Ecolab Q4 2022 Earnings Call Transcript

Presentation

[Operator]

Greetings and welcome to the Ecolab Fourth Quarter 2012 Earnings Release Conference Call. [Operator Instructions]. It's now my pleasure to introduce your host, Andy Hedberg, Vice-President, Investor Relations for Ecolab. Mr. Hecdberg, you may now begin.

[Andy Hedberg, Vice President, Investor Relations at Ecolab]

Thank you, and hello, everyone, and welcome to Ecolab's fourth 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 at ecolab.com/investor.

Please take a moment to read the cautionary statements in these materials which state that this teleconference and the associated supplemental materials include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described in the Risk Factors section in our most recent Form 10-K and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release.

With that, I'd like to turn the call over to Christophe Beck for his comments.

[Christophe Beck, Chief Executive Officer at Ecolab]

Thank you so much. Andy, and welcome to everyone. Our team delivered a strong fourth 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%, once again 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 third quarter to 13% in the fourth quarter. All this contributed to a strong 14% adjusted fixed currency operating income growth, even as we experienced expected peak in delivered product cost inflation, which reached 43% over the last two years in the fourth quarter. This led to adjusted EPS getting very close to last year's 128 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've 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 entering 2023 with a reasonable level of confidence. While we would have lost most of our $1.3 billion 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 high at the end of last year as what we offer water, energy and labor savings while delivering 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 macroenvironment remains unchanged. 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.

For the first quarter, 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 $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, well, this is a period of caution, we have a positive outlook on where we're heading. Over the last two years, our expertise grew as we focused on supporting our team and on developing strong new innovation. 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 macro trends in Europe by accelerating the productivity improvements we had planned for future years. We are adjusting institutional to win in 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, Purolite we 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%.

We remain good stewards of capital by continuing to invest in the business, increasing our dividends, 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 share of a high-quality $152 billion market and our future has never looked brighter. I look forward to your questions.

[Andy Hedberg, Vice President, Investor Relations at Ecolab]

Thanks, Christophe. That concludes our formal remarks. As a final note before we begin Q&A, we plan to hold our annual tour of our booth at the National Restaurant Association Show in Chicago on Monday, May 22, 2023, if you're interested in attending or have any questions, please contact my office.

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

Questions and Answers

[Operator]

[Operator Instructions] And our first question is from the line of Tim Mulrooney with William Blair.

[Tim Mulrooney, Analyst at William Blair]

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

[Christophe Beck, Chief Executive Officer at Ecolab]

Hello, Tim.

[Tim Mulrooney, Analyst at William Blair]

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 margins to inflect into positive expansion territory? And the same question goes for OI margin given some of the productivity gains that we're seeing.

[Christophe Beck, Chief Executive Officer at Ecolab]

Thank you, Tim. So,let me start with what we've done in 2022 because margins, gross margins, NOI margins were 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 $1.3 billion. And we've been able to rebuild most of it within the same year, so 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, they were slightly still down in the fourth quarter. So, that's a good sign obviously of where we're trending. Our OI growth, organic, was up 10% as well. So, if we look at the trajectory, we're in a fairly good place. So if. I look at 2023, we have some good momentum, pricing keeps accelerating, productivity is in a good place as well and we'll see what happens obviously so with inflation. Q1, so should be a continuation of the OI growth, which means that OI will keep improving as well in the first 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, 2023, but it's going to happen sometime in the second half.

[Tim Mulrooney, Analyst at William Blair]

Got it, very clear. Thank you. Just as a brief follow-up. I saw an announcement recently, 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?

[Christophe Beck, Chief Executive Officer at Ecolab]

I would love to Tim. So, first, it's not a consumer brand, it's a brand that's aimed at pros at the Home Depot, so 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, 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.

[Tim Mulrooney, Analyst at William Blair]

Got it. Thank you.

[Christophe Beck, Chief Executive Officer at Ecolab]

Thank you, Tim.

[Operator]

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

[Seth Weber, Analyst at Wells Fargo Securities]

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.

