Nalco Holdin Q2 2010 Earnings Call Transcript

Jul.29.10 | About: Nalco Holding (NLC)

Nalco Holdin (NYSE:NLC)

Q2 2010 Earnings Call

July 28, 2010 10:00 am ET

Executives

Stephen Landsman - Vice President, Corporate Secretary and General Counsel

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

Mike Bushman - Investor Relations

J. Fyrwald - Chairman and Chief Executive Officer

Analysts

Jeremy Hellman - Singular Research

Mark Gulley - Soleil Securities Group, Inc.

Richard Hoss - Roth Capital Partners, LLC

Robert Mason - Robert W. Baird & Company

David Begleiter - Deutsche Bank AG

Bill Hoffman - UBS

Jeffrey Zekauskas - JP Morgan Chase & Co

Chip Moore - Canaccord Adams

John McNulty - Crédit Suisse AG

Michael Harrison - First Analysis

David Rose - Wedbush Securities Inc.

Laurence Alexander - Jefferies & Company, Inc.

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

P.J. Juvekar - Citigroup Inc

Operator

Good day, everyone, and welcome to the Second 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. Please go ahead, sir.

Mike Bushman

Thank you. Good morning, and thank you for joining us for our second quarter 2010 conference call. Speaking today will be Chairman and CEO, Erik Fyrwald; and Executive Vice President and CFO, Brad Bell. Also joining us today is Lisa Curran, who joined Nalco this week as Division Vice President, Investor Relations and Innovation Office. Lisa will take the leadership role for the company in our Investor Relations outreach actions.

Some of the information discussed today constitutes forward-looking statements that are subject to certain risks and uncertainties. Our statement 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 the risk is available in our SEC filings.

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 free cash flow provide investors with additional insight into the ongoing performance of our operations.

I would point out that the current definition of adjusted EBITDA contains fewer adjustments than a previous definition we had used. A five-year historical view of our new, narrower definition of adjusted EBITDA is contained in the fact book available through the Investor Relations Financial Reports section of our website.

Accompanying schedules for reconciliations of all non-GAAP measures used in our second quarter earnings release 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'll restrict participants to a question with a clarification follow up, if necessary. And we'll then ask participants to re-queue to ask additional questions. We'll start with Mr. Fyrwald.

J. Fyrwald

Thank you, Mike, and good morning. As you've no doubt seen Nalco reported strong second quarter results consistent with expectations we outlined at our May Investor Day, and based on the strategy we outlined two years ago. We are executing well against our strategy.

BRIC+ markets continued nominal sales growth of better than 40%. 3D TRASAR automation unit sales were up more than 60% compared to the year-ago quarter. Our $35 million productivity gains is a record for the second quarter and puts us at 63% of our full year goal with half of the year remaining.

We made progress in working capital management with strong improvement from first quarter as we took five days each off of receivables and inventory days. And we did all of these while taking on and executing well against very demanding crisis-response expectations.

Record second quarter adjusted EBITDA and nearly double-digit organic revenue growth, excluding the dispersants sales, shows that our growth plan is on track and we are building momentum. Second quarter revenues grew 19% nominally and 17% organically.

Backing out $70 million in sales of dispersants used by the government and BP in responding to the Gulf of Mexico oil spill, sales still grew 9% organically compared to the second quarter of a year ago. We saw good organic sales growth in each division.

Energy Services grew 14%, excluding dispersants sales. Our Adomite Drilling-Support business, which is largely impacted by natural gas drilling led the way the by doubling during the second quarter. Oil field services grew 21% organically. Paper Services, 9% organic growth was strong with the biggest improvements in Asia and North America. Water Services organic sales grew 6% led by gains in our mining, metals, manufacturing and chemical markets, markets that had declined the most in the first half of 2009. And we are growing in every region with our leading technology, commitment to service excellence and responsiveness to customer needs.

On a region-wide basis, excluding the Gulf oil spill sales, second quarter organic revenues grew 15% in Latin America, 12% in Asia, 9% in North America and 6% in Europe, Middle East and Africa. Year-to-date revenues are up 15% nominally and 11% organically to $2.04 billion.

Organic sales in Energy, Paper and Water are up 18%, 8% and 5%, respectively, in the first six months of the year. Excluding dispersants, Energy Services organic sales were up 8% in the first half and total company sales increased 7% organically through the first six months.

So clearly, we are making progress toward our goal of sustainably doubling our base revenue growth to a 6% to 8% level by the year end 2011. Now while we exceeded that pace in this quarter, it is clear that our strong results was against an easy comparison because of the global economic difficulties last year.

Excluding dispersant sales, organic growth of 9% is a strong result. But we also recognize that the continued, painfully slow recovery in North America and Europe means it will be difficult to sustain this growth in the second half as global economy started to show signs of recovery in the second half of 2009, and hence, the tougher comparison.

