Ecolab - Q1 2023

Transcript

Operator (participant)

Greetings, and welcome to the Ecolab First Quarter 2023 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Andy Hedberg, Vice President, Investor Relations for Ecolab. Thank you, Mr. Hedberg. You may begin.

Andy Hedberg (VP of Investor Relations)

Thank you, and hello, everyone. Welcome to Ecolab's first quarter conference call. With me today are Christophe Beck, Ecolab's Chairman and CEO, and Scott Kirkland, our CFO. A discussion of our results along with our earnings release and the slides referencing this quarter results are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statements in these materials, which state that this teleconference and the associated supplemental materials include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described under the Risk Factors section in our most recent Form 10-K and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release. With that, I'd like to turn the call over to Christophe Beck for his comments.

Christophe Beck (Chairman and CEO)

Thank you so much, Andy, and welcome to everyone. Look, our team delivered another strong quarter. Once again, even slightly better than I would have predicted. Top line was very strong, volume trends remained stable, margins expanded, operating income growth got even stronger, and adjusted EPS growth kept improving as we promised. All as promised as we continued to face some real headwinds in foreign exchange and interest. Most importantly, our shift to offense showed some real encouraging signs of progress. Organic sales improved from 12% in the fourth quarter to 13% in the first, with strong performance across all segments. Our net new business pipeline once again reached new records in the first quarter as what we have to offer, water, energy, and labor savings while delivering the best and safest outcome in the industries we serve continues to grow in importance for our customers.

We also maintain very strong pricing at 13%, which we believe will be the peak as we will begin to lap against last year's strong acceleration. Our approach to pricing, and it's important to state that, is responsible and respectful, allowing our customers to absorb long-term increases in a progressive manner. This is backed by true eROI value, the Ecolab way, as we help them reduce their overall operating costs, usage of natural resources, and their environmental impact. Delivered product costs continued to increase versus last year. The rate of inflation began to ease. This, along with strong pricing execution, allowed us to drive modest gross margin expansion a bit earlier than expected. That being said, our margin recovery journey has only just begun. Despite our expectation that inflation remains stubbornly high, we remain fully committed to recovering our margin over time.

Done the right way, one that builds further customer loyalty as we continue to deliver more value. The repositioning of our institutional business, which is a big priority for us, is progressing well, as demonstrated by strong sales growth and margin leverage within that segment. Healthcare and life sciences organic sales growth strengthened, while operating income remained under pressure, near term at least, as we continue to invest in growth and transformation. There are two very different businesses and stories within that segment. In healthcare, we continue to take actions to improve profitability, whereas in life sciences, we're making further investments as we add capacity and capabilities in Purolite to capitalize on very attractive and profitable long-term growth opportunities. While we continued investing in our long-term capabilities and in digital technology, we also continued to make solid progress in SG&A productivity.

The combination of improved gross margins and better operational productivity led to strong organic operating income growth of 19%, up from 10% in the fourth quarter last year. Our adjusted earnings per share growth improved to 7%, which includes a 13% headwind from FX and interest. In summary, we started the year exactly the way we wanted, with strong top and bottom line momentum despite a challenging environment. Looking ahead, we anticipate inflation to remain high for the foreseeable future, interest rates to have a strong impact on global demand and continued geopolitical tensions. Although none of this is new, the good news is that we are very well positioned to win in this environment. Over the last few years, our expertise grew as we focused on supporting our team and developing innovative solutions.

Our customer retention rates remain high as we protected them from supply shortages. Our margins started to recover and our organic operating income accelerated as we drove pricing in thoughtful ways while increasing customer value. Now, as macro trends are softening, we will continue to accelerate our shift to offense by accelerating new business, by executing extremely well, and by driving productivity improvements and continuing to invest in our major growth engines to drive profitable growth. This will ensure we deliver stronger sequential earnings performance, exactly as we've indicated during our previous calls. With this, we expect adjusted earnings growth in the second quarter to be in the +5% to +14% range, and to end the year, as expected, with adjusted earnings growth in the fourth quarter that reaches low double digits.

Finally, we will remain good stewards of capital by continuing to invest in the business, increasing our dividend, reducing our leverage, and returning cash to shareholders, as we've always done. Most importantly, with the best team, science, and capabilities in the industry, we well prepared to grow our share of this high quality $152 billion growth market. I believe our future has never looked brighter. I look forward to your questions.

Andy Hedberg (VP of Investor Relations)

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

Operator (participant)

Thank you. We will now be conducting a question and answer session. We ask that you please limit yourself to only one question per caller so that others will have a chance to participate. If you have additional questions, please rejoin the Q&A queue. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing these star keys. One moment, please, while we poll for questions. Our first question comes from Tim Mulrooney with William Blair. Please proceed with your question.

Tim Mulrooney (Group Head of Global Services Sector and Research Analyst)

Good afternoon, Christophe.

Christophe Beck (Chairman and CEO)

Hi, Tim.

Tim Mulrooney (Group Head of Global Services Sector and Research Analyst)

All right. For my one question, I think I'll have to go with gross margin. You know, it looks like the adjusted gross margin expanded 20 basis points year-over-year in the first quarter. Now we weren't expecting to see that expansion year-over-year until the second or third quarter, so that was great to see. Taking into account what you're expecting for pricing and raw materials, I'm curious what you're thinking for the cadence of gross margin expansion as we move through the remainder of this year. Thank you.

