Michael J. Monahan - Ecolab, Inc. Douglas M. Baker, Jr. - Ecolab, Inc..

Gary Bisbee - RBC Capital Markets LLC John Quealy - Canaccord Genuity, Inc. David E. Ridley-Lane - Bank of America Merrill Lynch Manav Patnaik - Barclays Capital, Inc. John Roberts - UBS Securities LLC Laurence Alexander - Jefferies LLC David I. Begleiter - Deutsche Bank Securities, Inc. Christopher S. Parkinson - Credit Suisse Securities (USA) LLC Tim M.

Mulrooney - William Blair & Co. LLC Hamzah Mazari - Macquarie Capital (USA), Inc. Scott Schneeberger - Oppenheimer & Co., Inc. Dmitry Silversteyn - Longbow Research LLC Andrew John Wittmann - Robert W. Baird & Co., Inc. Rosemarie Jeanne Morbelli - Gabelli & Company Dan Dolev - Instinet LLC.

Greetings and welcome to Ecolab's Second Quarter 2017 Earnings Release Conference Call. As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Mike Monahan, Senior Vice President, External Relations. Thank you. Mr. Monahan, you may now begin..

Hello, everyone, and welcome to Ecolab's second quarter conference call. With me today is Doug Baker, Ecolab's Chairman and CEO; and Dan Schmechel, our CFO. A discussion of our results along with our earnings release and the slides referencing the quarter's results and our outlook are available on Ecolab's website at ecolab.com/investor.

Please take a moment to read the cautionary statements on these materials stating that this teleconference, the discussion, and the slides include estimates of future performance. These are forward-looking statements, and actual results could differ materially from those projected.

Factors that could cause actual results to differ are described in the section of our most recent Form 10-K under Item 1A, Risk Factors, 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 of the quarter, continued new business gains and pricing drove acquisition adjusted fixed currency sales growth in our Institutional, Industrial, and Other segments as well as increased Energy segment sales during the second quarter.

These sales gains along with product innovation and ongoing cost efficiency work offset the impact of higher delivered product costs, which included a previously discussed $0.04 per share unfavorable currency hedge and challenging end markets.

These, along with our work to lower interest expense and our tax rate as well as fewer shares outstanding, yielded the second quarter's 5% adjusted earnings per share increase.

Moving to some highlights from the quarter and as discussed in our press release, on an adjusted basis, excluding special gains and charges and discrete tax items from both years, second quarter 2017 adjusted earnings per share were $1.13.

Consolidated acquisition adjusted fixed currency sales for our Institutional, Industrial, and Other segments rose 3%, while Energy sales rose 5%. Regionally, sales growth was led by North America and Latin America. Reported operating margins increased 30 basis points.

Adjusted fixed currency operating margins decreased 70 basis points as volume and price increases were partially offset by the impact of higher delivered product costs in the quarter. Adjusted fixed currency operating income rose 1%.

The operating income gain, along with our work to lower interest expense and our tax rate as well as the fewer shares outstanding, yielded a 5% increase in the second quarter 2017 adjusted diluted earnings per share.

We continue to aggressively drive our growth, winning new business through our innovative new products and sales and service expertise as well as driving pricing and cost efficiencies to grow our top and bottom lines and improve rates.

We expect improving volume growth and pricing across all of our business segments in the second half and look for that to more than offset delivered product cost headwinds, which should ease sequentially through the second half, and yield strengthening operating income growth.

We expect full-year adjusted diluted earnings per share in the $4.70 to $4.90 range in 2017, rising 8% to 12% with the second half results outpacing the first half. We expect third quarter adjusted diluted earnings per share to be in the $1.36 to $1.44 range, up 6% to 13%.

In summary, despite a challenging market environment, we expect to deliver strong adjusted diluted earnings per share growth in 2017. And now, here is Doug Baker with some comments..

Well, hello, everyone. So, we had a solid Q2. We continue to expect to deliver double-digit adjusted EPS for the year. If we look at the macro environment, the economies around the world we'd say are mixed but in aggregate, are okay to good. FX headwinds have subsided. Energy markets have recovered some and certainly stabilized.

Raw materials, though, are rising and creating some short-term margin pressure but we believe are manageable over the year. So, this year is going to be a tale of two halves. The first half came in as expected, including Q2. Sales are getting sequentially stronger from pricing, new business, and energy improvement.

