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

John Roberts - UBS Securities LLC David E. Ridley-Lane - Bank of America Merrill Lynch John P. McNulty - BMO Capital Markets (United States) Tim M. Mulrooney - William Blair & Co. LLC Hamzah Mazari - Macquarie Capital (USA), Inc. Manav Patnaik - Barclays Capital, Inc. Laurence Alexander - Jefferies LLC David I. Begleiter - Deutsche Bank Securities, Inc.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC Christopher S. Parkinson - Credit Suisse Securities (USA) LLC Andrew John Wittmann - Robert W. Baird & Co., Inc. Dmitry Silversteyn - Longbow Research LLC Shlomo H. Rosenbaum - Stifel, Nicolaus & Co., Inc. Jeffrey J. Zekauskas - JPMorgan Securities LLC Scott Goldstein - Citigroup Global Markets, Inc.

Scott Schneeberger - Oppenheimer & Co., Inc. (Broker) Michael Joseph Harrison - Seaport Global Securities LLC Rosemarie Jeanne Morbelli - Gabelli & Company.

Greetings and welcome to the Ecolab second quarter 2018 earnings release conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mike Monahan. Thank you, Mr.

Monahan, you may now begin..

Thank you. 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 under Item 1A, Risk Factors, of our most recent Form 10-K and in our other posted materials. We also refer you to the supplemental diluted earnings per share information in the release. Starting with a brief review of the results, Ecolab's growth momentum continued in the second quarter.

New business gains, pricing, and product innovation drove strong second quarter acquisition-adjusted fixed currency sales increases in all of our business segments. That solid top line growth, along with cost efficiency and a reduced tax rate, yielded the second quarter's 13% adjusted earnings per share increase.

Moving to some highlights from the quarter and as discussed in our press release, second quarter 2018 adjusted diluted earnings per share increased 13% to $1.27. Consolidated sales rose 7%. Acquisition-adjusted fixed currency sales increased 5%, with good growth in all business segments. Regionally, sales growth was led by North America.

Adjusted fixed currency operating margins decreased 20 basis points as price, volume, and efficiency increases were more than offset by rising delivered product costs in the quarter. Adjusted fixed currency operating income rose 3%.

The operating income gain along with lower tax rate yielded the 13% increase in second quarter 2018 adjusted diluted earnings per share.

We continue to work aggressively to drive 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 at improved rates.

We also see continued good underlying sales volume and improving pricing across our business segments, and look for that to more than offset continued delivered product cost headwinds and yield stronger income growth.

We continue to expect 2018 adjusted diluted earnings per share to rise 13% to 18% to the $5.30 to $5.50 range, with second half earnings per share growth outpacing the first half, as volume and price gains increasingly offset the expected impact of higher delivered product costs and business investments.

We expect strong third quarter fixed currency acquisition-adjusted sales growth, with adjusted diluted earnings per share in the $1.49 to $1.57 range, up 8% to 14%. The efficiency initiative we have begun will leverage our recent technology and systems investments.

We expect these actions to make Ecolab better, faster, and more profitable as we simplify our structures, improve future sales growth, and increase operating efficiency while delivering better customer outcomes.

In summary, we expect further strong momentum in our business over the balance of the year to deliver our forecasted 13% to 18% adjusted diluted earnings per share growth this year, while at the same time we are making the right investments and taking the right actions to develop superior growth for the future.

And now here's Doug Baker with some comments..

Thank you, Mike. Hello. A couple comments on our second quarter, we feel good about our business. Our position is strong both near term and long term. If you look on a macro basis, our clean water, safe food, abundant energy, and healthy environment positioning is as relevant as ever.

While the news of the day in various positions seem to change frequently, the fundamental trends that we are betting on are constant. Population is growing globally. It's aging in developed markets. The middle class is growing, particularly in Asia.

A bigger middle class increases disproportionately demand for food as their diets shift and for energy as their expectations shift. Food and energy are the two largest users of water, and water is already scarce. The aging population also drives travel and consumer healthcare spend.

So in total, we see solid demand for our food safety, energy, water, and healthcare businesses now and over the mid and long term, and this is reflected in our results. We are executing well. We are seeing accelerating growth in all of our large businesses.

Industrial has moved from 3% in 2017 to 5% organic first half and expect 6% organic in the second half. Institutional moved from 3% organic in 2017 to 4% organic in the first half, and we expect 5%-plus in the second half; Energy from 5% organic in 2017 to upper single digits this year; and other, led by pest, from 7% organic in 2017 to 8% in 2018.

In total, we expect to move from 4% organic sales growth in 2017 to 6% organic in 2018. This is certainly above market growth and reflects share gains, as evidenced by our net new corporate accounts business, which was up 22% in the first half of this year versus last year's first half.

Now not only are we building top line momentum, we're building margin momentum too in spite of inflation. So it's no news that we're in an inflationary environment, with raw materials and transportation increasing by $0.45 for the year. This is plus $0.17 since our last call on May 1.

The dollar has also strengthened since that last call by $0.08, giving us a $0.25 challenge since May Day. The good news is we have overcome this primarily through increased pricing and volume. In fact, margin recovery is already evident, with Q2 gross margins in line with a year ago, where Q1 was significantly off a year ago.

So given our strong and consistent volume and pricing trends coupled with good management of SG&A, we feel confident we will deliver within our $5.30 to $5.50 range.

Let me take, though, a moment to address our second half, which looks a little lumpier than it actually is, with implied adjusted EPS growth of plus 20% in Q4 compared to low double digits in Q3. Mike already alluded to this.