[Christophe Beck, Chief Executive Officer at Ecolab]

Thank you, Seth. Maybe just a few comments from me and then I'll pass it to Scott, who would give you a little bit more details on that, I'd like to first and foremost, if you say that for us, productivity is an outcome of momentum. So, sales. Innovation, pricing, this is the best way of business to drive productivity as we've done over the past few years and we'll continue to do it 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 two businesses that we need to address, institutional, because the market has changed. We're in a good place, but market has evolved and we need to evolve here and Health Care because we need to bring that business back to profitable growth since it's been a challenge for many, many years. But I'd like to pass it to Scott to give you some more color on that.

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, 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 million savings program, which includes the announced program we talked about in Q3, as well as the expansion the Christophe talked about, which includes health care and institutional focus. So, the pacing of that $175 million, I would expect about three-quarters, 75% of it in 2023 and then the remainder in 2024.

[Seth Weber, Analyst at Wells Fargo Securities]

Okay, and it sounds like those changes are meant to be permanent. So, not volume -- if volume comes back, you wouldn't expect those costs to come back then?

[Scott Kirkland, Chief Financial Officer at Ecolab]

Exactly. And as Christophe talked about on institutional and healthcare, 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 and years to come. And so, yes, we will expect to retain those savings.

[Seth Weber, Analyst at Wells Fargo Securities]

Right. Okay, thank you. And then if -- just a quick follow-up on the Purolite. I mean, can you just -- are the capacity additions on there at this point? And I'm just trying to understand like what the run rate of that business really looks like today? Thank you.

[Christophe Beck, Chief Executive Officer at Ecolab]

Yeah, I will, maybe take that question, Seth. So, for the most part, it's done, but it's a continuing story. We would be maxed as I've mentioned, as well as in the previous calls. 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, but what we've seen in Q4 has been a very strong acceleration of sales, we didn't have pro forma 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.

[Seth Weber, Analyst at Wells Fargo Securities]

Thank you.

[Operator]

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

[John Roberts, Analyst at Credit Suisse Group]

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

[Christophe Beck, Chief Executive Officer at Ecolab]

Hi, John so two parts of your question. So, first the surcharge has not come down since we started it on April 1st, 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. It's not going to be 100% 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.

[John Roberts, Analyst at Credit Suisse Group]

And then on pros clean program with Home Depot. Will those be identical products to what you distribute through Cisco and others? And will be Ecolab salespeople service customers who buy through Home Depot?

[Christophe Beck, Chief Executive Officer at Ecolab]

So two parts in your question as well here. So, the first part. Those are different product. What we distribute through distribution like Cisco, they are 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 adapted for day needs at the right price point as well. So no real competition with anyone else out there.

And second part of your question. There will be no service to those products. It's straight consumer products as well. But knowing as well that those cleaning contractors sometimes become bigger as well and those ones might be shifting towards service program at some point, which is what we do with Cisco as well as they have their online like Keystone that we do for them and unserviced 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.

[John Roberts, Analyst at Credit Suisse Group]

Thank you.

[Operator]

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

[Josh Spector, Analyst at UBS Group]

Yeah, hi, thanks for taking my question. I'm curious if you could talk about your volume expectations in first quarter? And you mentioned in your prepared remarks you were surprised on some of the performance in the quarter. I wasn't sure if that was the volume or something else you were talking about.

[Christophe Beck, Chief Executive Officer at Ecolab]

Yes, hi, Josh. So, not surprised, it was in Europe, we were expecting worse situations like everybody else actually. So, the milder winter has been less negative news, generally for Europe and we'll 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 in here, we'll take the trajectory as it is right now.

But, generally, for the whole company, what you've seen in Q4 with volumes 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, 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, is driving some very positive results in terms of new business, which I think should mitigate 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.

[Josh Spector, Analyst at UBS Group]

Thanks. And just a 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?

[Christophe Beck, Chief Executive Officer at Ecolab]

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, we have great position, and I think it's going to be a great business for the future as well. So here's the situation, so. I would say it's north of 19%, 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 that people are ordering online, using takeout as well much more than they did before, is translating to the dining 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. So we need to adjust for that. So what we're doing, it's doing two things. On one hand, and we started that over the past 12 to 18 months, it's totally new, we're just accelerating that program right now. On one hand, it does have a dedicated sales organization that drives new units and increased penetration and the second service organization that drives productivity in order to reduce our cost structure as well and that's where our program is directly focused on.