Margins are under modest pressure from raw materials and hedging comparisons. The second half, though, it's going to be much stronger from an EPS standpoint, up 13% to 14% if you take the midpoint of our range.

This is driven by raws plateauing and hedging challenges dissipating, pricing and cost savings continuing to gain ground, and most importantly, sales acceleration from innovation, new corporate account investments and continued improvement in Energy.

As a result, we expect to deliver a very solid 2017 and leave the year with excellent momentum going into 2018. So, with that, I'll turn it back to Mike..

Thanks. That concludes our formal remarks. As a final note, before we begin Q&A, we plan to hold our 2017 Investor Day in St. Paul on Thursday, September 7th. If you have any questions, please contact us.

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

Thank you. We'll now be conducting a question-and-answer session. Our first question today is coming from the line of Gary Bisbee with RBC. Please go ahead with your questions..

Hey, guys. Good afternoon. So, I guess, the main question for me is just the dollar has weakened quite a bit in the last month or two. I would assume there is some benefit to that.

And so, should we think that something else has changed, leading to the flat guidance for the year? Or given that we're only halfway through, is it possible there's a little more conservatism in that view now given the currency moves? Thanks..

Gary, Doug. So, here's the FX. We said it was $0.05 negative in our first quarter release and neutral in the second quarter release. So, there's an implied $0.05 improvement. I would say simultaneously, we've had roughly a leak in raw materials of about a little over $0.03. And part of this move on FX was literally in the last days.

And what I would say is what seems to move quick sometimes moves the other way quick. So, we don't know the bake this in fully as we go through the year. So, there is I guess, a little bit of conservatism in here simply because the FX markets move rapidly and often in opposing directions.

So, really what we look at right now is we have some modest gain from FX in total, nowhere near $0.05 because some of it was eaten up by raw materials. If it stays or gets better, I would expect our year to get better..

Okay. Great.

And then the follow-up question, can we just get an update on the Institutional business, which in the Institutional segment within Global Institutional, in particular, which continues to lag history, and I think how you think about the growth potential? How close are we to better performance and what's the driver of that growth improving at some point? Thank you..

Yeah, Q2 was in line with what we expected and I think forecasted in Q1. If you cut through the noise, U.S. growth is a little softer. It's around 4%. Globally, I'd say Global Institutional is around 3%, same factors as last quarter which is what we had forecast. Same-store sales are a bit soft in U.S.

First-half comps are a bit noisy because of Swisher, and part of it is exits on our own. New business though, ramp-up is coming. We're seeing traction there. We're not going to really see it in the numbers until the second half. Simultaneously, you'll get a bit of easing comps because we'll start lapping against the takeout on Swisher.

So, I would say good news. Margins are recovering in that business. I think you'll start seeing sales pick up. We expect a better second half than first half and probably more normalized results as we close out the year..

Thank you. The next question comes from the line of John Quealy with Canaccord. Please proceed with your question..

Hey. Good afternoon, folks. In terms of pricing, so in terms of the Energy business, seems like that was more variable. Can you talk about whether it was upstream, downstream? Sounds like you gave some price for share and then I have a follow-up. Thanks..

Yeah, price for share, probably the latest stuff we've had to do would have been in downstream, but that's been a bit ago. I think if you look at pricing in Energy, we would expect to be net positive by year-end, probably neutral in Q3 from a pricing standpoint. It's been healing quarter by quarter by quarter.

WellChem is already positive just because of increased demand. OFC will probably be the next to flip to positive, and downstream will be fourth quarter. That's the pricing situation. And we never had the – I mean, we had significant pricing give-ups in many instances, but it wasn't like you heard around the industry..

Got you. And then the follow-up, inside Specialty, another double-digit type performance. You've commented in the past on some programs. Can you just give us an update on visibility on that sort of double-digit, upper single-digit growth rate moving forward? Thank you..

Yeah. No, largely, we would expect Specialty to have a strong year. I think in the first quarter, it was mid-single digits and we were asked, it was around 5%, 5.5%, was there anything wrong. It was really a timing issue. And so, now the new business that we talked about in the first quarter has kicked in. So, you're seeing double-digit type results.

And we'd expect strong results through the rest of the year for sure..

Thank you..

Our next question is from the line of David Ridley-Lane with Bank of America. Please proceed with your question..