The story is one of continued strong volume plus accelerating pricing and cost savings catching up and overtaking the forecasted second half step up in raw material cost. This takes some time.

Our volume forecast over the second half reflects current trends while the cost savings forecasted in the second half are in hand, and we've already secured 75% of the incremental pricing needed as well. All of this leads to our confidence in the forecast. Finally, we also formally announced the efficiency program we referred to in our last call.

This will generate $200 million in run rate savings by 2021. The program leverages our $600 million investment that we've made the last five years in technology. We are driving efficiency in G&A by leveraging our Workday and SAP platforms, by consolidating systems, by consolidating back offices, and by consolidating third-party vendors.

New field technology, which is tied to new customer digital programs like SMARTPOWER, 3D CIP and 3D TRASAR, new QSR and FRS digital safety platforms, and the like allow us to continue to improve field efficiency and customer service and capability. So all told, this will be additional fuel to drive continued mid-teens EPS growth beyond 2018.

So with that, I'll turn it back to Mike, who will open it up for questions..

Thanks, Doug. That concludes our formal remarks. Operator, please begin the question-and-answer period..

Thank you. Our first question comes from the line of John Roberts with UBS. Please proceed with your questions..

Thank you. I think you started to see a pickup in the full-service restaurant part of your Institutional business.

Are you seeing investments by the customers that might confirm that and reinforce it will be longer-term rather than a temporary uptick here?.

I would say the full-service restaurant segment has got two things. Sales have been consistently growing in almost all segments. What's been weak in the past and continues to be modestly weak is foot traffic.

With that said, I would say we don't consider that segment impaired or horribly unhealthy, meaning it's strong enough for us to continue to drive share growth and drive sales growth. I think what we've seen is that we've started to gain more traction. We talked how we had to delay last year a large platform introduction, SMARTPOWER.

We launched it late, late last year, and it's doing what we expected to and starting to lead to more share gains, which is why you're seeing really a recovery in Institutional first half of this year versus 2017..

And then could you characterize the M&A pipeline that's there? I think we've had some big transactions that you weren't involved with. I don't know if there are a number of things that you are thinking about right now..

We never go into specifics for obvious reasons. I would say we still have a healthy list of targets that we're looking at. We're going to remain careful, I would say, or smart with shareholder money. I think we've proven to be in the past. We'll continue to be going forward.

With that said, we've closed a number of deals this year and would expect to close several more before year end..

Thank you..

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

Sure. So I just wanted to check.

Based on your revised expectations around raw material prices, would pricing be catching up to raw material costs on a dollar basis in the fourth quarter? Did I hear that right? And what would you expect in terms of pricing into 2019?.

Yeah. Well, we're going to continue to accelerate pricing through this year. We've seen solid acceleration in each of the last six quarters in total and really across the board by business, and we're going to continue to need to accelerate pricing through the balance of the year.

That's going to leave us with a lot of carry-in into 2019, just simply by the math. You don't capture it all specifically on the last day of the year, and these agreements extend typically several years out. So we would expect to see pricing continue to grow. I think you would see pricing up in 2019 under almost any scenario as we look.

You'll see gross margins, they're already flat year on year. They're going to remain around that range for the balance of the year. You'll see OI margins expand, particularly in the fourth quarter..

And just a very quick follow-on, how disruptive would a new deal Brexit be to Ecolab's UK business, including perhaps some follow-on effects to your clients there?.

Well I think the direct effects to us would not be monstrous. We've already – that's how we calc'd it. It basically resorts to WTO duties. We've looked at that. We've already taken some steps to mitigate that potential; i.e., moves that would be good under almost any scenario.

With that said, I don't think it's going to be a big conversation piece for us if that's where it ends up. But the economic impact is probably the impact that everybody will feel..

Thank you very much..

The next question is from the line of John McNulty with BMO Capital Markets. Please proceed with your question..

Yeah. Thanks for taking my question.

With regard to the $200 million cost-cutting opportunity, I guess can you help us to think about the major buckets that you see those cost savings and efficiencies coming through and how we should be thinking about them phasing-in in 2019 and 2020? Is it relatively even or straight-line through, or is it lumpier than that?.

Yeah. I would say that the trajectory over the time period is fairly straight-lined. It's going to be close enough if you do a third, a third, a third. I would say in terms of buckets, it's going to be a little bit more on the G&A side, but it's going to be both on the G&A and the S side.

These things come from initiatives around Workday, which has allowed us to take 176 payroll systems down to one. We had 52 onboarding systems for people and exit systems for people. We've taken those down to one around the globe. This certainly is a lot simpler and a lot more cost-effective.

If you look at SAP, we're already rolling out looking at both tank monitoring upgrades, which is going to lead to route efficiency. Often, these are our carriers – our contracted carriers, our own people dropping off tank loads of product, putting it into the plant tank.

If we know exactly where they stand in all these tanks, you can route differently. You don't have any outages and it's a heck of a lot safer.

Logistics, we already now because of what we've done with SAP in the United States, where we have roughly a third of our production up, we already have better visibility and understand that 12% of what we thought were full trucks aren't actually full.

And the best way to reduce shipping costs is to reduce the number of trucks it takes to ship the same amount of volume. So we're all over this stuff. We have better cost visibility; i.e., you can start driving and understanding where it makes sense to maybe go direct and where it makes sense to partner with distributors in a more collaborative way.

