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Executives

Bradley Bell - Chief Financial Officer, Executive Vice President and Treasurer

J. Fyrwald - Chairman, Chief Executive Officer and President

Mike Bushman - Investor Relations

Analysts

Richard Hoss - Roth Capital Partners, LLC

Anthony Pettinari - Citi

Bill Hoffman - UBS

Michael Harrison - First Analysis

Mark Gulley - Soleil Securities Group, Inc.

Daniel Rohr

David Rose - Wedbush Securities Inc.

Chip Moore - Canaccord Adams

Brian Drab - William Blair & Company L.L.C.

Richard Eastman - Robert W. Baird & Co. Incorporated

Laurence Alexander - Jefferies & Company, Inc.

Tracy Marshbanks

Nalco Holdin (NLC) Q1 2010 Earnings Call April 28, 2010 10:00 AM ET

Operator

Good day, everyone, and welcome to the First Quarter 2010 Earnings Call hosted by Nalco Company.[Operator Instructions] At this time, I would like to turn the call over to the division Vice President for Communications and Investor Relations of Nalco, Mr. Mike Bushman.

Mike Bushman

Good morning. Thank you for joining us for our conference call to discuss the first quarter of 2010 results. Speaking today will be Chairman and CEO, Eric Fyrwald; and Executive VP and, CFO Brad Bell. Some of the information discussed today constitutes forward-looking statements that are subject to risks and uncertainties. Our statements describing the risks associated with forward-looking information is found on our website and on our press release which may also be found at nalco.com. Further background on our risks is available on our 10-K.

The information discussed today will include data that does not conform to Generally Accepted Accounting Principles. Management believes the presentation of non-GAAP measures such as EBITDA, adjusted EBITDA, adjusted EPS and adjusted effective income tax rate and free cash flow provide investors with additional insights into the ongoing performance of our operations. I would point out that the current definition of adjusted EBITDA contains fewer adjustments than what we've previously reported as adjusted EBITDA. A five-year historical view of our new narrower definition of adjusted EBITDA is contained in the financial fact book available through the Investor Relations reports section of our website.

The company schedules for reconciliation of non-GAAP measures used in our first quarter earnings to the closest GAAP equivalent have been provided as attachments to our earnings release. After comments from Mr. Fyrwald and Mr. Bell, we will open the call to questions. In order to allow for as many participants as possible to ask questions, we will ask that participants restrict themselves to one question with a clarification follow up if necessary. We'll then ask participants requeue in order to ask additional questions. And we'll start with Mr. Fyrwald.

J. Fyrwald

Thanks, Mike. After the financial crisis challenges of 2009, it feels good to start to see the recovery taking hold in many markets; and combined with the impact of our growth strategies, see Nalco return to growth. I also believe that there is potential for continued flow of end market improvement as we go through the year that will add opportunities to our ongoing business challenges and help us increase growth.

Several market trends continue to line up with our business strategy. First, stressed water resources in many parts of the world will be further strained as industrial demand recovers. Our world-leading water expertise makes us a focal point in helping industry increase water recycle rates, a key capability since the most water-stressed regions of the world are now delivering the fastest economic growth.

As energy costs rise, Nalco's ability to support oil and gas production increases in value as energy customers pursue harder-to-reach resources. We expect continued good growth in deep water, oil sands and other difficult oil and gas productions.

Now other environmental challenges, such as climate change and water quality, will return to the forefront in the coming years as economies turn up increased attention to quality of life concerns. Heading into the difficult environment we faced in 2009, it was clear that we needed to accelerate Nalco's productivity. We did this, putting in place capability to deliver ongoing efficiency improvements and generated $122 million in permanent productivity savings and $38 million in one time savings. We set a $100 million permanent productivity target this year and are off to a good start with $28 million achieved in the first quarter.

This step change in our ability to drive productivity allowed us to invest in growth in the right places through last year. We added 180 people in China and India as part of our BRIC+ strategy. We continue to improve our technical training and add it to our R&D investment. We knew this was the right thing to do and we continue to add resources in growth areas again this year, and our efforts are beginning to deliver a solid first quarter performance.

First quarter sales increased 10% nominally compared to the first quarter of 2009 including 4% organic growth and a 1% sales increase due to acquisition. The remaining improvement was due to year-on-year currency effect. All three segments delivered organic revenue increases. In the BRIC+ countries, our nominal growth was more than 40%, clearly showing the benefits of our growth strategy.

Paper Services led our growth with organic sales up 8% behind rapid growth in Asia and near double-digit increases in North America. Our PARETO mixing technology that saves energy and water is just one of the programs attracting new business.