Sure. I know Ecolab always has potential levers to pull through the course of any year. But the restructuring actions taken during the second quarter were more than what we were expecting.

So, any comments on those and potentially thoughts on the magnitude of the cost savings you'll receive?.

Yeah, payback will be in 18 months in total on the work that we're doing through restructuring, so very quick payback. I mean, some of the work pays back nearly immediately and some takes maybe up to two years max, but in average 18 months..

Great. And then in the water business, it sounds like you've finally getting to flat in mining.

Any thoughts on how fast the other areas are growing and if you expect mining to be positive in the second half?.

Yeah, we do expect mining to be positive in the second half. I will also say we expected mining to be positive in the second quarter. I mean, it was about flush. So, it's always a little hard to predict. But clearly, it's been healing, if you will, if you look at the sequential growth rates.

And we do expect it to pop into positive in the second half for sure in probably the third quarter. Yeah, I'd say, overall, we've got very solid momentum in the heavy and light businesses. We have a very strong portfolio of new business coming on.

The team has done a great job of getting after new business, had its most successful last two quarters, so really outstanding results. You're starting to see it. We would expect a stronger second half in every major business in the water area, heavy, light, and in mining. So, I think that team is in good shape. We feel we're in good shape overall.

Margins are starting to heal. We'll start seeing some pricing across the board in that business as well, so we'll have both fronts working more in our advantage going into the second half..

Thank you. Our next question comes from the line of Manav Patnaik with Barclays. Please proceed with your questions..

Yeah. Thank you, guys. The first question is just around raw material increases that you saw. I was wondering if you could give a little bit more color on maybe where particularly that change versus your expectations and how long before you guys can put in actions to offset that..

Yeah, I don't know that the timing is much different in terms of when we start to expect to see light, if you will, on both gross margin and OI margin. So, we would expect to be positive versus prior year in the fourth quarter on both GP or gross margin and also on OI margin.

Some of the businesses, Industrial will probably get positive in the third quarter; Institutional and Energy, more in the fourth quarter; total, around fourth quarter. So, I don't think it takes endless patience to start seeing pricing and cost savings offsetting the raw materials.

The delta in terms of our expectations versus first quarter really was driven by caustic , Europe and AP, in particular, that affects Institutional, F&B and water, and then isopropyl alcohol is sort of on a negative tear at least from our perspective in Europe. And that's really Healthcare and water that's up 30%.

So, it's really those two have been the biggest change drivers. I mean, it's leaked in other places, and forecasting this is never perfect. So, if you look in total, given our bill, it's pretty darn close. We're pretty accurate, but we spent a lot of money on raw materials. $4 million equals $0.01. It's not hard to be wrong by a penny or two..

Got it. Okay. That's helpful. And then just on Energy, if I may, I mean, we've seen a lot of the macro analysts and so forth lower their long-term targets in oil prices. I think it's in line with what you guys have been expecting longer term anyway. It sounds like you're still hiring this year to set up for more aggressive maybe share in 2018.

Any changes in your view and outlook broadly in Energy there?.

No, I think you're largely right. I think the Energy business and how we see oil price hasn't really changed from what we expected going in the year. So, we didn't have a particularly bullish outlook. So, we don't need to bring it down, I guess, is the easiest way to put it.

So, what we're seeing in Energy right now is what's bouncing back first what was hit hardest by the downturn and that was North America WellChem. And WellChem in the quarter was up north of 50% in sales year-on-year. The other two businesses, if you take them collectively, were really flat, downstream and OFC together, versus last year.

But that's better than Q1 where we were down a couple of points year-on-year. And if you look at the second half, I would say we expect more of the same. WellChem, continuing to improve and have strong year-on-year results as drilled wells are completed.

OFC and downstream will see continued strengthening as we go throughout the year really from pricing leverage, volume slowly improving from share gains and industry recovery. We'll expect the margin, as I mentioned earlier, to start recovering in Q4, start to make some progress.

So, in that, we think Energy remains positioned to do call it mid-single-digit type growth for the year on the top line, flat to modest OI gross on the bottom line but most importantly, leave the year with good momentum.

And we don't expect a magic year in 2018 from a oil price rise standpoint, but we think we're well positioned in this environment to continue improve results, both top and bottom line even if oil doesn't have a substantial recovery..