We'll have a number of other opportunities. Field technology, we're moving to online ordering. We're creating a portal so our customers can do online ordering today. Frequently, they phone us or even still fax us. And let me just say, fax machines aren't the most efficient way to take an order, as you can imagine.

So there's just a whole host of things that are going on, and these tools are being deployed now. And so you'll see it, both on the S side, but disproportionally on the G&A side early. We always drive S efficiency. We'll continue to do that, and these new platforms will enable us to do that for a longer period of time..

Great, thanks very much for the color..

Our next question is from the line of Tim Mulrooney with William Blair. Please proceed with your question..

Yeah, good afternoon. You guys typically get 50 to 60 basis points in operating margin expansion on higher volumes and net of pricing. And I'm calculating a 30 to 40 basis point expansion over the next three years from the restructuring plan.

So adding that together, thinking about over the next several years, I'm looking at 90 to 100 basis points in operating margin expansion over the next three years, I guess.

Is that how you guys are thinking about this?.

Yeah. It's designed to be additive. So by and large, that's the math that we would get to too..

Okay, great. And then looking at your free cash flow for the quarter, I guess it was lower than expected.

Was there a large working capital adjustment in the second quarter?.

I'll let Dan have this one..

Yeah. Thanks. It was, well, not an adjustment, let's be clear. The second quarter followed what I would say is a very strong first quarter cash flow performance. But yes, it was – taking the first half in total, it was below last year, which is not a typical outcome for us. And you put your finger on it.

So on a year-to-date basis, operating cash flow behind last year is something like $75 million, essentially all of that was in working capital. I would break it down for you maybe into a few drivers. Of course, good news increased pricing and increases, also the uncollected receivables balance. So that's a chunk of it.

There's also some payment timing, I would say in North America, which we watched it carefully at the end of June and saw accelerated payments in July. So the net of it, I would say growth of Energy likewise, which has higher days or cash invested is good news, but it has an impact on working capital.

So the net of it is I think there's some timing impact that will reverse in increased pricing. We'll have some impact for the full year as will strong Energy performance.

But look, the net of it is I feel very good about our cash flow performance for the full year and expect that we'll be delivering very good cash conversion from our reported net income..

Okay.

Dan, just even with higher working capital, is it safe to assume free cash flow grows faster than EBITDA in 2018 given the benefit from tax reform?.

Yes, I would think that that would be right, okay?.

Okay. Thanks, guys..

Our next question is from the line of Hamzah Mazari with Macquarie Group. Please proceed with your questions..

Good afternoon. I was just curious if you could share any color around customer churn. It feels like it's run slightly below 10% for a bit.

Any room to improve that, or does it structurally just – is that maxed out for you?.

The customer churn numbers or retention on the positive side is really different by business. I would say in a number of the businesses, we are at historic low levels, which is good. It's a strong economy. This is what we look for as we go through these periods.

I don't think that's where you're going to see dramatic improvement because we're typically best-in-class in most of the businesses we compete in. Where we look for improvement, if you will, from a sales driver standpoint is, one, just more new business.

We talked about how we had a lot of success in the first half this year capturing a number of large pieces of business. It was up 20% or over 20% versus same period year ago. That's a great number for us. It's our best leading indicator of sales acceleration in the past and we believe still is.

That's where we're going to focus our effort in terms of improving the top line..

Okay. And just a follow-up question, on Institutional, anything relative to your expectations you're seeing in the European business? I guess it was flat. I know it's more competitive and your scale isn't as big versus domestically, but just curious as to how you're thinking about that segment..

Yeah. Institutional overall, the underlying sales growth in the first quarter we cited as 4%, even though the printed number was larger and said we would expect maybe the printed number to be lower in the second quarter as distributor inventories balanced. We had some distributor inventory build in Q1.

Our underlying growth again was 4%, a little north of 4% in Q2. And we continue to expect that we're going to expand that to 5% in the second half and as an exit rate in 2018. So the business is I would say globally improving, accelerating at about exactly the pace that we thought it would.

We would have loved to have it go faster, but that's exactly what we thought we would see. In terms of Europe, we thought Europe was going to be soft in the first half. We believe it's going to be a little stronger in the second half, still do.

With that said, it's probably the toughest business environment that we compete in, in the Institutional business globally. With that said, we should be able to overcome it with better execution, which is exactly what we're focused on. So we don't believe it's a 1% growth business forever.

But right now, the business is not performing to our expectation. It's low, it will be low single digits for the year..

Thank you..

The next question comes from the line of Manav Patnaik with Barclays. Please proceed with your question..

Thank you, good afternoon. My first question is just on Healthcare performance. I guess it sounds like Europe was the weak area. I was just wondering.

I know you said there's obviously continued challenges in that business overall, but just some more color there in terms of maybe if you have the right portfolio mix, if you need more changes to make there..

I would say Healthcare, clearly of all – I would say all of our businesses are outperforming the market, the exception being Healthcare. With that said, the market is a little dicier in Europe than it is in North America. North America has some challenges. But in Europe, France in particular, they went through some changes in healthcare.

I think we've adjusted well. We're going to have a slow first half and expect to have an accelerating back half. I think there are a lot of reasons to believe we'll have an uptick in reacceleration starting in the third quarter and moving throughout the year. In North America, I would say it's as much execution on us as anything.

We have improved significantly our program efforts, things that we put around room cleaning, hand care vectors, operating theaters, central sterile, and the like. Cumulative they're growing by double digits, so they're doing well.