Still, based on strong first-half momentum, we are increasing our guidance for organic revenue growth for the year to a high-single-digit rate from our prior mid-single-digit guidance, while the revised guidance does incorporate Gulf dispersant sales, it also recognizes that our underlying business growth is there at a solid pace. We put substantial effort into what will turn out to be about 2% of our sales this year with the Gulf dispersants. But we remained fully committed throughout to continuing to drive improvement in our core applications, helping industry save water, improve energy efficiency, reduce emissions, increase productivity and turn out better quality products. We are seeing that focus lift our bottom line results as well.

Second quarter EPS was $0.41 compared to a $0.21 loss a year earlier that included restructuring charges and early debt extinguishment losses. Adding back the unusual items, adjusted EPS was $0.41 in the second quarter this year versus $0.13 a year earlier. Year-to-date, adjusted EPS has more than doubled to $0.73 per share from the year-earlier first half $0.30 per share.

Adjusted EBITDA was $199 million for the quarter, 40% higher nominally than adjusted EBITDA a year earlier and back above a strong second quarter in 2008. Adjusted EBITDA is up 30% year-to-date to $363 million with most of that, the vast majority, coming from organic growth. On the strength of excellent first half results, we are raising our guidance for adjusted EBITDA full year to more than $735 million, with this translating into an adjusted EPS guidance to increase to more than $1.40 per share.

We generated free cash flow of $71 million in the second quarter, solid enough progress to give us confidence to raise our full year free cash flow expectation to greater than $150 million from our prior guidance of greater than $100 million. Substantial improvement in receivable and inventory days during the quarter limited the investment required in working capital that generally results from the strong sequential sales growth that we delivered. Brad and team continue to work on our frustratingly high corporate tax rate, which he will give you more details about.

With the demand of the cleanup in the Gulf largely behind us, the management team here is working hard to deliver on our expanded 2010 commitments. And as we approach the remainder of 2010 and head toward 2011, we have focused the entire organization on driving growth through bringing more value to our customers, delivering consistently on productivity initiatives, driving cash flow and strengthening our infrastructure in BRIC+ geographies for a long-term success.

But let me take a moment now to provide perspectives on our Gulf cleanup response efforts with three points about this terrible environmental tragedy that began with the April 20 Deepwater Horizon explosion. First, for the families of the 11 men who lost their lives and many others injured and for the thousands of others impacted by the enormous Gulf oil spill, the past three-plus months have been terrible. Our sympathies and prayers go to all of these people. We had no involvement in the Horizon prior to the explosion, but we are all deeply saddened by the losses these people have endured.

Second, while paling in comparison to challenges of many others, the last three months have been an enormous challenge to many Nalco employees. The team here has risen to these challenges, demonstrating the commitment to problem solving and service that have been the cornerstone of the Nalco business model for more than 80 years. I personally want to thank the hundreds of Nalco employees who worked tirelessly to meet the expectations of the government response team, BP and the communities that would have experienced even more suffering from the oil spill had we not done our part to help.

And third, an unhappy consequence of our involvement in answering the call for dispersants used in the government-directed response in the Gulf has been the filing of several lawsuits against Nalco. Our formal disclosures are in our 10-Q, but let me be clear that we believe these lawsuits are completely without merit, fail to understand Nalco's role in assisting the government response team and will be vigorously defended. Furthermore, we will not allow our willingness to do what's right in the Gulf, impede the pursuit of our near- and long-term growth objectives. More information on our Gulf involvement is on our website, which I urge you to visit.

And we were very pleased to see continued evidence of core exit working, and let me share a quote from Jane Lubchenco from yesterday's incident command daily press briefing. "We know that a significant amount of the oil has disbursed and been biodegraded by naturally occurring bacteria. Bacteria that breaks down oil are naturally abundant in the Gulf of Mexico in large part because of the warm water there and the conditions afforded by nutrients and oxygen availability. While there's more analysis to be done to exactly quantify the rate of biodegradation, early indications show that the light crude oil is biodegrading quickly. When oil is dispersed into smaller bits from the use of dispersants or by weathering, it's even easier for the bacteria to get it and to consume it."

Now looking ahead to the rest of the year, the general economy is not yet on a sustained growth track in North America or Western Europe. We anticipated the slow recovery in these developed markets when we started the year. Unfortunately, that slow growth is playing out. Several end markets began recovering in the third quarter last year, making second half comparisons more difficult for our Water and Paper segments. We have lots of work to do the rest of this year to achieve a successful 2010 and to at least meet the guidance increases I have discussed today. But I am confident that we have the right leaders, the right team to make this happen.

And with that, I'll turn it over to Brad for some additional comments. Brad?

Bradley Bell

Thanks, Erik. As Erik mentioned, Energy Services revenue grew 14% organically in the second quarter or 33% if you include dispersant sales. Rapid base business growth was driven by a doubling of the Adomite Drilling-Support business and 21% organic growth in oil field services aided by a large Middle East product sales related to the start-up of a new unit. Most of these product sale was completed in the second quarter, accounting for more than $20 million in sales with several million more to be booked in the third quarter.

