Greetings, and welcome to the Ecolab Second Quarter 2022 Earnings Release Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andy Hedberg, Vice President, Investor Relations. Mr. Hedberg, you may now begin.

Thank you, and hello, everyone, and welcome to Ecolab's second 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 the 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 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 of our most recent Form 10-K and in our posted materials. We refer you to the supplemental diluted earnings per share information and release. With that, I'd like to turn the call over to Christophe Beck for his comments.

Thank you so much, Andy, and welcome to everyone to our conference call. And Andy, welcome to your new role as Head of Investor Relations after 15 years in the industry and 6 years alongside Mike Monahan. In 37 years, Mike has built a legacy of trust, transparency, and simple messages. He has built trusted relationships with all of you on the call by listening to you, by addressing your concerns, and by building on your ideas in good and in more challenging times. He said openly with you what we were seeing, what we were doing about it, and where we were going to keep winning. And in a world that feels like it's getting more complicated by the day, he kept describing our performance, our opportunities, and our concerns in simple and clear ways to make your life as investors as simple as it could be. And none of that will change. So under your leadership, Andy, we will simply build further on Mike's great legacy. Now to our results. The second quarter concluded as expected while facing 30% delivered product cost inflation and increased headwinds from FX translation. Our global team managed to deliver once again sustained double-digit organic growth by driving new business and by accelerating pricing, both great signs of the real value we create for our customers and our margin growth potential. We almost doubled our total pricing from 5% in the first quarter to 9% in the second as we further strengthened our structural pricing and executed our first ever global energy surcharge with customers around the world in all our businesses in 172 countries in an extraordinarily short period of time. We're now exiting the quarter with double-digit sales growth and pricing momentum that's now ahead of delivered product cost inflation, most importantly, with gross margins that have now turned the corner. In other words, we expect to see easing year-over-year margin pressure over the next two quarters. We're now in a fortunate position where our #1 strategic priority over the past 12 months has been addressed, getting ahead of inflation. This will now help us fully recover our gross margin over time and expand them even further in the long run. With margins getting on the right track, the time has now come to shift our primary focus to offense. With an environment that keeps getting more complicated, we do not expect the world economy to accelerate. We're, therefore, getting ready for that, too. Our new business is strong, and innovation pipelines are at record levels. Our customer retention has remained largely unchanged, still north of 90%, with the industry's largest and best-trained sales force, with the resources and the capabilities to get the job done and serve our customers better than ever, with a business model with over 90% consumable revenue, with innovative technologies and services that are helping customers reduce their total operating cost when they need it most, like right now, and a growing $152 billion market opportunity that will remain huge no matter what happens to the world economy. We, therefore, entered the second half of the year in a position of strength, with strong growth momentum and growing share across the board, with inflation and energy costs that seem to keep getting higher, especially natural gas in Europe and in the U.S., with the right pricing momentum to stay ahead of inflation and the right mechanism, if I may say, with the energy surcharge to mitigate spikes of energy costs over time. This shift from focusing primarily on pricing to major share gains will naturally take some time. But as we've demonstrated in the past, it will also lead to strong results down the road. We, therefore, expect overall performance to improve sequentially in the quarters to come. Q3 earnings will, therefore, continue to be driven by strong top-line growth, easing year-over-year margin pressure, supported by solid pricing, but in the short term will also be impacted by unfavorable currency translation and potentially softer volume growth as the team shifts their focus to major share gain. As a result, we expect Q3 to show a sequentially narrowing decline in year-over-year adjusted earnings per share, including the impact of at least $0.10 of FX headwinds. Now with the total pricing already at low double-digit levels, new business generation to drive share gains, breakthrough innovation and productivity benefits to drive margins, we expect fourth quarter to show accelerated adjusted earnings per share growth, resulting in modest growth in full year 2022 adjusted earnings per share. Now let me conclude my remarks on a more personal note. I love growth, and I hate just as much as you do low earnings growth. This is not, we are certainly not who I am, except when it's because we've done the right thing, the right way for our future, like keeping our global team and capabilities intact at a very high cost during the COVID lockdowns. Like managing pricing in a way that protected long-term customer retention, like maintaining growth investments in new products, digital technologies and new high-growth businesses to gain market share and significantly increase our opportunities. As intense as it is right now, our near-term momentum keeps building and our long-term opportunities have never been greater. That's why I've never been more bullish about the future of this company. Our $152 billion market opportunity keeps getting bigger. When infection risk keeps rising with pandemic, with hospital-acquired infections, and we put safety challenges like we've seen lately in baby food production, we need to help our customers. With water scarcity and a warming climate that's hurting businesses and people, we had to help our customers reduce their total water and carbon footprint while reducing the total operating cost, helping to deliver superior long-term performance for them and for our shareholders, which is why I firmly believe that with Ecolab, the best is still yet to come. I look forward to your questions.

