Apr 27, 2010
Operator
Welcome to the Ecolab, Inc. first quarter 2010 earnings release conference call.
(Operator Instructions) Now I would like to turn the call over to Mr. Michael Monahan, Vice President, External Relations.
Michael Monahan
Hello everyone and welcome to Ecolab’s first quarter conference call. With me today is Doug Baker, Ecolab’s Chairman, President and CEO.
A copy of our earnings release and the slides referenced in this teleconference are available on Ecolab’s website at Ecolab.com/investor. Please take a moment to read the cautionary statement on Slide 2 stating this teleconference and the slides include estimates of future performance.
These are forward-looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described in the section of our most recent Form 10-K under item 1A, risk factors, in our first quarter earnings release and in Slide 1.
We also refer you to the supplemental diluted per share information that is also in the release. Starting with Slides 3 and 4, we delivered strong earnings results and sequentially stronger sales growth in the first quarter despite generally challenging market conditions as we aggressively drove new account gains, sales of new products and benefited from favorable delivered product costs and cost reductions to drive improved margins.
Looking ahead, we raised our forecasted EPS range for 2010 as we expect outperforming our gradually improving markets and deliver superior growth once again in 2010. Starting with some highlights from the quarter, reported first quarter earnings per share were up 67% to $0.40.
On an adjusted basis, excluding special gains and charges and discrete tax items from both years, first quarter 2010 earnings per share increased 24% to $0.41. The adjusted earnings per share growth was driven by better volume, new products, new account gains, pricing, favorable delivered product costs and cost savings which more than offset higher operating costs and continued investments in our business.
Looking ahead, our U.S. and European food service markets appear to be starting a slow recovery.
Lodging room demand has increased and is showing recovering trends worldwide. Food and Beverage and Health care are seeing steady growth trends, and we continue to see good growth across all market segments in our Asia Pacific and Latin America businesses.
We continue to be aggressive, focusing on top line growth as we emphasize our innovative products and service strength to help drive market share growth in our core businesses and deliver new account acquisition among our national, regional and independent prospects, and we are making significant investments in key growth businesses to drive future growth. We also remain focused on cost savings emphasizing productivity and efficiency improvements to help increase margins.
We expect to show another quarter of sequential sales growth improvement in the second quarter with adjusted EPS increasing 8% to 14% to the $0.54 to $0.57 range compared with an adjusted EPS of $0.50 in the second quarter in 2009. We raised our forecasted range for 2010.
We now look for a double digit EPS growth in 2010 with adjusted EPS in the range of $2.21 to $2.26 per share, representing an 11% to 14% gain over last year. In summary, we expect 2010 to reflect yet another strong performance for Ecolab as the aggressive sales efforts to gain new accounts and achieve better sales penetration along with improved efficiency and cost savings to again deliver attractive growth and shareholder returns.
Turning to the details show in Slide 5, Ecolab’s reported consolidated sales for the first quarter increased 6%. Looking at the components, volume and mix increased 1%, pricing was up 1%, and currency benefited sales by 4%.
Slide 6 includes sales growth by segment and division. Sales for U.S.
cleaning and sanitizing operations rose 2%. Institutional sales improved, rising 1%.
New account gains and new products benefited the first quarter sales. We continue to outperform soft consumption from food service and lodging in the first quarter.
While still in the early stages, we believe the markets and our customers have an improving tone to their business, and we continue to expect gradual improvement and demand through 2010. We remain focused on driving sales using innovative products and wear washing, laundry and housekeeping that provide superior performance while delivering water, energy and labor savings for customers.
We are also targeting independent accounts and regional chains with additional and redeployed sales people and programs. These actions have resulted in good new account gains and we are continuing our efforts to drive more sales and margin growth.
We expect these aggressive sales efforts, investments in our sales team, and new accounts to help us continue to outperform our markets in the second quarter and the year. Kay first quarter sales grew 13% led by strong growth from both QSR and food retail.
We enjoyed good demand from existing and new fast food chain accounts. The food retail business also showed continued good sales growth driven by new account wins.
New products and programs like the introduction of Scrub ‘N Go, the floor cleaner for QSR restaurants bolstered Kay’s results. We expect these initiatives along with continued good new account growth to help drive strong gains in Cave’s second quarter.
Textile Care Sales were up 1% as customer gains, new product launches and additional sales with existing customers offset continued weak industry conditions. Ecolab is focused on innovative products and services, operational savings and service excellence to bolter results.
With industry conditions remaining weak, we look for sales to remain flattish in the second quarter. As expected, Heath Care sales were impacted by the reduced concerning H1N1 and the associated decline in demand for H1N1 sanitizing products.
Sales were down 1% in the quarter. Excluding the H1N1 impact, and a small acquisition, sales would have increased 6%.
Continued growth in skin care products and equipment drapes led the results. During the quarter, we launched several new products including a new line of Central sterile solid products as well as a program for patient room cleaning.
Looking ahead, second quarter sales are expected to improve as H1N1 inventories stabilize. Food and beverage sales were flat.
