that's going to go away as well. And we can feel as well, or the industry can feel already, that there's some pressure there. So there's going to be some good news and some less good news, but we'll see what's truly going to happen over the next few months That I can't influence. The only thing I can influence is new business. And new business and institutional has been doing extremely well actually during the pandemic and is continuing to do it right now as well on top of the pricing that they're getting, which is driving shares. I was mentioning to Chris as well before. So ultimately, I think that institutional is going to be in a good place. One might say we could have grown even faster if everything would have been unleashed at the same time as well. Well, that's not the way things work. So generally, the industry might slow down a little bit, and we might not grow as fast as we would have wished, but we will still remain in double-digit territory in 2022, which I believe is a pretty good performance.

Okay. Thank you.

Thank you, Josh.

The next question comes from the line of Vincent Andrews with Margaret Stanley. Please proceed with your question.

Thank you, and good afternoon, everyone. A couple of quick ones for me. The release mentioned in food retail, I guess because of staffing issues, that some of the cleaning intensity had declined. Can you just clarify, is that staffing issue, is that because in the quarter, you know, there was kind of COVID-related outages when Omicron was surging, or is that because customers are struggling? I'm just trying to understand how transitory the issue is.

Yeah, it's an interesting one, Vincent, because for the most part, the retail industry is doing quite well, especially the large customers, the large retailers that we are serving around the country and around the world. The trick is that they are all struggling with how much people they get, obviously, in their stores. So they need to choose where the people are going, ultimately. So do they go and serve customers or do they do as well or as much as they should? So on the cleaning side as well. I want to be careful how I'm saying that, obviously, because we make sure that our customers are doing things the right way. But in normal times, they would do much more than what they're doing today. And it's all related to the staffing that they're shifting. So from one part of the store towards the commercial one, which is driving their stays as well. Okay.

And just as a follow-up, Scott, if I could ask you about, you know, sort of how you expect working capital to trend through the year, obviously in an inflationary environment, you're going to need, you're going to need more of it, but yeah, It looked like a pretty good build in the quarter, and you finished the quarter with a low cash balance. So just how should we be thinking about working capital and free cash flow for the year?

Yeah, thanks, Vincent. As you mentioned, in the quarter, there was a bit of a build, as you'd expect. So free cash flows were in line with what we expected for the first quarter and really just below last year because we built working capital and CapEx, which you'd expect as sales are growing, especially this strong. And so as we look for the year on a free cash flow basis, expect that for the full year we would have free cash flows really in line with free cash flow conversion historical levels, which means that our working capital will sort of trend in line with the business growth.

Great. Thank you very much.

Our next question comes from the line of Scott Schneeberger with Oppenheimer. This is your third question.

Thanks very much. Good afternoon. Christophe, following up on the industrial segment, just curious, in the press release, it cited unfavorable mix as a headwind. Could you elaborate a little bit on that, please, and just discuss where that's going? And then a follow-up in there is to a discussion earlier on industrial about segment margin. A few years ago, it was in pre-pandemic in the mid-teens. How quickly could the margin get back to that level based on what you're seeing? Thank you.

Yeah, thank you, Scott. Two parts. A few questions, obviously. So margins and mix. So if I talk about overall margins, usually it takes two years to kind of get through the margin cycle. So inflation goes up. and you get the pricing, we get the dollars back the first year and the second year, we get the margins back and more. And that's how we've grown our margins in industrial, so at every cycle. And it's going to be the same in this one with one big difference is that usually Inflationary cycles will last much less time. This time, well, we're already planning for two years, last year and this year. So the cycle is going to be a little bit longer, but a very strong price muscle. In industrial, for a few reasons. First, because our premium products are competitive versus competition in terms of what they can deliver. So customers are interested in paying more to get more as well out of it. And second, we have a pricing approach which is driven by EROI, as you probably know, which is basically getting a share of the savings that we are generating for our customers as well. So it's kind of a very natural, organic type of pricing as well. So the underlying pricing and then you have the inflationary pricing that comes on top of it. Bottom line should be towards 23. I think that assuming that inflation obviously peaks now and eases in the quarters to come in 23. So we should really see so that rebuild and step up in margins in industrial. That was your second question. The first one was the mix. There's three things. One is business mix. If you have paper, for instance, growing faster than light water, paper has a lower margin than light water. Well, that has an impact in the mix of businesses. Within a business, you can take downstream. For instance, we have an important offering, which is called additives. that energy companies are using usually when the prices of oil are rather high because they can afford it. Well, those ones are growing really fast right now. They have lower margin than the chemical offering that we're providing to those customers. And the last one is the country mix. as well. So depending on where you grow, that has an impact as well on the overall margin of industrial. So those are the three big drivers of this margin mix. That's a great call. Thank you. Thank you, Scott.