Thanks, Christophe. That concludes our formal remarks. Operator, would you please begin the question-and-answer period?

Our first question is from Tim Mulrooney with William Blair.

So I'd love to ask you about your share gains and innovation and all that. But I think I've got to stick to the basics at least starting out here. So my first question is about raw material costs, not surprisingly. And then I've got a follow-up on pricing. So Christophe, the last time we spoke, it was your expectation that delivered product costs would be up about 25% in 2022. Is that still your expectation? And can you kind of break that down in between what you saw in the first half of the year versus what you expect in the second half?

Yes, great question. So talking about raw materials. So first, I'd like just to step back, so one step last year. So in '21, we had 10% of delivered product cost inflation, which includes rolls and freight, just to be clear as well on this one. We entered the year '22, expecting 15%. Then you're right, we talked about 25%. And today, we're closer to 30% right now in the second quarter, and we expect that level of inflation close to 30% to remain until the end of the year.

Okay, I understand. It was slightly below 30% in the first quarter, but it reached 30% in the second quarter and is expected to remain at that level for the rest of the year. That's helpful. Now, if we consider the pricing aspect, Christophe, how did the net price cost become a net positive in June? Can you discuss your expectations for the price/cost spread and how you foresee it developing in the second half of the year? What does that imply for gross margins moving forward?

Yes, with pleasure. So the 30% as well so that we are experiencing so right now and going forward for the next few quarters as well, just to put it in perspective, so represents $1 billion, of course, that our teams had or will have to overcome so during the year to 2022. And that's why it's been so remarkable that the team managed to get ahead of inflation during the last months of the quarter. When initially, we saw that would happen in the first quarter of the year, the war started then in Ukraine and shifted, unfortunately, one more quarter. Because energy costs went through the roof, we started with the energy surcharge, which worked out really well in the second quarter. We got structural pricing plus energy surcharge kind of well implemented during the last month of the quarter, and that's how we got ahead of delivered product cost inflation so at the end of the second quarter. So when I think about the second half of the Europe, we got the job done. We're ahead of inflation. That will remain for the foreseeable future, obviously, which means that the margin pressure is going to ease over the quarters to come. This is going to be true in Q3. But it is going to be even more true in the fourth quarter as pricing and the energy surcharge together are going to keep accelerating. I talked about low double-digit levels in the second half. And if we assume an easing of the 30% rate of inflation for the next two quarters, Q4 should be a very nice margin play, which is why we're expecting as well accelerated growth in terms of earnings per share in Q4.

Our next question is from the line of Manav Patnaik with Barclays.

This is Ronan Kennedy standing in for Manav. Christophe, could you please provide a recap of the outlook? I know you mentioned the possibility of unfavorable volume growth or growth not accelerating as expected. Can you outline the outlook for the second half and into 2023 from a growth perspective? Additionally, while the inflationary pressures are significant, are you also starting to notice some macro pressures?

Well, great question, Ronan. So the overall picture for 2022, we were expecting, from an economic perspective, a continuous acceleration during the year, over the past few months, obviously. So the environment has changed. That being said, our own trajectory as Ecolab has remained so fairly stable. So 13% organic growth in the first quarter, 13% in the second quarter and we expect something similar in the quarters to come as well. But it's basically, so having our own views focused on the potential risk of an economic slowdown, all indicators are showing that direction. In our own businesses, it's not obvious yet, but we're not immune, obviously, to whatever could happen in the world out there, which is why, first, we believe in our models being great in that kind of environment, which is very different than the lockdowns of COVID, which was just an industry, so stopping to operate. When we talk of a slowdown, this is something that we're very used to. And we like it because our model ultimately 90% consumable revenues. So that means recurring our promise to customers. It's to help them with premium products, reduce their total operating costs ultimately when they need us even more in those moments. So our model is very well aligned with a potentially slowing environment. And ultimately, that's why, as I've mentioned as well in my earnings calls that the shift from primarily focusing on pricing to primarily focusing on new business will come at the right time as well, which is a shift that we've done many times as well in the past. So overall, an environment that might be slowing down with what we're undertaking, so expecting some kind of a stable momentum in the quarters to come with a potential downside risk that we can manage as well.

That's very helpful. And with regards to that shift in focus, I think you had also referred to it as going from defense to offense. What does that entail, that shift to focus on new business wins? And then are there other elements to kind of a downturn playbook that may be different than the approach that was taken during the unprecedented height of the COVID pandemic, where the focus was on, protecting the company, your employees, and custom?