Christophe Beck (Chairman and CEO)

Thank you, Tim. I'm very pleased with the progress that we've made. We know that's an outcome of what the team has done the past two years. It's been a long journey. We wanted, obviously, to reach the point where we could turn the corner and then rebuild and expand on our gross margins and operating income margins as well. Quite pleased, as you said, with what we've delivered in Q1. Our operating income went up 90%, as said just before, which led to a 50 basis points improvement as well of the OI margin, which is the first trigger for me. The second is this gross margin of 20 basis points. It came a bit earlier than we had expected.

We thought it would happen so during the second half of the year, because ultimately pricing so got stronger, than what we thought, initially, which is a good news. Volume was better than feared, especially because of what happened in Europe, or did not happen because of the higher temperature, as well. Delivered product cost inflation that didn't go down, but went less up than what we saw in the fourth quarter, of the, of the past year. When we bring it all together, gross margins have turned a corner at that point, which is all good news. Gross margin turning good. OI, operating income margin turning good as well.

We're just at the beginning of that journey because our mission is really so to get back to our high watermark, as we call it, and then to keep expanding from there. We'll keep improving quarter after quarter as we've promised and committed as well. That will also depend on the rate of the delivered product cost inflation, which is hard to know exactly how it's gonna be. It's been up 9% in the first quarter. We had a delivered product cost inflation of 27% teaming 2022. 9% is obviously so lower than 27, but it's still going up, and I don't see it turn negative anytime soon. For 2023, I think we will be facing a continuous DPC inflation.

With that, well, we will keep working on pricing, we will keep working on volume, we will keep working on productivity in order, as committed, to make sure that our earnings improve quarter after quarter until we get to our traditional low double-digit operating income or earnings per share growth in the fourth quarter.

Operator (participant)

Our next question comes from the line of Ashish Sabadra with RBC Capital Markets. Please proceed with your question.

Ashish Sabadra (Managing Director and Equity Research Analyst)

Thanks for taking my question. I wanted to focus on the SG&A leverage that we saw in the quarter, pretty strong leverage there. I was wondering if you could talk about the productivity initiatives that you and the cost takeout initiatives, but also how the digital innovations are driving better SG&A leverage. Thanks.

Christophe Beck (Chairman and CEO)

Thank you, Ashish. I like a lot the progress we've made on SG&A. We've made great progress last year in 2022. As you know, we improved 200 basis points in the past year. We will continue on a very good trend in the quarters and years to come as we automate much of the transactional work that we're doing either in the field with our sales and service people, so they can focus really on creating value for our customers, which is where our investments are best focused on, obviously. As well in the whole backbone infrastructure, as we call it. This is the implementation of SAP.

We're north of 80% of the company on SAP as well now. We're trying to leverage all that critical mass in shared services, so it's helping on the G&A side while we improve on the selling side as well. It's not gonna be every quarter obviously the same improvement, but the trends long term are gonna remain the same. I think that we are probably midway on that journey. For the years to come, we will still have some upside coming up out of productivity.

Operator (participant)

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

Seth Weber (Senior Equity Analyst)

Hey, good morning. I wanted to just ask about the pricing commentary you made, Christophe. I think I heard you say the 13% in the first quarter was probably peak. Can you just talk to, you know, how you're handling the energy surcharge, whether, you know, that's starting to roll off, or whether you're trying to merge that into more structural pricing going forward? Just, you know, how we should think about the mix of pricing, you know, kind of coming off of this 13% number. Thanks.

Christophe Beck (Chairman and CEO)

Would love to, Seth Weber. Thank you. Pricing, the team has done a remarkable job over the last 18 months, making really sure that the pricing we were delivering was really backed by value that we're creating for customers as well, because we will never go down in pricing. It's been true for the last 20 years. That's not gonna change in the years to come. This is the Ecolab way of creating value for customers and capturing. A part of it, which translates into pricing for our business. When I think about the pricing we had last year, we had roughly 10% of price. In 2022, as mentioned, half of it will be carry over in 2023, which is unchanged.

The 13% that we have in Q1, you're right, you understood well. It's gonna be the peak for 2023. We will keep having strong pricing in the quarters to come, but the rate of increase will ease as we lap, obviously, year-over-year. To your point on the energy surcharge, we've been working with our customers over the past 12 months to merge as much as we could of the surcharge into structural pricing. It's a bit different in every industry that we serve, but for the most part, the transfer from energy surcharge to structural pricing is going quite well. It's not all the way there, but I like the progress that we've made so far.

Operator (participant)

Our next question comes from the line of John Roberts with Credit Suisse. Please proceed with your question.

John Roberts (Senior Equity Research Analyst)

Thank you. Nice quarter. Do you need to shrink the sales of the European healthcare business in order to turn around earnings?

Christophe Beck (Chairman and CEO)

John, it depends on how you mean it, turning earnings for the overall company now. But for purely healthcare in Europe, yes. It's important to keep in mind that healthcare is 5% of the overall Ecolab organization. I'm really glad that 95% is going really well, and 5% I don't like, and I'm staying focused on it. This is not my first priority, obviously, but this is an important priority for me. When I think about healthcare, I've committed that in 2023, we will see a turn. It's gonna take some time to get to the right place, but the first action that we've done, are doing, and will be doing is to rightsize the cost structure.

