Ecolab Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 14, 2023

There are 18 speakers on the call.

Operator

And welcome to the Ecolab Fourth Quarter 2022 Earnings Release Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. It's It's now my pleasure to introduce your host, Andy Hedberg, Vice President, Investor Relations for Ecolab. Mr.

Operator

Hedberg, you may now begin.

Speaker 1

Thank you, and hello, everyone, and welcome to Ecolab's 4th quarter conference call. With me today are Christophe Beck, Ecolab's Chairman and CEO and Scott Kirkland, our CFO. A discussion of our results, along with our earnings release and slides referencing the quarter's results are available on Ecolab's website atecolab.com/investor.

Speaker 2

Please take a moment to

Speaker 1

read the cautionary statements in these materials, which state that this teleconference and the associated supplemental materials include estimates of future performance. These are forward looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described under Risk Factors section in our most recent Form 10 ks and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release. With that, I'd like to turn the call over to Christophe Beck for his comments.

Speaker 3

Thank you so much, Andy, and welcome to everyone. Our team delivered a strong 4th quarter And honestly, even slightly better than I would have predicted. The milder winter in Europe certainly helped, but most importantly, our team executed very well In a macro environment that was far from ideal, organic sales grew 12% with good momentum across all segments. Industrial grew 14%, institutional and specialty grew 11%, Healthcare and Life Sciences got back to growth, delivering 7% organic And pest elimination remains very strong, growing 10%. Volumes outside Europe remained stable year over year, while our total pricing continued to accelerate from 12% in the 3rd quarter to 13% in the 4th quarter.

Speaker 3

All this contributed to a strong fourteen adjusted fixed currency operating income growth even as we experienced the expected peak in delivered product cost inflation, which reached 43% over the last 2 years in the 4th quarter. This led to adjusted EPS getting very close to last year's $1.28 EPS While mitigating $0.10 of currency headwinds or 8 percentage year over year headwind to adjusted EPS growth. Since the initial impact from the war in Europe, We have delivered consistent operating performance improvement quarter after quarter. And as mentioned during the last earnings call, This is the path we expected to stay on for the quarters to come. We're entering 2023 with a reasonable level of confidence.

Speaker 3

While we would have lost most of our €1,300,000,000 of earnings in 2022 to cost inflation, we have rebuilt almost all of it Within the same year. This demonstrates the true earnings power of our value proposition and the strong momentum we have in Margin rebuild. Most importantly, our shift to offense, which is where Ecolab is at its best, is also showing some very encouraging signs of progress. Our net new business pipeline reached record time at the end of last year as what we offer: water, energy and labor savings, while bring the best and safest outcomes in the industries we serve around the world continues to grow in importance to our customers, and we expect this trend to continue to strengthen. On the other hand, our view on the macro environment remains unchanged.

Speaker 3

We still expect inflation to remain high Well into the year. Interest rates to move higher and have an increasing impact on demand in most markets and geopolitics in Europe, China and now in the Middle East to remain unpredictable. Nevertheless, we feel ready. In 2023, We therefore expect to deliver double digit adjusted operating income growth and adjusted earnings growth that keeps accelerating toward our low Double digit historical performance. This includes an approximate 7% year over year unfavorable earnings headwind from higher interest expense and FX In 2023.

Speaker 3

For the Q1, we feel even more confident and are ready to resume quarterly guidance. We expect our strong top line momentum to continue and to deliver adjusted earnings per share to be in the range of $0.82 to $0.90 compared to $0.82 A year ago. This includes an approximate 15% year over year earnings headwind from higher interest expense and FX. And finally, while this is a period of caution, we have a positive outlook on where we're heading. Over the last 2 years, Our expertise grew as we focused on supporting our team and on developing strong new innovation.

Speaker 3

Our retention rates remain high As we protected our customers from supply shortages, our margin started to recover as we drove pricing in thoughtful ways, While increasing customer value, helping to drive a strong acceleration in operating income. We remain prepared for softening market trends in Europe by accelerating the productivity improvements we had planned for future years. We're adjusting institutional to winning the new reality And we're beginning to reposition Healthcare for profitable growth as we promised. We will also keep investing In our major engines of high profitable growth like Water that delivered 14% organic sales growth in the last quarter And Life Sciences that accelerated to 18% in Q4. Additionally, Pure Light restarted its Expansion exactly as expected with new capacity coming online, helping to drive a very strong acceleration in sales with operating income margins north of 30%.

Speaker 3

We remain good stewards of capital by continuing to invest in the business, increasing our dividend, reducing our leverage And returning cash to shareholders as we've always done. And most importantly, with the best team, science and capabilities in the industry, We're ready to grow our share of high quality $152,000,000,000 market and our future has never looked brighter. I look forward to your questions.

Speaker 1

Thanks, Christophe. That concludes our formal remarks. As a final note, before we begin Q and A,

Operator

Thank you. We'll now be conducting a question and answer session. A confirmation tone will indicate your line is in the question Thank you. And our first question is from the line of Tim Mulrooney with William Blair.

Speaker 4

Good afternoon, Christophe, Scott and Andy. Thanks for taking my questions.

Speaker 3

Hello, Tim.