The Adomite business grew on the strength of the globalization effort for that group along with increased onshore gas drilling from the very weak year-ago period. Energy's Downstream business continue to struggle but with only a modest reduction in the revenues as some of our newer technologies continue to gain traction. Geographically, 8% organic growth in EAME [Europe, Africa and Middle East] was Energy's slowest growth market with the remaining geographies each up double digits.

I should make a comment on direct contribution margin in our Energy business, which expanded nicely on the basis of strong incremental margin from substantial sales growth. However, the size of that increase is somewhat overstated since significant cost directly related to our Gulf sales are booked where incurred in the organization and not fully reflected in the Energy Services P&L. All in all, the profit contribution from the Gulf activity may not have been much more than the profit pull through on other incremental business, including the benefit we received from being able to normalize certain of the costs, such as expedited freight that we're at significant premiums when the crisis response first begin.

Paper Services, 9% organic revenue growth was concentrated in Asia, up 21%; in North America, up 10%. Latin America was up 5%, while Europe was flat. Paper direct contribution margins held flat compared to the prior year as modestly higher product costs and mix offset sales and volume impacts compared to the prior-year period. While product costs affected margins in Paper, a further impact came from the higher-than-average start-up costs we incur when taking new business and from starting to invest again in sales engineers in our growth geographies.

Water Services sales, up 6% organically, expanded the fastest in markets that have been particularly hard-hit early in 2009. The Water Services business grew fastest in Latin America where it grew 18%, with 10% growth in Asia, 7% growth in EAME and only modest growth in North America as the Air Protection business declined, offset good growth in the balance of the portfolio.

Water treatment automation unit sales, sales of our 3D TRASAR Boiler and Cooling Water programs, grew more than 60% compared to the year-ago period on a global basis. Water direct contribution margins improved nicely from the year-ago period with improvement largely supported by productivity and volume gains at the gross earnings level and OpEx productivity helping to offset BRIC+ investments.

Our margins across the portfolio would have been higher yet, but for continuing investment in people, hiring and training the experts needed to support our customers. Globally, we have added a net 450 employees in the first six months of the year with most of that growth in China, India, Brazil, Indonesia and the U.S., where we see attractive opportunities for continued growth and share gain.

Sequential administrative cost increases largely resulted from higher incentive plan accruals and merit increases as only a few of the headcount additions came at the administrative expense level. Adjusted EBITDA of $199 million was the company's best historical second quarter performance and 40% above 2009 second quarter adjusted EBITDA of $142 million. The beneficial impact of higher sales volumes and productivity gains of $35 million more than offset those BRIC+ investments. Adjusted EBITDA margin increase substantially from the 15.6% in the prior-year period to 18.3% in the quarter just ended. Most of that EBITDA gain was a flow-through of the direct contribution margin gains that were aided by good incremental margins on the significant sales increases.

The second quarter tax rate of 42% contributes to a full year tax rate expectation of 36% to 37% on an adjusted basis. This is a slightly higher tax rate than we had initially anticipated, and largely reflects adjustments to foreign provisions and stronger-than-anticipated results in the United States, which is one of the highest tax countries in which we work.

Strong working capital management improvements assisted our free cash flow results bringing the quarter to $71 million and our year-to-date results to $45 million. Substantial improvement in receivable and inventory days during the quarter limited the investment required in working capital to generally results from the substantial sequential sales growth. As mentioned, during the quarter, we pulled out five days from our DSO to take receivable days below year end 2009 levels. North America drove most of these gain.

Inventory days also came down by five days from March 31 levels, but remains slightly above December 31 days in investment and inventory. Inventory improvements were also largely North American improvements, where some of our improved planning and management processes were launched first.

At quarter end, we used a portion of our cash flow to pay down $50 million of the old Term Loan B taken out in 2003 as part of the original LBO financing. This leaves just $100 million outstanding on this instrument due this November, and we expect to satisfy that with internal cash flow as well. The only other meaningful debt maturity in 2010 was the $160 million accounts receivables securitization facility put in place in 2007.

As I reported with last quarter's results, we arranged a three-year replacement that was implemented in June, newly sized to our needs at $150 million. We have considerable flexibility in our financing with no other real maturities until late in 2013. In the interim, we continue to examine opportunities to address this debt in ways that would reduce our ongoing interest expense.

Capital expenditures stand at $58 million through six months, and we continue to expect a number of roughly $150 million or so for the full year. This is reflected in the free cash flow guidance of $150 million or more that Erik shared earlier in the call.

With that, let's move to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] We will take the first question from John Quealy from Canaccord.

Chip Moore - Canaccord Adams

It's actually Chip for John. I was wondering if maybe you could touch on the Air Protection business a little bit. In North America, your thoughts on the new Transport Rule and then internationally, China, Eastern Europe, et cetera?