We've announced it with our restructuring plan during the last call, and we're implementing it as we talk right now. That's not gonna be the whole solve as we know. The same time, there's a second point that we're focusing on, is really making sure that we refocus the business towards what we know how to run, which is the most institutional-like business. The infection prevention, it's a bit of a dish machine, obviously, because it's instrument and endoscope reprocessing as well. We know how to run that business. We know how to make money with that business. It's not where we focused in the past, but that's where we're gonna focus as well in the future.

The last point is, we're going to really think about options to make sure that we can strengthen this core business in order to make it a real Ecolab business and more profitable as well. Bottom line, still some work to do. Again, 5% of the overall company, it's not going to move the needle obviously for the earnings of the overall company, but I'm committed to make it work.

John Roberts (Senior Equity Research Analyst)

Thank you.

Operator (participant)

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

Josh Spector (Executive Director of Chemicals Equity Research)

Yeah, hi. Thanks for taking my question. Just curious on your thoughts on volume as you walk through. You know, a number of puts and takes, I guess, with maybe Europe being an easier comp, same thing with Asia. North America may be a bit more challenging. Do you see this kind of -1% persisting into next quarter? Do you have a different view on the second half given where comps are? Just curious on your thoughts around that. Thanks.

Christophe Beck (Chairman and CEO)

Yeah, thank you, Josh. On, on volume, as mentioned, we've been slightly negative. It was kind of the same trends as what we saw in the fourth quarter. Honestly, better than feared, if I may say, because Europe was less bad than we thought. From an environment perspective, honestly, I like a lot so how Europe has been delivering in the first quarter. Sales were good, margins were extremely good, and I think that they're gonna have a very good year in Europe in 2023. That's, that's a good news. If I look at overall volume for the company, if you exclude Europe, as mentioned just before, so we're slightly positive, which is a good news as well.

The third point, which is most important, is the shift to offense that we've initiated a few months back. While we wanted to really make sure that pricing was done the right way in order to enter 2023, very well positioned to improve our margins. Well, that was taking a lot of time for our sales team that they were not focusing on generating even more new business. That being said, new business in 2022 was stronger than in 2021. It's not that it was not good. It was good, actually, but I'd like to have much more. Now we've made that shift. It's what our teams like to do. It's where we are best at ultimately. I like a lot when I see the new business that's been generated.

We had a record high in Q1, which is a very good news. We need to execute that properly as well. We will be fighting a slowdown of the global economy. I don't know, where that's exactly gonna go, obviously, but it's not gonna accelerate, that I'm pretty sure about. We will have to drive volume the old-fashioned way with new business, with innovation, investing so behind our growth engines as well. It's gonna improve quarter after quarter, and I think that that's the journey that we are on, and you will see that in the quarters to come, especially in the second half of the year.

Operator (participant)

Our next question comes from the line of Michael Harrison with Seaport Research Partners. Please proceed with your question.

Michael Harrison (Managing Director and Senior Chemicals Analyst)

Hi, good morning.

Christophe Beck (Chairman and CEO)

Hi, Mike.

Michael Harrison (Managing Director and Senior Chemicals Analyst)

Sorry, good afternoon, I guess. Christophe, I know you're reluctant to put numbers around the full year outlook. The wording compared to three months ago is pretty much unchanged, but can you talk about how confident you are in that outlook today versus three months ago? What are some components that have changed for the better, and maybe what are some areas that you're more concerned about? Thank you.

Christophe Beck (Chairman and CEO)

Hey, thank you, Mike. Good afternoon. You're right. My wording hasn't changed, my level of confidence has risen in the meantime, which is a net positive. We're off to a good start in 2023, let's face it's the first quarter of the year, three more to come and a lot can happen still obviously. What we can control, I like what we're doing. Fundamentals are strong, that's new business, that's pricing, that's innovation, that's productivity, that's investments and so on, all the things that are all in our hands obviously, I think that the team is executing very, very well. We keep improving, so quarter after quarter, as we've done in the past few quarters, we will be doing in the quarters to come.

You know, the honest truth is I'd like to see what happens in Q2 in the world, not in what we can control in terms of inflation, in terms of interest rates, in terms of war in Europe, in terms of debt ceiling, you name it. The list is pretty long obviously here, and I wanna understand what happens on the delivered product cost inflation because of all those elements. You're right. Unchanged wording, unchanged outlook, higher level of confidence to deliver as I've committed to as well here, we will know much more after the second quarter, I will share with you what I'm seeing, and if things are getting better, I'll share that with you as well, we're gonna have a good year.

Operator (participant)

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

Manav Patnaik (Director of Equity Research)

Yeah, hi. Maybe I can just squeeze in a two-parter, but just as a follow-up to, you know, the new business comments you made, I was hoping you could help just quantify how much that new business is adding to get some sense of gross volumes, I guess. You know, the main question I had was just, you know, any update you have on, you know, a lot of the kind of the data initiatives you had talked about, you know, a while back if you know where that was today?

Christophe Beck (Chairman and CEO)

Help me understand, Manav. I really want to understand. When you say so, data initiative, what is it exactly that you'd like to know?

Manav Patnaik (Director of Equity Research)

Yeah, you. Well, just broadly, you had, you know, all the kind of data collection that you've done and all your on-sites. I think you hired a chief technology officer and, you know, the productivity, et cetera, whatever the outcomes there were.