Sales grew in the food and beverage markets as corporate account wins and new products offset soft results in dairy, agri and meat and poultry. In the second quarter of 2010, food and beverage will continue to focus on new account acquisition and new product sales.
However, the slow markets and softer pricing when compared to last year are expected to yield flat sales. Eco Care sales decreased 10%.
The division remains focused on new, more sustainable products and operational cost savings programs to gain efficiency and cost efficiency programs to gain new accounts. However, these efforts were more than offset by weak market demand.
We expect current growth efforts to benefit second quarter and look for improving trends in vehicle care. Sales for U.S.
other services decreased 2% in the first quarter. Test elimination sales were off 2% in the quarter as gains in fast food and food and beverage plant markets were offset by slow conditions in restaurants and lodging.
We continue to develop new products and program solutions to better serve customer needs in the current environment. For example, we recently introduced a new Bed Bug program that reduces room downtime for treatment cycles, and thereby helps to lower customer’s total costs.
We also recently introduced our first EPA exempt pesticide, which poses a minimum risk to humans and the environment, yet still provides an average kill time for common cockroaches of less than five minutes compared with eight hours for other liquid applications. Both have enjoyed a good start.
We are working on other programs to provide improved service, efficacy and efficiency. We continue to target specific growth markets like food and beverage processing to improve our service delivery and are working to build contract growth.
We expect these efforts to help offset the soft economy and yield improvement in the second quarter. GCS sales also showed signs of stabilizing as they decreased a modest 3% in the quarter.
Once again, profitability improved substantially over the last year and the fourth quarter. New account wins were offset in the first quarter by the impact of slow food service business conditions and by general market weakness, especially among independent accounts.
Despite the lower sales volume, GCS profitability was substantially better as we continue to see productivity and efficiency improvement throughout the business. The sales pipeline is improving and chain customer interest remains good.
We are using some of the improvement in profitability to invest in regional sales force additions to drive future growth and have seen account wins resulting from that investment. Looking into the second quarter, we expect sales to be flattish compared to the prior year with better profitability.
Longer term, further significant profit improvement for GCS will depend on improved volume gains as well as continued productivity and efficiency improvements. Measured in six currencies, international sales increased 2%.
Europe, Middle East and Africa sales declined 1% in the first quarter at fixed currency rates. Europe’s institutional sales were off slightly.
Food service appears to be stabilizing in most European countries, but we have not yet seen a return to growth. On the other hand, lodging demand has picked up.
Focused sales efforts targeting new business with regional and local customers and new products, helped drive new account gains in a soft economy. Food and beverage sales were flat, reflecting reduced beverage consumption and plant consolidation.
The business continues to focus on new customer growth, emphasizing cost savings benefits of our leading products like Dry X and Watercare. Textile Care sales declined reflecting reduces volumes from central laundries and lower equipment sales.
Europe’s health care sales increased modestly despite reduced demand for H1N1 product, as concerns about the potential pandemic abated. Europe’s sales were off slightly, however we continue to improve operations and drive profitability.
Europe’s business information systems platform work is nearly complete. At this point, we now have the critical mass and the tools with which we can begin to work job costs and complexity to drive faster sales growth and higher margins.
While we expect to realize sales growth and margin improvement from Europe as we exit 2010, we look for more significant improvement in the following years as the range of growth and profitability actions we will be taking begin to take effect. We expect new account focus and recovering business trends to result in sales improvement in Europe’s second quarter sales.
Asia Pacific sales grew 10% in fixed currency as recovery in the region accelerates. Institutional sales showed a good gain with growth strengthening as occupancy levels improve and economy’s recovery.
Food and beverage sales enjoyed strong growth. Both the beverage and brewing sectors continued to grow, benefiting from increased product penetration and account gains.
Looking ahead, Asia Pacific expects good sales growth in the second quarter reflecting recent account wins and better markets. The first quarter sales for Ecolab’s Canadian operations increased 8% over last year in fixed currencies.
Institutional showed a good increase as we leverage our strengthened distributor partnerships. Food and beverage and vehicle care recorded strong gains delivered by new account gains.
Health care sales growth slowed, reflecting the decline in H1N1 demand. We expect continued good growth in the second quarter for Canada.
Latin America reported a solid sales gain rising 6% in fixed currencies as all divisions in that region increased. Institutional growth was driven by new accounts, increased product penetration and continued success with global and regional accounts.
Food and beverage sales reflected good demand in the beverage and brewing markets as well as the benefits of new accounts. Pest elimination showed continued good growth.
Overall, we expect attractive growth trends to continue in Latin America with another solid gain in the second quarter. Turning to margin on the income statement, in Slide 7 of our presentation, first quarter gross margins continued their recovery, increasing 250 basis points to 50% compared with 47.5% last year.
The increase was driven by volume gains, pricing, improved delivered products costs and favorable comparisons against 2009 which included a restructuring charge. SG&A expenses were 39% of sales, 70 basis points above last year.