And this question comes from the line of Kevin McCarthy with Vertical Research Partners. Please just use your question.

Yes, good afternoon. Christoph, coming back to the surcharges that you're implementing as of April 1st, how much might you actually expect to realize in the June quarter? The reason I ask is I think your press release on March 15th indicated a range of 8 to 12, and I imagine in some cases you get to high end immediately. In other cases, maybe the low, and in still other cases, perhaps you have some contractual limitations. So Perhaps you can talk about the flow through as you begin to implement that program in the second quarter and also into the third quarter.

Yeah, so two things, Kevin. And I can explain it in a complicated way, in a very simple way. I'll take the simple one and we can get obviously some more in detail if you wish so. But the way we agree and align with customers in such a short period of time is really to make sure that the surcharge is an offset to the increase of commodity costs related to energy costs. So you get a net zero, ultimately, on our EPS delivery, but if we don't get the surcharge, obviously we have a negative EPS delivery because we get the inflation and we don't get the surcharge. So that's the way we think about it, really, that the surcharge is a natural offset for the increase related to the energy costs. So that's the first one. And the second, and I'll pause after that just to make sure that I addressed your question here. The second quarter is ending June, as you say. Well, it's a transition quarter because obviously we start from zero on April 1st. And we hope to be as close to cruising speeds in June or July, which is why I'm not perfectly accurate on where we're going to be at the end of June, because there's a lot of realization that needs to happen. for those thousands of customers, millions of locations around the world in 170 countries. This is real work. It's evolving very nicely, very well. I like the progress that we're making, but it's an imperfect journey, obviously, since we've never done it as well. That's the way we think about it in terms of net impact and offset. And second, for the second quarter, while it's not going to be a straight line to heaven, but it's going to end up in a good place sometime this summer. I don't know if it's going to be exactly at the end of June when the quarter ends.

Okay. Thank you for that. And then secondly, I wanted to ask you about your institutional earnings results in the first quarter. It came in a little bit better than we had anticipated. I guess my question is, did it come in better than you thought internally? And if so, what drove the positive variance in that piece of the portfolio?

So just to make sure I get you right, you're talking about, you want me to talk about sales or margin or both?

Sorry, I was referring to your operating earnings in global institutional and special.

Okay, okay, got it. Well, actually, those sales were really good. They could have been even better if Omicron wouldn't have hit the first part of the quarter. And the earnings were good, but they're still not as high as they could or should be because they've been impacted as well by the delivered product cost inflation. Good growth, good productivity work. You maybe remember that we've implemented in 2020 a global field system. as well that is really automating a big chunk of the transactional work that our field force is doing around the world. That's driving better productivity. Innovation is adding to margin as well. We mentioned Ecolab Science Certified, disinfection programs as well related to COVID and post-COVID as well. That's all helping on the margin. But the truth is going to happen in the quarters to come and probably as well in the years to come. Because when all that comes together, that the pricing gets ahead as well of inflation, I firmly believe that the institutional margins will be even better after that cycle than it was pre-COVID, whenever the future is going to be. But let's assume it's going to be 2023. But institutional on a very good path, both on top line and bottom line as well. And the best is to come.

Thank you very much.

Thank you.

Our next question is from the line of Eric Petri with Citi. Good afternoon, Christophe.

Good afternoon, Eric.

How are underlying sanitizing sales normalizing compared to the 2019 levels?

That's an imperfect science, obviously. When we look at all the sanitizing sales that we have in the company, It grew over 50% during the COVID times. And the way it looks like right now is that it should remain at roughly 20% above where it was pre-COVID, let's call it 2019.

Helpful. Thank you. And then typically your institutional margins over history are higher than industrial. How do you see that as you were talking about, you know, mix and so forth, 2023 and beyond, and some of the growth verticals that you have in industrial as well as net zero?