Thank you. Our next question is coming from the line of John Roberts with UBS. Please proceed with your question..

Thank you.

Any change in new win activity with the recent deals for your largest competitors in cleaning and water treatment chemicals?.

Yeah, we don't go blow-by-blow, never have. I would say in both, well all of them, Institutional, F&B and water in particular, we've had great success the last two quarters in net new business. And it's been increasing over the performance we had for prior quarters. I don't know if you directly attribute.

I mean, we're certainly beating the new business drum loudly within the business. And businesses are on it and starting to show really strong results, so I think it's a whole number of factors. I don't know that there is the same kind of dislocation feeling that we think will occur in the competitors, but we'll see..

And secondly, I don't think this is big, but supermarkets have been in the headlines recently. And I think you used to talk about supermarket locations as growth areas for both cleaning services for fresh food preparation and also a lot of supermarkets we're adding QSR facilities.

Has that stalled out with the pressures that are going on in that particular retail market?.

No, I think there's going to be probably more change in the food retail space, no doubt. There's all kinds of change and pressure in that business. But it will include more prepared foods likely, including potentially delivery and other things. So, we'll see a continued shift, if you will, around the foodservice landscape.

Our food retail business remains quite healthy. It's a global business, and so we have significant opportunity, not only in North America to continue to gain share, but also around the world.

And one of the things that I think we do particularly well is help customers manage through change, particularly when they have to change their risk profile, say, from selling raw food to prepared food. And we think that's going to be still a change and a move that you're going to see in that industry..

Thank you. Our next question is from the line of Laurence Alexander with Jefferies. Please proceed with your question..

Good afternoon. Can you just benchmark a little bit current thinking around direction of taxes and cash taxes given the progress that you've seen? And secondly, you allude in the prepared remarks to a comp effect affecting Q3. How do you think about comp affecting the bridge for 2018 versus 2017? It should be a net neutral.

Is that right?.

Yeah, I think this year, tax is going to be around 24-ish is where we had expected to end up. You know, Laurence, we do a lot of work every year looking at ways that we can improve our tax rate. We don't take bleeding edge strategies.

We've always tried to have a balance between, if you will, kind of cash fungibilities, so we don't end up with significant amount of trapped cash, sometimes as a tradeoff with rate to chase the absolute lowest rate. It's actually at the cost of trapped cash. And so, we try to have a balanced approach as we go through.

We would expect 2018 to be similar to 2017 right now as we look at it from a tax rate, so we don't believe it's going to be either a significant tailwind or a headwind next year..

Thank you. Our next question is from the line of David Begleiter with Deutsche Bank. Please proceed with your question..

Thank you.

Doug, back to the guidance, at the very low end, which seems very conservative, what would need to happen for you guys to hit that $4.70 number?.

Well, I guess, any number of things. I mean, the world is not the most stable place. I don't think it's likely that we're going to be down there. I would say it's unlikely we're going to be there. Looking at the range right now, given we had a benefit really from FX, which was quite recent since we've seen daylight, we're talking days.

And everything else, I mean, we are forecasting a pretty aggressive second half, 13% to 14% EPS, which is really kind of double-digit third quarter and a very strong fourth quarter.

We just said it probably made sense to stick with this range given all the uncertainty in the world, but I would be quite surprised if we end up on the very bottom of the range to your comment. I don't think it's highly likely. I think our position is good. Our businesses are improving across the board.

We feel like we've gotten most of the stuff in hand and understand it, which is always the time something shakes somewhere that we didn't predict, but I think we've got a little flex in a couple of areas to allow us to manage even some level of unhappy surprise going throughout the balance of the year, which is how we normally manage.

So, yeah, there is some conservatism on the bottom of the range, absolutely..

Got it.

Doug, just on Anios, how is that acquisition progressing seven months into it?.

Well, I mean, we're predicting to be on or above on both top line and bottom line in the first year. We always have very aggressive objectives, particularly when we do a management case, so we do two cases for all acquisition. We do sort of the financial case and then we do a management case.

Management has to sign up for the second, and we're beating and exceeding those numbers. So, we feel very good. It's a great company. The culture fit is what we expected, very solid and strong. They're very focused on customers, very focused on growth. We feel like we made the right move buying that company. So, so far, so good..

Thank you..

The next question is coming from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question..