The increase in the SG&A ratio was due to continued investments in our business and systems, and other increases which more than offset cost savings actions and leverage from sales gains. Operating income for Ecolab’s U.S.
Cleaning and Sanitizing segment increased 11%. Margins expanded by 140 basis points.
The increase was driven by volume gains and favorable delivered product cost which more than offset cost increases. Operating income for U.S.
other services grew 11%. Margins expanded by 160 basis points over last year driven by pricing and cost savings actions.
International fixed currency operating income increased 46%. Volume gains and favorable delivered product cost more than offset additional pension and systems amortization costs as well as people investments in growth areas, especially in Asia Pacific and Latin America.
The Corporate segment and tax rate are discussed in the press release. We repurchased 3.3 million shares during the first quarter.
The business performance is that Ecolab reported diluted earnings per share was $0.40 compared with $0.24 reported a year ago. When adjusted for special gains and charges, and discrete tax items in both years, adjusted earnings increased 24% to $0.41 when compared with $0.33 earned a year ago.
Turning to Slide 8, Ecolab’s balance sheet and cash flow remains strong. Total debt to capital was 36% at March 31 compared with 43% reported a year ago.
Our net debt at March 31 was 33%. Looking ahead, we expect continued gradual improvements in our key end markets in 2010.
Against that backdrop, we are taking appropriate actions to drive both our top and bottom lines. As outlined in Slide 9, we will continue to drive new account and market share growth using our product and service strengths that combine to help customers reduce their costs and improve their efficiency.
We will continue to focus on investment in growth businesses like health care, global pest, China and Latin America as well as new products and acquisitions to accelerate the top line, and we will expand our sales and service force and invest in their field technology to make them more productive. We expect fixed currency sales to rise in the low to mid single digit range in 2010 and look for gross margins to show good improvement.
SG&A will reflect the investments we are making in our sales force and systems. Corporate expense should moderate slightly as we near completion of the systems implementation in Europe.
Interest expense is expected to be comparable to 2009 and the tax rate is forecast to be in the 30% to 31% range. We raised our forecast range and outlook for full year adjusted diluted earnings per share to increase 11% to 14% and be in the $2.21 to $2.26 range in 2010.
Looking at the second quarter 2010, we expect another quarter of sequential sales growth improvement and look for low single digit year on year fixed currency sales increase as new account gains more than offset continued challenging food service market conditions. We look for international sales to lead the growth at fixed currency rates as good growth from Canada, Latin America and Asia Pacific are offset by modest sales gains in Europe.
Gross margin should increase. Our growth investments in sales firepower technology will be reflected in a higher SG&A ratio versus last year.
SG&A will also compare against the second quarter last year when we aggressively cut costs and implement restructuring that significantly reduced that quarter’s SG&A expense. The press release includes line item forecasts of our second quarter P&L.
Net, we expect adjusted diluted earnings per share for the second quarter excluding special gains and charges and discrete tax items to increased 8% to 14% to the $0.54 to $0.57 range compared with adjusted earnings per share of $0.50 earned a year ago. In summary, as noted on Slide 10, we had an excellent first quarter and delivered above our forecast while still investing in our future.
We continue to look for a solid second quarter gain and expect to deliver double-digit EPS growth for the full year 2010, reflecting gradually improving markets and reduced downside risk. A final note, we will hold a tour of our booth for the professional investors at the National Restaurant Association Show in Chicago on May 24.
If you have an interest in attending, or any questions about it, please contact me or Nicole in my office. That concludes our formal remarks.
Operator, please begin the question and answer period.
Operator
(Operator Instructions) Your first question comes from Nathan Brochmann – William Blair.
Nathan Brochmann
I wanted to talk a little bit specifically in terms of the additional growth that you’re seeing in some of the other regions and Asia, Canada and Latin America. You talked about some of the individual segments there, but is there anything that you’re doing different in those regions to spur any growth or is it more on the macro side?
Douglas Baker
I would say the answer to that I think is a little of both. Certainly those markets have been performing better than U.S.
and Europe. At the same time, as we started talking last year, we have invested in additional corporate account selling capacity in each of those regions in both F&B and institutional, and I would also say that we are picking up share there too.
Nathan Brochmann
Along with that question, do you think Europe gets going in a better economic position and we get the full system in place, that it’s possible maybe not to see those same magnitude of increases but to see more substantial growth kind of similar to that?
Douglas Baker
I don’t think Europe is going to have the same macro trends lifting it that you’re going to see in northeast Asia or Latin America obviously, but we expect Europe sales growth to be meaningful. We think we can get it back to mid single digits and we’ll start arguing what’s up from there.
But we think that’s realistic. At the level, with the work that we’ve done, we believe we will have a very healthy business in Europe.
Nathan Brochmann
I also wanted to talk a little bit in terms of pricing, what you’re seeing in general in terms of the ability to push through some pricing going forward for the remainder of the year.
