Earnings Call Transcript - ECL Q3 2020

Operator, Operator

Greetings, and welcome to Ecolab Third Quarter 2020 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mike Monahan. Thank you, Mr. Monahan, you may now begin.

Mike Monahan, Host

Thank you. Hello, everyone, and welcome to Ecolab’s third quarter conference call. With me today is Doug Baker, Ecolab’s Chairman and CEO; Christophe Beck, our President and Chief Operating Officer; and Dan Schmechel, our Chief Financial Officer. A discussion of our results, along with our earnings release and the slides referencing the quarter’s results and our outlook are available on Ecolab’s website at ecolab.com/investor. Please take a moment to read the cautionary statements in these materials which states that this teleconference and the associated supplemental materials include estimates of future performance. These are forward-looking statements, and actual results could differ materially from those projected. Factors that could cause actual results to differ are described under the Risk Factors section in our September 25, 2020 Form 8-K and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release. Starting with a brief overview. Third quarter results showed significant improvement from the second quarter, while still reflecting the divergent impacts from COVID-19 on the business segments. Fixed currency sales and earnings per share declines narrowed as we leveraged recovering customer end-markets with new business wins, increased customer penetration and cost efficiency actions to show the sequentially better results. Sales and income for our Healthcare and Life Sciences segment were strong as it continued to benefit from good underlying trends, strong cleaning and sanitizing demand and several large one-time sanitizer orders. Our Industrial segment saw a modest sales decline as end market activity returns toward more normal levels, while income growth continued to be strong due to pricing and lower costs. Institutional division results also improved from the second quarter as consumer activity within restaurants, hotels and entertainment facilities continued to recover, though foot traffic at them continues to run below last year due to COVID-related restrictions that yielded the lower Institutional results. We expect our improvement to continue in the fourth quarter, though likely at a slower rate as the second COVID-19 wave impacts reopenings. We remain confident we will emerge from 2020 with stronger competitive advantages and a more robust product offering. We continue to invest in the key drivers for our business. Our accelerated investments in hand care and sanitizer capacity are paying off, and our continued digital investments and accelerated field technology deployment are enabling us to provide excellent customer support, even where we cannot be there in person, while also enabling better value delivery and further efficiency in our cost to serve. We remain firmly focused on maximizing our post-COVID position. While COVID-19 creates a near-term challenge, it also creates long-term opportunities. In a world challenged by COVID, our food safety, clean water and healthy environments positioning has become even more important. We believe that our long-term growth opportunities remain robust, driven by our huge remaining market opportunity, our leading global market positions, our focus on providing our strong customer base with improved results by lowering their water, energy and other operating costs and our strong financial position with resilient free cash flow. We believe looking beyond the near-term uncertainty and focusing on these sustainable long-term business drivers will yield superior long-term performance for Ecolab and our investors. And now, here’s Doug Baker with some comments.

Doug Baker, Chairman and CEO

Thanks, Mike, and good day everybody. So our sales and earnings showed significant improvement in Q3 versus the lows we saw in Q2, which was expected. This is led principally by our Institutional division as its markets reopened, albeit partially. Our Healthcare Life Science businesses continued to accelerate with our third quarter sales up 29% and our Industrial businesses performed solidly as well with negative 3% sales but 18% OI growth. Importantly, we expect the overall improvement to continue in Q4, though at a slower pace, as COVID second wave is expected to dampen re-openings. Even so, we have a number of initiatives underway as the opportunities and challenges presented by COVID are much clearer now. We have a heavy upfront investment in hand care and sanitizer production, which is now coming online and starting to pay off. Our launch of new antimicrobial with best-in-class 30-second COVID-19 kill claims are well timed, it’s just going out now. Our continued investments in digital and our accelerated rollout of our newest shield technology is paving the way for further efficiencies in our cost to serve, which we’re capitalizing on now through targeted cost savings programs. Finally, our new business efforts continue to drive really good results, particularly in Institutional. Our ability to dramatically outperform our competition in terms of customer care during the COVID period is being rewarded with new business across the board. And our new Ecolab Science Certified Program is helping drive improved penetration in existing customers. You’ll recall, our objective for this year was to maximize our position for post-COVID success, and we are well on our way to do that. As a result, we feel we’ll be in very good position leaving the year. As we look forward, we expect COVID to run into 2021 fairly deeply, meaning through several quarters, but we also expect our business to continue and strengthen as our capacity, innovation, new market entries, Ecolab Science Certified and digital efforts put us in a great position to manage and grow our business. So, I feel really good about the steps our team has taken, how they’ve managed through this period and most importantly, how we position for success in 2021. Thank you.

Mike Monahan, Host

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

Operator, Operator

Thank you. We’ll now be conducting a question-and-answer session. And our first question is from Tim Mulrooney with William Blair.

Tim Mulrooney, Analyst

Hi, Doug. I know there’s a lot of uncertainty right now and a lot of moving parts between your different segments. But, I think, a key question for me, and what’s on a lot of investors minds this morning is, based on what you know today, when do you expect to get back to 2019 EPS or better?