Speaker 4

So the first one, unsurprisingly, on gross margin, I mean, they were down year over year, but that contractions continued to narrow for A few quarters now. Based on what you're seeing in your pricing outlook and inflationary cost inputs, when would you expect gross margin to inflect into Positive expansion territory and the same question goes for OI margin given some of the productivity gains that we're seeing.

Speaker 3

Thank you, Jim. So let me start with what we've done in 2022 because margins, gross margins and OI margins are where our Number one focus for the full year. And as I've mentioned in my remarks as well, so we were facing headwinds that were Equivalent to our net income, so close to €1,300,000,000 And we've been able to rebuild most of it within the same year, Which is really showing the earnings power that we have as a model and as a company. So I'm confident that we will rebuild our margins to where they were And we will expand from there as we've done many times in our history as well. So if I look at our OI margin in Q4, they turned almost positive.

Speaker 3

They were slightly still down in the Q4. So that's a good Obviously, where we're trending, our OI growth organic was up 10% as well. So if we look at the trajectory, we're Productivity is in a good place as well and we'll see what happens obviously so with inflation. Q1, so it should be a continuation of the OI growth, which means that OI will keep improving as well in 1st half, so I think that it's going to turn positive in the first half of 2023 and gross margin will probably follow in the second half Of the year, it's not going to happen on July 1, but it's going to happen sometime in the second half.

Speaker 4

Got it. Very clear. Thank you. Just as a brief follow-up, I saw an announcement recently, you're launching a consumer retail product line with Home Depot, I think. Can you just talk about what drove that decision to expand into this channel and what the margin profile looks like if it's Materially different than your institutional margins?

Speaker 3

I would love to, Tim. So first, it's not a consumer brand. It's a brand that's aimed at pros, as the Home Depot also calls them. It's mostly cleaning contractors. That's the vast majority of the customers buying this range, which is an end market that we never really addressed In the past, because we go through service and distribution, as we've done so for 100 years, so it was a white space basically for us.

Speaker 3

Again, focused on pros, not really on consumers. We have the best partner ever with The Home Depot to do that as well. So we'll see how big it's going to turn, but we're quite bullish about what that could deliver in the years to come.

Speaker 4

Got it. Thank you.

Speaker 3

Thank you, Tim.

Operator

The next question comes from the line of Seth Weber with Wells Fargo Securities. Please proceed with your question.

Speaker 5

Hey, good morning, everybody. I wanted to ask about the new cost program. How should we think about the Cadence on that flowing through and more importantly, are those savings meant to be permanent or will those costs Come back if volumes get better. Thanks.

Speaker 3

Thank you, Seth. Maybe just a few comments from me and then I'll pass it Scott will give you a little bit more details on that. I'd like 1st and foremost if you say that for us, productivity It's an outcome of momentum. So sales, innovation, pricing, this is the best way, obviously, to drive productivity as we've done over The past few years and will continue to do as well in the future. Now to the programs, it's really so to focus on Individual businesses or markets, as we've disclosed, our Europe programs during the last quarter and now to be more focused On 2 businesses that we need to address, institutional, because the market has changed.

Speaker 3

We're in a good place, but market has evolved and we need to evolve here And Healthcare, because we need to bring that business back to profitable growth since it's been a challenge so for many, many years. But I'd like to pass it Scott, to give you some more color on that.

Speaker 6

Yes. Thanks, Christophe. Thanks for the question, Seth. So just getting to your question about The pacing of the program, when I talk about the program, I'm talking about the combined $175,000,000 savings program, which includes the announced program we talked about in Q3 as well as the expansion that Christophe talked about, which includes healthcare and institutional focus. So the pacing of that 175%, I would expect about 3 quarters, 75% of it in 2023 and then the remainder in 2024.

Speaker 5

Okay. And is it it sounds like those changes are meant to be permanent. So Not volume volume comes back, you wouldn't expect those costs to come back then?

Speaker 6

Exactly. And as Christophe talked about, on institutional and health This is stuff that we're doing on those specific businesses, targeted those businesses. And then on Europe, it's really accelerating what we had been thinking about For quarters years to come. And so yes, we will expect to retain those savings.

Speaker 5

Right. Okay. Thank you. And then just a quick follow-up on the Purolite. I mean, can you just Are the capacity additions done there at this point?

Speaker 5

And I'm just trying to understand like what the run rate of that business really looks like Today? Thank you.

Speaker 3

Yes, maybe take that question, Seth. So for the most But it's done, but it's a continuing story. We will be Max, as I've mentioned as well, so in the previous call. So A couple of years down the road, again, which is out of a good problem because it's a business that's growing really fast. So it's not going to be done forever, Thank God, by the way.

Speaker 3

But what we've seen in Q4 has been a very strong acceleration of sales. We didn't have Pro form a reporting. So I don't want to get too much in detail here, but it's been so strong double digit growth, which is good with margins north of 30 So the trajectory that we've seen in Q4 is kind of a good indication of what we expect for the future or the near term future.

Operator

Thank you. The next question is from the line of John Roberts with Credit Suisse. Please proceed with your question.

Speaker 7

Thank you. Did the surcharge come down in Europe with the drop in energy prices? And do you have any plans to Merge the roll the surcharge, I guess, into the base price at some point here to get back to a simple pricing structure.