Yeah, as mentioned before, so institution is going to be better after that cycle concludes, let's assume. So 23 COVID inflation and all that, it's not all going to happen on January 1st, obviously, but post this cycle, the, the business performance, the P&L of institution is going to be better than it was in 2019 or pre-COVID. That's the first one for all the reasons I mentioned on the prior question. On industrial, we've had a very good journey of margin improvement over the years. And interestingly enough, also happening during those inflationary cycles, We had the previous one. You maybe remember the margin improvement we had in 2020 was growing north of 20% in terms of operating margin and ended up in a very good place, which is why I just mentioned before as well earlier on the call, even if the margins are down 10% in Q1, they're higher at 19% than they were in 2019 as well. due to the pricing mixed work that the team has been doing. So that's going to continue going forward. What you mentioned as well on net zero is obviously something that was much less relevant a few years ago, but that's becoming very relevant right now and going forward because many of our customers have made commitments on the sustainability objectives. Many of them are not progressing as fast as they were hoping for a bunch of good and less good reasons sometimes. This is obviously driving very good demand. So for us, we've created a dedicated net zero division now within industrial in order to serve those customers as well that are the most advanced And those customers tend to be higher margin as well at the same time, which will help contribute as well to better margins for industrial, which down the road, I expect industrials to reach the same level of margin than institutional and potentially even better. Great. Thank you. Thank you.

Next question is coming from the line of Shlomo Rosenbaum with CECL. This is your question.

Hey, Christoph. Good afternoon. Quick question. We had a lot of talk about pricing. I want to go back a little bit more to volumes and just ask, where are we on the overall company volumes, like for like vis-a-vis 2019? In other words, how much is left in terms of return to normal play in terms of revenue potential? Like you talked about institutional, being back to where it was, but with you know, in-person dining just down a significant amount. So if you were to put it like to like, what would you say the upside is or potential for revenue with just kind of normalization, say, coming if you were to assume that would come in 2023?

Yeah, so I had to get to some numbers. get that i want to make sure i get the right one so from a top line perspective we we're way ahead of 2019 already obviously but you asked the right question so in terms of volume so if you look at um so q1 um new 22 um we have businesses that are already ahead of 2019 industrial is ahead uh headscan life sciences are ahead Our other segment is ahead as well. And the only one that's below 2019, roughly 10% in terms of volume, is an institutional specialty and is expected to cross that line during the second half of the year where we're going to be in a place where all businesses, I mean all major businesses, will be ahead of 2019 in terms of volume during the second half of the year.

Okay.

When I'm thinking about the recovery, you still have, that should be largely a second half 22 and first half of 23 kind of improvement potential over there. Is that the right way to think of it?

Absolutely. Especially in institutional specialty, no doubt about that. That's why we're saying it's going to take, it's kind of a two, three year cycle where demand is going to be higher just because the industry is recovering and From a demand perspective and staffing, as we talked about before as well, as you get more staffing in hotels, for instance, you've probably been in hotels lately, so the service is a little bit different than it used to be, even though you pay the same prices for your rooms. Well, it's not because hotels want to have it that way. They don't have the staffing to do it. That's going to add as well. So to the demand for us, because those people are using our products, that's going to be a good thing, and that's going to help us drive demand in 22 and in 23. When it's going to stop, I don't know, but I think we have one or two years ahead of us of recovery, which is really good for that business.

Okay, great. And just for the follow-up question, is one quarter really enough time to get energy surcharge across the expanse of the customers that you guys have? It just seems like you're trying to hit everybody At the same time, people also want to make new sales. Is there a focus being taken off of new sales in order to be able to do this? How should we think about it?

Great question. So first, getting it all done in one quarter, the short answer is no. And that's why I'm saying that... In theory, if everything were done in the second quarter in a perfect way, yeah, we would be growing our earnings very nicely. Well, it's not going to happen because we started zero on April 1st. And at the end of June, we won't be 100% done either for all the reasons that you're mentioning. And that's why it's hard to know exactly where we're going to be. But I know that this summer, let's put it that way, we will be in a very good place because all businesses, everyone around the world needs to get this one done, but the right way. So exactly for the reasons that we mentioned before. And the second point on... The polarization, so new business versus pricing. We've been reasonably good at that, but I want to be perfectly honest with you. When we focus on pricing, let alone a surcharge, which is something totally new since we've never done that globally, well, you get your eyes off the ball of new business. So I expect it to slow down a little bit to get the pricing right, but that's why we want to get pricing done. as quickly as we can to make sure that new business maintains momentum as well down the road. It's hard to do both at the same time.

Great. Thank you.

Thank you.

The next question comes from the line of Mike Harrison with Seaport Research Partners. Please proceed with your questions.

Hi. Good afternoon. Good afternoon, Mike. Let me see if I could. Sorry, I wanted to see if I could attack this question around underlying market demand a little bit differently. You've talked about business travel. You've talked about maybe some macro concerns in Europe. I was just hoping to get some color more broadly on what you're seeing in terms of consumer behavior in an inflationary environment. Are there any signs at this point that inflation is starting to drag on consumer spending? I guess that would show up maybe in restaurant foot traffic. But most of us were not covering this space the last time inflation was this strong. So I guess any historical perspective you can provide would be very helpful.