Douglas Baker
Our view on price is pretty much as it was in the last call which is we expect to be more in the normalized or historic range of about 1% going forward. We think that’s the type of environment we’re in.
I’d also point out that pricing isn’t either the principal or sole way that we drive gross profit. A lot of it is by introducing new technology which has both enhanced benefits for customers as well as margin benefits for us, and that has been our traditional tool for driving margin, particularly environments like the one we’re in.
Operator
You're next question comes from Andrea Wirth – Robert W. Baird.
Andrea Wirth
I wonder if you could address just Europe a little bit more in terms of the ERP system being pretty well completed towards the end of this year. Where do you start first?
You’ve identified a lot of complexity and essentially where do the savings start coming first specifically and how do we evaluate what the risk profile of those next moves are going to be for the business?
Douglas Baker
I would say first of all, we are done with the waves in terms of SAP or ERP roll out in Europe at this point in time and have the system in place as was originally foreseen when we started this initiative. We are still stabilizing the last wave, but it went quite well.
So the great news is, here on forward, all the steps we’re taking are improving the business from here. So focus areas, I would say the first is, there is incremental costs that you layer on simply to roll this out, and we are going to work to take those out first.
You have incremental shipping costs. You have incremental temporary head count costs as you go through this and you lose productivity temporarily in the back office and other parts of the business.
So that’s priority one. The next priority is getting after supply chain efficiency.
One, we’ve got transparency on purchases across the continent, making sure we’re buying at the best possible price, and then it is adjusting inventories, working out our warehouse, distribution etc. and making sure that we capitalize on all of those gains.
Obviously we’ve always talked that we want to continually drive more of our investment in Europe toward sales and towards acquiring new accounts so we’re looking at then shifting and balancing our SG&A so that we’ve got increased sales capability and spend less on G&A over the long haul. That will be the next wave.
During all of this, we continue to invest in top line productivity. We have much more clarity as to what’s going in our business now that we have this system up.
Forever, we had very limited sales data, very limited customer profitability data, very limited data as to what products were penetrated where in terms of customers. So we’ve got a lot more data to go run this business successfully, like we run the business in other regions.
So we’re excited about the potential, and now it’s about unleashing it.
Andrea Wirth
On raw materials, I wonder if you could quantify more specifically what the actual raw material benefit was in the quarter and how do we think about raw materials going forward? I think prices on plastic and I think phosphates as well have been starting to creep up a little bit, so when does that potentially start becoming a headwind for you.
Douglas Baker
Year on year it’s about $20 million, but remember last year is a very high point so a lot of the comparison to a very high base. I guess we expect to have some raw material inflation in our business, but there’s a bit of a natural hedge that will ultimately come out.
We have a modest recovery in our forecast and if the recovery is more bullish, it’s going to push raw material prices up probably more aggressively than we have forecast, but that would be a trade we’d be very willing to take.
Andrea Wirth
What’s your FX impact assumption on an EPS basis for your full year guidance? I believe it was roughly neutral previously, so just wondering if that’s changed at all?
Douglas Baker
I think it’s $0.02% for the year.
Operator
You're next question comes from David Ridley-Lane – Bank of America.
David Ridley-Lane
I had a question on sales growth and the head count there. Can you give us an update on your 2010 plans and what particular areas you’re most focusing on and where you can drive growth.
Douglas Baker
Our plan is still to add significantly to the sales headcount and the plan for the year is in the 300 range of additional heads which is going to be in the 3% to 4%, range.
Operator
You're next question comes from P J Juvikar – Citi.
P J Juvikar
Your international margins were up year over year but were down sequentially. I was wondering if you could add some color on why they were down sequentially.
Was it raw materials that came in the picture?
Douglas Baker
It’s principally just seasonality. First quarter and particularity for our international operation, we run international operations a quarter ahead, so their first quarter is December through February, and December/January are seasonally low months.
We like our margin progression.
P J Juvikar
Do you provide the same level of service internationally as you do in the U.S. and do you think there should be a different service package internationally?
Douglas Baker
I would say of course that depends, but broadly, if we are talking to global players, the answer is yes, we do supply the same level of service. We certainly have the same level of capability internationally.
There are some sub segments that we serve in certain markets that require different levels of service, but by and large, if you’re going to look at the food and beverage or institutional, hotels, etc. we supply the same level of service.
P J Juvikar
On the institutional sales, you were up only 1% in sales despite easy comps. Given the increase in foot traffic at restaurants and hotel occupancy, we would have thought that you got better leverage on sales.
Can you talk about what’s holding that growth back?
Douglas Baker
I would say two things. We always want more growth too.
I guess my view on it is, a couple. One, the first quarter is going to be the hardest comp we have for this year.
The business last year sequentially went down. If you look at foot traffic, it still remains negative in food service in the first quarter.
So I would say the improvement you saw really wasn’t market driven, but was performance driven. We no longer have a declining or sinking market.
We have a stable market by and large, and you’re starting to see the impact of the new customers that we picked up. As the recovery unfolds, food service tends to be a laggard, but we also expect to pick up business as the market picks up, which includes better penetration, more robust consumption across the line, inventory and all the other things that happen as things recover.