Speaker 3

Hi, John. So two parts, a few questions. So first, the surcharge has not come down since we started it On April 1, so generally, so far so good. No change here. And the second part of your question, yes, We are progressively emerging as much as we can after surcharge into traditional structural pricing.

Speaker 3

It's not going to be This end game, every region is in a different place. You mentioned Europe, every customer is in a different place as well. But generally, we're trying to get everything in traditional pricings going forward.

Speaker 7

And then on the Pros Who Clean program with Home Depot, will those be identical products to what you distribute through Cisco and others? And Will the Ecolab salespeople service customers who buy through Home Depot?

Speaker 3

So two parts in your question as well Yes. So the first part, those are different product than what we distribute through distribution like Sysco. They're really made for smaller cleaning contractors. Those are not Concentrated products, those are ready to use products for the most part. So they're different, but really so Adapted, so for their needs at the right price point as well.

Speaker 3

So no real competition with anyone else And second part of your question, there will be no service to those products. It's straight to our consumer Product as well. But knowing as well that those cleaning contractors sometimes become bigger as well And those ones might be shifting towards a service program at some point, which is what we do with Cisco, as well. They have their own line like Keystone that we do for them are non serviced and when customers become bigger, we start to service them. So it's really finding ways to approach every Part of the market out there.

Operator

Thank you. Our next question is from the line of Josh Spector with UBS. Please proceed with your question.

Speaker 8

Yes. Hi. Thanks for taking my question. I'm curious if you could talk about your volume expectations in Q1. And you mentioned in your prepared remarks, You were surprised, at some of the performance in the quarter.

Speaker 8

I wasn't sure if that was volume or something else you were talking about.

Speaker 3

Yes. Hi, Josh. So not surprised, it was in Europe, we were expecting a worse situations Like everybody else, actually, so the milder winter has been a less negative news, generally so for Europe, And we take it. And I'm not taking it to the bank for 2023. We know that in the months to come, The geopolitical situation on the Eastern Front in Europe could change quite dramatically, but I'm not going to make any prediction.

Speaker 3

Here, we'll take the trajectory as it is right now. But generally, so for the whole company, what you've seen in Q4 With volumes so fairly stable, excluding Europe, is what I'm expecting more or less in 2023 as well. I think the environment is going to soften generally with interest rates going up in the U. S. And in Europe.

Speaker 3

That's the whole intent of rising interest rates, obviously. But the shift that we've made to offense, a few months back, as I've mentioned, so is driving Some very positive results in terms of new business, which I think should mitigate the further softening of the demand out there. So What we've seen in Q4, I think, is a good indication of what we could see in 2023.

Speaker 8

Thanks. And just to follow-up on the cost reductions and specifically institutional, I guess when you're adjusting to the current environment, I mean, is that restaurants and takeout or something different? And what does that mean in terms of your longer term volume recovery potential?

Speaker 3

Great question. So institutional is in a good place. As a business, we love that business. That's where we came from. It's a highly profitable business.

Speaker 3

We have great position, and I think it's going to be a great business for the future, as well. Here's the situation. So our sales are north of 2019, so which is good. Our margins are not there yet, Which is the opportunity that we have that we need to adjust. Now the market has changed because of the return to office, because of what you're saying as well, the People are ordering online, using takeout as well much more than they did before.

Speaker 3

It's translating so to the dine in traffic. So people sitting in a restaurant down 30% versus 2019. That's a fact that we all need to live with. It's not the demand reduction that we are seeing in our own business, but it has gone down. So we have the same amount of work because we have a similar amount Of customers out there for a demand that is slightly lower.

Speaker 3

So we need to adjust for that. So what we're doing is doing 2 things. On one hand, and we started that over the past 12, 18 months. It's not totally new. We're just accelerating that program right now.

Speaker 3

On one hand, it's to have a dedicated sales organization that drives new units and increased penetration And the 2nd service organization that drives productivity in order to reduce our cost structure as well, And that's where our program is directly focused on.

Operator

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

Speaker 9

Thank you. Good afternoon. Christoph, maybe if you could just help us with your price The price increase and also the raw material increase assumptions you made to 23%, I mean the 13% in the 4th quarter is obviously Very strong, like how sustainable and sticky is that versus whatever you're expecting for the roasteries?

Speaker 3

Hi, Manav. Well, 2 parts, a few questions. So first, the delivered product cost inflation outlook And then pricing, which obviously saw both are driving our margins. Starting with the market that we can't influence, Obviously, but the way we look at it from our perspective in 2023, it will keep going up, But at a lower rate than what we've seen in 2022. So it's not that our delivered product cost is going to get cheaper, It's going to increase less part than what it did in 2022.

Speaker 3

So that's the first part. And obviously, things can move One way or the other, depending on what's happening in the world. But that's the middle of the road that we've taken. Inflation Staying high as a rate for longer, well into 2023, as I've mentioned as well during the past call. Now on the pricing piece, We remain focused on pricing.

Speaker 3

We will have carryover in 2023 coming. So from 2022, we expect Half of it, so to be strictly carryover into 2023, and we will keep pricing further as we've always done As a company, and we'll keep doing going forward in order to recover and expand our margins. Where it will net out, We will see, but that's how we're estimating basically saw our sequential progressive earnings improvement quarter after quarter into 2023.