Yeah, a few things. First, that kind of inflation, none of us has really experienced that. I guess our parents did. I was not in business the last time it truly happened here, so 30 or 40 years ago. so it's totally extreme totally unusual as we all know so a few things here first we don't see a slowdown of demand yet so that's a good news but if we look at restaurants especially in the US if I look at the data that we get from the industry you clearly see a slowdown of demand, which is most probably related to inflationary pressure because of oil, because of food, because of mortgages, you name it. But that's very early. So those are indications that are probably so important to follow. The third thing and last thing that I'd say as well here is that when we move to slower times or more extreme recessionary times, which we don't assume it's going to happen in 22, could happen in 23, who knows, obviously, that we've gone through many times as a company. And the good thing with the Ecolab model is that, yes, the growth slows down, but we are still ahead of the market growth because we gain market share because of all that we discussed before in terms of new business, innovation, expansion of offering, and so on there. So that helps us grow faster than the overall market and kind of dampen the recession that we might have on our top line. And most importantly, in more difficult times for our customers, they need us more because our value proposition, as you know, it's helping customers get better results at a lower total cost. That's been true for 99 years as a company. So in more difficult times, potentially recessionary times, customers need even more what we're doing, which have been reasons why Ecolab has been doing so quite well during slower or recessionary times.

Thanks very much for that. And then a second question on the high-tech opportunity. I believe that's mostly centered around water and going into semiconductor fabs as well as data centers. Can you talk a little bit about your market position there, particularly now that you've combined with PureLight? And are you in a position to win more than your fair share of opportunities as we see some of this fab capacity expansion? Thank you.

Absolutely. It's a fascinating business, which used to be part of light industries, our water business that was serving hotels, light manufacturing companies, And so on. And now we've created a dedicated division that combines data centers and microelectronics. Obviously, they're related but different. The main driver for data centers is to help those high-tech companies reach their net zero ambition. And, I mean, you know all of them. They've all made bold commitments that by 2030, for most of them, want to be zero or positive carbon and the same for water um as well we're the only company that can provide that to them so that's obviously something we had to get organized um in order to get there and we're making very nice progress by working with those large companies this is ecolab at its best because we serve enterprise customers for a very long time forever um actually, and we have them understand where are they today, how much water do they use, what's the objective to get to zero, what's the roadmap to get there, and drive execution as well towards that, while we make sure that we maintain a 99.9% uptime for all data centers. Then microelectronics, just to conclude on that, is different but related. We wanted to have the same people because it's the same technology, type of expertise that we need in the field, well, it's a production of microprocessors. and that requires high purity, high quality water, which to a certain extent we were doing in the past, but we could not do the highest quality of water that's being used in the production process of microprocessors. This is something that we can do now with PureLight, which is a new offering that no one else can offer as well, which is helping not only PureLight, but our global high-tech business. kind of the beginning of the journey, but so far a very good story where I think that we're in a position that we could truly own that market.

Thank you.

Our next question is from the line of Rosemarie Morbelli with Cabelli Funds. Please proceed with your questions.

Thank you. Good afternoon, everyone. Bonjour, Christophe.

Bonjour, Rosemarie.

I was... I was wondering if you could touch on the progress you are making on life sciences. I believe we did not really touch on that particular part of your business during the call.

Yeah, great question. So life sciences has been a great business that we started, I think, five years ago, 2016. With Doug, we did that. So again, I'm not going to take any credit for that. It's been a great business that's been growing to almost 300 million today, growing double digit, some of the highest margin that we have in the company. And it's a business that's doing well. It's having hard comps versus 21 and 20 because it was such a crazy high growth that that business went through. So related to COVID demand. But the underlying growth of that business is double-digit and will emerge as double-digit in Q2 or Q3, I don't remember exactly, and will continue so very nicely as well as the business. On top of it, because Life Sciences, former Ecolab if I may say, was really providing solutions to make sure that production lines, clean rooms, factories were safe and protected from any infection risk. Now we add pure light, obviously, to it, which is purifying the product that's being produced in those production lines. So it creates a one plus one equals three type of proposition like water and food safety when we acquired Nalco as well. So it's going to help life science grow even faster today together. So it's kind of seven, eight hundred million growing double digit. We're constrained by capacity right now as mentioned earlier on the calls of the first half of this year roughly, but the demand is just getting higher. Two businesses doing really well, getting together, the offering is even more interesting. We just need to be able to produce what we're selling and that's going to happen during the second half of this year.

Are you signing up large pharma facilities?