Yes, I believe we are moving towards a situation that the company has experienced during tougher periods in its history. We are fundamentally a sales organization with a strong sales culture, meaning that a significant part of our business focuses on two main areas: acquiring new business and managing pricing. It's crucial to establish a clear priority for the organization: is the emphasis on pricing or on acquiring new business? While we aim to address both simultaneously, over the past year, the high inflation we faced necessitated a primary focus on pricing, and our team successfully tackled that challenge. Now, the focus is shifting back towards acquiring new business while still managing pricing. This involves attracting new accounts, increasing market penetration, and promoting innovation, all while maintaining our pricing strategy to generate more value. This transition in focus from pricing to new business is something we have navigated throughout our history. It typically requires a few months to ramp up, but it's a process we're well-acquainted with, so I’m not concerned about it.

Our next question is from the line of David Begleiter with Deutsche Bank.

I'm sorry, can you hear me?

Yes, we can hear you, David.

Sorry about that, Christophe. Regarding the Q4 guidance, you're forecasting about 20% share growth. The EPS growth from Q3 to Q4 shows a significant increase. Is this mainly due to the additional pricing, or are there other factors contributing to the increased earnings growth from Q3 to Q4?

It's the combination of many factors. When we think about the third quarter, so to begin with, so it's mostly impacted by FX, the $0.10 that we've talked about. Otherwise, the EPS would be growing in the third quarter. And if you look at Q4, it's going to be the combination of business momentum, so driven by new business, as mentioned before, added to a pricing that's going to keep strengthening together with the energy surcharge, as mentioned, so we'll be in the low double-digit territory as well. Our productivity work is going to keep working as well in our favor. And we expect, as well, a stabilizing of the 30% of delivered product cost inflation rate, as mentioned before. So the combination of all ultimately is playing to the Ecolab model where you see margins enhancement during the fourth quarter. It's not going to be an improvement versus last year, but it's going to be a sequential improvement from Q2 to Q3 to Q4, which, by the way, David is really playing in our favor longer term as well as we rebuild our margins fully and then afterwards even expand that.

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

I guess just another pricing question, Christophe. I mean talking about, say, 6% or 7% structural pricing. Can you just give us your view on Ecolab's ability to retain that next year into 2023? I'm not asking for guidance for next year, but just your confidence level and the company's ability to keep that type of pricing next year?

Yes. Thank you, Seth. The structural pricing, I have a very high level of confidence that we're going to keep it. This is what we've done over the last 99 years as a company. So we're not cyclical in terms of pricing evolution. So structural price is going to stick, the way we execute that with customers. The energy surcharge will be more of the question. I don't think that the energy costs are going to come down anytime soon, unfortunately, I may almost say. And maybe one piece of information for you, Seth, is also that our energy surcharge, which was anchored on oil price, Brent that everybody could read, has been complemented, but the natural gas prices as well, which is becoming a bigger issue in Europe and in the U.S. for the same reasons as we know. So it's going to be a combination of oil and natural gas, which is why initially we called it as well, the energy surcharge. How much are we going of keep all that? Whenever the market comes down, I think we're going to keep part of it and some might be given back. But overall, the discussion with customers is driven by how do we build margins on our side, that's our internal discussion, but most importantly with customers is making sure that the return that they get on the investment that they've made in our value gets a positive return, which is EROI. So I feel good about the way we can maintain our pricing that we've executed here. Some might get back, but it's going to be marginal.

That's helpful. I have a quick follow-up regarding the health care and life science margins being a bit lower than expected. I noticed some points highlighted in the slide deck, but is there anything that might be affecting those margins? Is there a structural issue at play? The Purolite margin is notably high, so we expect improvements there. Could you discuss the expected ramp-up in health care and life science margins moving forward?

Yes, it's really two different stories. As you saw life science and Purolite are doing very well, so no issue on that side, and it's been very steady in the past and it's going to be steady in the future as well. Health care is a different story. That's where our challenge lies. Three things that I would mention. The first one is pricing with TPOs takes more time than with customers. That has an impact on margin. Secondly, North America, elective surgeries took more time than expected initially, that's been on and off. So during COVID as we know. So quite a few times, that's where we make most of our money as well, like hospitals do as well at the same time. That has an impact on the health care margin. And third, in Europe, so we still compare to the so-called mega deals with government COVID activities related in '20 and '21, which is also having an impact on the Healthcare margins. But let me be very clear. Healthcare is not where it should be. It's not been so for a long time. There have been some better and some less great times in that business. We focused on it. We need to fix it, and we will fix it.

The next question comes from the line of John Roberts with Credit Suisse.

It sounds like base price is up 6% on its way to 7%. What is the base cost inflation that you're seeing? That is, what are costs up excluding energy?