Doug Baker, Chairman and CEO

Thank you, Tim. We’re not providing a specific forecast, but I can say this: even with the second wave of COVID, we have a clear understanding of its trajectory and are closely monitoring the situation. The recent reports concerning Europe and the U.S. are not new to us, as we’ve factored these developments into our business strategy while discussing further improvements in Q4 and our outlook for 2021. It’s possible that the situation could be worse or better than we expect, but I don’t think we are underestimating COVID. That said, we are positioned to surpass 2019 EPS in 2021. The key question is how much. We have several factors that bolster our confidence. We believe the markets will perform better on average in 2021 than in 2020, primarily because we don't anticipate a repeat of the global shutdown during March and April. This is likely to drive significant improvements in market performance. We have largely completed our inventory reduction, and the machine rent relief will not be repeated, along with other one-off actions we intentionally took in Q2. We are aware that we have gained market share, we have strong innovations, and we’ve increased our production capacity in hand care to meet demand. Finally, we are making efforts to lower our costs. Therefore, we feel well-positioned and have multiple strategies available for next year. I expect that we will certainly exceed 2019 EPS in 2021.

Tim Mulrooney, Analyst

Okay. That’s really helpful. I appreciate your thoughts there. I’d also like to ask about your new business wins and how that trended through the quarter relative to your expectations. Are these wins coming from developing growth opportunities, or is it more just from recovering end markets? I know you’ve got a lot going on with new sanitizers and Science Certified for example. So, I was curious how that’s all affecting the cadence of your new wins?

Doug Baker, Chairman and CEO

Yes. I’ll ask Christophe to go address this. But, we’ve been, I would say, very surprised at the strength we were worried early in COVID, with the fact that we couldn’t make in-person calls in the same manner that we did prior, impact our ability to get customers, yes, and that’s turned out to be a false worry. We’ve actually performed very well throughout this whole period. And I’ll give Christophe an opportunity to provide some insight.

Christophe Beck, President and COO

Thank you, Doug, and Tim, good morning or good afternoon. So, yes, new business has been going very well this year. When we think of year-over-year growth of new business that we track, so on a monthly basis, it’s basically growing at the same pace as it used to be, as well as pre-COVID, which is very encouraging. Doug is right as well. So, installing that new business has become a bigger challenge, which means that our full book of business ultimately will help us as well down the road. But, we’ve leveraged as well digital technologies. So, to do that in unbelievable ways where we could install new customers all remotely. We’ve learned as well. And those are capabilities that we can use as well tomorrow. And your question on the main drivers, I’d like to come back as well, to what we discussed during the previous calls, where many customers are coming to us because they’re looking for our expertise from a science perspective as well, how to deal with COVID, how to make sure that their guests or customers can be protected as well. That’s been a huge driver for many new customers to come to us. It’s also innovation. Doug mentioned our new sanitizing programs that we have that kill COVID-19 in 30 seconds or less. Those are world records out there. And that’s coming out of years of innovation as well. And last but not least, in more difficult economic times, our customers like our proposition of driving the total cost of operations down, which drives more business as well. So, net-net, new business generation is kind of steady even compared to what we had pre-COVID.

Doug Baker, Chairman and CEO

And I’ll just add, because Christophe said he’ll be humble today, from an operating standpoint, our businesses have done a great job performing in a tough environment and honestly have dramatically outperformed competition in our ability to meet our customer needs when it’s required in unit we get there. We’ve worked to leverage remote digital capabilities. And this has really been led by Christophe and all of our teams out in the field. And that has made a big difference here as well.

Operator, Operator

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

Manav Patnaik, Analyst

Thank you. Good afternoon. My first question is just around this increased focus on sanitization that clearly you guys are benefiting from. Maybe a two-parter. The first one is, you talked about you to now do more capacity in hand care. But, I was just curious if there was any updates on any other areas or maybe you still are restrained in terms of how much you can produce? And, I think for the first time ever I saw an Ecolab ad on TV for certified science. I guess, is that trying to target a little bit more branding versus the Cloroxes and Lysols of the world?

Doug Baker, Chairman and CEO

Yes. I’ll touch on the capacity question. Our capacity challenges really have been around hand care in particular, to a lesser extent to some surface sanitizers. It’s all driven by demand. Meaning, our hand sanitizer business is up 3x. Now, we’ve had to do a lot of work to be able to increase capacity, 3x. And now, we are expanding that beyond that, because demand is greater than that. But, these aren’t easy ramp-ups as you go through this. Right? This is GMP, you’ve got to make this properly. We don’t take shortcuts. We’re not the guys using bad ingredients, people can count on us. And so, we’re going to do this the right way, so customers continue to count on us going forward. But, the operations team has done really a terrific job working with the team to move these volumes up. And we have a lot of capacity now just coming online, because it takes months, or as equipment we found very creative ways to do this. Regarding the TV, Ecolab Science Certified, let me give that to Christophe.

Christophe Beck, President and COO

Thank you, Doug. And, Hi Manav. Good to hear you. Ecolab Science Certified, so, it’s something kind of new for us. So, we’re learning as well as we go. It was really meant to support our customers to provide reassurance for their consumers, their guests, for the most part, so in hotels and in restaurants. And it’s been really driven by the fact that we knew that guests were fearful about the risk of infection. We all know that. We knew as well at the same time that hospital-grade disinfectants were driving them to 2 to 1 times versus the retail brands that you mentioned before. So, that was a plus clearly, as well for us. And the third thing was really that we knew we heard from guests that they wanted to see clean, not just to have people telling them that it’s safe out there. All that brought together this fear of being infected, the fact that you like hospital-grade disinfectants, and the fact that you want to see that it is clean and safe, led us to this concept of Ecolab Science Certified that has been extremely well welcomed by our customers. Their customers seem to be liking it a lot as well. So, great reaction from customers. We’re really working now in the rollout of all those thousands of sites around the country. And from a media perspective, it’s just after a few weeks, so hard to tell. But early indications are way above average than what we had expected.