It's the non-program sales which are softer than expected, and we're simply going to have to do a better job managing both. I don't know what else to say. The team is on it. We expect to have a better second half. It's not going to be what I would call robust, but it will be improved..

Okay, got it.

And then just tied to your efficiency plans, I guess when you think about your 20% margin target, are there other opportunities that would be additive, like you said, to just the operating leverage you have in the business that you feel like you can touch on in the coming years?.

Yes, I think we're moving into a period – we've been in a recent period of fairly significant investment in our business, even while we were going through FX headwinds and oil market headwinds.

We did not blink on what we thought were critical investments for the business, and these are backbone technologies like one HR system and what we call Catalyst, which is SAP North America. But most importantly are also digital expenditures to improve our ability to serve customers.

All of this is paying off, and we've had significant investment there. And so I think what you're now going to see is probably increased focus on harvesting these investments as we go forward, the natural order of things.

And so we do expect that we're entering a period where you're going to see more expansion in terms of SG&A margins, for the simple reason that we're done upping investments. We may stay at this level for a while, but we don't have to increase investments year after year after year.

And you're going to start seeing the fruits from the investments already made..

The next question comes from the line of Laurence Alexander with Jefferies. Please proceed with your question..

Good afternoon. I guess two quick ones.

One is can you characterize the trends in the Life Sciences business, very strong growth there? But also just following on the last point you made, if you look out say four or five years, do you see a bridge as your productivity – as you flex the productivity and your pricing catches up to raws to get 200 – 250 basis points of margin expansion, or is that more challenging?.

On Life Sciences, yes, Life Sciences is a business we created a couple years ago ,and we took a hunk of it out of the Healthcare business and also a little bit out of the F&B business to create this. We wanted more focus on Healthcare, probably isn't perfect for the optics, but it's the right thing to do for the business.

And Life Sciences is doing exactly what we hoped it would do. It's going to grow by probably mid-teens this year in terms of top line as a percent growth. The bottom line follows. It's a very attractive margin business, as you would expect. Our technologies are highly valued in the pharmacos and cosmetic industries. We make a big difference there.

Why we haven't been after this for the last 30 years, I have no great answer to, but we're on it now. And the team is doing a very good job. This is an industry that's characterized by large multinationals. They're looking for consistent service around the globe in all their areas. They need cleaning-in-place technology.

They need water reduction technologies. All the stuff that we do is what they need. And so it's a perfect match for us, and so we're going to go after it. In terms of how much margin improvement we see, I guess we've talked. We're here for the year at 14%, just under 15% margins, and we've talked that we believe 20% is real.

I still believe it is very real. And we're now starting to lay out, because we can go harvest the investments that we've made, they're going to start adding fuel to margin accretion. We'll catch up on this pricing raw math. We always do. We will here again, and you'll start seeing more significant margin accretion over the next few years.

So I don't believe we're anywhere near running out of margin room..

Thank you..

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

Thank you. Doug, you mentioned some market share gains and some business wins.

Are these benefits from some of your competitor disruptions this year as they get acquired, or is this normal Ecolab winning at the customer?.

Given the history I seem to have with competitors and disruption, it seems more like a constant than anything else. So I don't know if it's because people are disrupted or not. We tend to gain share and have obviously over a number of years because we outpace our major competitors in terms of top line growth and have for a long time.

And we hold ourselves to a high bar, and we want to continue to do that. So we're gaining share in all of our major businesses across the board. The teams are doing a very good job. They're leveraging innovation that they've invested in and rolled out. We feel like we are – we really had a very strong first half. We had a very good quarter.

Sometimes you have a dip after that because you just get a collection of new wins that happen. They all just say yes at the same time, but we followed it up with another very strong quarter in the second. So we're doing well in that area..

And just on that second half volume acceleration that you're pointing to, Doug, I guess in Institutional, is there one or two drivers of that, or is it a multitude drivers for the acceleration you're talking to?.

Are you talking Institutional specifically or broadly?.

I'm really broadly speaking here..

I would say if you – our forecast for the second half, really the sales volume trend and the pricing trends are very straight-line, consistent with the trends that we see right now. There's no bend to them.

And so we have fairly good visibility, and I would say the very solid new business experience we just had in the first half makes us quite confident that we're going to continue to see acceleration through the second half and even into early next year. And that's typically the type of visibility that metric gives us.

The pricing, same thing, we're not looking for all of a sudden going from 2% to 4% in a quarter. It's very consistent with the type of acceleration that we've seen over the last six quarters we expect to continue in the next couple.

And as I mentioned in my preamble, we have visibility and have already secured 75% of the pricing that we need this year, which would be a little ahead of our normal trend in terms of timing of securing during – as we're looking to this. So those are not unique.

And obviously, cost savings are the easiest thing to codify and to understand simply because they're all under your control. So none of those trends are what I would say unique. They're very straight-line as we go through. That's what's going to drive the acceleration.

What it's offsetting is really a step function change in raw material costs third quarter to second, which basically stays roughly at that level through the balance of the year. It does not accelerate all through the year. And this is – we're using outside indices. They actually call for a let-up in the fourth quarter versus the third.

We have a very modest one, but it's really only $0.01 or $0.02. It's not a big deal. If it doesn't happen, it doesn't happen. We'll manage it. But those are the fundamental factors that drive our forecast. So when you look through it, there's not a hockey stick in this thing.

But it does mean that we've got to continue to accelerate as we've been on volume, continue to do what we've been doing on pricing, and deliver the cost savings. But those are all things that we're good at..