It's a difficult question, David, because when we talk about energy, we don't buy energy directly, as you know. But the way we think about it is 1/3 of our raw material cost is impacted by energy. And again, when we talk about energy, you have oil and then you have natural gas. So what we buy are second or third derivative of that. That's why it's a difficult question to answer here. But I would say one way to think about it, we were thinking 2022 to have an inflation of 15% plus. We are at 30% right now, to a great extent that DPC incremental inflation came through energy following the invasion end of February. So that's maybe one way to think about it. But hard for us to really split the two, I'd rather focus on the 30% delivered product cost inflation, which is the true number.

Okay. And maybe a different way to ask about price. But when you started to implement the surcharge, WTI oil was about $120 a barrel, and now it's $95. And back then, TTF gas was $25 million BTU, now it's $60. Can you help us understand like an average U.S. surcharge has gone down, I assume, because of the WTI drop and the average European surcharge is going up because of the TTF gas increase?

No, the Brent price is still above $100, similar to where we were in April during the second quarter, so there’s been no change. It's not a straightforward calculation because if customers were to look at the numbers directly, it would be different. The amount you're considering includes a percentage based on what was shared earlier, but it involves negotiations, so that figure doesn’t fluctuate monthly. Additionally, as mentioned earlier, the focus has shifted to natural gas, which is rising quickly in the U.S. and even more in Europe. Currently, the surcharge in the U.S. remains relatively stable as we continue discussions with some customers, while in Europe, the surcharges are increasing due to rising natural gas prices.

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

I have a follow-up question along the same lines. Can you clarify whether the surcharge is now applied to all customers, or is there still a portion under negotiation? When will it take effect in the third quarter? Additionally, if energy prices increase by 20% or 30% in the fourth quarter, and the surcharge is already in place, will there be discussions about a price cost adjustment in the fourth quarter? Or do you believe that your current measures have effectively mitigated that risk?

It is not major shock in the system geopolitically, which could happen. If you look at what's happening with Russia and Ukraine today, we should be in a good shape. We are ahead of inflation as we exit the second quarter, as mentioned, and we will stay ahead with increased pricing in Q3 and Q4 and further execution of the energy surcharge as well in the months to come. So both together brings me in a reasonable place for Q3 and Q4 that we will stay ahead and expand as well. So the margin leverage or margin impact that we have on our business. Second, if something happens as well in the world, in Western Europe, especially impacting natural gas, as we just mentioned before, with David as well. With the energy surcharge, we have a mechanism as well that we can fairly short-term change in order to capture more pricing through the energy surcharge. So this is pretty handy, which was what we had in mind when we launched as well that, but was not just to react to what was happening back then following the invasion in February, but also being able to react with whatever could happen as well in the months and the quarter to come. So bottom line, I feel quite good about staying ahead of inflation and rebuilding margins in the months and quarters to come to fully restore and expand even further. And if something happens in the world, it might take some time to increase the energy surcharge, but we have the mechanism to address that as well.

And just to clarify, the inflation for the second half, you talked about 30%. What is a 2-year stack of that inflation that you guys are planning for?

The 2-year stack, that was your question, Josh?

For the second half, specifically, yes.

Yes. Last year, we had, as mentioned, so we had 10% in Q3, we had 20% in Q4. And you add the 30% of this year itself, that's how you get your stacked 2 years model. Directionally, that's right. Yes, over 2 years.

The next question comes from the line of Christopher Parkinson with Mizuho.

Christophe, a lot of your platforms and services ultimately pertain directly to your customers facing their own inflation, whether it's low temperature warewashing systems and even some stuff around your commercial and water treatment in terms of prevention and obviously facing inevitably rising costs in their own side of things. Can you just offer a little bit more color on your ability to kind of continuously push price just given the environment your own customers earn? I mean has the narrative really changed between the value-added proposition of your products and services over the last year and do customers ultimately recognize that? So just any color on that would be greatly appreciated.

That's a great question, Chris. Thank you. Well, it speaks to our model that you're really familiar with. And our promise as a company has always been best results at the lowest total operating cost which we measure with EROI, which is basically, so how much cost savings versus investment customers are making. And our ambition is to be north of 25% return for the customer in here with pricing in here as well, and we stick as well to that model, the way we're operating with customers today. Usually, we know of the 25%, which gives us as well some margin as well, need to get even further pricing. So, so far, it's worked out pretty well. That's why I mentioned that our customer retention has remained very stable over the past 12 to 18 months. But going forward, focusing even more on EROI will be essential for 2 reasons: first, to really keep executing pricing. But most importantly, in times where economic environment might evolve as well. So to the downside, if I may say, without mentioning the R word as well in here, customers need it even more. This is true in warewashing. This is true in laundry. This is true in water. And it gets compounded as well that most of the customers have a hard time as well to find staffing to get the job done. Well, our offering helps them get the same results or even better results with less people and less cost at the same time. And that's why our value proposition is pretty ideal in such an environment where we help customers get better results with less people and lower cost. That helps us execute margin and drive more new business.