But that’s later.
Operator
You're next question comes from Lawrence Alexander – Jefferies & Co.
Lawrence Alexander
Can you give us an update on what you’re seeing in terms of M&A? Most polls are starting to come down towards the levels that you’d be more interested in?
Douglas Baker
I don’t know about broadly. I would say we feel very good about our specific pipeline and I don’t know if it’s the exception or not, but feel like we’re going to have a successful year in M&A which means by default, we are going to buy businesses where we think the price is out of line, so we think we will successfully come to conclusion, meaning, meet eye to eye on price.
Lawrence Alexander
A couple of markets, on the dairy and food and beverage side, can you talk a little bit about how you’re thinking about those businesses over the next two to three years and also are there any businesses within the portfolio where you feel they just really don’t fit at this point?
Douglas Baker
That’s a trick question. In dairy and the food markets, those markets are fairly steady growth markets and you look at the long term macro trends, we like those markets a lot.
We’re doing a lot of work in that space around water and energy specifically because we believe it’s a great way to further leverage our position which is quite significant in that industry, and help our customers who will also by the way, grow our sales there quite handily. So we view that market as very promising in terms of its long-term potential for the company.
In terms of the portfolio I would say we are overall quite happy with our portfolio and until something’s announced, I think that’s the standard. But if you look at it, by and large, we think it matches up quite well with the long-term track.
Lawrence Alexander
As you think about the energy and water markets, I know in the past you’ve tried to establish a review of your strategy in those areas. Should we be thinking about this as something that will be a multi-year process or is there an inflection point where you have a clear strategy and then it’s a matter of trying to execute it and benchmark against particular targets?
Douglas Baker
I think it will be multi-year, but I think the later is probably how we’re going after it. We’ve been on a pretty extensive review of how we want to go after this market and have what I would call a very good blueprint right now and we’re flushing it out, but it’s something that’s going to take a period of time to fully realize because it’s a big ambitious and I think pretty significant plan.
Operator
You're next question comes from John McNulty – Credit Suisse.
John McNulty
At the beginning of 2010 when you gave guidance, you had a couple projections for some of your end markets like food service in the U.S. being down 1%, lodging being up 3%.
Now that you’re a quarter in and it looks like the consumer may be coming back a little bit, do you have an update as to what you’re looking for in some of these end markets?
Douglas Baker
The quick line would be lodging which is about 10% of our sales is doing better than we projected at the last call. Clearly room demand is higher, and this is really a global story.
So lodging has bounced back faster. I would say food service by and large we had right which had kind of a stabilization toward the end of the year.
We would expect to see traffic in others move to the positive and that’s consistent frankly with most of the third party projections as well.
John McNulty
With regard to Europe, can you give us an update as to what the actual margins were for the quarter?
Michael Monahan
Europe ran a very small loss.
John McNulty
If I remember correctly, you had a pilot program going on with two large hospitals for your health care platform. Can you give us an update as to what you’re seeing and when that might come to a close?
Michael Monahan
That was part of our beta testing for what became the Encompass program and we’ve got two of the hospitals which we’ve got, I think we’re very near a contract. Another one is evaluating it.
So I think we’re pretty close on those. But that was a beta test Encompass program which has rolled out in the first quarter.
A rich pipeline of Encompass in test right now.
Operator
You're next question comes from Mark Gulley – Soleil Securities.
Mark Gulley
Back to lodging versus restaurant, can you give us a feel for how historically has the restaurant business lagged a recovery in the lodging side?
Douglas Baker
I don’t know that I have a specific answer there. There one thing I would say is, I don’t know if there’s any great past history that will indicate how we will come out of this particular recession.
What I would say is, restaurants typically lag in terms of coming out of economic challenges. I would say the lodging bounce back, obviously surprised us in its intensity.
I think it also surprised some of the lodging players. So business travel has really been what’s been driving the lodging recovery.
It has bounced back and obviously business travel, but the larger percent of the lodging market than it does the overall food service market. So consumer’s going to have to keep getting strong and remain strong for the food service market to fully recover.
Mark Gulley
The NRA show is about a month from now. Would you care to give us a bit of a preview of some of the key things you’ll be highlighting on the floor at that time?
Douglas Baker
We’ve got a couple of new initiatives which are going to be showcased in terms of most innovative new idea over there. We will unveil those at the show.
But there’s going to be a lot of show casing the technology that we have that we think is particularly relevant in these environments. So while we do expect modest recovery and improvement in our customers’ underlying business, they’re still going to be very focused on do they both get great food safety results and do it cost effectively, and we think we’ve got very good stories along those lines, and that’s the stuff we’re going to be highlighting.
Operator
You're next question comes from Michael Harrison – First Analysis Group.
Michael Harrison
I was wondering if you could help me understand why health care sales are declining year over year given the expected top line synergies that you talked about when you bought Microtech and you’ve done a couple other small acquisitions since then. You’ve rolled out new cleaning and sanitizing program offerings.