Manav Patnaik, Analyst

Okay, I understand. It was nice to hear the comments on 2021 EPS. Regarding fourth-quarter trends, it seems like the fourth quarter won’t be as severe as the June quarter, even if there is a resurgence of cases. It might fall somewhere between the June quarter and the September quarter that you just reported, with some partial lockdowns and impacts. Would you agree with that assessment?

Doug Baker, Chairman and CEO

Yes. I believe that entering Q4, we are experiencing a very different market consumption rate compared to when we entered Q3. As a result, there is the potential for some decline this quarter. We anticipated the second wave of COVID-19 and the implications it may bring. This has influenced our outlook. While the situation could become more challenging than we expect, we anticipate that Q4 will outperform Q3 in terms of revenue, income, and earnings per share compared to both the previous quarter and last year. We are approaching this situation with caution, understanding that it's a volatile environment. We are prepared to adapt as necessary and will make prudent decisions. Overall, I believe the business is in strong condition, and we will manage it wisely. I will not alter our investments in Q4, as they are crucial for our optimistic outlook for 2021 and beyond.

Operator, Operator

Our next question is from the line of John Roberts with UBS.

John Roberts, Analyst

Thank you. Your institutional organic sales were down 28% year-over-year. What’s your estimate of what the market was down, maybe to give us some perspective on the share gain?

Doug Baker, Chairman and CEO

Yes. It's not as simple as just doing the math, because if the market drops by 50%, we won't necessarily drop by the same amount. There is a base level of consumption in these units when they are operational. The figures we shared indicate that over 90% of restaurants in the U.S. were open by the end of the third quarter, operating at approximately 55% capacity. In addition, they have been doing a lot of off-premise business; however, off-premise doesn't typically generate much warewashing demand, as you might expect if you've utilized off-premise services. I would say our volumes are certainly healthier than the overall volumes of restaurants. We believe we are gaining market share because we carefully monitor what we gain and what we lose, and our losses have been minimal. Furthermore, we've successfully secured a significant amount of new business during this period.

John Roberts, Analyst

Then water downstream sales were down 11%, petrochem was up, so refining was down more than 11%. They’re not that surprising or not, but I thought the utilities, the steam system and the cooling tower were relatively insensitive to the refinery operating rate, or is that not the case?

Doug Baker, Chairman and CEO

I’ll give it to Christophe. Our water businesses improved. You’re talking downstream and you’re right. Downstream was worse in Q3 than Q2. Christophe, do you want to…?

Christophe Beck, President and COO

That’s right. Yes. Overall picture, so Industrial is in a very solid shape, as you see, so up modestly and the OI is up double-digit. As you’ve noticed, driven by a few great businesses, obviously like water being one of them, food and beverage really good, water improving very nicely. On downstream, you underlined petrochem, which is positive, this is really true. Otherwise, for the fuel refining business, we’re kind of in line with the consumption, which was down 12%, roughly, in the quarter. But, when the oil price is low, refiners have a tendency to go for light crude, which means that they need much less of our additives as well, which are usually used for harder to treat products. So generally, we like the petrochemical, which is where we focus most of our attention, especially going forward.

Operator, Operator

Our next question comes from David Begleiter with Deutsche Bank.

David Begleiter, Analyst

Thank you. Doug, you guys increased your savings this quarter to $275 million, from I think $270 million. Where are those additional savings coming from? And if COVID impacts go well into ‘21, are you looking at additional temporary or internal costs levers to pull to offset these headwinds?

Doug Baker, Chairman and CEO

Yes. I’ll have Dan answer specific questions around numbers. But, yes, I would say a couple of things. What we wanted to do is allow time so that we can see more clearly where we are going to be hit, say for several quarters at least or even a couple of years, like we talked about lodging recovery and some other things. And we are starting to adjust our costs in businesses that are going to have more lingering effects. You might think also, we are investing in some businesses like Healthcare and Life Sciences, where we expect the lingering impacts to be positive. And so, we have increased a 2020, which was the program that we had underway, which is really a place where it supports early moves there. They were not a big impact at all in Q3, will start impacting Q4 somewhat, but the major impacts will be in Q1 and Q2 of next year. And, Dan, if you want to add some detail?

Dan Schmechel, CFO

Yes. Thanks. So, just as you’ve indicated, rightly, we’ve announced that we’ve taken up the full year target from 270 to 335. And of this incremental 65, as Doug has indicated, that anticipates that the big bulk of that, say, maybe $50 million will fall into 2021, with a little bit recognized in 2020, not much, frankly, given the fact that we’re, you can imagine, starting where we’re starting now, near the end of October, and a little bit of cleanup in 2022. In terms of what drives it, I mean, I would go back to sort of how we’re thinking about 2020, or this cost savings initiative generally, which is some of this is reorganization. A lot of it frankly is driven by getting back benefit from the significant investments that we’ve made in institutional. And as Doug has indicated, we’re really sitting here in the era of COVID, taking a look at our deployment principally and where we might see continuing benefit. And so, of the 50, it’s pretty evenly spread frankly across the Industrial business, opportunities and supply chain too where we can true-up and have an opportunity to think of improving efficiency of some of the lines and some also in the institutional business, not surprisingly.