Got it. In honor of Mr. Monahan, I'll make sure to express this correctly. Regarding your pest elimination business, not just control, but elimination, please provide a quick update. It seems like things are starting to reengage there, particularly in North America. This has been a significant focus of your ongoing enterprise selling initiatives. Can you help us understand the current environment and how we should view it in the immediate and longer term now that it appears you are gaining more traction in terms of recovery?

I love the relation to Mike Monahan, that's true. It's pest elimination, unlike competition, that's controlling. You still have mice and rats running around, but you have less than before. With Ecolab, you have none, which is our promise. So to the business in here, pest elimination has been an exceptional business for many, many years. It's been strong during COVID in 2020. It was strong last year as well. You maybe remember it was a double-digit top line growth. It's been expanding its margins as well both gross profit and OI ratio as well. And when I look at 2022, while it's kind of steady eddy, we are in double-digit territory as well in terms of top line growth as well, with very strong margin as well. That's why I don't talk much about pest elimination because the business is doing extremely well, has done well during difficult times and is doing well right now. It's a great team, very well led. And I look forward to even more going forward, a beautiful business.

The next question comes from the line of John McNulty with BMO Capital Markets.

Christophe, maybe we can speak to the end markets for Institutional. So I know you're kind of battening down the hatches it sounds like for a potential recession at the same time. I guess I'd be curious to know where your institutional business is relative to pre-COVID. And if there's still some uplift to go there even if we do kind of stumble a little bit into recession, I guess, how would you characterize that?

Yes. Great question. John, Institutional is in a good shape and evolving very nicely. Honestly, I had expected that the market recovery would happen way faster, way bolder. It's not what happened. That has nothing to do with us. Obviously, this is a market question. But when I think about our business Institutional, well, if you compare it to 2019 for instance, which is kind of the base of pre-COVID, we are 5% ahead of 2019. We were 2% ahead of 2019 in the first quarter. So that shows that the business is kind of in a good place and evolving very nice as well. What's most interesting is that we're gaining shares as well to the comparison that we've done so many times as well as for the U.S. restaurants. If you look at dine-in traffic, which means people coming in dining rooms, well, it's down 36% versus 2019. Our business in the same place is down only 3%, which means that we've gained a huge share as well in the meantime. So at the end of the day, we're ahead of '19 in terms of sales in the second quarter. In the quarters to come, 2 or 3 quarters, we will also recover the volume and in the second half of '23, I believe we will recover as well the margins, which is the plan that we had all along. So all in all, in a pretty good place.

Got it. That's helpful information. The second question is about raw materials. Your Industrial business, if I understand correctly, has a significant exposure to propylene derivatives. Currently, propylene prices have decreased by about 25% quarter-over-quarter. Can you provide insight into that area and whether you're beginning to experience any relief with raw materials, or if it's a matter of waiting since these are derivatives and it takes time? How should we consider the potential for relief in the coming months?

It's clearly the latter, John. We generally don't make purchases at spot prices, except for some exceptions. Our approach is primarily contract-based and focuses on long-term arrangements. As you mentioned, we deal with derivatives and second or third feedstock, which means it takes time for us to process these through the system. Consequently, while price spikes are not very high, they tend to increase and remain elevated for longer periods. Regarding our Industrial sector, they have excelled in pricing, staying ahead of averages and managing the impact of delivered product costs since inflation began in the second quarter last year. They've effectively navigated pricing and energy surcharges, and as they exit the second quarter, they are poised for even higher pricing compared to the company's overall average. Their momentum in new business, pricing strategies, and productivity has been impressive. Looking ahead, we are optimistic about the Industrial business, which constitutes half of our company. Notably, this part of our business has consistently performed well in pricing during every inflationary cycle, helping to enhance gross margins as we move forward. As challenging as the current situation may be, it's set to become a positive narrative for Industrial margins in the future.

The next question is from the line of Ashish Sabadra with RBC Capital Markets.

Just wanted to focus on two items that was discussed at the National Restaurant Association Show. One was on reigniting the Ecolab certified program. I was wondering if you could talk about how that's coming along? And then obviously, there was a discussion also around the significant pull from customers for digital solutions, next-gen products, if you could comment on that as well?