Water Services overcame a steep drop in the Air Protection business related to regulatory lapses in the U.S. to increase total global sales 4% organically on significant recovery in mining, primary metals and manufacturing markets, and ongoing performance improvement in food and beverage. Solid growth in Asia, Europe and Latin America was partially offset by continued weakness in North America that was due to the air protection decline.

Energy Services sales increased 2% organically despite a very difficult refinery market in North America and Western Europe. And price pressures across the Energy Services business tied to what had been lower raw material costs.

Now we did turn the corner in the Adomite business in the quarter growing not just with year-on-year gain in rig count, but also the results in our strategy to expand our customer base into additional geographies. Our Adomite business growth in Asia and the Middle East is now contributing nicely to global results.

From a regional perspective, organic sales increased 11% in Asia, 8% in Europe and 4% Latin America while declining a disappointing 1% in North America. Excluding the large decline in downstream refining and air protection, our North America organic revenue increased 4%. Importantly, direct contribution margins improved in all three segments, with particularly significant margin gains in Water and Paper. Business growth and productivity gains were the key elements of this margin expansion in each business. As you may recall, we encouraged significant volume variance charges in the early part of last year. Combining growth with the plant closings we implemented last year helped overcall this negative. In addition, the 30% reduction in product line by eliminating older products is resulting in our internal supply chain operations working more cost effectively.

Also our best technology does the most for customers and helps to contribute to margin improvement for us. Including for technologies such as 3D TRASAR automation. After selling 503 3D TRASAR cooling units in the first quarter of last year, we sold nearly 800 in the first quarter of 2010. We are aggressively focused on both converting the roughly half of existing customers not yet using 3D TRASAR over to our best technology and on using the significant total operating cost and environmental benefits of this program to win new customers. New technologies also are contributing to margin gains in Paper and Energy. In downstream energy, for example, we have had a very good start our 3D Boiler technology launch.

Adjusted EBITDA increased 20% compared to the prior year period and at $164 million was back above the pre-recession 2008 first quarter level of $157 million and was a Nalco first quarter record. Adjusted EPS increased 82% to $0.31 from $0.17 in the prior year quarter. Brad will give you more details on the adjustment items.

Now free cash flow was one area where we did not show improvement from the prior year, as we expected with the return to growth. Our regions delivered improvement in receivable and inventory days from the prior year period, but most of the days were higher than our outstanding 2009 year end achievement. We continue to make progress strengthening our working capital management processes and fully expect every business in every region to show days receivable and inventory improvements by the year end 2010 from the year end 2009 levels.

Now because our business mix is shifting towards countries with historically higher receivable and inventory levels, this may not net to overall days improvement on a company-wide basis. Given our growth expectations, this means working capital is expected to be a use of cash in 2010. However, having said this, we remain fully committed to deliver more than $100 million in free cash flow for the full year.

Now we are pleased, but never satisfied with our recent results, and are very excited about how we are strengthening for an even brighter future for Nalco. However, there are still challenges to navigate. Broad economic growth remains uncertain and raw material cost increases force us to seek price improvements. We are confident, however, that we can continue to drive growth as new technology we are bringing to the market continues to increase the return on investment we deliver to our customers by saving water and energy, preventing maintenance shutdowns, improving product quality and helping increase the amount of oil and gas productions among the other benefits we bring.

We continue to forecast growth through the year with organic revenues expected to increase at a mid single-digit rate. Adjusted EBITDA is now expected to exceed $710 million for the year and with an improving tax rate contributing to an adjusted EPS target of more than $1.30. Productivity targets remain at $100 million. Working capital tied to growth has already become a use of cash and capital expenditures will increase from the 2009's depressed level, including increases in automation and other high return investments in our customers. But as I said, we are committed to exceeding $100 million free cash flow for the year.

With first quarter behind us, our confidence that we will be able to deliver against our objectives is higher. And with those remarks, let me turn the call over to Brad to discuss our financial results in more detail. Brad?

Bradley Bell

Thanks, Eric. As Eric mentioned, our sales growth was very strong led by the BRIC+ strategy that we instituted beginning in 2008, and continued to fund through the difficult economies of last year. More broadly, Asia was the first to show the beginnings of recovery and led our organic growth with 11% followed by Europe, Africa and the Middle East of 8%, Latin America at 4% and finally, North America, at negative 1% on the weak refinery conditions and the regulatory hiatus that stalled Mobotec's domestic progress.

Earnings growth was also led outside of North America with Europe and Asia making particularly strong year-on-year gains. Driving leverage into our operations is an important component of our productivity efforts which created $28 million in additional permanent cost take out in the first quarter compared to the year ago period. The benefits of this leverage was felt throughout our P&L in including helping to achieve 46.2% gross margins that were fully 260 basis points ahead of the 43.6% achieved in the prior year period.

Direct contribution margins also grew nicely compared to the prior year period, with sales and margin contributions in all three segments and a consolidated gain of 310 basis points from last year's first quarter to 20.4%.