I think Mike mentioned that you saw H1N1 boost last year. I don’t think anyone had ever heard of H1N1 in Q1 of ’09, so I don’t really see how that could be a year over year head wind or tough comp.
So help me understand this negative 1% number.
Douglas Baker
You’re right. H1N1 was not part of the story last year in Q1.
H1N1 impact this year was the trade reduced high inventories by not purchasing virtually any of these products for a period of time in the first quarter because the inventories had become inflated in the fall during the H1N1 peak. So that’s the adjustment impact we’re talking about.
It’s not going against a base. It is really distributor inventory take down during the first quarter.
That’s largely behind us. It’s very easy to pinpoint that.
The health care business was in the mid single digits when you take out that impact. We expect it to perform around mid single digits next month without H1N1 in terms of reported number and will be back to high single digits possibly double digits in the second half, even though it will be going against tough comp in the second half, because that’s when H1N1 inventory build and consumption was at its peak.
The business, all the fundamentals, the new customer work, the innovation, all that is on track, so we’re just going through a little adjustment period and we feel very good about the future of our health care business this year.
Michael Harrison
In food and beverage, are we still seeing year over year negative impact related to [Ecovation] or has that turned positive year over year?
Douglas Baker
They were down 5%, up in the later part of the quarter. Down 5% for the quarter, but that wasn’t a real material story.
Michael Harrison
If you excluded [Ecovation] though, you might have been up a percent in food and beverage?
Douglas Baker
Diminuous.
Michael Harrison
I was wondering if you could talk on pest elimination. Are those services something that lodging customers will cut back on when times get tough similar to what you see in food service?
And in that context, what sort of improvement might you be expecting from pest elimination services to lodging customers and what kind of traction do you expect from this new bed bug program?
Douglas Baker
The answer is yes, lodging customers will also cut back on certain services when times get very tight, and we’re watching. The industry went through an incredibly difficult period last year.
So we’d anticipate that the underlying market demand will start increasing for these services and in fact, I mean if you look at our underlying metrics which are reported, we see building demand in our service businesses, as we would expect. So we feel better about pest’s growth prospects through the year.
Bed bug programs will be one part of the story, but so will other traditional programs. We rolled out a new program designed after pests in restaurants which has got significant sustainability and health benefits.
So there’s a number of things we’ve got going in pest beside the market lift that makes us feel like we’ve turned the corner and moving the right way there.
Operator
You're next question comes from Gary Bisbee – Barclay’s Capital.
Gary Bisbee
After not doing a whole lot of buy backs for several quarters, you’ve accelerated a bit the last couple of quarters. Is there anything I should read into that in terms of thoughts around strategy for your cash, inability to get the right acquisitions done or is it just more that maybe after the slug you did after the [Ankel] transaction, you just took it easy for a few months and you’re now getting to more normalized pace?
Douglas Baker
I would say it’s much more the later. It does not reflect any change in use of cash philosophy, but obviously we made a big purchase in the fourth quarter of ’08 and took a few quarters off as a result of that which was planned.
Our principal or primary use of cash is going to be for M&A and when M&A is not there, we said then we will go to share buyback. As I alluded to earlier, we are pretty confident that the M&A opportunities are going to be here in the near term.
Operator
You're next question comes from John Roberts – Buckingham Research.
John Roberts
When I look at the developed markets, U.S., Europe plus minus percent, Canada up 8%. Is there a significant mix difference in Canada than the other developed markets.
Douglas Baker
The history lesson would be if you’ve got minerals and gas, things are going to be rosy. The Canadian economy is fundamentally healthier than either the U.S.
or the European economy. They didn’t have the banking crisis.
They didn’t have the housing crisis. They kind of skipped it.
I would also say they are fairly rich in minerals so it’s not a bad economy.
John Roberts
Back to the pest elimination question you just got, I thought that was typically a relatively temporary phenomena, that after six months or so the bugs come back and the customers really have to come back to usage levels that they had pre their hiatus. Are you a little surprised you haven’t seen that yet?
You’re down in comp’ing against year ago numbers.
Douglas Baker
The only real answer is I was surprised by a lot of things that happened the last 18 months. I guess at the end of the day, it’s lasted longer than it has previously, but I would also say we see the type of underlying metrics that we expect to see and we expect the business to be coming back.
Clearly last year was unique on a number of levels.
Operator
You're next question comes from Edward Yang – Oppenheimer.
Edward Yang
You mentioned that inventory destocking hurt health care comparisons. Conversely, are there any other businesses that you operate where there’s some potential for inventory restocking?
Douglas Baker
I don’t know that it’s quite at the level that you might have seen in more industrial companies by any means but certainly as demand picks up, just the way our ERP systems work, it drives a pickup in inventory levels. This isn’t any new phenomena.
We didn’t spend much time talking last year about significant erosion in terms of inventory levels, but it’s a natural occurrence in a decline and an increasing economy.