Thank you. Within Industrial, can you sort of view your new account pipeline in F&B, the share gain outlook in conjunction with your enterprise solutions effort for the second half of into 2018 and whether or not it is meeting or exceeding your expectations, which I recall were a little more upbeat during your last call? Thanks..

Well, F&B, we expect to have a better second half than first half, and it's being driven by two of the issues you just cited. One is they've had a lot of success in new business in the first half. It will start showing up Q3 and Q4 as they roll it out. I mean, you have to actually install it and start shipping.

It's not the signed contract that moves the needle from the P&L standpoint. Additionally, I would say, when we look at a number of the new initiatives, the new initiatives particularly Industrial have longer legs than they say in Institutional because it takes longer to get uptake.

When you're going in and switching systems in a food plant, there's a lot of things people have to be concerned about, making sure that they don't impact quality or safety as you change out systems or move from one antimicrobial to another, et cetera. So, it always takes a little longer to ramp up.

But our 3DT CIP systems are really starting to take off. We feel very good about a number of antimicrobial platforms that we have coming. So, all in all, I'd say we feel bullish about the F&B business, particularly given what it's had to come through in terms of plant shutdowns and consolidation.

In North America and other places, they continue to keep their nose above water in the top line. The dairy business looks like it's starting to move in the right direction. Milk prices were incredibly low for a period of time. So both dairy, food, some of our big segments are improving. We expect it to have a strong second half..

And as a quick corollary to that, as it pertains to the enterprise selling effort, is F&B typically the anchor for your sales force for the water and pest businesses or is it the other way around? Is it typically mixed? Just any outlook on that as well. Thank you..

It's worked both ways. When you're in the food and beverage business, our food and beverage team, the food safety portion of that team had a higher share, if you will, of that business than did Nalco Water when we put the companies together. So, the majority of the introductions, if you will, came from the F&B side to the water side.

But it wasn't all F&B introducing water. We've had a number of instances where the relationship was with the water team and they brought F&B in. But that's been a huge success for us. The customers see these as completely interrelated. They understand the advantages of having, if you will, one company do both for them. We've worked to make it obvious.

We continue to do other things around reporting, synergistic chemistries, service. We're looking at organization structures, et cetera, to make this work even better for our food and beverage industry customers. So, we feel good about this.

There is still legs, plenty of room and opportunity to sell more here, working together, and we're going to continue to push them..

Thank you. Our next question is coming from the line of Tim Mulrooney with William Blair. Please go ahead with your question..

Yeah. Good afternoon. I understand that restaurant foot traffic became more of a headwind through the first half of this year than maybe it's been over the last several years. Given how much you guys see the touch points across thousands of restaurants, I'm just curious if you have any insight as to why this deceleration is taking place.

Is there some underlying secular trend? Is it more macro related? What do you think is going on here?.

Well, I would say the softness in the first quarter in particular was also timed identically to the retail softness broadly. There's all kinds of assumptions or guesses about what was driving it then, timing of tax refunds, et cetera. I don't think you've got any huge fundamental change that you're currently seeing in U.S.

food service, i.e., takeout or some other magical thing. Those things move year-on-year but at a fairly slower rate, so I don't believe those are the trends that we're seeing. I think what we're seeing is some softness broadly in a certain segment of the foodservice industry. We've chased it before over time. We'll probably chase it again.

So, that's really I think the issue. I don't believe there's been any fundamental secular change that we're dealing with at this moment. That's not what the industry sees. It's not what the stats suggest. So, I think for us, we're having to overcome some softness in one of our key segments. We deal with this all the time.

And the best way to deal with it is sell more business, and that's exactly what we're working to do. If same-store sales start rebounding to more normalized levels, we'll be the beneficiary of it, probably on a greater scale because we'll have larger share..

Okay. Thank you. That was helpful. Maybe switching gears to life science. Life science decelerated I think in the second quarter to 5%.

Is that how we should think about long-term growth for this business? Or do you think about it more as a high single-digit grower through the cycle? And can you also remind me how large this business is today? Is it about $100 million? Thank you..

Yeah, it's about $100 million. It's going to be lumpy. I think we expect this to be a double-digit business over stretches of time. We'd expect it to grow north of – I mean, into the teens, maybe early teens in balance of the year. And it's really you sell – this is the old feed the village with an elephant, so that's the nature of this business.