Paper Services sales led the company, growing 8% organically and 13% nominally. Direct contribution margins were up 450 basis points from the prior year level, a nice recovery from the heavily recession impact in year ago period. However, this DC margin is down quite a bit sequentially from fourth quarter 2009 levels due to increases in bad debt provisions, incurrence of annual sales meeting charges and other costs. We believe the team is doing a great job managing ongoing raw material costs and price pressures helped by very solid growth in several markets.

Water Services organic growth of 4% was 13% nominally as the water business has the most geographically dispersed exposure of our businesses. Direct contribution margin at 19.9% was down only slightly from the fourth quarter 2009 levels and up 460 basis points from the first quarter of 2009. Going forward, continued growth will be necessary to help offset raw material cost pressures.

Energy Services organic sales growth of 2% was 6% nominally. At 22.7%, direct contribution margins were up 100 basis points from the prior year and held flat with strong year end numbers despite the price pressures being felt in the business. Productivity gains and new technology rollouts are particularly critical to success in the markets.

Administrative costs in the quarter were higher than year ago levels, rising $11.6 million on increased consulting tied to our productivity efforts costs and to higher incentive pay accruals. Admin costs were down only slightly on a sequential basis. We expect these consulting costs will be with us for sometime in the admin line. But as already noted, we are seeing benefits in strong productivity results across the company around the world.

Looking at the bottom line, you will see that we've adjusted our reported profitability in the first quarter for three items: First, the January devaluation event in Venezuela which impacted EBITDA by $18.4 million and EPS by $0.10. Effective January 1 of this year, the Venezuelan economy was designated as highly inflationary under U.S. GAAP accounting rules since it had experienced the rate of general inflation exceeding 100% over the most recent three-year period. As such, the functional currency for our operations there must now be the U.S. dollar and all gains and losses resulting from remeasurement from local financial statements are recorded through the P&L.

In January, the Venezuelan government announced the devaluation of the bolivar and the establishment of a rather complicated two-tier exchange structure. The official rate change from 2.15 to the U.S. dollar to 2.6 for the importation of essential items and 4.30 for everything else. At the time we discussed our earnings for last year's fourth quarter, we indicated the devaluation action prompted a one-time charge estimated at $0.07 a share which we've now determined to be the $0.10 number I shared. The difference is driven by our requirements to write down the value deferred taxes and by the fact we repatriated less money in the first quarter in the quarter than had been anticipated.

We do not anticipate any further significant impacts from this devaluation as we are modifying our business practices in the contracts to reflect the new realities in the country, which include a fair amount of our business activity being considered essential, and being conducted at the preferential exchange rate. Also hitting our P&L was additional restructuring, primarily in Europe, affecting EBITDA by $1.5 million and EPS by $0.01.

Lastly, we, like others, had to record the impact of the recent tax law change eliminating the deductibility of Medicare Part D subsidies. Fortunately, it's a relatively small item for us in comparison to some of what we have been seeing. But being a tax event alone, the write-down of deferred tax assets in the amount of $2.6 million, it is neutral to EBITDA but affects EPS by $0.02.

Adjusting for these items, EBITDA then becomes $164.1 million, a gain of more than 20% relative to the same period last year and nice pullthrough on incremental revenues. Aided by the anticipated reduction to our tax rate, 34% in the quarter before the aforementioned items, adjusted EPS became $0.31 versus last year's comparable $0.17 or a gain of 82%. This reconciliation back to the $0.18 earnings per share figure on an as reported basis is included in Attachment 7 to our earnings release. Attachment 8 provides a reconciliation back to the effective tax rate of 45.3% reported overall as both the devaluation and the restructuring provided little in the way of tax recovery while the Medicare Part D charge was a tax-only adjustment. We continue to believe that our tax rate for the full year 2010 will approximate 35%.

As mentioned, free cash flow was negative in the quarter as operating working capital turned from being a $100 million source of cash in the year ago quarter to a $44 million use of cash in this period. The $28 million build in inventory reflecting the normal increase we would see this time of year.

Accounts receivable consumed $23 million with a global DSO number up two days on growth. As Eric mentioned, our focus is on maintaining DSO performance and continuing to improve inventory days in each region, though working capital can be expected to be a use of cash in an amount that will depend in part on the pace of economic recovery around the globe.

Next, at $27 million, capital expenditures increased by $8 million in the quarter compared to the prior year period, driven largely by faster growth of 3D TRASAR technology and other automation technology sales.

Lastly, uses of cash included our 9% senior discount notes which were still operating as payments in kind notes in the first quarter of last year. They converted to cash pay with semi-annual interest payment made last August with the second such payment in Q1 of this year. This consumes $20 million in cash compared to Q1 2009. As mentioned earlier in the call, we don't see any reason why free cash flow shouldn't exceed $100 million this year even with continued investments for ongoing growth.