Edward Yang
It sounds like in the health care business, there’s more of a guess middleman that maintains inventory. In your other businesses like institutional or textile care etc., is there a middleman that is significant in terms of being part of the supply chain?
I know you’ve had some change in inventor incentives last year that provided some volatility.
Douglas Baker
The answer would be it is different. F&B largely is going directly to the end use consumer, i.e.
food production facilities. However at institutional, a large percentage of sales go through distribution which means that there’s an inventory plus/minus equation as well as in health care and some parts of our textile businesses and some parts of our vehicle care etc.
So it exists, and I would say as the economy picks up, one of the things you see is underlying consumption picks up which starts triggering increased inventory levels in distribution.
Edward Yang
Your overall volumes swung positive this quarter. Is that more a function of getting new customers or existing customers buying more solutions from you?
Douglas Baker
It was a piece of both on a year over year basis, but I would say I don’t think we fully felt the market impact yet. A lot of the recovery we’re seeing I think were our own efforts last year.
Operator
You're next question comes from Robert Koort – Goldman Sachs.
Robert Koort
I was curious as you took a more critical look at the cost structure in the downturn and as we come into this recovery phase, how much leverage do you see at the operating margin line or do you think it will stay in this high teens range in the U.S. and sort of 13% range globally.
Douglas Baker
I would say we certainly did about in areas where we had improvement, we capitalized on some of that. We expect that to continue to show up in the business.
Obviously the biggest margin play that we have is in Europe and we have just gone through a period of sizeable investments which are largely in the base now in Europe, and we’re going to start capitalizing moving that. That’s a third of our business, so obviously every 100 basis point, a third of that accrues to the total margin improvement.
So we see steady improvement in our margins over the next few years primarily fueled by the improvement in Europe. There’s still margin opportunities in the other regions.
AP&LA is principally volume on an existing infrastructure base and in the U.S. it is continuing to refine our business model.
Robert Koort
And how on Europe specifically, what metric should we hold you accountable for success or lack of success in terms of that margin progression?
Douglas Baker
I think we said that we believe we can get Europe up to the 13% to 14% and we would be disappointed if progress wasn’t at least 100 basis points a year.
Operator
You're next question comes from Rosemarie Morbelli – Ingalls & Snyder.
Rosemarie Morbelli
When you talk, following up on the margin in Europe, when you talk about getting to the 13% to 14% operating margin, can we see that as soon as we see top line growth of 5% or do you require a multi-year process?
Douglas Baker
I hope we see 5% top line before the time it takes us to recover margins fully. That would be the short answer.
The 5% is not going to come magically in a quarter. It takes us awhile in any region to rebuild the sales growth, but my hope and belief is that we’ll see 5% well before the time it’s going to take to get 13T to 14% in margin.
Rosemarie Morbelli
Have you seen any change in trends since the end of the quarter or when you address the fact that markets are stabilizing and so on, that was actually talking to after the end of the quarter or was it a trend going through between January and March?
Douglas Baker
I would say, I think clearly we incorporated the most recent data we had in terms of market performance, so that comment is what we’ve seen to date.
Rosemarie Morbelli
Back to the number of shares, what was the number of shares at the end of the quarter, and then if I look at last year, between the beginning of the year and the end of the year the number of shares went up by three million. Is that the kind of outlook for this year or are you going to buy much more and therefore you will more than upset the impact from options by the time 2010 rolls around.
Douglas Baker
If you look at the number of shares, the basic numbers of shares declined. The increase in the diluted shares was due to the stock price causing more shares to be in the money, and for the full year, with 3.3 million shares bought in the first quarter we would expect that the number of shares would decline following quarters.
Rosemarie Morbelli
But you are going to have more options in the money most likely between now and the end of the year, so if you buy more shares, we are going to have the same pattern we had last year.
Douglas Baker
It’s not a dramatic impact. With the stock price rise, there’s not too many shares left under water.
Rosemarie Morbelli
In the past, new technologies are what really drives this company and you had this big leap from liquid products to solid products. What is coming up the pipeline that would have a similar impact?
Douglas Baker
What we, as you know, have moved our solid concept to a new platform level and have been and are only partially launched on this concept. So [Apaks], which is really taking the old solid and making this in an extruded form, which also allows us to reduce significantly plastic and you can do a number from the same formula, is now launched in wear washing.
We’re starting to extend it in line products where we have been using this technology as a platform in QSR. This is only so far been really launched in the United States so we will be expanding this globally throughout institutional.
If you go to the F&D space, there are a number of technologies that we have that we’re rolling out that follow the trend line that dry loops which are technologies t hat significantly reduce water and enhance performance. We are working at recovery vehicles in terms of finding ways to make the products we use even more efficacious without adding more chemical to the process and reducing water.
I don’t want to get into too much detail because it’s a public forum for F&B. So we’re very excited about the number of platforms we have there that we think are going to boost sales long term as we move forward.
We’ve talked the water area. We have a number of applications there that are going to fit our large businesses.