[Josh Spector, Analyst at UBS Group]

Thank you.

[Operator]

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

[Manav Patnaik, Analyst at Barclays]

Thank you. Good afternoon. First off, maybe if you could just help us with your price -- the price increase and also the raw material increased assumptions you've made for 2023 and in the 13% in the fourth quarter is obviously very strong. Like how sustainable and sticky is that versus you know whatever you're expecting for the [Indecipherable].

[Christophe Beck, Chief Executive Officer at Ecolab]

Hi, Manav. Well two parts of your question, 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 fast than what it did in 2022. 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. We will have a carryover in 2023 coming from 2022, we expect half of it to be strictly carry over 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, weight will net out, we will see, but that's how we're estimating basically our sequential progressive earnings improvement quarter after quarter into 2023.

[Manav Patnaik, Analyst at Barclays]

Okay, that's helpful. And then you talked about couple of times in the call, just the cost reductions that you're making, which categories like are you doing the headcount reductions? And I guess the question is more tied to, are you beefing up your sales force at a faster pace maybe?

[Christophe Beck, Chief Executive Officer at Ecolab]

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, Purolite, high tech those ones are clearly being fueled and we add people, we add investments for those ones, because we know it's driving 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 billion 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 for 2023, it's about new business. Mana, 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. 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, 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 real surgical way, this is not going to be our main priority in 2023.

[Manav Patnaik, Analyst at Barclays]

Thank you.

[Operator]

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

[Mike Harrison, Analyst at Seaport Research Partners]

Hi, good afternoon.

[Christophe Beck, Chief Executive Officer at Ecolab]

Good afternoon, Mike.

[Mike Harrison, Analyst at Seaport Research Partners]

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 rate. 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 towards the higher end or lower end of that outlook?

[Christophe Beck, Chief Executive Officer at Ecolab]

So, a few buts to your question, but generally no change versus what we said, what I said during the third quarter call. And now in our release and in my remarks as well in in the fourth quarter, the way we look at the outlook hasn't changed. We've decided to provide a formal guidance for the first 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 yet, it will come at some point, obviously, but it's two parts for Q1 and for the full year.

Now, as I've mentioned, we expect continued sequential improvement as you've seen as well in 2022, by the way. So, Q3 was a nice improvement versus Q2; Q4 was a nice improvement versus Q3; and Q1 is going to head in the same direction of being a further improvement as well and that's what we're providing is 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 going forward, which will lead to an operating income growth that's going to be in the double-digit range, which will drive, operating income margin turning positive sometime in the first half and the gross margin some time as well in the second half.

That leads to an EPS improvement quarter after quarter keeping in mind that we have headwinds in FX and interest, $0.30, as we've mentioned in the half of it in the first quarter 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 fourth quarter.

[Mike Harrison, Analyst at Seaport Research Partners]

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 the main reason that volumes are looking better in that downstream business as we're seeing some improvement in refinery utilization rates?

[Christophe Beck, Chief Executive Officer at Ecolab]

That's exactly right. You gave the answer, 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, 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 at 14% total growth as well in the fourth quarter. So water is in a very good place, downstream being this special case, in additive, as you've mentioned with the one time.

[Operator]

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

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Thank you, Christophe, just on your cost inflation in 2023, is it primarily wage inflation in for rise this year. Are you expecting rise to be actually down year-over-year for you guys?

[Christophe Beck, Chief Executive Officer at Ecolab]

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, 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 part of the outlook that described before.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

So I don't know which rise you're seeing the most inflation right now year-over-year and through the rest of the year, is some raw materials specifically?

[Christophe Beck, Chief Executive Officer at Ecolab]

You know, we buy 10,000 different raw materials, 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 went up 90% for instance, lately. So those are things that we need to deal with and everything else, is between zero, 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 then it will be hard with the thousands of customers -- commodities that we're buying out there.