I'll close with a couple of comments on the financing front. We have two due debt maturities of any size this year. Our $160 million ABS, or accounts receivable backed facility, from 2007 matures in June and we have already negotiated a replacement done for another three years, as markets continue to be receptive to higher quality names like Nalco. The new facility now carries a slightly higher spread given where markets are today versus three years ago, but the incremental interest expense amounts to less than $2 million on a fully drawn basis.

Next, before November, we will have to retire the $150 million remaining outstanding under our old 2003 Term Loan B. Sadly, I'll add, for these carry a spread of just 175 basis points over LIBOR. On the other hand, we see very healthy conditions in the high yield markets and you see our notes issued in November trading with yields less than 7%. This can present opportunities to address higher coupon debt currently on our books, bringing down interest expense.

With that, let's move to your questions. Can I turn this back to Cynthia?

Question-and-Answer Session

Operator

[Operator Instructions] We will take our first question from John Quealy with Canaccord Adams.

Chip Moore - Canaccord Adams

This is actually Chip for John. Talking about some of the growth initiatives, you mentioned some of the traction you're seeing with boiler automation on the downstream side. Maybe you can provide some color there?

J. Fyrwald

One of our 3D TRASAR last year in other markets, but we waited until beginning of this year to launch in the Energy Services downstream market because we have to have additional requirements for that use. We have those units built. We piloted them last year. They were very successful and we've launched early this year, broadly, in the downstream markets and the receptivity has been very strong. The performance of the units has been outstanding. And what I would say is the demand going forward looks very strong.

Chip Moore - Canaccord Adams

On the BRIC+ growth, very good. Can you provide some additional detail on specific geographies?

J. Fyrwald

Just a few points here. Russia was very strong, coming off of depressed levels. China, up more than 30%. India, Brazil up more than 20%. So very strong growth across all of the BRIC+ geographies. We didn't see any areas of anything but strong double-digit growth.

Operator

We will take our next question from Mark Gulley with Soleil.

Mark Gulley - Soleil Securities Group, Inc.

First question is regards to price increases, Erik, you touched on and so did Brad. What kind of price increases do you think you're going to need given raw material increases particularly on the energy side? And Brad, when you talked about this, you talked about growth initiatives necessary to offset raw's increases. Is that suggesting that perhaps you don't think the customers will be receptive to pricing?

J. Fyrwald

Let me talk about the energy side and roughly 30% of our energy business is already built in a price adjustments with raw material changes. The other 70% and the rest of our business that isn't built in price adjustments. Our sales organization, our marketing organization is well aware of the raw material increases that we see coming and have built that into our plans. And we believe that we will be able to, through the year, cover those increases. So we've been through this and higher increases in the past few years and are well prepared.

Mark Gulley - Soleil Securities Group, Inc.

The way you answer that question, it sounds like there'll be the traditional lag of about a quarter in terms of getting that?

Bradley Bell

There can be, Mark. This is Brad. Again, the indexing is probably a little broader than it was back in 2005 when we really had to hit this hard for what might have been since the first time in a lot of memories. I think the technology aspects that Erik cited earlier also make it a better conversation without the customers. We're bringing them value. They understand that. Obviously, it's easier when your customers are doing well, which is not a good descriptor of the refining space right now. But both sides of the table have a vested interest in seeing something accomplished here. And they've recognized the value that we're showing them.

J. Fyrwald

And the rate of run-up of the oil prices has not been as steep as it was a few years ago. Plus the amount of 3D TRASAR we now have embedded in the marketplace has increased substantially, which is very helpful for our margins.

Mark Gulley - Soleil Securities Group, Inc.

With low natural gas prices, rig count is down in the U.S. Is that a factor behind some of the weakness in the energy side or are you mainly focused customer based, mainly focused on the oil side as opposed to natural gas?

J. Fyrwald

Well, we're seeing rig count begin to climb in natural gas. So that's starting to be a positive. In addition to that, we've expanded beyond the U.S. natural gas focus for our Adomite business and started to gain traction there. We actually see that starting to be a positive and think that that will continue through the year.

Operator

We'll take our next question from Brian Drab with William Blair.

Brian Drab - William Blair & Company L.L.C.

My first question's for Brad. Brad, you touched on, just at the end of your comments, regarding the maturity of the previous Term Loan B, the first Term Loan B, and LIBOR plus 175. I'm looking at your 10-K at $167 million out on that at the end of 2009. Can you just talk through the details of that again and give us more insight as to how you're going to roll that over later this year and what the difference in the interest rates could be between what it is now and what it would be?