It's a lot like QSR and lumpy like QSR. I'd say over time, QSR has got a big base now, so it's not as lumpy as it was. We explain this all the time in QSR. I think it's going to be the same story in life sciences. They've sold a bunch of new business. They feel confident in the second half. I would expect to see much different results in Q3 and Q4..

Thank you. Our next question comes from the line of Hamzah Mazari with Macquarie. Please proceed with your questions..

Good afternoon. My first question is just on the European business, if you could provide a little more color. It seems like it was weaker across most segments, except for the water business and Healthcare..

Yeah, I mean, in total, our Europe business was really weak in the first quarter and obviously, better in the second quarter. We expect the top line to be better still in the second half. Water was one of the main drivers for the performance improvement from Q1 to Q2, and it was welcome to see.

We'd expect Institutional to improve through the balance of the year, F&B as well. So, I don't think it's going to be only a water story for all of 2017. It was principally a water story in Q2..

And just a follow-up, on the balance sheet, the leverage is still low but has ticked up a bit. Maybe just frame for us your appetite to do larger deals longer term and ability to use the balance sheet. Thank you..

Yeah, our appetite hasn't changed nor have our taste buds, meaning we want really good deals that have the ability to deliver favorable returns to shareholders over the long term. And so, if that's the environment, obviously, it's got to be a strategic fit of business, we have a right to own and run and run well, fit our model, and all of the like.

We have a big appetite to do those deals when they make sense. And so, our balance sheet, we don't believe is any way a hindrance in our ability to do that. We've ramped up what we needed to. We have room in the balance sheet even sitting here today. We expect those metrics to improve as we go throughout the year.

So, we'll have more room, if you will, by the year-end than we do now, but we don't even view it as an issue right now..

Thank you. Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please go ahead with your questions..

Thanks. Doug, you talked a little bit earlier on Manav's question about kind of what you're expecting in the back half in Energy.

Could you just refresh us on how to think about how well completion activity progresses to production? I know we've seen a steadiness now in the oil price? And then a follow-up on that is in the press release, it was discussed, the soft international markets in Energy. Could you delve in a little on that, too, please? Thanks..

To the first one, I mean, all the pressure initially in the downturn really hit the North American market, the unconventional piece in particular. And that's where you saw almost all the volume takeout in the industry was in the U.S. The rest of the world often I would say oil production is directly tied to some economy like Russia or Venezuela.

And when prices go down, oil price per barrel, their production tends to go up over the near term. They're trying to offset, if you will, the bleeding in their economy. And so, you get this kind of perverse activity going on. That can only last so long because it simultaneously cut CapEx.

They start losing the ability to keep and maintain production without new CapEx. And what we're seeing is the shift. First, the pain was in North America. In 2015, our international non-North American business was up in Energy and was pretty strong. In 2016, you started seeing pain on both sides.

And what you're now seeing is recovery first in North America because it went down first and international will lag. So, that's, by and large, the geographic story in this business. Our WellChem business is predominantly North America. And so, we took it on the chin when we had the North America pain early in the downturn.

Likewise, when you see – the really significant pickup in the business is in North America. It benefits disproportionately as well, and we're also seeing that. In terms of drilling activity, there's a one to two quarter lag often from drilling to completion. Our WellChem business doesn't really realize the benefits until you've got completion.

And if you look at drilling but uncompleted units, they have risen recently. It's a little north of 6,000 right now. And those will be completed, and that's what's going to drive benefit for WellChem over the next couple of quarters. So, I don't know – hopefully, that answers the two questions you posed..

It did. Very helpful. If I could just sneak a follow-on on that. The compensation rebuild, obviously, it's baked into the guidance for the rest of the year, which we can see, but is that something that's going to affect 2018 as well? Or is that kind of a catch-up right now this time of this year? Thanks..

Much more of a 2017 issue than a 2018 issue. I would say both things. You're going to have better balance between price and raw materials in 2018 than you did in 2017. And comp rebuild is predominantly a 2017 story. I mean, it's going to be a little bit in 2018 but not at the same level..

Thank you..

Our next question comes from the line of Dmitry Silversteyn with Longbow Research. Please proceed with your questions..

Doug, Good afternoon. Thanks for taking my question. I just want to make sure I understand what's going on with the Energy business and given that your margins are still sort of in the high single digits versus I would expect it by now to see more of a recovery into a low double-digit range.