J. Fyrwald

This is Erik, Chip. The Air Protection business was down again in the second quarter as we had predicted, very weak in North America with some growth, continued opportunities in China and Eastern Europe near-term. I believe that those growth opportunities with the lower comparators for the second half will allow us to return to some level of growth in the second half. I don't expect a significant pickup in North America until probably some time next year as the clarity around in new -- as the new regulations we put in place but also the clarity around them leads to people starting projects again. We have had more discussions with customers in North America. I think they're getting their heads around us, but it will take more clarity on the regulations to get the North America growing again. As we've talked about before, our Opole success in Poland has opened up a lot more opportunity in Europe. We expect to be closings some projects in the second half that will lead to some revenue in the second half but more into 2011. And in China, our initial projects that were successful are leading two additional projects that we also believe will start to close in the second half. So disappointing to be at this point without growth in that business given the North America situation, it's understandable, but we really want to get back to growth in the second half and accelerate that growth into 2011 and 2012. We continue to be very pleased with the results of the technology, but we now need to translate that into real-dollar growth.

Chip Moore - Canaccord Adams

With regards to your outlook for the second half, it sounds like you're a little bit more cautious, overall, given the better-than-expected results in the first half. Does that imply a slightly slower expected results in the second half? How should we look at that?

J. Fyrwald

Well, what we're saying is that the second half should be about what we talked about previously without the dispersant sales. Obviously, that stopped, thankfully. So we see it about the same that we saw it before, continued growth, mid-single-digit type growth. But obviously, as the economy start picking up more, that will increase. If the economy's further decline, we still believe we'll be able to achieve our forecasted increased forecast.

Operator

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

P.J. Juvekar - Citigroup Inc

My first question is on shale gas, which holds a lot of potential. How big is shale gas for the Adomite business? And just give us a run rate of the Adomite business and where it can go.

J. Fyrwald

Shale gas was a small contributor to the Adomite doubling of revenue in the second quarter. But we do see it as a significant opportunity going forward, both for Adomite business and for our Water Treatment Services business. We're not scaling that exactly right now, but we're putting in place the plans, we're putting in place the resources and we'll give you more update on that later in the year and into next year, P.J. But obviously, a big opportunity.

Operator

We will take the next question from Brian Drab with William Blair.

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

First question, just to be clear on your thoughts on the second half of the year. Clearly, the year-over-year comparisons become more difficult. I think what a lot of people are interested in is, how does the second half look sequentially compared to the first half in your view, excluding any impact from the oil spill?

J. Fyrwald

We'll continue to see the increases. I mean, we're making good progress across the company. I would say that the toughest end-use market that we are in is Downstream market and Energy in North America and Europe. We expect that to continue to be difficult. But the rest of the economy certainly Asia-Pacific and BRIC+ economies will keep growing very nicely. And we'll continue to do well there both with the market growth as well as our strengthening position. Our biggest concerns are what's going to happen in North America and Western Europe in macro economies and how that's going to impact us. And right now, we're forecasting very slow growth as we expand our outlook for the second half, and that's how we see it today.

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

And then on the SG&A line, that came in quite a bit above my forecast. I know Brad mentioned higher incentive and merit accruals, but you're coming of the first quarter where you spent, I would guess, $5 million to $10 million in a lot of sales meetings that didn't happen in the second quarter. So can you talk about some of the dynamics that drove SG&A from $307 million roughly in the first quarter to $328 million in the second quarter? And what should we expect in the second half of the year?

J. Fyrwald

Let me start by making a couple of comments, and then I'll let Brad add to that. But first of all, we continue to invest aggressively for growth. I think that is the number one point. We hired 450 people in the first half, largely in BRIC+ geographies and for growth opportunities and both on M&A that we did in North America. We're going to continue to have some additional hires in the second half in these growth areas, and they're paying off. You saw the 40% nominal growth in BRIC+. So the investments that we made last year are paying off now. The investments that we will make this year are going to start paying off next year. So that will continue. Secondly, in April, we went back to our annual merit increases, which obviously, have some impact from then on. And we continue to deliver good solid performance off of a low year last year. So the incentive accruals have increased. But beyond that, Brad any comments?

Bradley Bell

I think you hit the big one. Investments in OpEx for business opportunities that are still on the horizon by the time it takes to get these engineers trained, et cetera. If you look at the SG&A line in total on the P&L, it's about 30% of revenue, and it was up about 13% of the incremental year-over-year revenue growth. So despite all this investment, we think we were's getting good traction. If you're looking at the administrative line alone on Attachment 4, it comes back to the incentives and the merit increase that you heard us spoke to. And I'd kind of point you to Q3 and Q4 levels that probably look a lot like Q2. We continue to have some consulting expense in there for some projects around the company. It's helping us get the working capital traction. It's helping us to get the top line traction and no major shifts for the balance of the year.

Operator

We will take the next question from P.J. Juvekar from Citi.