Bradley Bell

It was $167 million remaining from the refinancing we did last year. It is at LIBOR plus 175. This the old 2003 instrument. There's 150 outstanding right now. We paid some down with surplus cash, this is part of the cash sweep requirements of that old facility. We just have to put that in the stack against what we'll do with free cash flow generated in the course of the year. I will tell you that if you're looking at the leveraged loan in the high yield markets right now, they are setting record levels of issuance, much of which is refinancing activity, both here and in Europe. We like the levels that we're being shown. We think we've got some opportunities to refinance appropriately over the course of the year and we're looking at various permutations of that right now. I think if you want to recreate that instrument in kind, you would be probably in the 200 kind of spread. You wouldn't need a LIBOR floor for -- the increase over that piece won't be huge and the more interesting comparison is what could be done today versus what's on the books elsewhere in the balance sheet.

Brian Drab - William Blair & Company L.L.C.

On the Energy business, you talked last quarter about a large order. I believe it's in the Oil Services business, an order of maybe $20 million in revenue. Can you talk about the timing of that order and if that's been delivered at this point?

J. Fyrwald

Yes, that was a start up for a unit that's going to continue to operate. It did not happen in the first quarter. We do think it's going to happen between the second and the third quarter. But we'll let you know after that's happened. The project itself is still going to start up.

Brian Drab - William Blair & Company L.L.C.

Between second and third quarter, meaning it might spread across the two quarters?

J. Fyrwald

Right.

Operator

We will take our next question from P.J. Juvekar with Citi.

Anthony Pettinari - Citi

This is Anthony Pettinari standing in for P.J. I had question on European restructuring. I was wondering if you could give us a view on where your European margins where in 1Q versus company averages. And maybe more broadly, if you could talk about how far along you are in rationalizing the European salesforce and footprint and when you realize benefits from that?

J. Fyrwald

So the European margins are attractive and I would say up there with a corporate average, the salesforce rationalization has been completed. We'll continue to look to optimize how we deploy our salesforce in Europe to the growth markets, geographies and growth segments. The manufacturing, several of those rationalizations have occurred. We still have some additional manufacturing work to do, but largely complete. Now we're looking at how do we continue to just streamline our processes and operations in Europe to better serve our salesforce, to better serve our customers. And we continue to work on that and I think we'll continue to make progress with our goal being to be very strong Europe and be able to take full advantage of our capabilities and grow market share. We do have some consulting work being done in Europe that Brad referred to in the admin cost increase for the quarter, to help us be able to better streamline and standardized how our processes operate Europe, again to better serve customers. And I think that help will allow us to do this without any disruption, as we've seen in the past, to our customers, our sales organization. In fact, it's going to enhance our performance. And the changes that we will make will include relocating a small senior management team to Switzerland in Europe.

Anthony Pettinari - Citi

Would you anticipate taking any further restructuring charges in 2010 on Europe?

J. Fyrwald

There may be some small charges here and there across the world but nothing major anticipated.

Bradley Bell

I think if you look back in 2009, the big restructuring charges we did there were footprint-related, were essentially aimed at the steps being taken in Europe. So the vast bulk of this is well behind us.

Anthony Pettinari - Citi

A follow-up on China. One of your big initiatives in China has been going after the state-owned enterprises rather then just export-oriented Western companies. I was wondering if you could give us an update, if you've seen any, kind of, contract wins with the SOEs? Or just generally, how that process is going?

J. Fyrwald

We really stepped up that effort about a year ago now. And the way I would describe it is the first six months were building the relationships, opening doors, starting to get through those doors. The last six months have been starting to get projects, formulated and we've got a good project pipeline. And we have seen some successes with closed business. And we're making progress. So I feel very good about it. As I said, the China sales in the first quarter were up 30%. I think that's ahead of even the very aggressive industrial growth we're seeing in China. So our position is increasing. And we're excited about it. So, good progress. More benefits to come in the coming quarters and years.

Operator

We'll take our next question from Mike Harrison with First Analysis.

Michael Harrison - First Analysis

This is Tracy Marshbanks sitting in for Mike Questions on refining in North America. Obviously, we're moving into the gasoline season so I assume sequentially things improved a bit. But what's your outlook? Your customers' outlook for the rest of the year? And how are you managing and planning your business based upon that?

J. Fyrwald

It's still a tough environment. The summer driving season is coming so that should begin to increase volumes. But I think that the refining companies are continuing to look at their assets and say, "What's the demand out in the future?" Industrial recovery, trucking, shipping, all of that, if the economy continues to strengthen and the U.S. will be positive, but off of a very challenging period. So we are not looking for any significant recovery in downstream in North America. We continue to work diligently to expand our position and grow with the market in the growth geographies to offset the declines in North America and Europe. But overall, it's a challenging market in downstream.