It sounds from your comments like you do expect that recovery in the second half of the year.

So, I'm just trying to understand if that's going to be driven by volume or by better sort of pricing, raw material mix or kind of where is your confidence coming from that the revenue growth is going to translate into profit growth and profit margin growth?.

Well, Dmitry, I mean, here is what we're seeing and as I mentioned on an earlier question, a couple back, we will start to see daylight in Energy between price recovery and raw material incremental cost starting really in Q4.

We're starting to see some price recovery in WellChem, but as I mentioned, the Other businesses is going to be a little later in the year. So, you'll start seeing that dynamic work more in our favor than against us, which it has for the last several quarters.

The comp rebuild is really – the heavy pieces are Q2, Q3 on that business, so we'll start annualizing against that, and you just start having more significant volume gains, and those start translating into, right, overhead coverage and the like.

I mean, I think we were very clear this year even at the beginning to say we expected sales to be mid-single digit, NOI to be flat or modestly up, which implies margin linkage just by nature. And so, what we're seeing isn't a real surprise, and it's also quite consistent with past recoveries. You start seeing sales recover before margin.

Margin follows more like year two than year one, but it starts recovering. And what we're seeing right now suggests we're exactly on that trajectory, and we'll start seeing improvement in margins Q4..

Q4. Okay. I just wanted to confirm that.

And then the second question, I think it was a couple of quarters ago when talking about a slowdown that you guys seen in your Industrial business that you mentioned that uncharacteristically for you, you sort of took the eye off the new wins ball, if you will, or getting new relationships going and just expanding your business and capturing market share.

We saw a little bit of improvement in the first quarter, not so much in the second quarter in terms of year-over-year comps.

So, where do we stand in that, I guess, re-energized initiative, if I will, of going out and getting the business and making sure that you control more of your destiny than the market?.

Yeah, I would say the business is strengthening. I'd say the new business productivity has been very strong the last couple of quarters. You are right. I mean, I think we looked at our new business productivity honestly across the board and felt we needed to turn up the heat and we've done it, and we're starting to see the results.

I would expect Industrial, so predominantly F&B and water, to have an improved second half, both in top line, margin, frankly across the P&L in the second half versus first half, and we think we're well positioned to do it. So, we feel good about what's going on in those businesses. I think the teams have positioned them.

The work they've been doing is going to start bearing fruit starting Q3..

Thank you..

Thank you. The next question comes from the line of Andrew Wittmann with Robert W. Baird. Please proceed with your questions..

Hi. Great. Thanks. I guess my question is on the Other segment. This is one of your faster-growing segments and has been for a while. In your release script, you guys talked about some investments there.

I guess, I'd like to understand a little bit more about those types of investments, what they were, and how you expect them to affect the margins on a go-forward basis from here..

I mean, some of the investment is just strictly people, so that's a variable expense. And we're having sales growth. We want to continue to make sure that we're feeding it, and people aren't immediately productive when you put them on. So, there's always a little bit of a drag.

I think more significant in past, we've been leveraging much more effectively technology in the field. We had a large group of field meetings this year, which we didn't have the prior year to the tune of a couple million dollars. It didn't sound like a lot. It's not. But it does affect a 13-week period at times, and so that's the other cost.

That's a onetime cost this year. It is not going to repeat in three and four. That also has some impact on the margins here, net. We don't have a high concern about the margins in the Other segment. We think they will do what they're supposed to do as we go on. We want to make sure that we continue to drive top line success there..

Okay. Great. I'll leave it there. Thank you..

Our next question comes from the line of Rosemarie Morbelli with Gabelli. Please proceed with your questions..

Thank you. Good afternoon, everyone. Doug, following up on the Other category, equipment care was up only 2%.

Could you bring us up-to-date as to what you are doing there and remind me of what the anticipated growth rate over the long term is? Can you get to the 8% or thereabout that pest is enjoying?.

Yeah. No, I mean, we'd expect our equipment care business to accelerate. The 2% is not anywhere near our target. We were growing upper single digits recently as last year, so I don't think there's anything – we're in a bit of a lull in that business. We don't plan to hang out here very long. The team is on it. We need to get after it.

We got a little behind on keeping manpower levels where we needed them. That's been improved per the earlier question, and so I would expect we'll start accelerating that business again..