David Begleiter, Analyst

And Doug, just looking longer term, given the impact of COVID on Institutional, is the Institutional a fast growing business post-COVID than it was pre-COVID?

Doug Baker, Chairman and CEO

Yes. Institutional was certainly at the center of COVID's impact, and there will be some lingering effects, but they won't last indefinitely. Many lodging forecasts suggest that business travel will decline for a few years before it begins to recover, but this recovery is expected to happen relatively quickly. While I believe the lodging sector will take a couple of years to bounce back, restaurants are likely to recover much faster. Historically, even when restaurants close, there are always individuals eager to open new establishments. This trend leads to numerous opportunities with capital-light investments after recessions. There are vacant spaces in strip malls that are actively seeking new tenants, and this pattern continues. So far, we've been surprised by the number of restaurants that have remained in business during this time. We anticipate more closures as winter approaches, but it may still be below our internal forecasts from last March and April. Ultimately, we are very confident in the long-term potential of the Institutional business. We expect to see earnings growth before we achieve record sales growth due to the proactive measures we have taken. Many efficiency and technology initiatives we had planned pre-COVID are being implemented more rapidly now, enhancing our operational capabilities and making our teams more efficient and effective. We are also adjusting our field service team to align with anticipated service demands and operational efficiencies. Additionally, we are increasing our sales efforts because we want to capture the new business that will arise as the economy rebounds. Other forecasts indicate that mid-sized chains and similar businesses will significantly increase their number of units in 2021 to take advantage of these changes. Our goal is to be well-positioned to secure this business. We are willing to accept some SG&A risks in this context, as we believe they are prudent investments that will support a quicker recovery. If necessary, we can easily modify our approach.

Operator, Operator

The next question is from the line of Gary Bisbee with Bank of America.

Gary Bisbee, Analyst

I guess, if I could go back to the cost program for a second, it’s good to hear about the incremental and where that’s coming from and the timing. But, can you just give us an update on where you are versus the initial plan? As I recall, it was a significant number and growing number from ‘19 to ‘20 and then into ‘21. Are you on pace, did you pull them forward given the challenges of this year, or is there still an expectation that there’s a significant step up from the original plan next year, before this $50 million incremental that you’re adding here? Thank you.

Dan Schmechel, CFO

This is Dan again. I'll walk through the sequence. We announced the plan, which was initially 200 and increased it to 325, so we accelerated it. Of that 325, 55 million was specifically aimed at the upstream business. The cost savings and all expenses associated were related to the ChampionX business, which led us to the 270 million total. We described this 270 million as 200 million in run rate savings for Ecolab, offsetting 70 million in stranded costs linked to the separation of the ChampionX business. That's the background on the 270 million. If we focus on the 270 million, our capture of that opportunity has been almost exactly on track with what we previously stated. Now, we are indicating that we'll increase it by 65, largely benefiting and falling into 2021.

Gary Bisbee, Analyst

I understand the breakdown you shared a few years ago. Part of that was lost, but the initial targets were $80 million in 2019, $105 million in 2020, and $140 million in 2021. Assuming much of what was lost occurred in 2021, there remains a significant increase from the original plan. Are you also planning to add to that?

Dan Schmechel, CFO

I would say, yes. Okay. From the 200 to the 270, that was the step up. Really though I would think about that as an offset to the ChampionX stranded costs. What we disclosed as incrementally benefiting 2020 originally was $110 million. And it will be essentially that number with a little bit of increase related to the $65 million increase. So, I view this as being once we expanded the plan for the first time, if you net down to the 270, which is ex-ChampionX piece, we have been pretty much in line with the targets year by year as we’ve communicated.

Doug Baker, Chairman and CEO

I’ll add this. Early on, when asked if we would make cost adjustments, we said we were in a fog of war and didn’t know what actions to take. We needed clarity to understand where the opportunities and challenges lie, what would last, and what would disappear quickly. Now, we have a much better understanding of what needs to be done moving forward. We feel more confident about taking steps that won’t cause unintended harm. The team is in a great place, and everyone is on the same page. As we add some businesses and reduce others, we’re also creating opportunities for our team in different areas than we have in the past. These are the moves we’re making. In Institutional, we are implementing steps related to field service costs, especially considering the number of units and the efficiencies gained from our technology and digital investments. We now have a clearer picture of the situation, and we are proceeding with those actions. I anticipate that we will continue taking more steps as we gain clarity on the financials and what they mean for 2021.

Operator, Operator

Thank you. Our next question is from the line of Ryan Connors with Boenning & Scattergood.

Ryan Connors, Analyst

I wanted to ask a question about what you mentioned regarding the fog of war, Doug. It seems that the larger chains are gaining market share and performing better than some smaller mom-and-pop restaurants, which appears to be a trend across various industries. This seems to benefit a company like Ecolab, which likely has many of those large national accounts. Can you discuss this dynamic and whether you see it as significant? Additionally, how might it impact your business if this trend continues over the next few years?

Doug Baker, Chairman and CEO

Yes, I believe this situation can only benefit us. It’s uncertain how it will unfold regarding their ability to continue gaining market share compared to smaller competitors. We observe the same trend and I anticipate they will increase their share in the coming periods, especially during the recovery phase. They are well-positioned to aggressively add units and could do so at a faster rate than some smaller and mid-sized players. So, while it’s challenging for us to determine the exact implications for our business, making a case for it being negative seems unlikely. Overall, it's definitely a positive development.