Yes. Thank you, Ashish. So the two points situation hasn't changed much, obviously, since we met a few months ago. Ecolab Science Certified, as mentioned, it has been launched during COVID to support our customers in order to protect their own guests and ultimately, so having more people coming to their restaurants or their hotels. It's kept being a very good story. We've become the leading program in the U.S. It's become stronger as well in the meantime. We're expecting to get in the next few quarters close to $100 million of incremental business, close to 100,000 of locations as well down the road. So it's becoming a major program for us, and for our customers. And ultimately, it's going to move beyond COVID and really making sure that our customers feel safe when they get to their own restaurants as we've talked all along. Now to digital solutions. Interestingly enough, with most of our customers struggling with staffing conditions as we've seen when you go to restaurants, to hotels, to airports, or wherever you go, ultimately, our automated solutions for customers are helping them get the same job done with less people as well. Well, this is not only helping them on the staffing side, it's helping them on the cost side as well, which is good now and even more important going forward. So thank god we kept investing behind digital solutions, which, by the way, are helping ourselves as a company, if you look at our SG&A productivity that has kept improving year-over-year and accelerated as well. So during the past few years, this is almost directly related to the work that we've done with digital.

That's very helpful color. And maybe if I can drill down further on the volume side of the Industrial segment. Can you just talk about how that business obviously has morphed since the last GFC both on the Nalco front, but also on the core side. And also some of the growth drivers there, particularly animal health and data centers, how those are progressing. So any color on those fronts would be helpful?

What's good in Industrial is that it's very broad-based. All the businesses are doing really well. When I look at water, which is the biggest, and strong growth, food and beverage, downstream, and paper. So the four big ones, obviously, that we have had are all doing really well. So it's not one business driving the whole Industrial, it's very broad-based. And it's very broad-based geographically as well, which is why I feel confident about that business, especially as well going forward. So in terms of demand, we haven't seen much reduction, if I compare to 2019, for instance, as well, which is the right base because you remove all the noise of COVID as well. In between, there is some noise and variation as well in there. But otherwise, they're pretty steady month after month. We'll see what happens in the months to come with the economic environment, but ultimately, very strong new business. That's going to help them obviously mitigate any softening of demand out there. And second, the pricing evolution is extremely strong as well as mentioned before. So the combination of both is driving a very steady and healthy story for Industrial.

Our next question comes from the line of Jeff Zekauskas with JPMorgan.

You expect the lower earnings per share comparison in the third quarter versus the year ago. You've said that your raw materials are being offset now by price increases. You've got a little bit of negative currency. So does that mean that volumes are about flat in the third quarter year-on-year?

So the key points, Jeff, sorry, you're right that Q3 2022 is going to be lower than Q3 2021, as mentioned, mostly impacted by the FX, the $0.10 that I've mentioned as well earlier. So without that, we would be in positive territory. That being said, I'd like to add two points. The first one is we compare to Q3 last year, which was a strong recovery in our institutional market. So ultimately, the volume growth in Q3 will be lower than what we have in Q2 because we're comparing to this reopening post the third or fourth COVID wave that we experienced in institutional. And the last point I'll mention as well, there might be some conservatism as well in terms of volume from my side as well in here. But looking at what's happening around the world, I want to be as well on the safe side. So you have all three, the FX, the comparison to reopening in Institutional in '21, and there might be as well some caution from our part in terms of economic development.

Ecolab has maintained its staffing levels since 2020. I think with the idea that the global economy would recover and the restaurant industry would come back and that there would be no strong inflationary effects, but there have been inflationary effects. It has been a slower recovery for the restaurant industry. And it looks like we may be going into a recession. Should you be thinking about restructuring your operations or having a lower cost structure than what you've got now?

We're not planning for restructuring, at least nothing broad-based. You will always have some pockets around the world. We are a large organization operating in many countries around the world. Obviously, not everything is created equal, and we will keep improving our operations wherever we operate around the world. Broad-based, no, nothing major is expected at least with everything we know right now, so from the environment. If you look at our SG&A as well as over the past few years, we've done some very good progress as well in terms of productivity, and we're going to keep doing that as well going forward, mostly driven by digital automation, which means that with the same team we can serve more customers and do more with the customers that we're serving as well are directly driven by digital automation. Which means that if in the past, our company was growing its team more or less at the same speed as the company was growing, that's going to change in the years to come, not because our model has changed, but because our technology is helping our teams do more with less. And last point, I'd say in hindsight, Jeff, I would do again the same thing. If we would have reduced our team in 2020, when most of our customers did ultimately, well, we would have lost all those relationships. We would have lost all the capabilities and expertise that this team had. We've kept it. This is a huge advantage for us, for our customers in going forward, but our productivity is going to keep improving in the years to come.

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

Christophe, can you provide some insight into Europe? I'm particularly interested in the energy situation there and how Ecolab might be affected by potential natural gas or electricity shortages in the fourth quarter and possibly into the first quarter. How would this impact your operations and your ability to source raw materials? Additionally, what effects could this have on a portion of your customer base? And I assume there are no considerations for these risks in your guidance for the second half?