Christophe Beck (Chairman and CEO)

Okay, got it. Thank you. That's helpful. Two questions here. First on new business. We've never disclosed the exact numbers on new business pipeline and growth, so I'm not going to start now. But we haven't changed our definitions, so it's really comparable. Q1 was quite a bit better than what we had in the past few quarters and even compared to Q4 as well. The fact that new business is accelerating year-on-year is good news, obviously. For the new business generation, then once we have sold that new business, we need to install it, as you know.

We don't sell, for the most part, software, so people need to install our technology and make sure that the chemistry is working and that the processes are working as they should and all that. That usually takes a few months or a few quarters to implement. Nothing new. That's always been true, and that's gonna be true this year. Very good new business pipeline. A major refocus of our team on new business. If you wanna think about it, in the past 2 years, our team was 80% focused on pricing and 20% on new business. Now it's the other way around. It's 80% on new business and 20% on finishing the price and keeping pricing for the future as well.

That's gonna have an impact, obviously, on our volume, which we will have to net obviously with the market evolution. I feel confident for now, that we will master that quite well. The second part of your question, very different, on digital. We're still focusing on three major pillars. That hasn't changed. The first one is really so to generate value for our customers. The way we've done it in the past with 3D TRASAR is going really well.

Ecolab3D, which is the Ecolab cloud, one of the largest in the industry, by the way, since we're connecting tens of thousands of plants on the cloud, is giving us a very unique view, Manav, on what's the best performance that we can reach within a company. What's the site that's having the best performance and how to lead to that performance and then expand it across that customer. We can do it within industry, across the industries, and that's we're really focusing on with our team. Just for perspective, we have over 1,000 people in digital today, so we have quite a bit of firepower for that. The second pillar is really so to focus on field automation.

As mentioned before, and you see it in the SG&A productivity as well. This is not squeezing our teams. It is really so providing them with the tools that they can really focus on creating value for our customers and that we can automate all the transactional work. We're early on that journey, but it's progressing well. You can see it in the numbers. The last component is really the customer experience. Really making sure that they can have a real-time data-driven type of experience.

E-commerce is something that has expanded very well over the last 12 to 18 months, but it's also what we call so digital industrial bulk has been an interesting project as well, where ultimately saw all our distribution to industrial customers is connected to the cloud and can be done not only in real time, where customers know when the products are gonna come, but we can also increase the safety level of the delivery because it makes sure that what's being delivered is being delivered exactly in the right tank. That's been a great plus, not only for our customers, but for our team, because safety still got better. Sorry for the long answer on that, but good progress on the digital front as well, and we're still on our journey here.

Operator (participant)

Our next question comes from the line of Chris Parkinson with Mizuho. Please proceed with your question.

Chris Parkinson (Managing Director and Senior Industrials Equity Research Analyst)

Great. Thank you so much. Just in your supplemental, when you break down the water business, it's pretty clear that you're still enthusiastic about, you know, pricing gains as well as, you know, new business wins. Chris, just given understanding you don't have a crystal ball, but just given what you're seeing right here right now and what you're hearing from the customers with those various substrates, can you just comment on, you know, what your expectations are for the evolution of those for, you know, for the balance of the year? Then perhaps comment on, you know, it seems like this business has been under-earning along with institutional and just how long you think it will take to get back to its, let's say, full potential at trend line? Thank you so much.

Christophe Beck (Chairman and CEO)

Thank you, Chris. The water business, as you could see, is doing really well and has been doing really well, in the first quarter as well. It's our largest single business. As you know, it's been growing 14%. Volume has been nicely positive, as well. Very nice new business, in that field because customers need always more what we're offering, which is basically helping them produce better products, more products while reducing their water usage. Why do they do that? Is not only to reduce the impact on the environment, but when they reduce the water usage, they reduce the energy usage, reduce their carbon footprint, reduce their cost as well, and that's why they invest even more in what we're doing.

The water promise that we started 10 years ago, when we acquired Nalco, is really paying off in a really big time. When I look at the pricing journey, a very nice one, over the past few quarters. When you look at industrial as a whole, the OI margin was up 80 basis points. Gross margin was even better than that. Very nice margin improvement, good sales momentum. Within that sales momentum, like just to mention, a few interesting highlights. Our global high-tech business went up 36%. Power was 20%. Mining was 40% plus. A lot of very good things happening in water. I love what the team is doing in that field.

Operator (participant)

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

Jeffrey Zekauskas (Managing Director and Senior Equity Research Analyst)

Thanks very much. I have a two-part question. I understand that you'll be annualizing the price increases of 2022, but in the course of 2023, do you expect to raise prices? Normally, Ecolab's prices go up 1%-2% a year, but my general sense is, you think it should be greater than that, maybe 3%. Is that what you planned for this year? Secondly, SG&A costs went up 8% in the quarter. Isn't that too high? I understand that the, you know, overall SG&A margin was a little bit better, but given the restructuring efforts that you're making, shouldn't SG&A be growing at a more moderate rate? Is that your target or no?

Christophe Beck (Chairman and CEO)

Thank you, Jeff. Let me take pricing and then, I'll give the floor to Scott, who needs to work a little bit here as well during that call. On SG&A. On pricing, you're right. We've always increased prices over our history, 20+ years. It's not gonna change in 2023 and in the years to come. There will be a combination of a few things that are gonna happen. As mentioned before, 10% was the pricing we had last year. Half of that will be carry over. That's math, since we're not gonna give it back in 2023. We will build on that some incremental pricing. You do the math obviously, and then there's the lap year-over-year.