Ryan Connors, Analyst

Understood. My other question is about the investments you mentioned in capacity for hand care and sanitizers, given the threefold increase in demand. Clearly, you're not alone in making these investments. If things return to normal after the vaccine, even if it's a year or two down the line, how do you protect the company and the industry from overexpanding capacity? We want to avoid entering a negative pricing cycle for those products once everything stabilizes.

Doug Baker, Chairman and CEO

Yes. I would say there are two things to consider. First, we have an expectation for the hand care market. In the near term, we think that the combined market, which includes hand soap as a much larger segment than hand sanitizer, could triple and then stabilize at double the pre-COVID levels. There is certainly a COVID-related surge, but post-COVID, we anticipate a run rate that is significantly higher than what we saw before, due to increased awareness around hand hygiene, which is beneficial in preventing various viruses beyond just COVID-19. Regarding consumer behavior, yes, people are going out, and we are not the only company expanding capacity. However, prior to this period, we were heavily involved in co-packing. Now, we have created additional capacity, and if it turns out that our strategy was unwise, we have the ability to bring some production in-house if necessary. Therefore, we have several options moving forward, and we aimed to increase our strategic choices. As for a price war, I don't believe that will be effective in this space. Even in hand care, there are maintenance issues, such as dispensers falling off walls. We have positioned ourselves at a premium price point. In almost all of our markets, we are either the global leader or number two in hand care, and we can maintain this premium because service remains important in this field. So, I don't foresee a pricing conversation being the central issue we face in two years.

Operator, Operator

Our next question comes from the line of Chris Parkinson of Credit Suisse.

Chris Parkinson, Analyst

So, you hit on this a little bit, but I just want to get down a little bit further. But just, despite a lot of noise on the Institutional revenues right now, how should we be thinking about the current market share gain environment? It still seems despite a lot of noise, like you’re outperforming a lot of your peers. And then also, just when we think about the growth and innovation investments, how do those ultimately factor into your expectations for your framework for ‘21 and ‘22? Just any additional color would be greatly appreciated. Thank you.

Doug Baker, Chairman and CEO

I’ll summarize what we've already discussed in a different way. Firstly, we are confident that the business will exceed 2019 levels next year in terms of earnings. We don't expect the Institutional sector to fully recover just yet, as we've mentioned before, but we believe it will eventually achieve record sales and earnings. We haven't yet seen the peak of the Institutional market, which we anticipate will recover, with foodservice leading the way, followed by lodging. The positive aspect is that foodservice is much larger, and we are observing favorable trends in this segment, including market share growth that will help us outpace the market as we recover. Therefore, looking beyond the peak of COVID, there are numerous positive earning opportunities within our business. The Institutional sector is set to recover more quickly than some competitors, aided by technology that reduces our costs on a sustainable basis. We feel that the actions we've taken in the past six months will have long-lasting benefits. Our goal was to implement changes that would provide advantages for years rather than just weeks. I am proud of the team for managing through this challenging period, even when reporting results is tough. However, I believe our strategic steps will prove to be effective in the long run, and we are not far from returning to the level of performance that everyone expects from us.

Chris Parkinson, Analyst

Great. That’s very helpful. And just very quickly on the Industrial front. There’s been a fairly material divergence between end markets. Just versus your initial expectations, let’s say, coming out of the second quarter, could you just assess your performance in F&B, water and downstream? And then, similar to my questions on Institutional, how would you also view your own relative end-market performance on a go-forward basis? Thank you.

Doug Baker, Chairman and CEO

Yes, I’ll let Christophe handle that.

Christophe Beck, President and COO

Hey Chris. Hi. Maybe starting with your Industrial question, and then I’ll cover Institutional. So, as mentioned, overall, Industrial is in a very solid shape, saw slightly off at sales, but income up 18%. And that’s the advantage we have that we have so many different end markets as well that we serve, but all driven by these needs of water purity and hygiene, food safety as well, which are obviously some big trends right now. So, when we think in terms of the water businesses, the way we call them, so this one has improved very nicely. So from a minus 5 to a minus 2 in Q3, and we expect that to improve as well in the quarters to come. F&B, which has been a very strong franchise, pre-COVID, has remained fairly strong positive for sure during COVID as well. Q3 being a little bit of an unusual quarter for those two reasons. One is the total shutdown of brewing in Latin America. You’re not allowed to produce beer basically over there, and we have business over there, extremely strong, extremely profitable as well. But, that’s going to come back. People are not going to stop drinking beer obviously. And dairy as well in the U.S., which is related to schools as such, but this is very temporary. New business is really strong in F&B, good momentum, great relationship with customers. There’s no one even close to us who can really bring the water and hygiene, as mentioned before. So, a very strong position on Industrial. And in Institutional, a lot has been said, obviously before, firmly believe that people are going to go back ultimately to what we call out-of-home. As such, people are not going to start cooking from scratch in the long term. So, these trends are going to be positive. At the same time, people are going to look for more demonstrated safety in restaurants and in hotels. This is well to our advantage. They’re going to look as well for more expertise. This is Ecolab’s strength as well. They will want to have global standards that you have in every unit anywhere around the country or the world. Well, this is what we offer to customers. And last but not least, as well as such, well, it’s mostly driven by corporate accounts, as Ryan was asking before, two-thirds of our business are large customers. Well, that’s where the growth is going to come from and that’s where we have most of our focus. So, Institution long-term is going to be a positive story as well. So, I hope you have it, Chris.