P.J. Juvekar - Citigroup Inc

My second question was on the European turnaround. You didn't make much comments on European margins. But can you tell us how do they compare today compared to pre-recession levels?

J. Fyrwald

I would say that we are at or above pre-recession levels. We've done a very good job, David Johnson and his team, in terms of not only reducing our cost base in Europe, which we continue to work on, but also in getting the sales force strengthen leadership, strengthen processes, more time selling, we've eliminated a number of the back office problems that we had before, and I think we're doing a better job of targeting the higher-value customers and winning business that's allowing us to enjoy attractive margins again in Europe that we believe we can continue to hold and build on.

P.J. Juvekar - Citigroup Inc

Do you believe that the European turnaround is complete?

J. Fyrwald

No, I don't think it'll ever be complete. We've got a project to further streamline and simplify the back office and the leadership structure that we'll implement by the first quarter of next year. I think we'll add additional benefits. We continue to work on all the global improvements, the commercial excellence that we've talked about, the Nalco-integrated business model for a more efficient effective supply chain and to get set productivity. So all of that is continuing to build momentum in Europe. And I'd add to the base business that we've been improving, we've I think significantly strengthen our position in Russia. We're doing the same in the Middle East and we've recently returned to South Africa, and we're off to a great start there. So I think we're going to keep getting better in Europe.

Operator

We will take the next question from David Begleiter from Deutsche Bank.

David Begleiter - Deutsche Bank AG

Erik, you talk about paper price increases, how they are progressing? And how is the overall environment or the market dynamics given the MPSF perks, the Ciba, et cetera?

J. Fyrwald

I think we've been through the worst. I think Europe still has too many competitors for the size of the market, but at least the market has stabilized in terms of volume. You saw that our organic growth was flat in Europe for Paper, and that's after quite a long string of negative market growth. So I think things are bottoming out, and the growth opportunities in Asia, Latin America are there. We're going after those with our best technology, which advantages us in regard to pricing. I think the raw material increases that we've seen with the weaker economy are abating to some degree. So I think overall, I'm confident that not only in Paper but across the company, that our pricing will offset any raw material impacts. There'll be a wash for the full year.

David Begleiter - Deutsche Bank AG

Erik, you just mentioned also some potential share gains in the U.S. Could you comment on where they might be?

J. Fyrwald

Are you talking specifically about Paper?

David Begleiter - Deutsche Bank AG

No, overall. And I assume in the other portions of the business.

J. Fyrwald

I think we continue to make progress across all of our businesses. In Paper specifically, with the technology in water treatment with our 3D TRASAR, giving us stickier customers for our existing sales and giving us opportunities to win new customers. And with Adomite, our base that we've had growing with the natural gas drilling but also going out to find new customers across the downstream markets. Even though it's a very tough economy in downstream, the market is down more than we are, as we bring more value to our customers. So I would say that we're making progress across the company, not only North America but globally on market share.

Operator

We will take the next question from Laurence Alexander from Jefferies Bank.

Laurence Alexander - Jefferies & Company, Inc.

Would you mind giving some more detail on the Middle Eastern customer? And is this characteristic or are you going to be seeing a shift towards more larger orders going forward?

J. Fyrwald

The large order that we referred to that we thought was coming in the first quarter that came a little bit in the first quarter mostly in the second quarter and, well, kind of little bit in the third quarter, was the startup of a large unit in the Middle East. The way I look at it is we've got other -- that was a charging of a unit that will still seek ongoing sales from that business. We've got other units starting up around the world in the second half in our OFC business. So I wouldn't look at it as an aberration, significant -- that we will be able to see continued growth in our OFC business through the year and on into next year.

Laurence Alexander - Jefferies & Company, Inc.

And secondly, can you also address competitive intensity in the Energy Services and Water Services segments? Are you seeing any shifts in the landscape, particularly as Baker Hughes changed their behavior?

J. Fyrwald

No, we haven't seen any change there. All I would say is that we're very focused on developing new technologies and continuing to enhance our service capability. So continuing to bring more value that we can define for the customers and increase our business by doing that versus any price issues. So I would say, we have not seen much change in the competitive environment.

Operator

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

David Rose - Wedbush Securities Inc.

I was hoping you can give a little bit more clarity on margins in the second half of the year. Looking at the second half of last year, you had some very solid margins and your margins in Q2 were up over the prior year. Do you expect those trends to reverse in the second half? And maybe you can give a little bit more clarity in which segments are likely to hold up year-over-year better than the others?

Bradley Bell

This is Brad. Yes, we saw Paper margins at 16% in the quarter, and we've always said that we believe that this business is probably an upper-teens opportunity set for us relative to the 20% overall for the company. I don't see big shifts in that. Energy, I mean obviously you saw surge for the reasons we outlined. You had a huge piece of incremental business pour forth and not all of that cost structure -- it was built inside the Energy DC. So you can expect some realization there with that now behind us.

David Rose - Wedbush Securities Inc.