There's the last question, or part of the question, which is what's gonna be the run rates are going forward. We were 1 to 1.5% in average in the last 10 years as a company. Depending on where inflation is gonna be in 2024, I don't know how it's gonna be, but it's gonna be north of 2%. I'm almost sure about that. Jeff, I think that our incremental pricing so will be higher than what we had in the past before this inflationary cycle. If you combine both the carryover and the new pricing, you can see more or less where we're gonna be and for the years to come. I think that the company has developed a very strong muscle in pricing, not because we're jamming pricing to customers.

As mentioned before, we've taken our time to do it really well, really respectfully and backed by value with our customers, and we're gonna continue to do that in the future. It's gonna be good for customers, it's gonna be good for us, and it's gonna be good for shareholders, especially as inflation will be easing since our margins will improve as well at the same time. That's the general picture on pricing. Now for SG&A. Scott, you might wanna make a few comments.

Scott Kirkland (CFO)

Sure. Thanks, Christophe. Hey, Jeff. As you mentioned on SG&A, we think about it from a productivity perspective as a ratio. As you mentioned, the SG&A leverage continued to improve in the first quarter. We were down 30 basis points year-over-year. That's on top of them comparing it to very strong quarter last year, where the SG&A ratio improved by 200 basis points. Also, as you know, seasonally, just from a ratio perspective, it's our lowest quarter in sales. Obviously that's gonna drive less SG&A leverage as well as just timing of investments and spending. We feel very good about where SG&A is.

The programs we're doing expect to continue to drive that SG&A leverage through those productivity, normal productivity programs as well as the cost savings programs that you mentioned. Feel really good about the trajectory we have on SG&A and getting back that OI margin.

Operator (participant)

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

David Begleiter (Managing Director and Senior Equity Research Analyst)

Thank you. Christophe, in institutional, we are seeing some better trends amongst your customers. Are you yet seeing those trends in your volumes? Actually in Q1, were your volumes down in institutional? Thank you.

Christophe Beck (Chairman and CEO)

David, I like the progress we're making in institutional. You've seen the numbers, 14% growth in institutional and specialty and 16% on the operating income, which is good. This is the beginning of the journey. As I've mentioned a few times over past calls, the industry behavior has changed quite a bit. If I take the example of restaurants, which unfortunately are the same numbers as the ones that I've mentioned during the past few calls, the dining in traffic, which means people going in a restaurant and sitting at the table is down 30% versus 2019. We were all hoping that that would improve quarter after quarter, while the ugly truth is that it's not.

People have gotten used to order online, to do some pickup or being delivered as well the food, and that's amazingly sticky, interestingly enough. It's been good for our customers, and I'm really pleased for them because at the end of the day, while they're selling the same or more at a lower service cost because they have less people staying in the dining room. Very good deal for restaurant operators, and I think this is a very good thing for them as well. We had to change, obviously.

For us, when I think about it, versus 2019, if you take in restaurants this -30% of food traffic in their dining room, well, our sales in comparison in North America are up 12% in 2023, the first quarter. We've gained market share. Our teams has managed to really sort of drive share, drive pricing, drive innovation to make sure that we could get ahead of the curve. The baseline has changed quite a bit. A bit similar in hotels as well, because we're all experiencing that our room prices are higher. Good things for the industry, obviously. The services provided have gone down. This is helping the margins. This means less natural demand for what we're doing.

Our teams is and will be offering more services in order so to drive penetration of all we do for the lodging customers we have around the world in order to make sure that we keep growing in an industry that has changed a bit what they're offering for their guests. For perspective, the rooms sold are versus 2019 in North America up 8%, and our housekeeping business is up 18% for instance as well. Showing as well that we're gaining share. A lot needs to be done in an industry that has changed because guests demand has changed as well.

I like what the team is doing, so offering Ecolab Science Certified, which means offering the whole Ecolab offering to customers in order to make sure that their guests are safe and satisfied in a way that's reducing cost as well. We need to reduce our own cost as well at the same time, which is why we've announced this restructuring program in institutional that is done for the most part as well and is gonna pay off in the quarters to come. We're early on that journey, but I like what the team is doing in repositioning itself for a new industry, which I believe is gonna be better after that whole phase than it was even before.

Operator (participant)

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

John McNulty (Managing Director and Chemicals Analyst)

Yeah, thanks for taking my question. my question's on the global Healthcare and Life Sciences businesses. the, you know, the margins in the 3rd quarter were in the single digits. They spiked back up to mid-teens, and then again this quarter they're back down into the single digits. Can you help us to understand what's driving, you know, the big volatility that we've seen there over the past few quarters, in what I would assume is normally a pretty stable business? I guess to one of the points you brought up earlier, you indicated that you're looking to strengthen the core of the specific healthcare side of Healthcare and Life Sciences. I guess, can you, can you flush that out a little bit? Does that include potentially M&A, or is it really just internal self-help?

I guess, how should we think about that?

Christophe Beck (Chairman and CEO)

Good question, John. Healthcare life science, it's one group, but it's two very different businesses, as we both know. One is doing really well, Ecolab Life Science, the other one not so much. I've been very outspoken about my view on the performance of this business and my commitment to improve it. When you talk about volatility of earnings in healthcare, well we're talking about the small base, unfortunately. Small dollar variances have a big % of variances as well. It's kind of a good/bad problem, but it's still a problem that I have here. As mentioned before, healthcare is 5% of the company. I'm glad 95% of the company is doing quite well.