Operator, Operator

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

John McNulty, Analyst

So, looking at the other segment, it seems like it’s mostly going to be driven by pest. The profitability surged pretty dramatically compared to kind of the revenues where both were up, but not nearly to this degree. Was there a bit of a catch up in there, or I guess, can you help to explain kind of the incremental margins from 2Q to 3Q in that business and help us to think about how to think about that business going forward?

Doug Baker, Chairman and CEO

I would say that within our pest business, it recovered even stronger than we anticipated during the third quarter. It was down 2% year-on-year in that quarter, but they made significant progress afterwards. They have implemented several effective strategies and are set to achieve growth, even in the fourth quarter. Among those businesses, it is arguably the most significant in terms of profitability, and it represents the most encouraging development from the other segment.

John McNulty, Analyst

And then, maybe just a housekeeping question, just because admittedly, I’ve gotten probably a dozen emails on this since you’ve been talking. But, so when you talk about EPS growth in 2021 versus 2019, I assume that’s on the 5.12 base, the kind of pro forma, the oilfield services split base. Is that right? Am I thinking about that right?

Doug Baker, Chairman and CEO

Yes. That would be the 19 number we would compare to.

Operator, Operator

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

Vincent Andrews, Analyst

Just thinking about trying to bridge institutional a bit more, and I’m looking at that slide four you provided in the supplemental data, and in particular, just trying to think about the multiplier effect of a product use in COVID. And, what percentage of operating rates in full-service restaurants do we need to get back to in order to kind of make you whole with 2019? Because presumably, you don’t have to get back to 100% or 90% or something like that just given more product being used and likewise for lodging. So, any thoughts there would be helpful.

Doug Baker, Chairman and CEO

We don’t have a specific number to provide, but it would be less than 100. The reality is there will be a natural recovery limit until we have a vaccine. We believe vaccines will be approved soon, starting with frontline workers, then moving to those at highest risk, and eventually to broader populations. A significant portion of the population will need to be vaccinated, and that will take several quarters. I think we will see improvements in institutional metrics, both on the top and bottom lines, as time progresses. I don’t anticipate surpassing 90% until there are significant advancements in addressing COVID. We have expanded into other markets, but a fundamental fear prevents people from engaging in these environments, even with low COVID rates. While there is definitely potential for improvement from the current 55% level, I don’t believe we will reach 80% until we see substantial progress against COVID. That said, we don’t expect the institutional segment to fully recover in 2021, but we do expect to exceed 2019 earnings per share in 2021.

Vincent Andrews, Analyst

Thanks. And just as a follow-up. Just thinking about the SG&A line into next year, you’re down about $165 million year-to-date. And I’m just trying to reconcile, you have some discretionary cost savings that maybe some of that starts to come back later next year versus the cost program that you’re running to take things out. So especially, as we think about SG&A trending into the fourth quarter and then how much do you think it can actually stay down next year?

Doug Baker, Chairman and CEO

Yes, I believe that discretionary savings, particularly in travel and entertainment, will remain strong next year. Our approach will be to react to the real situation with COVID, rather than our assumptions. We anticipate that COVID will persist for much of 2021. If it resolves more quickly, we will benefit; if it doesn't, we will not. Our travel patterns will not shift significantly until COVID restrictions are lifted. There seems to be a natural benefit aligned with sales pressures. Therefore, for the majority of next year, we expect travel and entertainment expenses to remain low. We won't return to 100% of 2019 rates for an extended period, as we've learned that many trips in the past were unnecessary. We will increasingly rely on digital technology for tasks we previously completed through travel. So, while travel won't disappear entirely, it also won't rebound to previous levels.

Operator, Operator

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

Scott Schneeberger, Analyst

Thanks. Good afternoon. With regard to Healthcare and in Life Sciences, the growth rate certainly is impressive. How sustainable do you think that is? And then, the margin in the segment was very strong. Just curious, how much was pricing and other factors for the margin expansion, and maybe some discussion of sustainability of that?

Doug Baker, Chairman and CEO

I’ll give it to Christophe?

Christophe Beck, President and COO

Thank you, Doug. So, it’s been another great quarter for this group. So, 29% top-line growth, 82% income, and it’s been driven by both, big businesses in there. So, Healthcare and Life Science, both were in the double-digit top-line growth and income growth as well, driven from one part, because of COVID, on the other hand, as well, a lot of government business as well, that we could conclude as well in Germany, in the UK, in Australia because of the expertise that we could provide, as well as to those agencies with whom we have great relationships. That’s going to partly stay in the future, but it’s going to ease as well over time, whenever coverage is going to ease as well. So, that’s back to Doug’s comment of the vaccine and how many quarters we’ll have to wait for that. Bottom line, when we think in terms of underlying growth, we’ve said, so for Healthcare that if you exclude those big one-timers, it’s roughly 12% top-line, but that’s still driven by the COVID wave as well. So, when that eases as well, we believe that we will be in Healthcare, kind of 6% to 8% underlying growth, which is really where we always want it to be. So, ultimately, that’s a business that has truly benefited from what’s happening here. And on Life Science, it’s a business that’s totally on fire. It’s really an industry that loves what we do. So, then, new business is extremely strong. Innovation is very strong as well, think Bioquell as well, so has grown 100% during the quarter as well in Q3. Well, those are offerings that are going to stay as well going forward. So, it’s not going to stay at the same high level as what you’ve seen in Q3, but it’s going to be double-digit underlying, going forward, for sure.