[Operator]

Our next question comes from the line of Jeff Zekauskas with J.P. Morgan. Please proceed with your question.

[Jeff Zekauskas, Analyst at J.P. Morgan]

Thanks very much. Historically, Ecolab has raised prices about a 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 your customers understand that, if that's true.

[Christophe Beck, Chief Executive Officer at Ecolab]

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 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 rate remained almost unchanged during that remarkable time is a good indication. We've gained customers during that time and we keep gaining customers. 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 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.

[Jeff Zekauskas, Analyst at J.P. Morgan]

Then maybe quickly for Scott, Are your inventory -- it looks to me like your inventories are maybe $150 million too high. What would working capital be a source of cash in 2023?

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, Jeff, thanks for the question. We certainly have 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 the supply chain constraints around the world to make sure that we can get products to our customers, help our customers and with that made very unintentional 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. And so certainly. I wouldn't expect the same level form inventory in 2023 as we head in 2022, but at the same time, we are going to continue with 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.

[Christopher Parkinson, Analyst at Mizuho]

Great, thank you so much, Christophe, you hit on a little bit on the volume trends in the water segment. I was wondering if you just parse down a little -- get 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

[Christophe Beck, Chief Executive Officer at Ecolab]

So it seems 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 sale is going to go down. So, we will need to drive our own growth through new business, innovation, new end markets and so on as we've done as well in the past.

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 their 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.

[Christopher Parkinson, Analyst at Mizuho]

Just a quick follow-up on Pest Elimination, it seems like your market share gains, I mean, obviously, coming out of COVID is bit difficult, but it seems like your market share gains are beginning to reaccelerate. Can you just confirm that and talk about how your innovation in that segment is going to further drive and whether or not you're interested in the further M&A? Thank you.

[Christophe Beck, Chief Executive Officer at Ecolab]

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&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. 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 fourth quarter as well. And I expect them to continue to do so.

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 right now as well. So, strong business with strong margin, with the highest return on invested capital because there is 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 questions.

[Ashish Sabadra, Analyst at RBC Capital Markets]

Thanks for taking my question. I was just wanted to drill down further on the first quarter 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?

[Christophe Beck, Chief Executive Officer at Ecolab]

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 the 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, but we're getting close to the end of the first quarter, obviously, as we speak. 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 first quarter and the war started. At the end of February, we had one month to go and we had to deal with that. It's those external factors that are driving ultimately the range that we're providing for the first quarter as for every quarters in the past.

[Ashish Sabadra, Analyst at RBC Capital Markets]

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 PV perspective, can you provide any color on new innovations that we can potentially expect of that event? Thanks.

[Christophe Beck, Chief Executive Officer at Ecolab]

It's, it's a great business. As mentioned before, 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 restaurants and hotel companies around the world. So, I'm very bullish about the future of that business. 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 that we have for our customers and to really drive full penetration, 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 one 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.

[John McNulty, Analyst at BMO Capital Markets]

Yeah, thanks for taking my question. So, on the healthcare and life sciences business, when I look at the third quarter, you kind of made some comments at the time this is not acceptable and literally one 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 a little better as to how -- what drove kind of that big improvement?

[Christophe Beck, Chief Executive Officer at Ecolab]

So, two things, John, and very different stories, obviously, 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. So, it was more of a year-on-year comp than anything else and life sciences as mentioned before is back to 18% growth, driving very good earnings, as well as they did prior during, but comp was an issue and back ultimately to that tradition trajectory. So, life science in a very good place, which you see fully in Q4 and you couldn't see fully in Q3.

Second, Purolite, as mentioned many times, we were tapped 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, saw in Q4, it's not in our organic numbers by definition since it's an acquisition and it's the first year, it's going to change as of Q1.

And then you have health care, 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. It's one 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.

[John McNulty, Analyst at BMO Capital Markets]

Got it. And then thinking about the Industrial segment and China. You had the lockdowns in, but you had the virus kind of rip 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 fourth quarter? And how should we think about how that may snapback?