I'm sorry Brad, that's a big number. At least the range is big, fairly large from what it had been. Can you give us sort of a tighter range with which to work?

Bradley Bell

It's kind of an awkward one and I think if you looked at any piece of incremental business, if you dropped $70 million of incremental business into anyone of the segments, you'd see a big surge. And this is an area where our field support is not in the form of engineers administering products. Remember, the EPA and the Coast Guard handle that element to this. The support for all of this really resided in the labs and people back here in the center that were scampering to comply with government requests and the like to handle this crisis as it came along. So you're going to see the Energy segment margin, if you will, dial back to more normal ranges as this activity is now behind us with the July sales of $15 million as was outlined. And the Water business continues to do well. We're getting more with differentiated offering, with her technology, as Erik pointed out, makes a difference that's helping us win market share. We don't see raw material threats of any order of magnitude that we don't have already contemplated in pricing plans and strategies for the second half of the year. So I think you could look at some of the normal seasonal movements. We're in the summer cooling season, which drives for a lot of the 3D products in the summer months. So we don't...

David Rose - Wedbush Securities Inc.

I'm sorry Brad, would it be closer then to third quarter of last year or somewhere in between the recently reported quarter and third quarter last year?

Bradley Bell

I think I'd point you back to the guidance we gave for the full year expectations on earnings and EBITDA rather than get into quarterly margin progression. But the only aberration here you need to think about is the surge that we had in Q2 with the crisis response.

J. Fyrwald

This is Erik. I'd like to make another comment on the disbursements, though. Because I think it's important for people to understand that it was a significant piece of business at $70 million of revenue. But there were some cost associated with it. And let me give you some examples beyond the normal. We made a $2 million Gulf support fund contribution to help with the cleanup. We had to increase our government relations, lobbying, public affairs efforts beyond what is normal for us because we had to help get the truth out there about the disbursements. We increased our spend on research and analytical support for state and federal agency work. And we had repeated trips to the Gulf and to Washington. We had a number of people located in the Gulf with the emergency responders. We air freighted a number of ingredients. We diverted product from other growth opportunities. And we had some special charges for expediting some of the ingredients. And not all of these costs are included in the Energy Services DC. But it's important to understand that while this was a significant piece of revenue, there were some extraneous cost associated with it that you should understand.

Operator

The next question comes from Rick Hoss from Roth Capital Partners.

Richard Hoss - Roth Capital Partners, LLC

Not to belabor the whole gross margin, but if we took out towards it from the second quarter, would gross margin be below that of the first?

Bradley Bell

We have a number of things in the quarter. I'm not sure I'm going to be able to answer your question directly. But gross margin was up. It was certainly helped by incremental business like this, but you're also seeing the early economic growth in businesses of ours that carry lower gross margins. It's the heavy industries, et cetera. Now similarly, the cost to serve those in the FX line is also less. You get a few effects flowing through here. Again, if we're trying to look at margins for balance of the year, let me just kind of just repeat something I offered up a moment ago. We don't see big swings in raw material cost that we haven't contemplated in price. I would kind of point you back to the guidance we gave for minimum thresholds on EBITDA and earnings per share and leave it at that.

Richard Hoss - Roth Capital Partners, LLC

And then a follow up and kind of the same vein of thought. Operating metrics, we would still see sequential improvement x the benefit from having corrected in the financials.

Bradley Bell

Sure.

Richard Hoss - Roth Capital Partners, LLC

And we're talking about the activity analysis receivables, inventory turnover, et cetera.

J. Fyrwald

Yes. I think that we we're seeing the surge -- the year-over-year surge has been great just in terms of the revenue rebuild, if I can call it that. And so, the working capital investment has largely been put back on the books. So you'll get a far flatfish look at working capital first quarter...

Richard Hoss - Roth Capital Partners, LLC

First quarter.

J. Fyrwald

if our flattish look at the second half of the year and we're delighted with the performance improvements in DSO and in inventory. As I said, some of the processes we've rolled out for better planning on inventory, et cetera, have kicked off and have matured well in North America and are being deployed in other parts of the world.

Operator

We will take the next question from Jeff Zekauskas from JPMorgan.

Jeffrey Zekauskas - JP Morgan Chase & Co

Were your average prices above -- were your average prices up 3% or more or 3% or less in the quarter?

Bradley Bell

They were relatively flat.

Jeffrey Zekauskas - JP Morgan Chase & Co

Slight year-over-year.

Bradley Bell

Yes.

Jeffrey Zekauskas - JP Morgan Chase & Co

And then as my follow up, in your 10-Q when you talk about the suits, what you say is you say you have rights to various indemnifications and contributions from third parties? Are you referring to insurance companies or something else?

J. Fyrwald

The four cases that we referred to are very preliminary stage. Nalco has not been served with a complaint in all of them and that a date for Nalco to respond has not even been sent at this time. When we respond, indemnities will be among the defenses available to Nalco in these cases. These defenses are all under review by our council at this time. And so, that's the limit of our comments in regards to the indemnities today.