Scott Schneeberger, Analyst

Thank you, Christophe. Doug, I have a follow-up question for you. I'm interested in the significant capacity you've built for hand sanitizing. What considerations did you take into account regarding the supply chain, especially if we face another shutdown situation, which we hope to avoid? Was this largely done domestically or near-shored? I'm curious about your thought process and the strategies you employed in developing that supply chain approach.

Doug Baker, Chairman and CEO

Yes. Our historic supply chain strategy is to make in the currencies we sell in. I.e., if you go to China, we have multiple manufacturing facilities. They’re really designed to meet China demand. And like 93% of our China volume is produced in China. So, that’s been the historic strategy. And it’s a strategy that governs us going forward. It was really designed because we didn’t want currency to become a strategic problem, i.e. producing in U.S. dollar gets strong and our competitiveness is weakened everywhere else. That was the initial reason for it. It obviously is also proven to be a good strategy in a tariff world, and a more restricted supply world. So, that strategy has been, let’s say, cemented, at this point time is a good idea. So, where we’re building? We’re building a lot of the capacity in the U.S. and in Europe, which are two largest markets where you’d expect but we also made capacity moves in China too.

Operator, Operator

Our next question comes from the line of Laurence Alexander with Jeffries.

Laurence Alexander, Analyst

I have two quick questions regarding the cost reduction measures you’re implementing. How will these changes impact operating leverage once conditions improve? Additionally, I have a longer-term question. I recall that most of our discussions about the Healthcare sector focused on antimicrobials. Can you elaborate on that?

Doug Baker, Chairman and CEO

Sorry. Laurence, the last couple of words got garbled. What was the last question about Healthcare antimicrobial?

Laurence Alexander, Analyst

Can you speak about your capabilities in antifungals, specifically the antimicrobials?

Doug Baker, Chairman and CEO

Yes. In Healthcare, spores represent the biggest challenge, particularly C. diff and others. We have significant advantages in that area. This is a sector where we demonstrate standout capabilities. The importance of our Healthcare capabilities extends beyond the healthcare market opportunity; what we learn here can also benefit our other businesses. Christophe mentioned the positioning we are using with Ecolab Science Certified, which involves hospital-grade disinfectants that appeal to consumers due to their effectiveness. The kill claims and kill times for these products are much superior compared to consumer products. For example, a consumer product may take 4 minutes to kill what we can eliminate in 30 seconds. The issue is that very few people are willing to wait 4 minutes for anything. This aspect is crucial to our operations. Regarding the leverage question, we don’t have a specific answer at this time. As we fully articulate our program, the leverage impact will become clear, but it will certainly improve leverage, which you likely already understand.

Operator, Operator

Thank you. Our next question comes from the line of Mike Harrison with Seaport Global.

Mike Harrison, Analyst

Doug, you mentioned this reduction in on-premise dining, a lot of your restaurant customers are shifting toward more takeout and delivery, some are coming up with these novel ideas like those kitchens or cleaning meal kits to help make ends meet or survive in this challenging time. What kind of changes are you making in your approach to help your customers navigate this trend toward less on-premise dining? And, how do we think about kind of the future of your business? What we used to think of is warewashing being kind of the anchor or the cornerstone of your institutional business. Is that going to be shifting towards hard surface cleaners, going forward?

Doug Baker, Chairman and CEO

I’d say two things. I mean, there are certainly new business categories in institutional that we are pushing and exploring that frankly we think will have staying power, no matter which way the industry goes. With that said, I would say, we think post-COVID the industry reverts back to principally on-premise for two reasons. It’s what diners want mostly; and two, the profit of takeout, given packaging and other is not great. If you’re in a pizza business, it’s hard not to make money on pizza, because the ingredient costs are so low, and all you got is a cardboard box. But when you’re getting into, let me just say, some of these fancier meals and the packaging costs and the rest, I have a number of friends who are actually in the restaurant business; it is not a perfect solution for them. They’re trying to keep the doors open, cash flow moving and everything else. But, their preference greatly would be to be serving these meals on-premise versus off. We have supported those kitchens. They’ve been longstanding in a number of ways; think about food trucks and the rest. They are going to have a place going forward. And it’s probably the way to run just a delivery business. But, there will be modifications in this industry as a consequence of COVID, but I don’t think it’s a revolution.

Mike Harrison, Analyst

And then, in terms of the food retail side, you mentioned expanding cleaning protocols and frequency. Can you give us a sense of how much that’s increasing sales right now? Like, is the typical grocery store customer for example using 10% or 20% more of your product or is it double how much they would typically be using?

Doug Baker, Chairman and CEO

I believe the situation is stabilizing with a double-digit increase in consumption. Additionally, we've observed that some retailers are gradually reducing the level of cleaning they initially implemented, though it's still higher compared to pre-COVID levels. For instance, where there used to be four people sanitizing every cart, now there might be just one person or they are using cart wipes and other alternatives, all contributing to consumption. We anticipated this trend. Consequently, we expect certain categories to benefit going forward. However, in the Institutional business, the primary volume challenge stems from a decline in warewashing, an area where we have invested significantly in innovation. This sector will recover, but in the meantime, we're facing a mix challenge in Institutional that won't improve until the demand for dishwashing services increases.