Speaker 9

Okay. That's helpful. And then you talked about offense a couple of times in the call. Just the cost reductions that you're making, Which categories, I guess, are you doing the headcount reductions? And I guess the question is more tied to, are you beefing up your sales force How the fast the program may be?

Speaker 3

So when we talk about the beefing up our sales force, they're not all created equal. We have the High growth businesses, like life science, pure light, high-tech, those ones are clearly Being fueled and we add people, we add investments for those ones because we know it's driving so high profitable growth. And we have on the other side of the spectrum, other ones where we need to do some work, healthcare being one of the examples, because it's a $1,000,000,000 business that's not making much money, as we know. So we'll have to work on cost efficiencies, including, in our sales structure as well, But all done with a long term view of building a profitable growth business. So When we talk about shift to offense, this is by far the number one priority that we have as an organization.

Speaker 3

So for 2023, it's about new business. Manav, you're familiar with that. And we had some very good results in Q4. It's about innovation. The Home Depot that we talked about is a Good example as well and fueling the high growth businesses as I just mentioned.

Speaker 3

So it's what we're really good at. It's what the organization loves Doing and while we do that, we'll stick as well. So, need to pricing because we need to get our margins back to where they used to be and expand further. And third, we will address those programs as mentioned, but in a real surgical way, this is not going to be our main priority in 2023.

Operator

Thank you. Thanks, Adam. The next question comes from the line of Mike Harrison with Seaport Research Partners. Please proceed with your questions.

Speaker 10

Hi, good afternoon. Good morning, Mike. I was wondering Christophe, I was wondering if you could give a little bit more color on how you're thinking about the earnings cadence in 2023. You talk about getting to an EPS low double digit growth rate later in the year. But if I look at your guidance for Q1, the top end of that range is already kind of a 9% to 10% growth range So growth rate.

Speaker 10

So maybe just help us understand how you expect the year to play out And maybe what are some of the key drivers that could lead you to be maybe toward the higher end or lower end of that outlook?

Speaker 3

So a few parts to your question, but generally, no change versus What we said, what I said during the 3rd quarter call and now in our release and in my remarks As well in the Q4. The way we look at the outlook hasn't changed. We've decided to provide a formal guidance for 1st quarter because we see pretty clearly what's happening or more clearly than what we've seen in the past. We're not providing formal guidance For the full year, yes, it will come at some point, obviously, here, but it's 2 parts, so for Q1 and for the full year. Now As I've mentioned, so we expect continued sequential improvement, as you've seen as well in 2022, by the way.

Speaker 3

So Q3 was a nice improvement versus Q2. Q4 was a nice improvement versus Q3. And Q1 He's going to head in the same direction of being a further improvement as well, and that's what we're providing so with the range. That's going to continue in the quarters to come, driven by the momentum that we have, The pricing that we've done and we'll keep doing, obviously, the productivity that we've done and we'll keep doing as well. So going forward, Turning positive sometime in the first half and the gross margin sometime as well in the second half.

Speaker 3

That leads to an EPS improvement quarter after quarter keeping in mind that we have headwinds in our FX and interest, $0.30 as we've mentioned, half of it in the Q1 as well. So you will see continued improvement quarter after quarter. And then the question, when do we get to the low double digit traditional Ecolab performance? I said during the last call, it's going to happen sometime during the second half. With everything I know today, everything I see today, I think that's Probably going to happen in the Q4.

Speaker 10

All right. And then a quick question on The water business, particularly the downstream portion, I was just hoping to understand the additives impact That you called out in the prior year, were those sales kind of one time in nature? And I guess is that the main reason that Volumes aren't looking better in that downstream business as we're seeing some improvement in refinery utilization rates.

Speaker 3

That's exactly right. You gave the answer, Ekuri. It's one time in nature. It's depending on where the crude is coming from as Well, so sometimes they need additives and sometimes they don't need. That's not under our control.

Speaker 3

That's our customers' control. Whether they need additives Or not, depending on where they're buying the crude from. On the other hand, the water business in general is doing really well. So it's close to 2.5% volume in that business, 14%, so total growth as well in the Q4. So water is in a very good place, downstream being this special case in additive, as you've mentioned with the One time is.

Operator

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

Speaker 11

Thank you. Christophe, just on your cost inflation in 2023, is it primarily wage inflation? And for raws this year, are you expecting raws to be actually down Year over year for you guys?

Speaker 3

No, we don't. Hi, Dave. We expect, as mentioned before, that our costs are going to keep going up As they did in 2022, the rate is going to be lower than what we've seen the rate of increase is going to be lower than what We've seen in 2022, but our delivered product cost is going to keep rising in 2023. The wage part is a minimal part of it. It's going to contribute to an increase in cost.

Speaker 3

That's always the case every single year, Obviously, so that's not exactly material, but that's going to go up as well and all parts of the outlook that I've described before.

Speaker 11

So on that note, which raws are you seeing the most inflation right now year over year and through the rest

Speaker 12

of the year? Just some raw materials specifically.

Speaker 3

We buy 10,000 different raw materials. So that's going to be hard for me, David, to go in all details. And The truth is that most of them keep going up. Some are more extreme than others. The caustic in Europe So went up 90%, for instance lately.