Jeffrey Zekauskas - JP Morgan Chase & Co

I was just wondering about the meaning of the language, though, what you're referring to?

J. Fyrwald

Well, I'll let Steve Landsman...

Stephen Landsman

The indemnities are being worked out at this point. And we really don't want to go any further than that.

Bradley Bell

For those who don't know Steve Landsman's our General Counsel.

Operator

The next question comes from Mike Harrison with First Analysis.

Michael Harrison - First Analysis

In the Energy business, what portion of your upstream Energy sales are in the Gulf of Mexico? And can you also comment on how much disruption, if any, your customers in the Gulf saw? And what your outlook would be for business in the Gulf, particularly on the Deepwater projects and when they could proceed?

J. Fyrwald

So our Gulf sales are roughly 20% of the overall sales that you're referring to. We did not see any -- and our sales are around producing of oil and gas. They are not around the drilling. So we have not seen any disruption in our business because of what we sell other than the increased sales with the dispersants. So if the question then would be, over time, will the drilling moratorium impact our business going forward? We believe that the gas and oil demand for the world will be there. It will be drilled and produced somewhere. And wherever that is, Nalco will be there to service our customers. So we do not see an impact on this either short, medium or long term for Nalco.

Michael Harrison - First Analysis

And if I could follow up on the downstream side of the Energy business, it sounds like that business continues to lag and the customers continue to be hurt there. Did you see any improvement in the downstream business as the quarter progressed? And can you maybe talk about your expectations for the Downstream business for the second half?

J. Fyrwald

Well, I would say that the improvement that we saw was a higher refinery utilization. But that's due to a number of refineries being shut down in North America. I think there's going to be a continuing challenge in both North America and Western Europe until there's a bigger pickup in the overall economy before there would be significant improvement in the downstream market place. Given that, we continue to work very hard in growing the business in the BRIC+ geographies, new capital, new refineries that come on around the world by bringing more value throughout the world, including North America and Western Europe with our 3D TRASAR for boilers, with our additional automation for processes throughout the system and other technologies. And also, as more heavy and more difficult to manage crudes come through, that plays into our hands. So I think our position will continue to strengthen, but we're not seeing any rapid, significant turnaround in North America or Western Europe. We're not counting on that, let me put it that way, as we look at our forecast for the year. As we've expanded our outlook, that does not include a significant turnaround in North America or Western Europe downstream refining. Now if that happens, that would be an upside.

Michael Harrison - First Analysis

You said BRIC+ growth was more than 40% nominally. What was it organically, excluding FX?

J. Fyrwald

We don't publish that because there's such a large basket of currencies that we'll stick to the nominal. But you can imagine that it was still very robust. Those currencies weren't that big of a tailwind or a headwind.

Operator

Next question comes from Mark Gulley from Soleil Securities.

Mark Gulley - Soleil Securities Group, Inc.

Not to belabor the Deepwater Horizon situation, and maybe you've already answered this question indirectly, Erik. But would it make sense to pursue some of the ongoing cleanup efforts shoreline-type stuff with your other dispersant products? Or have you kind of learned a lesson as to participating in that sort of a market?

J. Fyrwald

Here, again, just like with what we've seen already, the government responders are making all the decisions. We've certainly made our product line available, and they will decide if shore cleaners like we have get used. And if they do get used, whether or not Nalco products get used. We're not out there proactively pushing them. We are waiting only to see if we are requested to respond.

Mark Gulley - Soleil Securities Group, Inc.

And I don't know if you're prepared to quantify, but I was coming up with an earnings per share contribution somewhere in the 10-plus cent per share area in a quarter from your efforts. Brad, you've already talked about some of the puts and takes there, but if you get down to the bottom line, is that about right or not?

Bradley Bell

Again, it's very hard for us to comment on something like that. I think we'll leave our comments where they were.

Mark Gulley - Soleil Securities Group, Inc.

Finally, I want to return to the subject of competition, particularly in water and particularly with respect to any changed competitive behavior. I mean, in terms of the old Betts and the old ChemTreat, do you see them advancing or retreating in terms of competing with you? Or are you emerging more now as a leader, particularly -- I'm talking about developed countries.

J. Fyrwald

What I would say is that the needs for water around the world in develop and emerging economies is getting bigger and bigger. There's vigorous competition all over the world, including in the developed economies. But we are very focused on industrial water treatment, and I think that we continue to bring out more value in automation, Specialty Equipment and services. And thereby, I think we can continue to advance our position with our customers by bringing them more value that we can define and being able to share in that value. I think, it's very good for our position.

Operator

The next question comes from John McNulty from Credit Suisse.

John McNulty - Crédit Suisse AG

On the raw material front, we've seen a lot of the commodity start to drop down, some of the derivatives are taking a little bit longer. Can you give us your outlook for what you're thinking sequentially into 3Q and 4Q relative to what you just saw in the raw material font?