Very good, thank you..

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

Thanks and good afternoon, guys. I just wanted to ask in the Energy segment, in the quarter you had very nice margin expansion year over year. And as I recall from the call three months ago, you didn't really expect that to happen till the second half of the year.

So what made it happen earlier?.

I'd say a couple things. One, we did – I think OI was up 28% I think in the second quarter for our Energy segment. There were some beneficial one-timers in there. With that said, it would still have been 15% if you control for those, which still obviously indicates good margin recovery. Look, we're getting pricing. We've had very solid volume.

The team is doing a good job. We're emphasizing profit recovery. We're being very disciplined on RFPs. We aren't going to chase really low-margin deals or deals that could turn cash negative if you're not careful. We don't want to play that game and we're not.

And they're all over pricing, rolling out new technology, and recovering the profit that we know that business can deliver. And so I think you see that work coming through. The Energy business base is a little lumpy, and so we're going to see changes throughout the year.

But our expectation remains now what it was when we entered the year, which is high single-digit sales and low double-digit OI, so the beginning of margin recovery. We think going out a few years, we're going to continue to see high single-digit sales, but better profit recovery in the out years as pricing overtakes raws, if you will..

Okay. And just as a follow-up, I think this was a big quarter for the ERP implementation. It doesn't sound like there have been any hiccups or anything like that.

But separately from that, within the – are there any plans to install any of the pricing modules, other things like that with ERP that might be down the road or any opportunities there at all?.

Yes, there's a whole commercial piece that you put on this system. A lot of it is our own because we've been running SAP in a number of parts of the world and have configured a lot of this work. We rolled out Canada first because it's going to run exactly the North American design, if you will, and it's been running now for a little over a year.

But yeah, those will be follow-on implementations on this system. But we've done it many times. I would say – I can't say that you never have hiccups as you roll out SAP. SAP is always difficult to do. We've just done it a number of times. And as I say, none of these events and we've managed through a bunch, our team has done an excellent job.

And I would say the big risk is more behind us than in front of us, but there's never zero risk with an SAP implementation..

Thanks very much..

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

Hi, guys.

You hit on this a little, but just given the composition of just your outlook for global energy market growth over the next few years, can you just walk us through some top level outlooks for your three sub-segments, your comfort with the existing cost base, and just any quick thoughts on your ultimate ability to reach prior peak margins? Thank you..

Look, we had a mid-teens margin in the Energy sector as a total, and I'm quite confident we'll reach that again. I don't believe that's the ceiling for that business. If you want to go by segment, WellChem continues to re-expand fairly quickly. It falls fast and recovers quickly, and it's doing exactly what we would expect it to do.

It grew around 40% in the first half and will slow a little bit just because it's starting to go against a bigger base. But for the year, it's going to be north of 30%.

And you're seeing significant OI recovery in that business as well as they, one, feed off higher sales and also have margin expansion because they're getting price and driving new technology doing exactly what they need to do to recover. Downstream is the steadiest business. Downstream also has pretty solid top line growth.

Mid to upper single digits this year is our expectation. We're seeing margin recovery there as well, as they're starting to recapture price that they gave up through the downturn. That business, though, is what I would call acts much more like a traditional Ecolab or Nalco Water business in its characteristics.

And so you're seeing that play out through all parts of the cycle. And then OFC, OFC is always a little bit of a laggard versus WellChem in terms of recovery, but you're starting to see recovery now. We'll have very modest margin recovery this year. Sales are going to be mid-single digits this year.

We expect that business to accelerate next year, and it's really a tale of two cities. The U.S. is closer to double-digit growth where you've got strong unconventional recovery. And international lagged, it lagged falling in and it's lagged coming out. None of this is unexpected.

Next year, we would expect to have both North America and international be positive contributors..

Great, and just a quick follow-up. Can you just give us a little more color on the new selling initiatives within Healthcare and how you're ultimately progressing? I understand it's the early innings, but just any color on how to think about these and the effect on growth and margin in 2019 versus 2018 would be helpful. Thank you..

As I mentioned earlier, our program efforts around room hygiene and central sterile and operating turnover, et cetera are doing quite well. They're growing double digit year on year. We continue to have success. We have a good pipeline. The team's on that. We like the margins. We like the trade with the customer. Obviously, the customer likes it too.

In terms of – we have a host of products. Many of them are even included there, but they're also sold in non-program formats, sometimes through GPOs or through other distribution arrangements. And there we just had weaker sales than we expected.

And we need to up our focus on that area as well because you can't just – you don't want to just sit there and fill the hole with great work on the program side. We need more stability on the other side, which we're quite confident we can obtain. So I don't know what to tell you. We expect to move off the floor, which is where we're right now.

The team has done a good job I think rethinking their plan for the balance of the year, and we expect to see accelerating growth in the third and fourth quarter this year leading into 2019, which we believe will be a stronger year..

Great, thank you..

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

Great, thanks for taking my question, guys. I was just hoping to get a little bit more context on some of the volume trends that you've seen in the business. I know we're going to get detail on this in the 10-Q. But for the discussion today, volumes did decline sequentially.

Obviously, the Institutional thing we've talked about a couple of times already, but I don't know if that's enough to explain the full 2 percentage points decline in rates. So I was hoping you could just maybe, Doug, go through the segments a little bit and talk about where the other reasons for the sequential decline was at.

I think one that might stick out to me would be potentially that the comparison in Energy.