Operator, Operator

Thank you. Our next question is coming from the line of P.J. Juvekar with Citi. Please proceed with your question.

Eric Petrie, Analyst

Hey, Doug. Good morning. It’s Eric Petrie on for P.J. Can you talk a little bit more about your growth opportunity in these new fast kill cleaners? And how long does it take to reach peak sales in your view? And then, as these viruses mutate, can you talk about how effective the cleaner is over the long-term and whether or not you reformulate?

Doug Baker, Chairman and CEO

Yes. I’ll turn it to Christophe on this. They have quite a bit of staying power as you go through. And there’s different ways you kill organisms. And I would say, for instance, hand sanitizers, alcohol basically destroys a cell. So, it’s hard to develop immunity to a sphere if you think about it that way. Some do poison. And you can have immunity built over time to poisons, but not to everyone and it’s not a fast issue, i.e., we’re using quads that still have effectiveness that have been around for decades, right, in a number of instances. So, it’s not a short life in terms of our business careers. It’s a short life in terms of human history. So, I don’t know if you want to add in terms of, Christophe, how long it takes to get to peak sales, etc.

Christophe Beck, President and COO

The only thing I would offer is that we’re really watching every pathogen out there. So, the ones that we know well and how do they react against our products as well or how do our products are effective against those, the new ones as well, COVID being one of those that we didn’t know, obviously in the past and we learn from each other. The latest disinfectant that we talked about today with this extremely fast kill time was developed for the norovirus, for instance. So, we really look at all pathogens out there, try to understand the type of effectiveness, how is it still working, is there any reaction to it as well? And generally, so we develop our innovation in order to stay ahead of that. So, I believe that we are in a very unique place, especially compared to any competitor out there.

Eric Petrie, Analyst

Helpful. And then, just maybe talk, Christophe, on peak sales related to that question. And then, for my follow-up to Doug, as end markets recover, some managements have been talking about building out their M&A pipeline or returning to share repurchases. So, Ecolab’s net leverage has improved to the low 2s. Can you discuss both uses of cash? Thank you.

Christophe Beck, President and COO

Okay. So, I’ll take the first question and I’ll give the M&A part to Dan, just in a second. To your point, on the peak annual sales, we usually take five years, which is the best average that we have out there. Some products or sometimes shorter term, but most of them are longer than five years. So, that’s why it’s the metric that we use. On M&A, Dan?

Dan Schmechel, CFO

Yes. So, I’ll interpret it more as a cash priorities question. You also asked the question on share repurchase. So, let me just say this. We ended the quarter with a little north of $1 billion on the balance sheet in cash, which is by any historical standard, a very, very big number for us. So yes, that’s the premise for the question. Right? I will follow the thread of a lot of the Q&A today to just say that the world remains a very uncertain place. And I’m comfortable with the amount of cash that we have on the balance sheet. Partly this is a cash is king environment. And there’s a lot of who knows what’s to be seen. We are getting increasing confidence, as you’ve heard, from the tone of the call today too, about the shape of the world with many uncertainties yet to be known. I presume that as we go forward, it will present both challenges, right, maybe some unforeseen, but also opportunities. And so, I guess the shortest answer I can provide is that as our confidence continues to build, you’ll see us return to more traditional cash levels and cash priorities, including share repurchase and M&A activities.

Operator, Operator

The next question is from the line of Jeff Zekauskas with JPMorgan.

Jeff Zekauskas, Analyst

Revenues declined $250 million in Institutional business, and Institutional operating profits were down $200 million. Why is the decremental margin 80%? If a decremental margin were 50%, you would have earned double? What is it about the business where the incremental returns are so high?

Dan Schmechel, CFO

Are you talking about year-on-year on third quarter to third quarter?

Jeff Zekauskas, Analyst

Yes. Exactly right.

Dan Schmechel, CFO

Well, I would say a couple of things. They won’t be 80% over any long period of time, as you go through this. But, you get into quarters. Now, you’re getting to what happened last period, you get into bonuses, bonuses where you know are taken down and up in different quarters in different years for different reasons, and these going to have impact as you go forward. There are other investments or bad debt and some other things as you go through this period. But, our decremental margins either going down or going up over a period of time aren’t going to be in the 80% range. The gross profit of that business is right in the mid-60s, right, on the good day. So, a lot of that’s going to happen. We are starting to take decisions on fixed costs and other things. And so, what we will see is a recovery of those margins as we go forward.

Jeff Zekauskas, Analyst

Were raw materials down about 5% year-over-year in the quarter?

Dan Schmechel, CFO

Raw materials in total were not a material impact. If anything, they were negative in Institutional. A lot of that is stuff you’re seeing around heightened demand in hand care and some other areas, where you really just have shortage of supply, and Industrial, year-on-year minorly favorable.

Operator, Operator

At this time, we’ve reached the end of our question-and-answer session. And I’ll turn the floor back to Mr. Monahan for closing remarks.

Mike Monahan, Host

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

Operator, Operator

Thank you to those who joined us today. This concludes our conference call. You may disconnect your lines at this time. And we thank you for your participation.