J. Fyrwald

I think there's potential for a lot of volatility so it's difficult to forecast anything here other than to say that we're following it closely. We saw raws come up. We're seeing them start to come down. Our conclusion overall is that our pricing ability versus what's happening in raws will be essentially awash for the year.

John McNulty - Crédit Suisse AG

On the large Middle Eastern project that you called out earlier in the call, did this come before you had moved your headquarters over to Dubai? Or are we starting to see kind of the early benefits of having a headquarters positioned over in Dubai?

J. Fyrwald

I think we're starting to see the early benefits of our having a lot more horsepower on the ground in the Middle East to support the sales force there. And I think you'll see continued strengthening of Nalco in the Middle East in the coming years.

Operator

Next question comes from Rob Mason from R.W. Baird.

Robert Mason - Robert W. Baird & Company

Erik, you had mentioned that some of your developed markets were still slow to recover. And if you look at your Water Services business in North America, the first half to growth has been very anemic there. My sense is that the APC business is dragging that down. Do you have any sense of what the growth might have been this quarter without APC or the Air Pollution business?

Bradley Bell

This is Brad. Mobotec is really our only offering in that space, and they enjoyed a very nice quarter last year. If you look at the North American space and eliminate air presence, you've got something in the high single digits for the Water business itself. So it really masks that. The absence of legislation here has really stalled our build-out of that space in the United States. So the air protection market is dead for us in the second quarter of this year. We believe that'll start to come back next year. So the net impact was significant on the total Water sales. X that, we would be high single digits in water. And I tell you, we're doing well.

Robert Mason - Robert W. Baird & Company

And then just, Brad, real quickly. Currency was actually a positive contributor to sales in Q2. Do you have an expectation for what second half currency impact would be today?

Bradley Bell

The euro is bouncing around so much. And that's our biggest non-dollar presence. For a while there, we're hovering at the 1.20 kind of level. We are now at the 1.30 or so level, probably not a wild swing from the kind of numbers we saw in Q2 terms of relative impact if we stay at current levels.

Operator

The next question comes from Jeremy Hellman from Divine Capital Markets.

Jeremy Hellman - Singular Research

I wanted to get your perspective on what's coming down the pipe in terms of regulatory legislative actions here in the U.S. particular drafts are circulating about Senator Reid's energy plan. And kind of the two-part question to that is, do you see any real shake out with respect to the Energy business? How that might affect you guys? And then part b is, do you see any opportunity to grow and drive in anything on the water side that might create a more fertile environment for you guys?

J. Fyrwald

I think with the Gulf oil spill, that there will be additional regulation. I think that's inevitable. We hope that it's thoughtful science-based and results in improved safety but does not decrease or limit, stop oil companies from drilling and developing the energy for this country. If it were to decrease the amount of Energy developments in this country, we think that, that would go overseas and we will be there wherever it is. So I don't see significant impact on our business. But I do think that with the critical needs of oil and gas around the world, that our enhanced Oil Recovery business will benefit from this. People want to get more out of existing wells. I do think the shale gas play, there'll be a strong desire to do that. In a very environmentally friendly way, we can assist making that happen. And also, as Energy efficiency will continue to be a key driver around the world, and we bring Energy efficiency to any industrial process. So I think that'll only help our business. But bottom line, yes, there will be more regulation. I hope it's thoughtful because I think it's good for the country to have improved regulation that enables successful, safe drilling and energy development in this country.

Operator

The next question comes from Bill Hoffman from RBC Capital Markets.

Bill Hoffman - UBS

Just quickly, when looking at the working capital situation at the back half of the year, I guess the expectation here is we'll be throwing off some freebies and cash from working capital especially as the receivables come down from the disbursement sale. What's your general thought on usage of the cash? Do you have more debt paydown as well? I mean, obviously the CapEx is going up.

Bradley Bell

Yes, we talked about free cash flow guidance of at least $150 million this year. We're less than $50 million on a year-to-date basis. And that's not a typical for our pattern over the course of the 12 months. So what it says is we're going to get better than $100 million in the second half of the year. We have about that outstanding on the old Term Loan B that is due in the 4th of November. We could handle that comfortably with internal cash and cash on the balance sheet. Working capital improvements have been good, and as I said, some of the major advances have been in North America. As these processes have been launched and get traction overseas, we'll see a flattish kind of pattern to the working capital spend for the year. So that's a huge contributor to this accompanying the sales.

J. Fyrwald

So let me just sum up by saying thank you all for joining the call. I believe that we are absolutely on track with executing our strategies; strategies that include aggressive growth in BRIC+, bringing more value to customers with our technology and services, bolt-on M&A to increase the amount of value we can bring, while we drive aggressively on productivity and cash flow to fund that growth. And we are very glad to have the oil spill situation behind us and look forward to continued progress in the second half. So thank you very much.

Operator

That does conclude today's conference. Thank you for your participation. You may now disconnect.

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