I wanna make sure that healthcare gets to a better place by driving the three things I mentioned before. The cost structure, making sure we refocus on our institutional-like business, speak infection prevention, and third, to your point, strengthening the core. Overall, healthcare is not gonna get bigger for the company in the years to come, to answer your question on the M&A piece. We will keep working on adding new offering, new expertise, new capability. I wanna make sure that the future is gonna be focused on a business that we truly understand, the business that we know how to make money, which is the closest to the in-institutional business, where you have kind of a dish machine at the core of what it is. More to come.

I will share with you, along the journey what we're doing and what we will be doing, but you will see, a change of performance in 2023.

Operator (participant)

Our next question comes from Shlomo Rosenbaum with Stifel. Please proceed with your question.

Shlomo Rosenbaum (Managing Director and Equity Research Analyst)

Hi, good afternoon.

Christophe Beck (Chairman and CEO)

Good afternoon, Shlomo.

Shlomo Rosenbaum (Managing Director and Equity Research Analyst)

Hey, Christophe, can you talk a little bit about whether you're seeing any tangible results yet from splitting the sales and services role within the institutional segment? That seems like a pretty big difference from the way you guys have operated from before. I'm not sure if it takes a while to see results, if you're actually seeing the results right now, you know, when you would expect to see a significant change. Maybe you could just flesh that out a little.

Christophe Beck (Chairman and CEO)

Yeah. Thank you, Shlomo. It's a, it's a change that we've initiated in 2021, if I remember right. It's been quite a while ago. It's something that we have been preparing very carefully. It's a large business. It's a successful business, in an industry that is changing and that will be changing in the future. It's combining a repositioning towards what our customers truly need while making sure that we're improving the performance of our overall business, and that's why we're doing that in a very careful, thoughtful, manner. Might be taking a bit more time than some would wish, but I wanna make absolutely sure that the institutional after that cycle is in a better place than it was pre-COVID or pre-cycle. This is my objective, number 1.

As mentioned before, when you look at the numbers I mentioned, on restaurant with traffic, in dining, so down 30% and our own sales up, so 12% versus 2019. Pre-cycle as well. Same on hotels, as mentioned before as well. It's showing that we're gaining share. At the same time, our margins are improving as well, in that business. The fact of splitting sales and service has reached or is reaching, because we're still on that path, our two objectives. The first one is to gain share, as mentioned before, so we did. Second is to reduce our cost because we have a service organization that is really organized in order to have the best performance in serving and servicing our customers.

When you look at the cost structure that we have in institutional, it's improving as well. We get both: gain share in our end markets and at the same time reduction of our cost structure that leads to better performance for the business. Work in progress, but I like a lot where we're going here.

Operator (participant)

Our next question comes from the line of Andrew Wittmann with Baird. Please proceed with your question.

Andrew Wittmann (Managing Director and Senior Research Analyst)

Great. Thanks for taking my question. I guess, Christophe, I had a question about the gross margin. You talked about you're targeting, getting back to the prior gross margins and eventually even exceeding that. I guess with, the business mix has changed over the recent years, certainly in the waning days of your energy ownership. You know, Purolite goes the opposite way. That was a very high margin, gross margin business.

Ryan Connors (Managing Director and Research Analyst)

I guess I don't know what the target gross margin to get back to the prior levels is and was hoping you could kind of clarify what that gross margin is that would be equivalent on today's mix of business to kind of where it was pre-inflation or pre-COVID, if you understand what I'm asking here?

Christophe Beck (Chairman and CEO)

I think so, Andy. What we said is that we wanna reach first, our 20% operating income margin, and we've been pretty clear of that. That's, that's where we wanna get to. The quicker the better, and that's not the sound barrier. Once we reach that, it's to keep going further after that. To your point, yes, job one is to recover the margins that we have lost over the past two years during this inflationary time. That's always been true. As you know, in the past, we get dollars first, we get margin second. It's lasted longer this time because inflation was way higher than what it used to be mentioning so earlier as well on that call.

27% in 2022 only, which adds to 20% as well, in 2021 of delivered product cost inflation, as well that we had to face as a company. While it's taking a bit more time because it's longer and deeper, but we will get back to where we used to be, and we will expand from there. The second thing or third thing is the business portfolio, as you mentioned. While on one hand, institutionals are was the most behind after COVID, just the fact of having institutional recovering will help our gross margin and operating income margin as well, as a company. That's an old business kind of performing better in the future. That's not a new thing.

On top of it, yes, you have businesses like Life Sciences that are above the average of the company that are growing fast as well at the same time. That's gonna help further. Overall, good pricing work, delivered product cost that hopefully is gonna ease, but I'm not expecting to turn negative anytime soon, and certainly not in 2023. Portfolio that's gonna keep improving. Innovation that's always above the company's average. Last but not least, so the new businesses like Life Sciences that are gonna contribute. We're gonna get back to where we used to be in terms of margin, and we will keep expanding from there in order to get to the 20% ROI margin I talked about.

Operator (participant)

Our next question comes from the line of Ryan Connors with Northcoast Research. Please proceed with your question.

Ryan Connors (Managing Director and Research Analyst)

Thank you. Good afternoon. I know you've indicated it's not necessarily a needle mover in the near term, but I wondered if you could give us any update on the rollout of The Home Depot initiative and how that's tracking relative to your expectations.