[Christophe Beck, Chief Executive Officer at Ecolab]

First, China represents 4% of our global business, so 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 water, safe foods, preventing infection, it's obviously very important 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 fourth quarter. 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.

[Adam, Analyst at Stifel Nicolaus]

This is Adam on for Shlomo Rosenbaum. What tax rate for 2023.

[Christophe Beck, Chief Executive Officer at Ecolab]

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

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, I'll cover off on that. Thanks for the question. I expect the rate for 2023 to be slightly higher than this year, just due do sort of geographic mix, but right around, call it 19%.

[Adam, Analyst at Stifel Nicolaus]

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

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, 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 expect the free cash flows 2023 to be right in that mid 90s conversion on net income.

[Adam, Analyst at Stifel Nicolaus]

Thank you.

[Operator]

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

[Rosemarie Morbelli, Analyst at Gabelli Funds]

Thank you, good afternoon, everyone. We are talking about -- first of all, congratulations on a great quarter and a great year. But we talked about the challenging economic environment currently and new beginning to see it. Now what you see if you compare it to what you saw prior to the last recession. Are those signs indicating a recession or just a slowdown from where you stand?

[Christophe Beck, Chief Executive Officer at Ecolab]

It's hard to tell. I don't have a clear opinion on whether they're going to be hard landing, soft landing, recession, no recession. We're seeing some softening in the demands of individual customers like-for-like with same-store sales. Demands 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 is 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 tool we have to mitigate against that.

[Rosemarie Morbelli, Analyst at Gabelli Funds]

Can you tell whether it is real demand slowdown or whether it is actually destocking?

[Christophe Beck, Chief Executive Officer at Ecolab]

It's probably a combination of both, especially in industrial segment for hotels and restaurants. They don't have much inventories. Distributors 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, we 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, we'll it's what we're good at.

[Operator]

The next question is from the line of Kevin McCarthy with Vertical Research Partners. Please proceed with your questions.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Yes, good afternoon. How would you apportion the $175 million of targeted productivity savings between the institutional and healthcare segments?

[Christophe Beck, Chief Executive Officer at Ecolab]

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 program is in Europe. That's what we 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, but maybe any more comments Scott.

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, no, not a lot to add there. Christophe, exactly that. Certainly, the year program will impact other businesses as well, but certainly institutional will have the largest portion of the overall $175 million.

[Kevin McCarthy, Analyst at Vertical Research Partners]

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?

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, we do expect some modest headwinds, but we're talking in the sort of five to six penny range, so not overly significant.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Thank you.

[Operator]

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

[Steve Byrne, Analyst at Bank of America]

Yes, thank you. If you had to estimate what your raw material costs are to purchase today versus 10,000 products versus what your average costs would have been in the fourth quarter? What would you estimate that sequential change to be, now that's just purchasing the products, what would you also estimate the average number of say months that a raw material is purchased versus when it flows through cost of goods?

[Christophe Beck, Chief Executive Officer at Ecolab]

So we don't buy any spot price or product at spot price to begin with. It's usually contractual. There are some exceptions, but it's not material. Generally, it should be less than 5% range.

[Steve Byrne, Analyst at Bank of America]

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?

[Christophe Beck, Chief Executive Officer at Ecolab]

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

[Steve Byrne, Analyst at Bank of America]

The last quarter to where we are today.

[Christophe Beck, Chief Executive Officer at Ecolab]

Between Q4 and Q3. So, overall...

[Steve Byrne, Analyst at Bank of America]

And where we are today. I mean, are you seeing anything in recent weeks that is in your view it.

[Christophe Beck, Chief Executive Officer at Ecolab]

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 third quarter, our total cost as mentioned, we're up 30%. They were up in Q4 a little bit less than that 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.

[Steve Byrne, Analyst at Bank of America]

Well, I see the year-over-year trend, you're starting to lap higher costs and thus that maybe as part of that decrease, but there's two things here. Our raw material costs actually starting to deflate. Are you seeing cost deflation and then how long does it take before that flows through cost of goods because I'm sure there some of your outlook is just the lag that it takes for the the raw to flow through COGS.