But is there anything else there that explains and helps us get context for the volume decline sequentially – volume rate decline, not decline?.

Yes, it's really two things. It is Institutional in Q1, where you had a distributor upping inventories and in Q2 distributors taking down inventory. The, if you will, consumption of Institutional products was very consistent and improved versus 2017. It was more around the 4%, so you have that.

The second factor was we had I would call unusually large Q1 Energy volumes, which we talked about in Q1, and some of it came out of Q2. So Q1 was a little hotter than it indicated in terms of actual consumption, and Q2 was a little lower than actual consumption would indicate.

That stuff stabilizes, and what we expect to see is volume growth and recovery, acceleration in the second half much more on a straight-line basis because we know what's going on underneath, if you will, the reported volume numbers in terms of inventory impacts and one-time, where stuff fell in Energy.

We have shipments at the end of the quarter at times that fall on one side of the day or the other. And we know they're really designed for the next quarter consumption..

That's really helpful. Thank you, that's all I had..

Thanks..

The next question is from the line of Dmitry Silversteyn with Longbow Research. Please proceed with your question..

Good afternoon, thanks for taking my question. You guys paid down about $200 million of debt between the first and second quarter. I'm just wondering if there is a goal for end-of-year debt level.

Or how should we think about that versus share repurchases given that your share count did go up? So obviously you didn't repurchase as much shares as you did previously.

So in terms of capital deployment absent M&A, how should we think about between debt paydown and share repurchases?.

Hi, Dmitry. This is Dan. So yes, you're right. We did not repurchase shares in the second quarter. However, let me just say we got off to a pretty good start in the first quarter. So we did about $200 million I think in the first quarter.

I would think about share repurchase for the full year sitting here today to be in line with what we did last year, which is about $550 million, as always and as we talked about consistently, and certainly there's no change in our thinking about capital deployment. So from a free cash flow perspective, we will continue to pay the dividend.

Of course, we will make investments in the business. We will pursue accretive M&A. And I would really think of share repurchase as being the balancing act in the deployment of free cash flow. So no change in our thinking, and if you look across the full year, I think it will be very much in line with last year and expectations..

If I can paraphrase you, it looks like you're going to be spending $550 million in share repurchases this year or somewhere in that neighborhood. My model tells me you're going to generate a little bit north of $1 billion in free cash, more like $1.2 billion.

So absent M&A, if I assign that difference to debt paydown, I won't be terribly off?.

I would think that you would not be terribly off. So we've targeted A-range metrics in terms of how we think about the capital structure. I've asked for an allowance, we say it's about two times net debt to adjusted EBITDA number. We run a little bit north of that. We should be in line Q2-Q3, by the end of the year.

And I'll accept your free cash flow number. I think we can beat it by a little bit, but you're thinking about it the right way.

Okay?.

Thanks very much..

The next question is coming from the line of Shlomo Rosenbaum with Stifel. Please proceed with your questions..

Hi, thank you. Most of my questions have been answered. I was hoping to just, Dan, maybe pin you down a little bit more in terms of the free cash flow expectation for 2018. You touched on that a little bit, but do you have a more specific goal? Should we think $1.4 billion? If you can, just give us a little guidance on that for my follow-up..

So I said I would accept the $1.2 billion number and think we can beat it by a little bit.

I think that $1.4 billion is pretty good estimate of where we would expect to land the full year, okay?.

Okay, that's good. Thanks..

Give me a little leeway, but yes..

Okay. Doug, I just wanted to ask. What do you see? It seems from your comments that you think you're shaping up to have pretty good organic growth year in the context of the last say four or five, and then 2019 to be able to build on that.

What are some of the components that would in your mind have to work right in order to make 2019 be better than 2018? Or I guess another way, is what are you most concerned about in terms of not being able to achieve a better organic growth rate next year than this year?.

I think the fundamental drivers of our growth don't change year to year. And so we need to continue to take share, make sure that we're doing the right thing with customers, and deploy technology, which we're in the midst of, which also enables us to grow our business with our existing customers.

And so the investments we've made on digital technology have already grown borne fruit. I would say that we're probably ahead of where I thought we would be at this time. If you went back a year, we've had two big wins in digital with big large customers of ours. We're in the midst of rolling it out.

I think these are going to lead to a host of new follow-on opportunities for us simply because it's going to give us all more visibility in how can we continue to improve operations, how can we continue to improve food safety, carbon reduction, water reduction, et cetera.

And all of this is exactly how we drive our business, how do we help our customers operate better. So I think it's all in that camp. I don't sit here right now seeing a lot of metrics that make me worried about our organic growth rate next year. Now almost anything is possible in this world, as we're all learning.

And my expectation is that we're not going to all play tariff roulette to a point of huge destruction. I just don't think that's how it's going to play out, but I don't know.

We aren't directly in the bull's eye of tariff problems; i.e., it's not going to lead to big cost increases specifically for us, because of our strategy of making our products where we sell are in the same currency. But it could have an impact on the global economy, which obviously has an impact on us as well.

Barring that, I think we're going to be in good shape moving into the year with very strong momentum on the top line and very strong momentum on the bottom line, as pricing starts overtaking raws clearly in the fourth quarter and strong momentum leading into 2019 for margin recovery..

Okay, great. Thank you..

The next question comes from the line of Jeff Zekauskas with JPMorgan. Please proceed with your questions..