Christophe Beck (Chairman and CEO)

Great question. Thank you, Ryan. Yeah, it's not our biggest business, obviously, but it's quite a fascinating journey because we all see, obviously those products when we get to the stores of Home Depot. I hope, Ryan, that you participated as well. To our new venture here, it's been a great story over the last few months. It's early. We started in January. Home Depot had their market manager conference a month ago with 5,000 people. The number one innovation was our rollout of the Ecolab products that we do exclusively for them. It's a big deal for the Home Depot, and it's an interesting deal for us. We take it extremely seriously.

We have a great team, after it. We're doing it very thoughtfully. We're trying to learn as much as we can, what the consumers, what the pros, since it's the main focus of that whole business, are looking for as well. Far, so good. Every week we track the progress, and it's been a remarkable progress week after week without disclosing numbers, that need to be Home Depot's numbers, obviously here. I like where we're going. It's not gonna move the needle for the company, in 2023. Down the road, I think it's gonna be a nice growth engine for the company.

Operator (participant)

Our next question comes from the line of Laurence Alexander with Jefferies. Please proceed with your question.

Laurence Alexander (Equity Analyst)

Good afternoon. Just to follow up on your discussion around, sort of the pricing environment, particularly in a more inflationary environment. As you've done experiments around the world, do you get a sense that your ability to take share and your pricing initiatives have kind of a linear relationship, or is there kind of a nonlinear kind of break point where if you push too hard, the share gains really deflate very quickly? Just give me a sense for how you see the customer psychology playing out based on what you've seen over the last couple of years.

Christophe Beck (Chairman and CEO)

We haven't felt any elasticity issue, which is a good news. The reason why is because our focus is really making sure that at the end of the day, the customer is better off. Even if it takes us more time, more effort to get to the right place, we want to do it in a way that we can keep the customer for life, which is the mantra that we have in our company. It's not to win a quarter, it's to win a lifetime together with our customers, and many of them we've had for decades, as you know as well. We start focused on creating even more value for customers.

Honestly, we've discovered ultimately value that we've been creating for customers that we've not been merchandising as well as we should have in the past because pricing was not such a big deal in the past. It has been an argument in order so to get a bigger share of what we were creating as well, but always making sure that the return for the customer remains very strong. This ROI of 25% return for the customer is our mantra. It's not always the same for every customer everywhere around the world, but it's showing that it's pretty high from a return perspective. This is good for us, this is good for the customer, and ultimately it's good for our share gains as well.

When customers get better outcomes, both from a product perspective and from a performance perspective as well while reducing their impact on the environment, well, they want to buy more. This is helping us as well gain further share. Overall, I think it's been a very positive journey for everyone. It's been a learning process, and it's always a painful process to learn. At the end of the day, it's been good for everyone.

Operator (participant)

Our next question comes from the line of Kevin McCarthy with Vertical Research. Please proceed with your question.

Kevin McCarthy (Partner and Equity Research Analyst)

Yes. Good afternoon. Christophe, would you comment on your volume experience in the life sciences business in the quarter, as well as what you think it might be for the year? The reason I ask is on slide number 10, you cite sales growth of 10%, including robust pricing, which seems to imply there wasn't as much volume, and I found that to be counterintuitive following the capacity expansions you've done in the U.S. and U.K. Just wondering if there's anything anomalous there with regard to, you know, the comparison or customer behavior, if you could help us put that in context. Thank you.

Christophe Beck (Chairman and CEO)

No, in general, it's been a very good story. It's not gonna be every quarter the same because in life science, obviously we're half is our Purolite business. We're building new foundations. We're expanding the capacity as you mentioned before. We're investing as well in the team. That requires time to do it very thoughtfully. When I look at the capacity built, we exactly on schedule. It's going really well. We're learning while we're doing it, but for the most part, it's going well. When I look at the whole new business generation, good progress being made here as well at the same time and driving it towards customers. Take time for us to do it really, really well.

We had as well that shift obviously, so from pricing to new business, which impacted as well, life sciences, good on margin, and it's a shift that's required in order to get more volume going forward. The stars are aligning very nicely in this overall life science business. I like a lot where we're going long term. It's not gonna be every quarter the same as mentioned a little bit early on, but the trajectory very good, very promising, and we're gonna do that really well.

Operator (participant)

Our next question comes from the line of Steve Byrne with Bank of America. Please proceed with your question.

Steve Byrne (Managing Director and Senior Chemicals Analyst)

Yes. Thank you. To what do you attribute the primary driver of the new business wins in water? And I say that not, you know, not discarding the effort that your sales force is putting in, but is this, you know, new customers or is this expanded treatment for existing customers? Is there something particularly driving it, such as, you know, increased regulatory or legal scrutiny on your customers?

Christophe Beck (Chairman and CEO)

Yes, Steve. It's mainly 3 things, and some of those you've just mentioned, obviously. A good business doing really well, and that keeps improving. A very good story. It is the leading water business in the world. Enjoying a very special situation in the industry even though we're small versus the whole market that we're serving. The 3 main drivers of growth. The first one is we're trying to focus as much as we can towards the end market that are growing the fastest. When we think about data centers, for instance, people don't think data centers mean a lot of water.