Yes. This is a great question. So these some I know and some we don't know, obviously. So starting first with our business in Europe, overall, doing really well, growing double-digit. It's been very resilient during the COVID times as well. So overall, Ecolab in Europe doing really well. Now to your question of operational resilience, depending on what could happen on the eastern front. We have a very good supply chain team that has been tried years after years when you think about it, so what we went through over the past few years being so natural catastrophes in the U.S. like the Texas freeze or what happened in China as well. So we saw all the lockdowns that we had to go through. We've managed to really supply our customers in remarkable ways around the world in a very difficult situation. So when I think about Europe, our team was there together as well over the last few weeks thinking about the extreme scenarios and ensuring supply during those times. I feel reasonably good about our ability to ensure supply in the case that natural gas would be stopped from Russia, which I guess is the core of your question. The impact on our customers is way harder to answer because obviously, we don't operate for them. So depending on how they're going to do, that's going to have an influence on us. But this is something I can't obviously influence. The only thing we can do is ensure the supply and driving as well new business with existing and new customers as well to try to mitigate that as well as we can.

Okay. And as a follow-up, you referenced in the back half guidance, you sort of let us knew that maybe you're being a little conservative on the volume side of the equation. Where do you think the biggest risks are to the back half forecast. If it doesn't come in where you think it's going to, what are the one or two things that you're worried about in relation to the forecast?

It's hard to tell. But the hotspots are obviously starting with Europe for all the reasons that you mentioned before, geopolitically, not an easy situation. Obviously, there, we have a great business, doing really well with a very strong team. But okay, we can't create miracles as well either. So I'm very cautious about what could happen in Europe. In the U.S., the economy is not going to accelerate. We'll see what the print will be for GDP as well in the second quarter in the U.S. Well, it's going to head towards more of a slowdown than an acceleration. So that's the second area. And the third one that was a bit of a question mark, at least a few months ago, was China, have become a little bit more comfortable with the situation in China. Our business is doing reasonably well, all considered as well over there. So first Europe, quite a bit behind the U.S. and way further out China. But overall, it's to remain cautious and to think about all that could happen, to have as well contingency plan in place in case things would differently than what people would expect.

The next question comes from the line of Steve Byrne with Bank of America.

Within your water treatment business, are municipal water supply authorities currently customers of yours? And if not, is there something structural about that end market that is not of interest to you? One would think that drinking water standards are only going to get more challenging for these municipalities. And just curious to hear your outlook and interest for that end market?

Well, let me start by saying, Steve that we are literally not in the municipal water business by choice. We do maybe a few million here and there. But it’s totally irrelevant for our company because we do not want to be in that business. We have so much more to do on the Industrial and Institutional and Healthcare end markets that we know extremely well as a company. When I think about what's the main reason for that? Well, first, it's choice of priorities. We want to really stay focused where we can truly win. And second most importantly, the way we sell, as mentioned before, it's really helping customers improve their total operating cost while reducing their environmental impact. This is a value proposition that resonates extremely well with companies. Municipal, by definition, are governments. Governments do not think that way. In terms of total operating cost, it's much more what's my budget that I have for the year. This is not the way we drive our business. So there's a mismatch as well here. Is it going to stay like that for the next 50 years? I don't know. But for now, no interest in entering the municipal market.

And with respect to innovation, can you comment on what areas of focus you're particularly excited about with respect to new products from innovation?

Yes, we have some great stories. It's been the case for many years, obviously, in our company. I would start with a few macro innovation. The first one is Ecolab Science Certified. As mentioned before, this is a comprehensive program for institutional customers, restaurants, and hotels that are protecting their guests. That's been a major innovation for us. In the industrial field, think about net 0 water. This is a comprehensive set of programs that's helping our customers deliver on the sustainability commitments or ambition as well. We are uniquely positioned to help customers get there. This is a major driver for the future. Think about Purolite. It's an acquired, obviously, innovation that's growing fast, very high margin. This is new to our portfolio. And the last I'd mention is Ecolab 3D, probably one of the largest industrial clouds out there that we've been building over the years where we have thousands of clients that are connected that can improve their performance in real time compares what the performance unit versus unit within a company, across an industry and across industries as well. So those are four key innovation that I would qualify.

The next question is from the line of Scott Schneeberger with Oppenheimer.

Could you elaborate on the Healthcare segment, Christophe? Are we expecting a return to revenue growth in the third quarter, and what are your thoughts on elective procedures compared to pre-pandemic levels?

Yes. I want to be careful on this one. So as mentioned before, so Healthcare is a business that still needs work. I like the focus that we have on it. It's going to take some time as much as I hated and you hated as well, I think so, thinking about the fourth quarter, so to see growth in Healthcare, not in the group, Healthcare and Life Science. Obviously, Life Sciences is in great shape. It's clearly so health care. I think it's more looking at the fourth quarter growth, it's probably more realistic. And if we can improve in Q3, well, that's going to be even better. But I would really focus on Q4.