Thanks very much. I have two questions. The first is your intention is to knock out $200 million in costs in SG&A, and your SG&A base is about $4 billion, so that's about 5%. And you want to do it over three years, so that's 1.5% per year.

So does that mean that instead as a base case of your SG&A growing 5% per year, it will grow 3.5% per year? Is that generally the right way to think about it?.

It's a curve bend. Yes, you have inflation, which is a natural part of this. Often, I think these discussions become almost binary, where if you have $4 billion and take $200 million out by 2021, somebody wants to model $3.8 billion, which just isn't realistic. We expect to continue to grow this business from a top line simultaneous to this.

But I would say if you modeled our traditional margin accretion that comes from volume, you're going to have additional margin accretion on top of that, which is going to come from pricing, raw favorability; i.e., that formula goes.

And the third component will also be getting more efficient at the same time, which is represented by this efficiency program..

Okay. And in your discussion during the call, I think you referred to some one-time items in the Energy business.

Can you describe and quantify what those were?.

There are some one-time large sales of specific products that are even close to commodities in some cases. They have big volume. We sell them. There's very little SG&A associated with it. And so it's just not business we count on routinely, but we captured a very large couple of orders in the second quarter.

So we back that out on run rate looking at it, just because that's how we get from 28% to 15%. We'll take if it we find more, don't get me wrong, but we don't think it's – it's not right to indicate that that's our trend..

Okay, great. Thank you so much..

The next question is from the line of P.J. Juvekar with Citi. Please proceed with your question..

Hi, good afternoon. This is Scott on for P.J. So I guess I was looking at the business investments you made in the Institutional business. I think you started some growth initiatives that you announced late last year.

Is that still ongoing now that you started with this efficiency program?.

Oh yes, absolutely, a lot of them were designed for growth. But yes, they will continue..

Okay.

And maybe just as a follow-up, can you remind me where you were adding, what cost bucket you were adding to in Institutional? Was it head count, or was it more on the IT side?.

We were adding, one, you've got SMARTPOWER, and the new technology takes enhanced merchandising equipment or dispensing equipment that you put in customers. Two, we had G360 rolling out. And three, we added manpower specifically in the corporate accounting area..

Okay, got it. Thank you..

The next question comes from the line of Scott Schneeberger with Oppenheimer. Please proceed with your questions..

Thanks, good afternoon. I was just curious. The industrial acceleration of growth, could we speak, Doug, I guess granularly in each of the subcomponents of what's going to be driving that? I think you've given a good overview of the call.

But could we delve in a little bit to the sub-segments in Industrial on how that's going to progress? And I think it was in Shlomo's question you addressed tariffs, but maybe specifically in each of those categories how that could influence one way or the other? Thanks..

Our Industrial business has been doing great. Thank you for asking about it. So I would say a couple things. If you look at our F&B business, it's clearly benefited over the last few years and you're seeing a lot of the culmination of that work right now and its partnership and marriage with Water technology.

So the Food & Beverage, food safety program, and the Water are very interlinked. And those together bring outsized value to our customers. And so we've had a lot of success really across the board, and so our F&B business is really performing quite well everywhere.

The only exception where it's got any negative – it doesn't have negative pressure, but tough pressure is on the agri side or the dairy side simply because of the kind of pressure in the milk market. So that business, beverage, brewery, protein business, processed food, all of those areas are doing quite well.

And I would say that's in the face of a number of customers who are having to close operations, consolidating and everything else. So it's in the face of what I would call a difficult underlying situation for most of the industry.

The reason we're succeeding there is because we're bringing great value, world-class food safety I would say probably the best capabilities in that area at significant lower use cost because of the reductions in water and energy that come with the combination of those programs. And that also leads into Water Light.

So the Water Light business, which focuses on really all but the heaviest industries, so the Institutional business, the F&B business, even auto manufacturing et cetera, has done I think a great job identifying the best opportunities.

They're creating brand new, very exciting programs around legionella prediction and specific programs because people need increased help in that area. They've done a whole host of things. And so that business has really been very steadily in the mid to upper single-digit growth profile and is accelerating as we speak.

And then the heavy has been more in the recovery mode. And the heavy business is really set to have a very good year. I think you see two things. One, industry broadly is doing fairly well, so we don't want to skip that part of it. With that said, where we had specific challenges in the heavy business was in China.

And while not every place was glowing as a hotspot, China was a bit of a problem. And China is really flipping around now. So we've done a good job I think getting down to the portfolio we need in China.

We sold some pieces of the business there that didn't make sense for us to operate, which has allowed us to focus on the pieces that we can operate best. And so you're starting to see real uptick in China, which we think is going to continue from an organic growth standpoint, and it's a big opportunity for us. Water is a big challenge in China.

It's part of their five year plan, and our technology helps there. So it's pretty much across the board. Mining is recovering. Paper had a very strong quarter. We expect to have an improved second half versus first half.

Again, they're driving new technology, and China recovered in paper as well, which is very important for us for that business given all the high percent of the market that exists there now.

So Industrial across the board very strong, really moved from 5% last year to a 6% this year and we expect to even do better in the second half in terms of organic growth in Industrial..

That's great. Thanks for the comprehensive answer. Just a quick follow-up, it's been about 1.5 years that you've had Anios in the portfolio. It's a really sizable acquisition. Just give us observations at this juncture. Thanks..

We just had our first year review on Anios, and it was above all of our internal metrics and projected to stay that way. Our next big review is year three. We watch the business every month, but we always do specific look-backs on every acquisition at 90 days, at one year, and at three years. And so the business is performing.