They use huge amount of water, and that's driven by cloud consumption, obviously by the high-tech companies. They've all made commitments to get to net zero in the foreseeable future for the most part in 2030. That's growing fast because the industry is growing fast. At the same time, they're trying so to get less water consumption. That's a double win for us. Think about microelectronics as well. Require a lot of ultra-pure water, it's a fantastic business. For us, while that's driving growth as well at the same time, it can be as well, more traditional businesses like mining, as I mentioned before as well, huge amount of water that's being required.

We've shifted years back, away, thank God, from the coal business towards fertilizers and premium high-tech materials, like copper and nickel, all related to renewable EV technology. Well, that's driving very nice growth as well. We have first and foremost an end market focus that's helping us drive growth. The second is most of our customers have made commitments in terms of carbon and water, and they all have, or most of them have a hard time. To get to their commitment, we are best positioned to help them get to where they want to be the right way, which means while saving money as well at the same time. We don't believe in the green premium. We believe in the green benefit. That's the way we're partnering with our customers.

Well, that's driving more demand for what we're doing. Last but not least is innovation. We keep innovating in our water business in a remarkable way, especially on the digital front, which is high margin, by the way. It's something that's connecting our customers as well, increases the stickiness as well of the relationship, but all for the right reasons, obviously. If you think in terms of end markets, in terms of what we do for customers to reach the sustainable commitments and third, innovation, well, those are the three main drivers for our water success.

Operator (participant)

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

Vincent Andrews (Managing Director and Senior Equity Analyst)

Thank you. Christophe, I just wanted to follow up on Delivered Product Costs. I heard you earlier in the call say that they would be up for all of 2023, and I'm wondering if you can just disaggregate them a little bit. I believe there's some labor included in your Delivered Product Cost as well as freight. I'm assuming labor is up. Freight, I would think would be down, and I know you buy 10,000 raw materials, but I would think as we move through this year, shouldn't we be heading into a deflationary environment for your actual raw materials, or do I have this wrong?

Christophe Beck (Chairman and CEO)

A few elements, Vincent, here. Labor is not in delivered product cost for us, so that's outside those numbers that we've always been talking about and that I've been talking about as well. Just maybe a comment on labor and wages. I feel really good with how we've been able to manage that. The fact that we've had very high retention of our team has helped us as well keep our labor cost within a good framework ultimately. Driven by the digital automation, as mentioned before, we managed to drive the productivity that you've seen as well in our numbers. On the labor side and wages, I feel really good.

When we talk about the delivered product cost, which is ultimately, raw materials, freight/logistics, and technology, dispensing equipment and all that we are bringing to our customers as well, that's what we mean with delivered product costs and that you see in our numbers that represent roughly a third of our sales. Overall, I wish you were right, Vincent, that it would turn negative. It will not in 2023. The question is only, how much is it gonna ease? As mentioned a little bit earlier on the call, we had an overall increase of delivered product cost of 27% in 2022.

We had a further increase of 9% in the 1st quarter of this year, so better than the increases we've seen in the past, but still an increase. I hope that in the next 2 quarters, this rate of increase will ease. We do not expect that it's gonna cross the 0 line to become negative in the quarters to come. Well, when it comes, and if it comes earlier, Vincent, we'll take it, but this is not what we're seeing right now.

Operator (participant)

Our next question comes from the line of Scott Schneeberger with Oppenheimer. Please proceed with your question.

Scott Schneeberger (Managing Director and Senior Analyst)

Thanks very much. Good afternoon, Christophe. I think, let's go to the pest category. 1 segment, 2 questions. The momentum's been really, really strong there. We've seen margin expansion. Some of the reference in the releases is about innovation and competitive advantages. I was hoping you can elaborate on that a little bit. The second part of the question is, it was cited unfavorable mix was one of the headwinds in the segment. I'm just curious, if you could share a little bit about what that means. Thank you.

Christophe Beck (Chairman and CEO)

Hey, thank you, Scott. You know that the other segment is a little bit of a weird combination of things because you have our pest elimination business, we have our textile care business in there, and we have our Colloidal Technologies business. Three businesses, sorry, that have nothing to do together, but that are all part of one same segment, for simplicity reasons. When we talk about the mix, it's the growth mix of those three businesses that are very different. Colloidal is very related to microelectronics. Which is very different than what we do in textile, which is very different than what we do in pest elimination. The biggest business by far in that segment is pest elimination, which is doing extremely well.

It's an unbelievable team with great positions on the market. They delivered 14% growth globally, 19% in North America. That's been a great journey over the past few years. It's true today. It's gonna be true tomorrow. The big reason for that, as mentioned, great team, great position in a few markets where we have very good strong positions. We are very focused on commercial, so we have no residential business, as you probably know as well in there. A very pure play in what we're doing here. In terms of innovation, well, without going too much in detail here, we have millions of traps that we need to serve, obviously, in the world in order to get the job done well.

You can imagine that there's a lot that we could automate in here with the vast capabilities that we have in digital in the company. That's a primary area where we could improve the work we do and making sure that we send our teams where there is truly something to do and not just to go and check in places not knowing if there is some pest activity as well in that location. Combining the two, a great business, great performance, great positions with the innovation, especially in digital capabilities that we have, I think the test is of not only a great year, but an even better future result that's being done. A good contributor of the performance of the company, so for 2023.

Operator (participant)

Mr. Hedberg, there are no further questions at this time, and I would like to turn the floor back over to you for closing comments.

Andy Hedberg (VP of Investor Relations)

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

Operator (participant)

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.