Thank you for that. Could you provide a summary of the company's overall investments, particularly highlighting those mentioned in the recent press release? Last quarter, there were investments in the sales force. Can you broadly categorize where the company is directing its investments and the scale of these efforts? Do you expect to increase these investments or would you adjust them if the economy declines? You noted earlier that digital spending is consistent, but a broad overview of the investment landscape would be helpful.

Yes. The overall macro picture shows that our investments have remained stable over the past few years and are expected to continue to do so in the future. For example, our capital expenditures, which account for 6% of our sales, have been consistent for a long time and will remain stable. Additionally, our selling, general, and administrative expenses are showing improved productivity each year, and we plan to maintain that trend. This involves investing in our team while also enhancing SG&A productivity. When considering incremental investments, we will focus primarily on three areas. First, our growth businesses such as Life Science, Purolite, data centers, and animal health are high-growth and high-margin sectors. We plan to continue investing heavily in these areas to strengthen our leadership position. Second, we will invest in digital initiatives because they add value for our customers, enhance customer experience, and improve productivity. This includes a focus on cybersecurity, as increasing digital engagement brings additional cyber risks that we need to address. Lastly, we will keep investing in innovation and the various programs mentioned previously. Overall, our investment strategy remains steady with consistent levels of capital and operational expenditures.

The next question is from the line of Laurence Alexander with Jefferies.

This is Dan Rizzo on for Laurence. Just one quick one. If we think about the $0.10 FX headwind in Q3 and a $0.30 for 2022, what are the assumptions for where the euro and the pound are going to be trading over the next six months or so or next five months or so?

That's a great question. Dan, let me pass it to Scott, our CFO, who has more details on that.

Yes. Thanks for the question, Dan. Yes, as you might expect, we're expecting continued rate hikes through the end of the year, probably in the range of 8. And so as you see that FX, it's ramped up through the second quarter, and we're expected to double basically in the second half relative to the first half, so about the $0.30, as you said.

The next question coming from the line of Andy Wittman with Baird.

Scott, I was hoping to keep you going here, I guess and talk about free cash flow. Year-to-date, the free cash flow of the business is, I guess, I'm calculating just under $200 million, which I think is probably a little bit behind pace. It looks like inventory and accounts receivable has consumed a decent amount of capital. And I suppose given the revenue line, that's somewhat explainable. But could you just talk about your forecast for the year? What we should be thinking about what free cash flow generation could potentially look like? And if there's anything else going on in some of these key working capital accounts that we should know about besides effects from the top line?

Thank you for your question, Andy. You're correct that the free cash flow for the first half of the year is in line with our expectations. As we see increases in sales, there are also investments in working capital and capital expenditures, with about half of our CapEx being related to customer equipment. Therefore, as we experience new business growth, we will invest in CapEx, but we anticipate that it will remain consistent, around 5% to 6% of sales, as Christophe mentioned. Looking ahead for the full year, we continue to expect our free cash flow conversion to be in the mid-90% range, consistent with historical figures.

Our next question is from the line of Eric Petrie with Citi.

It's my understanding to get the Ecolab Science Certified deal, you have to buy the majority of products from Ecolab. How does that compare to your existing customer base in terms of supplier diversity?

I want to make sure I get your question right. When you say supplier diversity in terms of ethnical minorities, is it what you're talking about?

Yes. How much of your existing customer base buys from you versus others?

Okay. Well, in terms of customers, this is a good question. I don't have the exact answer for that. So we can work on that and come back, obviously, to you. We are extremely driven, obviously, so by both diversity inside our company and outside our company. So this is true for our customers, and we have good progress there, but I want to make sure we get the right facts, and Andy is going to come back to you. And when I think about supplier diversity for the company, we've delivered on our commitments. We've improved dramatically as well. So our purchases from minorities as well and diverse suppliers in the country in the U.S. as well, we’re perfectly on track versus what we had expected so far.

Okay. For my follow-up, how does your volume mix fare by month in the quarter? And directionally, how did it trend in July with the surcharge in place?

We usually don't give that granularity. So within the quarter, it's also not a straight line. So within the quarter as well, we have some seasonality as well that's coming as well into play. But we usually don't have big spikes within a quarter as well. So what we've communicated for the quarter is a good proxy in what we've seen in the second quarter. And the third quarter pricing is going to be an even bigger share versus volume which is not surprising since pricing is going up. Total organic growth is going to remain strong, which means that volume is going to remain stable/down in the meantime going forward.

We reached the end of our question-and-answer session. I'll hand the floor to Mr. Hedberg for further remarks.

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

Ladies and gentlemen, thank you for your participation. This concludes today's teleconference. You may disconnect your lines at this time. Thank you.