The first quarter and part of the second quarter notwithstanding, we were way ahead of sales in the first year in a number of areas.

What we're doing in terms of expanding the Anios business globally, particularly in markets where we don't want to build, if you will, a street-up healthcare business, that strategy has worked quite well and the business has been well led, and that's growing at double digits and continues to.

I would say we have a lot of untapped opportunity there that Anios can unlock for us. We also have new technologies from Anios that were acquired with Anios that we're now, one, looking to expand to some of the other markets we're in and also considering expansion in the U.S. and starting the registration process.

So Anios I think was an excellent acquisition. It's performed very well. We have high bars in terms of what our expectations are for businesses that we acquire, and it met or exceeded all of those in its first year..

Okay, thanks very much..

The next question is from the line of Mike Harrison with Seaport Global. Please proceed with your questions..

Hi, good afternoon. I was wondering if you could give some detail on the $200 million restructuring program in terms of the savings by segment.

Is it going to be pretty evenly divided across the three major segments, or will it have an outsized impact on one or the other?.

Mike, here's what I would say. It's too early to go into that much detail. We have very specific, but we're going to have to go make a few calls in terms of which projects we do first. So it's certainly not going to be falling evenly across all three every quarter simply because that's not how the projects work.

With that said, I think by year end we'll be able to give you more insight as to what we expect when across the segments..

All right, and then a question on the margin improvement that you saw in the Energy business. You talked about the positive mix that you saw of products there.

Are you introducing new products, or are you taking actions to shift customers toward higher margin products? I'm just trying to understand what exactly is going on there and how sustainable those mix changes could be..

Yeah, well, we're doing both. One, we held back a number of our new technologies during the downturn because we knew we could never price appropriately for them. And if you go out too low of a price, you'll never recover. And so some of those are being introduced now.

If you will, you can have a heavy up portfolio in the near term, but there's a lot of mix change going on in that industry. I would also say what you're starting to see is customers turning back on the technologies they turned off like anti-corrosion technologies in a number of the fields.

When they were basically trying to conserve every dollar so that they could survive to the next quarter, they're not really worried about corrosion, which may eat a hole in the pipe in three years. So they are worried about it now because they know they've got a much more stable environment. So a lot of these technologies they're turning back on.

These are higher-margin technologies for us. And you start seeing, if you will, more sales per site, which obviously is always highly accretive. So it's a number of those factors. I would expect that we will see continued margin recovery over the next few years, which is why I mentioned we would expect to be back in mid-teens by 2020..

Thanks very much..

Our final question comes from the line of Rosemarie Morbelli with Gabelli. Please go ahead with your questions..

Thank you, good afternoon, everyone, and thanks for going past the hour. Doug, you emphasized the focus on digital technology.

Does that mean that you are no longer increasing by the same 2% to 3% annually the size of your sales force? And linked to that, is the growth we are seeing coming from market growth or by the fact that you have more feet on the ground, or are they becoming less important given the technology issues and other issues that progress?.

Yeah, well, we have different parts of our sales team. We've been certainly adding even at a faster rate than 2% to 3% to our corporate account team. They are full-time sales professionals who are focusing on the largest opportunities around the world.

And so that's been a steadily – we've been investing in that arena steadily for the last few years and a lot faster than 2% to 3%. So that's going to continue to be an important part of our strategy. Field service capability is going to be vital. I would say what we've learned with the digital capability is we are getting enhanced visibility.

One of our great attributes and winning propositions is not only can we identify challenges before they become problems, but we can fix them because we've got the field team to get into restaurants, food plants, hospitals, hotels, et cetera, to actually make a change and change what might be an alarming trend or a concerning trend before it turns into a real challenge.

And so that capability is going to become, I would say, more important. How that manifests itself down the road, I think two things. I think we are going to be able to continue to increase our team's ability to handle more business.

We'll do it by continuing to offload admin work, other work, make setup easy, make ordering easy, even do automatic ordering, do all this work that today takes their time and free up time to solve problems for customers and identify opportunities. That's the job.

And how that shows up in terms of head count I think really depends on how successful we are using the increased capacity that we're creating for sales. If it shows up as increased sales, we're going to love adding people at the same rate. If it doesn't, then we'll harvest it as margin..

Okay, that's very helpful. And then I was wondering if you could talk about pest elimination. We have turned the corner. It is now growing in line with expectation organically.

Any potential acquisitions, are there opportunities out there and at a reasonable multiple?.

As you might expect, we are very active looking at potential acquisitions all the time. And we're finding a number of them and we're closing on them. They all seem though to be on the smaller to medium size. Part of that is just valuation today. Valuations for a number of these businesses is high.

And if they're relatively small, a high valuation doesn't really get in the way of generating return because we have such a large footprint, we could leverage the technology or whatever they do over our large footprint and more than compensate for maybe a high multiple. If it's a large business, that opportunity doesn't exist in the same way.

And if you pay a lot of money for a large business, it's often very hard to generate reasonable returns for your shareholders over a period of time, and we're quite cautious about doing anything in that area. And I would say the landscape is rich of M&A opportunities.

We don't need to buy anything to make ourselves competitive to grow the business, I even think to hit 15%. So we're going to do it opportunistically and do it when makes a heck of a lot of sense for our shareholder..

All right, thank you very much..

Thank you. I would now like to turn the floor back to Mr. Monahan for closing remarks..

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

This concludes today's teleconference. Thank you for your participation. You may now disconnect your lines at this time..