Tracy Marshbanks

As a follow-up, your Energy business, you actually -- in spite of North American refining, showed some pretty nice margins. What's your view of a reasonable and sustainable margin in that business if we, sort of, get back to business as usual if that exists anymore?

J. Fyrwald

I think we're going to continue to work to bring new technologies. You talked about 3D TRASAR. In downstream, we've got new low-dose hydrate inhibitors. We've got some green retarder chemistries that we've launched and a number of other chemistry products. EOR, enhanced oil recovery and our BrightWater technology is really starting to ramp off of a small base but exciting growth there. And more and more projects coming on to the plans for the coming quarters. So I think driving the new technology is our approach and winning new CapEx with new technology is our approach to maintaining high margins in that business. And we're optimistic about the growth certainly in OFC, the upstream towards the last half of the year. Continued growth in enhanced oil recovery and continued strengthening in our Adomite business, offsetting the challenges in downstream.

Operator

We'll take our next question from Laurence Alexander with Jefferies & Company.

Laurence Alexander - Jefferies & Company, Inc.

First question I have is just about your European exposure. Could you break it out in terms of how much is the Northern countries versus the Mediterranean?

Bradley Bell

Western Europe out of European operations has been about 26%, 27% of sales on total company basis. Almost 20% of that would be in, kind of, the Western European region. So significant growth opportunities in the Middle East and Africa. But we haven't broken out between Northern and Southern Europe.

J. Fyrwald

But the Russia, the Middle East, the Caspian and parts of Africa are part of our BRIC+ numbers. So obviously, the growth was very strong in those markets in the first quarter. I would also add that we've launched our joint venture that we described in the last call in South Africa. And it's off to a very good start. So we're optimistic about the contributions of South Africa and then Sub-Saharan Africa mining opportunities from that to contribute in the second half of this year. But certainly much more significantly in the coming years.

Laurence Alexander - Jefferies & Company, Inc.

And as you look at the year-over-year growth, and I'm thinking both in the Energy Services and in the Paper business, do you have any sense for how much of that might be ascribed to market share gains?

J. Fyrwald

Well, the way I would say it is, we are growing with the economy recovering. And we are growing our market share with our new technologies in Energy Services, Paper and Water. I don't have a specific number for you. That's something we look at, at the end of every year. In some areas, it's challenging to calculate but we are gaining position and particularly in the BRIC+ countries where we've put a lot of horsepower. And we expect to continue to do that.

Laurence Alexander - Jefferies & Company, Inc.

Lastly, just a clarification on the outlook commentary. The increase to the outlook seems to suggest that -- are you trying to suggest by moving outlook up by as much as you did, that there's a slowing in momentum in the rest of the year after the three solid Q1 results?

J. Fyrwald

No. I think that there remains some significant uncertainty in some of the markets. But we are feeling more confident about the full year. And I expect us to be able to continue to build on the first quarter performance and have a very solid year. But we're going to make sure that as we increase our outlook, as we have increased our outlook, we're giving you numbers that we are confident and committed to delivering.

Operator

We will take our next question from David Rose with Wedbush Securities.

David Rose - Wedbush Securities Inc.

The first is if you can provide a little bit more guidance on the quarterly tax work as we go through the rest of the year? What rate should we expect in Q2, 3 and 4?

Bradley Bell

David, this is Brad. Again, we said we expect our full year rate to approximate 35%. The friction that we faced in 2009 around valuation allowances, et cetera, is behind us. And as we get through the year, the impacts of things, like Venezuela and Medicare Part D just get diluted down by higher pre-tax income earned in the later quarters. So we would expect to be showing that 35%-ish kind of rate on adjusted EPS. And I don't have of any other adjustments for the ensuing periods.

David Rose - Wedbush Securities Inc.

So then I can assume that we just take the weighted average from the first quarter assuming that there are no adjustments in the second, third and fourth, to come up with a year on tax rate of 35%?

Bradley Bell

Correct.

David Rose - Wedbush Securities Inc.

On the SG&A side, you indicated -- and clearly, I understand. With an upside on the sales side, you made some accruals for performance accruals. Are these accruals, what you see is forecasting for the rest of the year? Or should we see additional accruals in the second, third and fourth above and beyond what we have seen in the first quarter?

J. Fyrwald

I think we are anticipating continued solid performance through the year and are accruing on that basis. If the performance of the company should go farther, the accruals will increase but they'll be more than paying for themselves.

David Rose - Wedbush Securities Inc.

So if we saw a similar increase -- because your performance are based on cash flow off income in sales, if we saw a similar increase in off income and sales, then we should not see an increase in accruals but it would be at the same rate. Is that fair?

J. Fyrwald

Yes, that's fair.

David Rose - Wedbush Securities Inc.