Speaker 3

So those are things that we need to deal with and everything else It's between 0, slightly negative, but nothing much negative to 100% plus Like the caustic that I mentioned before, so being close to the 100% here. So not an exact answer to your question, but that will be hard. So With the thousands of customers of commodities that we're buying out there.

Operator

Our next Questions come from the line of Jeff Zekauskas with JPMorgan. Please proceed with your question.

Speaker 13

Thanks very much. Historically, Ecolab has raised prices about 1% or 1.5% per year, In that, its rate of inflation and costs has been pretty low. But over time, there's much less Commodity production in China and domestic producers of chlorine and caustic soda Are operating their businesses differently. So as a base case, are your expectations that Annual price increases for Ecolab are no longer in the 1 to 1.5 range, but maybe now are more 2 to 3 And do your customers understand that, if that's true?

Speaker 3

It's a great question, Jeff. The short answer is We can deliver more pricing than what we've done in the past. We've learned that over the past few years, And our teams has built as well, saw new capability during that time because we had to, and we wanted to do it in a way that was Thoughtful and smart with our customers as well. And the fact that our retention rates have remained almost unchanged during that remarkable time It's a good indication. We've gained customers during that time and we keep gaining customers.

Speaker 3

The big difference beyond the capability that we are improving Within our team, Jeff, is the fact that we've become much, much better at documenting the value, The savings that we are providing our customers with our service, how much we can deliver for them in the years to come as well. We've become much better at that. We can document it. We can share it with customers. We can make sure that we align on those numbers as well.

Speaker 3

And we have a discussion ultimately on what's our share of that savings that we have delivered for our customers. It's been at the core of the way we've been selling for 100 years. We've never brought it to such a high level Than the past 18 months, and that's going to help us get more pricing in the future. What's going to be the exact range, Jeff? I don't know yet, But it's going to be higher than where we were before.

Speaker 13

And maybe quickly for Scott. Yes. Are your It looks to me like your inventories are maybe $150,000,000 too high. What will working capital be As a source of cash in 2023?

Speaker 6

Yes, Jeff, thanks for the question. We certainly have As seen throughout the year, working capital increased in both because of inventories as well as just because of the sales growth with this very high pricing. And again, we expect Higher pricing next year relative to history as Christophe and you had talked about. And so the inventory was again very specific decision as we dealt with Supply chain constraints around the world and to make sure that we could get products to our customers, help our customers, And with that made a very intentional decision. So now as we've seen the supply chain constraints ease a bit, then we will start working our inventory in DOH levels down.

Speaker 6

And so Certainly, I wouldn't expect the same level from inventory in 2023 as we had in 2022. But at the same time, we are going to continue with I'm having very high sales growth and so you will have some natural drag there.

Operator

Thank you. Our next question is from the line of Christopher Parkinson with Mizuho. Please proceed with your questions.

Speaker 14

Great. Thank you so much. Christoph, you hit on a little bit on the volume trends in The water segment, I was wondering if you could just parse down a little go down a little bit more between just the trends in light, heavy and mining And how you see those evolving throughout the year? Thank you.

Speaker 3

So It feels like your question is focused on the industrial segment here. Good. So generally, Industrial is in a good place, not because the market is booming and we know that Interest rates are going to soften the demand. So that's our base case of saying our general demand like for like Same store sales is going to go down. So, we will need to drive our own growth through new business, innovation, In new end markets and so on, as we've done as well in the past.

Speaker 3

Industrial is in a very solid place, In a very good trajectory in terms of margins as well. So it's doing that balancing act of making sure that we can drive pricing, Getting the right margins driven by value, as I mentioned to Jeff, as well before, while we drive the new business with this shift to offense, Which I like a lot because it's ultimately where our teams want to focus the time. It's where we are best at and what we love most doing. So generally, industrial is going to keep being in a good place and some quarters will be A little bit lower in volumes and some will be a little bit higher, but generally, in a very good place.

Speaker 14

Just a quick follow-up on pest elimination. It seems like your market share gains, I mean, obviously, coming out of COVID is a bit difficult, but it seems like your Your gains are beginning to reaccelerate. Could you just confirm that and talk about how your innovation in that segment is going to

Speaker 3

It's a great business. It's been a great business for a long time, And I'm a fan of that business going forward. I can't comment on the M and A side, obviously. But generally, it's a business that has done very well during the COVID times and has done very well In the years after that as well, a very nimble business, very strong leadership team, unique market positions As well, and we see that in the 10% growth that they've delivered in the Q4 as well. And I expect Damsa to continue to do so.

Speaker 3

When I think in terms of innovation here, they're starting to provide disinfection services For their customers as well, which I think is going to be a very promising proposition. It's a good complement To what our teams are doing, so right now as well, so strong business with strong margin with the highest return on invested capital because there's almost no capital involved obviously in that business and driven by good innovation for the future. So Great story that's going to keep staying great.

Operator

Our next question is from the line of Ashish Sabadra with RBC Capital Markets, please proceed with your question.

Speaker 2

Thanks for taking my question. I just wanted to drill down further on the Q1 EPS guidance and follow-up on a prior question. That range Seems pretty wide. What are the key factors which takes you to the top or the bottom end of the range? Is it more volume, raw material or below the line items?