And then looking at both Europe and Asia Pacific and I apologize if you talked about it already, but could you talk about the impacts from the higher raw material costs and then the trend in demand in both of those regions for the different businesses that you operate there?.

Well, Europe, we talked about a bit. We've got in Europe, we would expect Industrial recovery first but Institutional improved throughout the year. So I think overall, we'd expect to have a pretty good year in terms of top line performance in Europe. We're up about 2.5% in the second quarter after being slightly negative in the first quarter.

So, it was a pretty strong sequential recovery, if you will. In terms of raw materials, they're biting us in Europe. No doubt about it. We have the same story there. It takes us a while to recover via pricing, but we're starting to get pricing in Europe as well.

And we expect a kind of tried-and-true formula we've talked which is absolute raw material cost coverage, year one and margin recovery, year two. Sometimes we do it in a little more accelerated basis, but it's not a bad way to think about it. So, I think Europe is going to be okay.

We probably won't see our 100-point OI margin improvement this year simply because we're dealing with the raws, and we'll expect to have more than 100 points next year. And we've also seen this in the recent past, so I'm comfortable that we're more right than wrong in Europe. AP, yeah, we've got some work to do on some of the businesses.

We see improving results in a number of areas but it's inconsistent. And AP is sort of it's not really a region, right? We've got Australia, Japan, Southeast Asia. You've got very different markets there. And all in all, where we really need growth, I think the team is doing the right stuff.

And in some of these markets, we want more balanced growth in margin given our share and where we ought to be in kind of tradeoffs and opportunity. So, I think there is stuff we can continue to improve in our AP performance, and we expect to see that improving throughout the year as well. That's a harder market to get pricing traditionally..

Okay. Thank you..

Thank you. Our final question today comes from the line of Dan Dolev with Nomura. Please proceed with your questions..

Hi, Doug. Thanks for taking my questions. Two questions. First one on raws. If I heard you correctly, you expect raws to plateau in the second half of the year.

Did I hear you correctly and is that what's embedded in the guidance?.

Oh. Yes. Sorry. I missed the pun there. Yeah, it's embedded in the guidance. Otherwise, I wouldn't have offered the comment. But I would say, we look at kind of peak Q3 on raws, but we also have pricing increasing in Q3, so the delta is more in our favor in Q3 than it was in Q2 because it takes a little time for pricing to catch up with raws.

Additionally, our hedge, which we've talked about and said it was principally first half challenge dissipates down in the third quarter versus the first two and basically gone in the fourth quarter..

Okay. Great. Thank you. And then my second question is on the SG&A. If I look back over the last 10 years, you've done a really good job lowering your SG&A as a percent of sales. How much lower do you think you can go? How much more room do you have to decline? I guess, you went from 33% in the first guidance to 32% to 33%, and now, you're at 32%.

So, how much lower can you go and how do you plan to get there if you needed to? Thank you..

Yeah. Well, I would say our SG&A has benefited from a number of things. I mean, certainly, we're a lot of bigger, and so you've got a lot better leverage over, say, G&A resources broadly, corporate, regional, et cetera, over the last 10 years. We're also leveraging field technology and improving the way that we drive that technology.

And so, you see some of that benefit. I would say what we would expect, we'll continue to grow, so I think you'll still see G&A leverage going forward, predominantly from growth but also from technology. But in the field, which is really the big spend area, we're working now.

We've got, I don't know, some 2 million customer sites nearly if you add up all the restaurants, probably collecting data 90%. But we only have a small fraction of it currently connected to the cloud.

So, in most instances, our people have to walk into the unit, download via an RF port, and then they have the data to start analyzing how they can further improve the customer's operation.

We know that if we take that and send it to the cloud, do the analytics, send it to our person in advance of them arriving at the front door that we're going to improve their productivity significantly and improve the amount of time they have for up-selling and for doing other things, even handling more accounts.

So, technology, I would say in all industries, we have not yet pushed boundaries in these areas we are going to. We're doing a lot of I think very smart things in these areas, and we believe ultimately we'll see benefits that will show up in lower SG&A ratios, probably the ability to do more for our customers.

Also in a host of areas, we think it will benefit our business..

Thank you. Mr. Monahan, there are no further questions at this time. I would like to turn the floor back over to you for closing comments..

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

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