In a boiler, 3D TRASAR, with respect to the boiler market -- and actually, just not the boiler market but 3D TRASAR as a whole, I've noticed a little bit more activity in the muni market. Is this an area that you're emphasizing more? I understand there's a bit more on the West Coast, some activity there. Is this something that we should internationally? Or is there something that's just very small at this point?

J. Fyrwald

I think it's smaller a niche for us. We focused on the industrial market. We see so much opportunity on the industrial market. We have put a lot more emphasis on 3D TRASAR everywhere. So the fact that it spills over to some municipal markets is not a surprise. But by far, the bulk of the growth going from 500 units to 800 units is the industrial market. And we continue to see huge, huge opportunity in industrial. And that's where our focus is.

Operator

We will take our next question from Adam Goodwin [ph] with Goldman Sachs.

Unidentified Analyst

Your subordinated notes and the senior discount notes are callable at the end of May. So given that you're currently paying pretty high coupons on those and the credit markets are looking pretty attractive right now, do think it makes sense for you to refinance bonds now or to wait for the call price to step down further? And if you guys got in the sense of where you might be able to price the deal in the current market?

Bradley Bell

This is Brad. If I look at the 8 3/4% senior unsecured that we issued last year, those have been trading south of 7%. So you've got a little bit of a bump for a new issue but not terribly much. And it's something that we look at. And whether you go now or whether you wait for step down in call dates or even to maturities is arithmetic. And that's arithmetic that we run and look at regularly.

Unidentified Analyst

And then secondly, it looks like your short-term debt balances went up pretty significantly during the quarter. Did you guys draw on the revolver at the air [ph] facility and if so, was it just mainly for working capital purposes?

Bradley Bell

It's timing only. We drew down the ABS through the receivable-backed facility in the first quarter.

Unidentified Analyst

Just a quick bookkeeping question, do you know what cash tax is and cash interest were for the quarter?

Bradley Bell

Yes. Not too terribly far off of book. Now that most -- all of our cash, all of our interest expense is cash interest. We have a semi-annual payments on interest occurring in the second quarter. I'm not sure where the question's going. And I would just use cash as a proxy. Book taxes, approximately for cash tax in general.

Operator

We'll take our next question from Rick Hoss with Roth Capital Partners.

Richard Hoss - Roth Capital Partners, LLC

Eric, on the Mobitex, what is the expectation for EPA guidance on Care? And then the second part of it is can you give us an appreciation for the projects or the opportunities that you're looking at in China as far as Mobitex again?

J. Fyrwald

Care, we expect to have regulatory clarity by the end of the year. And that, that will reinitiate projects in the U.S. by the end of the year or early next year. China, we continue to make progress with the projects that we initially have talked about in the past. The three projects continue to demonstrate performance. That has opened up some new opportunities in China and we're optimistic about growth in China. We also, in the first quarter, had a very big success in Poland, a project called Opole, where we demonstrated more than target NOx reductions at very low capital and operating costs. That has become very public in Europe and has been well received by coal-fired units producing electric utilities across Europe. And we're seeing, I would say, stepped-up interest in considering new projects in Europe and we'll be reporting on that progress in the coming quarters.

Richard Hoss - Roth Capital Partners, LLC

So the near-term opportunity comes from Europe, maybe some China? And then we have to wait until 2011 before we see anything from the U.S. markets?

J. Fyrwald

Yes. I'd like to able to report some progress on projects in the U.S. by the end of the year. But certainly, the business growth will come from Poland and China at this point, and then other parts of Europe and the U.S. for 2011, correct.

Operator

We will take our next question from Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

First of all, on the Energy side of the business, can you just characterize the growth rate in the upstream, downstream in Adomite business relative to that plus 2% organic number for the whole segment?

Bradley Bell

The Adomite business would have grown faster in the quarter. The oilfield, in about that range and downstream, struggle.

J. Fyrwald

Downstream was negative.

Richard Eastman - Robert W. Baird & Co. Incorporated

It was upstream in Adomite, were they plus double digit?

J. Fyrwald

Adomite was plus double digit. OFC was single digits.

Richard Eastman - Robert W. Baird & Co. Incorporated

And then also, we saw BP won a significant contract in Iraq for drilling rights. Does that contract and that opportunity for BP give Nalco an outsized opportunity?

J. Fyrwald

We are creating capability in Iraq. We see our global customers going to Iraq. And we see that there will be opportunities there. So yes, BP and others will create opportunities for Nalco and Iraq.

Richard Eastman - Robert W. Baird & Co. Incorporated

But it's not realtime? It's not next quarter or two?

J. Fyrwald

No.

Richard Eastman - Robert W. Baird & Co. Incorporated

For Brad, could you just maybe slow down in terms of -- and maybe just repeat the comments that you made on the paper margin first quarter versus fourth quarter? You suggested a receivables charge. But how does the operating margin or segment contribution margin for Paper look for the balance of the year? Should it step up meaningfully in the second quarter and beyond?