[Christophe Beck, Chief Executive Officer at Ecolab]

So, to the lag question, it takes a quarter or two 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 a lower rate of increase than what we saw in the past few quarters.

[Steve Byrne, Analyst at Bank of America]

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 contains 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 minute levels of PFAS out of water? Yeah, we've proven that we're the most advanced company in the science of water, in mastering water, in managing water. So, PFAS is an opportunity that we have been looking at for quite a while. The demand hasn't been as clearer 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 micro plastic 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.

[Vincent Andrews, Analyst at Morgan Stanley]

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

[Christophe Beck, Chief Executive Officer at Ecolab]

Yeah, we've shifted what we do for petrochemicals 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 debt cost as well at the same time. So, even though the utilization rates are going down to your point, our business is still in a very healthy place. And I think it's going to keep staying good for the years to come.

[Vincent Andrews, Analyst at Morgan Stanley]

Okay. Thanks very much guys.

[Christophe Beck, Chief Executive Officer at Ecolab]

You're welcome, Vincent.

[Operator]

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

[Scott Schneeberger, Analyst at Oppenheimer]

Thanks very much. Good afternoon. Following up on the 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 third quarter and now it's been to other regions. So, first part of the question, just curious, it is mostly global non-U.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 million savings to $175 million, more than a double with this incremental announcement, yet the costs incurred to an act only go up by about half as much as what it originally cost for the enactment. So, just curious how you were able to basically get more leverage off this second iteration?

[Christophe Beck, Chief Executive Officer at Ecolab]

So two parts of your question. I'll let Scott to answer the cost versus savings first and then I'll build on your question, U.S. and non-U.S. Scott, first.

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah. The split of the savings as you pointed out certainly the first program and this is very consistent with 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.

[Christophe Beck, Chief Executive Officer at Ecolab]

And maybe to build on that to your question outside U.S., the vast majority is in the U.S. And those are programs we've been working on for quite a while. As mentioned before, healthcare is a business that I have committed to bring to the right place at the right time as well and that's the 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 the shift that has happened mostly in the U.S. 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 to keep driving the 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.

[Scott Schneeberger, Analyst at Oppenheimer]

Great, thanks. And a quick follow-up, you've addressed working capital a bit and free cash flow. 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? And going one step farther, where the free cash flow might be utilized this year? Thanks.

[Scott Kirkland, Chief Financial Officer at Ecolab]

Yeah, sure. I'll talk -- I'll start with your capex question, then get to the sort of the the capital allocation question next. So, this year, we are at about 5% of sales, which is at the low end of sort of our historical range, certainly a 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 I talk about capital allocation, certainly, we completed our $500 million program, share buyback program this year and continued and will be on our 31st year of increasing dividends. In between the two of those, returned 100% of our free cash flows to shareholders over $1 billion 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&A as well as increasing our dividends as I mentioned and then with excess cash, looking at share buybacks.

[Scott Schneeberger, Analyst at Oppenheimer]

All right. Thanks, gentlemen.

[Operator]

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

[Andy Hedberg, Vice President, Investor Relations at Ecolab]

Thank you. That wraps up our fourth quarter 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. Hope everyone has a great rest of your day.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Andy Hedberg, Vice President, Investor Relations
• Christophe Beck, Chief Executive Officer
• Scott Kirkland, Chief Financial Officer

Analysts

• Tim Mulrooney, William Blair
• Seth Weber, Wells Fargo Securities
• John Roberts, Credit Suisse Group AG
• Josh Spector, UBS Group AG
• Manav Patnaik, Barclays PLC
• Mike Harrison, Seaport Research Partners
• David Begleiter, Deutsche Bank Aktiengesellschaft
• Jeff Zekauskas, J.P. Morgan
• Christopher Parkinson, Mizuho
• Ashish Sabadra, RBC Capital Markets
• John McNulty, BMO Capital Markets
• Adam, Stifel Nicolaus
• Rosemarie Morbelli, Gabelli Funds
• Kevin McCarthy, Vertical Research Partners
• Steve Byrne, Bank of America Co.
• Vincent Andrews, Morgan Stanley
• Scott Schneeberger, Oppenheimer Holdings Inc.