We do. That's where we focus on. Life science, Rosemary, is 80% plus pharma, and the balance is cosmetics, the traditional brands. But life science, for the most part, is pharma. We're now a renewed focus on bio-pharma. on mRNA and monoclonal antibodies, which is really the industry within pharma that's growing the fastest and expected to be 40% of the overall pharma market by 2026 or 2027, so in the next few years. So really interesting.

Okay, thanks. And then I was wondering, given the stock price decline, which continued today, are you considering accelerating repurchases?

Well, it's what we've announced a few weeks ago or a month ago. I don't remember exactly the timing. I might ask maybe Scott if you want to give some perspective as well on that.

Sure, Rosemary. As we announced in March that we're repurchasing $500 million of shares during the year and through Q1, as you might have seen, that we repurchased a little more than half of that. And we'll continue to pace that repurchase program depending upon market conditions, but also while maintaining our commitment to return to A-range credit metrics by the end of next year.

Any way, should nothing improve, any way you can expand that $500 million, or do we need to wait until next year before you take another look at it?

I think we'll keep pace on that $500 million this year. Again, as I mentioned, we want to make sure that we're committed to returning to these A-range level metrics by the end of 2023.

Okay, thank you.

Our next question is from the line of Andy Whitman with Robert W. Baird. Please proceed with your question.

Yeah, great. Thanks for taking my questions. I guess I just wanted to follow up on the earlier question around free cash flow. I think that question was centered more around working capital, and you said it would be kind of like historical levels. But, Scott, you know, it looks like if you back into – your EPS guidance into net income, it kind of walks back up to around $1.5 billion of adjusted net income. Historically, I guess you guys have said about 95% is a good way of thinking about kind of free cash flow for Ecolab. So is that applicable for this year with higher than average growth rates and inflation? I guess that's the other way of kind of asking that question, but is basically then that backs you into about $1.4 billion in free cash flow. Is that the right kind of order of magnitude? And can you just comment again, if you could, on the CapEx budget for the year as well?

Yeah, just on your first question. Yeah, your math is about right in that mid sort of 90 range, which is our historical cash conversion. So that would be where we would expect the year on free cash flows to be. And then as we think about CapEx, talked a little bit about this after the fourth quarter, and we'll expect CapEx to return to sort of our historical levels, which is like 5.5% to 6%. And as you're probably aware, about half of that CapEx that we do is merchandising equipment, which is at customer locations. And so that will grow as the sales grow and as new business grows.

Thank you.

Our final question is from the line of Kevin McVeigh with Credit Suisse. Please proceed with your question.

Great. Thanks so much. Hey, Christoph, I wonder any, um, just client reaction to the price increases. I know you were thoughtful through COVID. So are they more accepted given how thoughtful you were through the COVID process or just any puts and takes? I mean, obviously everyone's seeing a lot of inflationary pressure, but just any thoughts from, from a client perspective?

Yeah. Um, I'm, really pleased with uh what we've done uh in pricing so let's keep in mind uh we have to overcome a billion dollar uh over a billion dollar over 18 months so starting some mid last year towards um the end um of this year so 18 months is a very short period of time as well and we want to make sure that we do that um in in achieving two things uh the first one is that we stay or get ahead of the inflationary curve. We've done it last year. We'll do it as well this year, as mentioned. So we were on a path to be now basically ahead of the inflationary curve in 2022. That was pre-war in Eastern Europe. Now it's postponed a few months, but we add the energy surcharge to that and we get to the right place as well. So it's on one hand making sure we cover inflation and at the same time that we do it in a way that we grow our margins as well down the road. The second objective we have is to make sure we're not losing customers. While we do that, it's not 100% play, obviously, but that we can maintain 90% plus of our customers, which we're doing. We haven't lost any major customers while we were doing that because we need to keep in mind that we are a growth company. I want to make sure we keep our organic momentum, which is extremely strong right now, while we get the pricing right, while we keep the customers, because down the road, that's the beauty of the Ecolab model. When your fundamentals are right, of new business, of innovation, of pricing, of customer retention, and that inflation eases, you get a very significant windfall in margin, which we know always happens. The question is, when is it exactly going to happen? But so far, so good. I'm very pleased with what the team has been doing in terms of pricing while keeping the customers and driving growth at the same time.

Thank you very much.

Thank you, Kevin.

Thank you. At this time, we've reached the end of our question and answer session. I'll now turn this over back to Mike Monaghan for closing remarks.

Thanks, Rob. That wraps up our first quarter conference call. This call and the associated discussion and slides will be available for replay on our website. Thank you for your time and participation and our best wishes for the rest of the day.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day.