Speaker 3

It's a good question. So for Q1, the range we provided is Reasonably consistent with what we've done in the past when we were providing guidance as well. The inflation component of the delivered product cost is a timing that we cannot manage. Obviously, that's market depending. That's probably the main driver for the minimum or the maximum of the range as well in here, We're getting close to the end of the Q1, obviously, as we speak.

Speaker 3

So we have a reasonable view on how it's going to end. But in a month, A lot of things can happen. Last year, I was pretty confident in the Q1 and the war started. At the end of February, we had 1 month And we had to deal with that. It's those external factors that are driving ultimately the range that we're providing for the Q1 As for every quarters in the past.

Speaker 2

That's very helpful color. And then good to see that strong momentum in the business as well. Maybe just a quick question on the National Restaurant Association. I was just wondering from a preview perspective, can you provide any color On new innovations that we can potentially expect at that event? Thanks.

Speaker 3

It's a great business as mentioned We've been in that business for 100 years. Today, we've been successful. We have great positions. We are very close partner to most of the restaurant and hotel companies around the world. So I'm very bullish about the future of that business.

Speaker 3

That being said, as mentioned before, we need to adjust As well, because the market has evolved from dining in a restaurant versus taking out From a restaurant as well, we need to adjust. We've done that in the past. We need to do it today. That's going to take some time, but we're going to get in a stronger place As well after that. And in terms of innovation, I think the most important for institutional Is the overall program of Ecolab Science certified, because it's one way of bringing all the solutions that we have, all the innovations We have for our customers and to really drive full penetration.

Speaker 3

It's good for us, it's good for the customer and it's good for the guest, Ultimately, because that's the way that they are the most protected from whatever that can happen and at the same time making sure That I have a good experience being in that hotel, that restaurant or that retail store as well. So if I had to pick 1, that would be the most important one.

Operator

Our next question comes from the line of John McNulty with BMO Capital Markets. Please proceed with your questions.

Speaker 1

Thanks for taking my question. So on the Healthcare and Life Sciences business, when I look at the Q3, you kind of made Some comments at the time, this is not acceptable and literally 1 quarter later, the segment had earnings that were double. I guess how much of that would you attribute to The Purolite capacity getting unlocked versus some of the changes that you're trying to enact with the sales force, the team, the cost cutting, Those types of initiatives, because it's such a dramatic move. I guess I'm trying to understand it a little better as to how what drove kind of that big improvement?

Speaker 3

So two things, John, in very different stories, obviously. So in that segment, Life Science has been in a good place for a long time. They were just lapping against Very high numbers during the years prior, as well as it was more of a year on year comp than anything else. And Life Sciences mentioned before, so is back to 18% growth, driving very good earnings as well as they did Prior, during that comp was an issue and back ultimately, so to the traditional trajectory. So Life Science In a very good place, which you see fully in Q4 and you couldn't see fully in Q3.

Speaker 3

2nd, Pure Light, as mentioned many times, we were capped in terms of how much we could produce Until Q4, which limited the growth by definition because we couldn't produce the products That we could sell ultimately that has created a bump, obviously. So in Q4, it's not in our organic numbers By definition, since it's an acquisition and it's the 1st year, it's going to change as of Q1. And then you have Healthcare, Totally different story. I like the fact that they're turning slightly to positive growth. The fact that they have made some money, but I'm not getting overly excited with that.

Speaker 3

It's 1 quarter And it's not a dramatic change in that business. On the other hand, I like a lot the efforts that are being made by that team To release or drive it back to the performance that it should be from a growth and most importantly, from a margin perspective, The program we've announced is part of it that will help, obviously, the cost structure. But at the same time, We know that we need to improve our offering. We need to make sure we focus on the programs that make most sense as well for our customers and for us. So it's still a long road ahead, but we will get to the right place as I've committed to that.

Speaker 1

Got it. Got it. And then Thinking about the industrial segment and China, you had the lockdowns in, but you had the virus kind of ripped through the country and That business of yours doesn't tend to be overly economically sensitive, but it is sensitive if plants have to close. I guess, how much of a pressure was that in the Q4? And how should we think about how that may snap back?

Speaker 3

First, China represents 4% Of our global business, it's hard to be material like Europe would be in our results. We have a good position in China. Our industrial business is a very strong business. What we do is something that Customers and government likes a lot as well. It's about clean waters, safe foods, preventing infection.

Speaker 3

It's obviously Very important. So for all of them as well out there, we've had a decent performance in 2022 in China, In Q4 as well, so it's positive growth. It was kind of in the mid single range in China during the Q4. And we'll see how Q1 is exactly happening. There's the New Year that's happening during the quarter with the shutdown and reopening that's going to be a bit of a messy quarter In China in Q1, but ultimately, I think we're going to get back to a good place once This kind of volatile period is behind us because what we do matters and our team is really strong as well over there.

Operator

The next question comes from the line of Shlomo Rosenbaum with Stifel. Please proceed with your questions. Hi, this is Adam on

Speaker 4

for Shlomo Rosenbaum. What tax rate are you assuming for 2023?