Bradley Bell

I'm not going to get out ahead of the sales guys managing the Paper business. I mean you've got large contracts that come up for rollover. And I think that's a healthy conversation best left to those facing customers. There are some raw material increases that are coming through that we need to be mindful of and pass through as we are able to do. I think if you look at the difference in Paper today and in Paper a few years ago, we have become far more selective about playing to our strengths and deploying people and other resources at areas where we can win and do well. And with that, you saw a nice acceleration of margins from where we were in 2008. I think that will remain the strategy going forward. And I think if you, kind of, look at where we are today, I think we're going to be plus/minus to that rather than wild increase or wild degradation.

J. Fyrwald

And part of that is that we've sold a lot more -- we've put a lot more technology into Paper with PARETO, OxiPRO, and even 3D TRASAR units now. We're putting into more paper mills water systems. So that's helping to solidify our higher margins.

Richard Eastman - Robert W. Baird & Co. Incorporated

But Brad, would you characterize the first quarter segment contribution margin as wild degradation?

Bradley Bell

Described it as what? Say it, again, I'm sorry.

Richard Eastman - Robert W. Baird & Co. Incorporated

Your terminology was wild degradation or accretion to the existing margins. But again, when I look at the step up in revenue from the fourth quarter to the first quarter and I look at a decline of $11 million in segment profitability, that's pretty significant. And again, are we going to see any rebound in the second quarter as we don't have a receivable to write off?

Bradley Bell

This is going to be a high teens DC margin business in the go forward. A lot of our growth in the Paper business in Q1 came from Asia. And we've readdressed some of the ways we're providing for receivable bad debt reserving, et cetera. And they, kind of, all arrived in Q1.

Operator

We'll take our next question from Dan Rohr with Morningstar.

Daniel Rohr

Hoping you could offer some color on the sequential decline in sales for each of the three business segments? I'm guessing a weaker euro had something to do with it. But to what extent did seasonality affects laying the top line?

J. Fyrwald

It's an annual way the business plays out that's repeated every year. So that's why we look at the year-over-year results for the first quarter. We'll see that the sequential gains, the seasonal gains into the second quarter and through the year, as per normal.

Bradley Bell

Dan, and the only years when you would not have seen this sequential move down from Q4 to next year's Q1 would be when you had a really big rising cost and price environment that was masking what would otherwise be a normal step down in activity.

Daniel Rohr

But the seasonality is a characteristic that defines each of the businesses? I mean, I've been under the impression, I guess that it was perhaps greater in Water Services where you've got higher cooling tower demand in the hot summer months.

Bradley Bell

No, that's true. I think what you saw in Energy was that the refining market, independent of a seasonal impact, just got much weaker. So you saw more of an impact in the energy space than you might in an environment where the Refinery business was stable all the way through.

J. Fyrwald

Also, a number of our OFC CapEx projects are landing in the second half of the year. So we will see that improvement through the year.

Operator

We'll take our next question from Bill Hoffman with RBC Capital Markets.

Bill Hoffman - UBS

Just a quick question on these raw material costs. I'm just curious how much of the chemical cost increases started showing up in March versus coming into the second quarter? And then I'm assuming you're responding with price increases that show up mostly in the second half of the year?

J. Fyrwald

Correct. So we've started to see some increases. We expect them to continue through the year. And we've been preparing our sales organization and our customers and are working through that.

Bill Hoffman - UBS

So if we expect to see our normal seasonal, sort of, top line improvement here, make it a little bit of a margin squeeze Q2, but start to catch up as you normally would in the second half here?

Bradley Bell

The sales will increase sequentially and then we've got, as I said, some OFC programs that will come on in the second half of the year and strengthen our position through the year, make gains that results from all the growth investment that we've been making.

Bill Hoffman - UBS

Specifically, in the industrial institutional services side, I wonder if you could just talk a little bit about what kind of top line growth do you expect to see there? Energy and Paper, where we can get a pretty clear view of?

Bradley Bell

I expect the Water business to deliver growth in line with the corporate average. So we're talking about increasing from our 4% in the first quarter. I expect the Water business to also increase through the year.

Operator

And gentlemen, at this time, there are no further questions. Mr Fyrwald, I'll turn the conference back over to you for any closing comments.

J. Fyrwald

I'd just like to summarize by saying that we feel like we had an okay start to the year. And that with that start, plus continued economic improvement together with the actions we are taking to strengthen our position in the marketplace, along with continued progress with our productivity efforts, that we are driving to strengthen our performance and look forward to updating you on our progress in the coming quarters. Thank you.

Operator

Ladies and gentlemen, this will conclude today's conference call. We thank you for your participation.

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