We have some very innovative sustainable ideas. We feel very good about our platforms and our innovation technology.
We did not stop investing in our R&D anchor technology platform at all during the crisis. In fact, that was one of the areas that was in the bright line of protect no matter what, that investment, because we knew we were going to be sitting here on the other side needing to stimulate and drive growth the old fashioned way, which is start getting after organic sales.
So we feel pretty well equipped.
Operator
You're next question comes from Dmitry Silversteyn – Longbow Research.
Dmitry Silversteyn
I want to talk about the GCS business. It sounds like you’re going through another investment cycle there with expanded sales forces coverage.
My understanding was that this business, that you were done investing in this business until you start seeing some positive profitability out of it and then make a decision whether or not you can continue to grow or scale it back. Have you seen enough of a recovery to justify continued investment in this business and step up investments as a matter of fact?
Douglas Baker
Probably to be more clear about what we’re talking about, a lot of what we did was we transferred resources to give us more selling resources in that business. So we’ve been doing a lot of work.
I guess you could argue we’ve been taking it out of the business, but we felt taking some of the heads that we have saved in that business and applying them towards regional sales efforts made sense and it’s looking like in fact, it does make a lot of sense for us. The GCS business is moving in the right direction.
We continue to lower the breakeven point. We would estimate that around $140 million at this point.
I think the last time we articulated a number it was around $155 million, so we continue to make good progress there. Sales have absolutely stabilized in the business so we’re looking to start driving this in a positive direction which is what needs to happen to close the remaining, now increasingly small gap that we have in terms of a Y there.
So we like the promise of this business. I think there’s been a lot of work that’s gone on.
This business is in a lot better shape than it’s been for years.
Dmitry Silversteyn
The second question is a follow up on the health care and the 1% decline that you’re seeing year over year sales. I just want to make sure I understand what you’ve answered directly because I agree with the previous caller in that the H1N1 should not have been a year over year impact, but what you’re saying is that with H1N1 concerns, there was a lot of inventory building of product towards the end of 2009 that may or may not have something to do with H1N1, just a general desire to be cleaner and safer, and now that inventory took place not necessarily in products directly tied to H1N1 but in overall cleaning and sanitizing market dealing with health care.
Is that what you were saying or did I misunderstand?
Douglas Baker
I’ll try it again. Basically what happened is distributors serving this market built their H1N1 related product inventories.
There was high demand, and then the demand went down after the H1N1 scare went away. But the way ERP systems work is, they work behind and keep building inventory for past demand not immediate demand, so the end of the year was very high inventories compared to immediate demand.
Once this is recognized by the system, they basically go on a full stop. So they stop ordering the products until the inventory adjusts to the current consumption pattern.
That’s the adjustment we went through in Q1 of 2010. It had nothing to do with 2009 Q1.
Michael Monahan
These are sanitizers, hand sanitizers that have other uses. They’re not uniquely for H1N1.
Douglas Baker
They will continue to buy these products, and they continue to move. There is just an adjustment in inventory.
So consumption was higher than sales as the inventories adjusted. If you take out the inventory adjustment, sales would have been mid single digits for the quarter.
Not a great quarter. We would have been beating our chests, but no means a disaster and we feel very comfortable that the business underlying growth metrics are on the right trajectory.
Dmitry Silversteyn
If you look at the previous three years, you had double-digit growth in that business in nine out o twelve quarters. The fact that even without an inventory correction you would have been in a single digit growth, does not necessarily seem any kind of a trend.
It could be just one quarter in the year when you would experience that type of growth so there’s nothing fundamentally different about the business in 2010 versus 2009 as far as maturation or market penetration or stiffer competition.
Douglas Baker
No. There’s nothing fundamental.
It’s a 13-week period. As I signaled earlier, we would expect this business to have a reported growth rate in the mid single digits in the second quarter.
The inventory situation will be behind us fully by then and it will be upper single to possibly digit in the second half, so we’re spending our time doing what we do and figuring out how do we drive innovation and new customer acquisition in this business.
Michael Monahan
That second half remember, will be going up against the H1N1 demand which was heightened demand at that point so we feel pretty good about the growth rates.
Operator
You're next question comes from Gary Bisbee – Barclay’s Capital.
Gary Bisbee
When you talk about the system in Europe being on line and the long-term margin plan, what should we expect this year? I’m assuming you’re starting to amortize some of the capitalized cost there.
Is that going to offset the Europe margin gain this year or should we think about it beginning to get it and then it really starts ramping next year?
Douglas Baker
We absolutely are taking on increased costs, as the system is fully online and amortize the investment fully, and we’ve always talked that you’re going to be at a period where you are fully paying for two systems. What we expect is, fourth quarter will be the first quarter you start seeing year over year margin improvement and we would expect that to be the trend moving forward.
For the year, the margin is going to be roughly flat, maybe modestly up from last year.
Operator
There are no further questions.
Michael Monahan
Thank you for your time today. We appreciate your interest.
Have a great day and take good care.