Speaker 3

Hi, Sloane. You talked about the tax, right? I'll give it back to Scott, who is much better than me to talk

Speaker 9

about that.

Speaker 6

Yes, I will cover off on that. Thanks for the question. I expect the rate for 2023 to be slightly higher than this year, just Due to sort of geographic mix, but right around, call it 19%. Okay.

Speaker 4

And how should we think about cash flow in 2023 in light of the restructuring items related to the expanded cost savings program?

Speaker 6

Yes. You should think about the free cash flow in 2023 Much like we did this year in terms of our historical conversion, certainly from a pacing perspective, Q1 will always be lighter, but I would Back the free cash flow is 2023 to be right in that mid-90s conversion on net income.

Operator

Thank you. Our next question is from the line of Rosemarie Morbelli, Gabelli Funds. Please proceed with your questions.

Speaker 15

Thank you. Good afternoon, everyone. We are talking about a first of all, congratulations on a great quarter and a great year. But we talked about the challenging economic environment currently, and you are beginning to see it. Now what you see, if you compare it to what you saw prior to The last recession.

Speaker 15

Are those signs indicating a recession or just a slowdown from where you stand?

Speaker 3

It's hard to tell. I don't have a clear opinion on whether they're going to be Hard lending, soft landing, recession, no recession. We're seeing some softening In the demand of individual customers, so a like for like or same store sales Demand from our customers, that's not true in every segment, obviously, but the indication that it's Softening is there even though it's very minimal. So what we're seeing here feels very traditional versus what we've Seen in the past and the shift to offense, which is the typical Ecolab way of responding to it, is going to be the best Do we have to mitigate against that?

Speaker 15

Can you tell whether it is real demand slowdown or whether it is actually Just talking.

Speaker 3

It's probably a combination of both, Especially in industrial segment for hotels and restaurants, they don't have much inventories, Distributors, so could be the case. Everyone is becoming a bit more cautious, so that has an influence of it. Exactly how much, I can't tell, but it's definitely not helping. So you have softening of straight demand, reduction of inventories as well at the same time, Having saw a slight impact on the rate of demand, but so far nothing dramatic and I feel good with our Shift to offense approach because getting new business, driving penetration, getting innovation on the market, well, it's what we're good at.

Operator

Thank you. The next question is from the line of Kevin McCarthy with Vertical Research Partners. Please proceed with your question. Yes. Good afternoon.

Operator

How

Speaker 16

would you apportion the $175,000,000 of targeted productivity savings Between the institutional and healthcare segments.

Speaker 3

So let me give you just a few comments and then I'll pass it as well to Scott. But as you've seen, half of the overall programs are easy in Europe. That's what we've communicated, well underway on this one. I like the progress that the team is making over there. And the balance of the overall program is mostly institutional with healthcare getting its fair share.

Speaker 3

But maybe any more comments, Scott?

Speaker 6

Yes. No, not a lot to add there, Christophe, exactly that. Certainly, the year program will impact other businesses as well. But certainly, We'll have the largest portion of the overall $175,000,000

Speaker 16

Okay. And then secondly, if I may, for Scott, if we go back a Quarter or so, my recollection is that you anticipated higher pension expense in 2023. Is that still the case? And if it is, how large might that headwind be?

Speaker 6

Yes. We do expect some modest headwinds, but we're talking in the sort of $0.05 to $0.06 range, so not overly significant.

Operator

Thank you. The next question is coming from the line of Steve Byrne with Bank of America. Please proceed with your questions.

Speaker 12

Yes. Thank you. If you had to estimate what your raw material costs are to purchase today Versus so this 10,000 products versus what their average costs would have been in the 4th quarter, What would you estimate that sequential change to be? Now that's just purchasing the products, Well, would you also estimate the average number of, say, months that a raw material Is purchase versus when it flows through cost of goods?

Speaker 3

So we don't buy any spot Price or product at spot price, to begin with. So it's usually contractual. There are some exceptions, but Not material. To which generally it should be less than a 5% range.

Speaker 12

I'm sorry, I didn't follow that. You mean, what is the less than a 5% range? I'm trying to assess whether there has been a sequential change in your raw material costs.

Speaker 3

During which, I want to make sure, so I understand your question.

Speaker 12

The last quarter to where we are today.

Speaker 3

Between Q4 and Q3.

Speaker 12

So Overall, before and where we are today, I mean, are you seeing anything in recent weeks that is That is just in your view. Okay, got it.

Speaker 3

Got it. So you mean today, so in Q1. The trends, as mentioned before, they keep going up. So just to be very clear, so in the Q3, so our total cost, as mentioned, so we're up 30%. They were up in Q4, a little bit less than that.

Speaker 3

And in Q1, they will be up a little bit less than what we had in Q4, but still up. Did I answer your question like that?

Speaker 12

Well, I see it as the year over year trend, you're starting to lap higher costs and thus that Maybe as part of that decrease, but there's 2 things here. Our raw material costs Actually starting to deflate. Are you seeing any cost deflation? And then how long does it take before that flows through cost of goods? Because I'm sure there's Some of your outlook is just the lag that it takes for the raws to flow through COGS.

Speaker 3

So to the lag question, it takes a quarter or 2 to get through the system. Generally, not every product is created equal in here. But I want to be very clear that the increase that We see in Q1 is a net increase, which means that the cost of our delivered product cost is clearly going up As well in Q1 versus what we saw in Q4, in dollar terms as well. So the cost of what we buy Keeps going up, albeit at the lower rate of increase than what we saw in the past few quarters.

Speaker 12

Okay. And then maybe just one on a potential end market opportunity for you. A lot of Industrial companies are getting sued because the products they're selling contain some PFAS and it's not because they're making Stuff out of PFAS, it's in the water. Is that an opportunity for you? Do you have expertise in taking these Really, really minute levels of PFAS out of water.

Speaker 3

Yes. We're probably the most advanced company In the science of water, in mastering water, in managing water, so PFAS is an opportunity that we've been looking at For quite a while, the demand hasn't been as clear as we would wish so far. So it's something that's going to come at some point, which will be most probably something interesting for us, like microplastic, By the way, as well, so the technology, the science, we have it, will be ready when the market is ready, to use those solutions.

Operator

Our next question is from the line of Vincent Andrews with Morgan Stanley. Please proceed with your questions.

Speaker 17

Thanks. I just have one question left here. In your Downstream segment, you talked about particular strength in the quarter in petrochemicals. And I was just wondering if you could bridge that With the fact that in most cases, particularly in the U. S.

Speaker 17

And Europe, the petrochemical assets were running at very low operating rates.

Speaker 3

Yes. We've shifted what we do for petrochemical, so towards Water management, energy footprint reduction, cost reduction, which I think the team did exactly the smart move. Our customers are looking for solutions to reduce their environmental footprint, while reducing their cost As well at the same time, so even though the utilization rates are going down, so to your point, our business It's still in a very healthy place, and I think it's going to keep being good for the years to come. Okay.

Operator

Thanks very much, guys.

Speaker 3

You're welcome, Mitu.

Operator

Next question is from the line of Scott Schneeberger with Oppenheimer. Please proceed with your questions.

Speaker 11

Thanks very much. Good afternoon. Following up on an earlier question on the cost savings program you guys shared on institutional versus healthcare breakout. I'm just curious, it was Originally in Europe, but when you announced in Q3 and now it's spanned to other regions. So first part of the question, just curious, Is this mostly global non U.

Speaker 11

S? How involved is the U. S. With regard to These cost savings plans. And then also, Scott, I guess specifically for you on this topic, you're going from $80,000,000 savings to $175,000,000 more than a double With this incremental announcement, yet the cost incurred to enact only go up by about half as much as what it originally cost For the enactment, so just curious how you're able to basically get more leverage off this second iteration?

Speaker 11

Thanks.

Speaker 3

So two parts of your question. I'll have maybe Scott to answer the cost versus savings first, and then I'll build On your question, so U. S. And then U. S.

Speaker 3

Scott first?

Speaker 6

Yes. The split of the savings as you pointed out, certainly the first program And this is very consistent in what we've experienced historically with programs where the cost to implement these programs is higher in Europe and then less so In the U. S, just due to the nature of the environment.

Speaker 3

And maybe to build on that to you question outside the U. S, it's The vast majority is in the U. S. And those are programs we've been working on so for quite a while. As mentioned before, so healthcare is A business that I've committed to bring to the right place at the right time as well.

Speaker 3

And that's a first step in that direction. And what we've announced is mostly in the U. S. Same for institutional, the shift from dining in To take out is a shift that has happened mostly in the U. S.

Speaker 3

And that's where we want to adjust As well. But I want to be very clear as well that those programs are kind of a surgical way of improving our businesses. The vast majority of our margin and earnings improvement as a company is really so to keep driving new business, getting pricing right, Innovation and productivity as well, while the programs is helping us do surgical work, where we truly need it In a short period of time.

Speaker 11

Great. Thanks. And a quick follow-up. You've addressed working capital a bit and free cash flow and thanks for that. Just curious on CapEx levels this year versus the past and what a normalized level percent of revenue perhaps is a good way to think about that.

Speaker 11

And going one step farther, where the free cash flow might be utilized this year? Thanks.

Speaker 6

Yes, sure. I'll talk I'll start with your CapEx question and then get to the sort of the capital allocation question next. So this year, we're at about 5% Sales, which is at the low end of sort of our historical range, certainly the couple of years prior to that, below that, and would expect in 2023 to get To that sort of close to the middle of that historical range of 5% to 6%. And then as we talk about capital allocation, Certainly, we completed our $500,000,000 program share buyback program this year and continued and now we'll be on our 31st You're of increasing dividends and between the 2 of those, returned 100% of our free cash flows to shareholders, over $1,000,000,000 in 2022. Going forward, I would expect to continue the dividends increase, but continue our consistent principles, which is first, investing in the business, which includes M and A as well as increasing our dividends, as I mentioned, and then with excess cash, looking at share buybacks.

Operator

Thanks, gentlemen. Thank you. At this time, we've reached the end of our question and answer session. And I'll turn the floor back over to Mr. Hedberg for closing remarks.

Speaker 1

Thank you. That wraps up our Q4 conference call. This conference call and the associated discussion slides will be available for replay on our website. Thank you for your time and participation. I hope everyone has a great rest of your day.

Operator

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Ecolab Q4 2022
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