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Nalco Holdin (NYSE:NLC)

Q3 2010 Earnings Call

October 27, 2010 10:00 am ET

Executives

Lisa Curran -

Bradley Bell -

J. Fyrwald - Chairman and Chief Executive Officer

Analysts

Richard Eastman - Robert W. Baird & Co. Incorporated

Mark Gulley - Soleil Securities Group, Inc.

Richard Hoss - Roth Capital Partners, LLC

Robert Koort - Goldman Sachs Group Inc.

John McNulty - Crédit Suisse AG

Michael Harrison - First Analysis

David Rose - Wedbush Securities Inc.

John Quealy - Canaccord Genuity

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

Laurence Alexander - Jefferies & Company, Inc.

P.J. Juvekar - Citigroup Inc

Operator

Good day, everyone, and welcome to the Third Quarter 2010 Earnings Call hosted by Nalco Company. [Operator Instructions] At this time, I would like to turn the call over to the Nalco Division Vice President Investor Relations and Innovation Office, Ms. Lisa Curran. Please go ahead, ma'am.

Lisa Curran

Good morning and thank you for joining us for our conference call to discuss third quarter 2010 results. Speaking today will be Chairman and CEO, Erik Fyrwald; and Executive Vice President and CFO, Brad Bell.

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 www.nalco.com. Further background on the risk is available in our 10-K. The information discussed today will include data that does not conform to generally accepted accounting principles. Management believes that 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 what we 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 Financial Reports section of our website. Accompanying schedule for reconciliation of all non-GAAP measures used in our third quarter earnings to the closest GAAP equivalent have been provided as attachment to our earnings release.

After comments from Erik and Brad, we will open up the call to questions. In order to allow for as many participants as possible to ask questions, we will restrict participants to one question with a clarification follow up, if necessary. We will then ask participants to re-queue in order to ask any additional questions.

With that, Erik, can you start, please?

J. Fyrwald

Thank you, Lisa, and good morning, everyone. We are pleased to report this morning a solid third quarter and an increase to our 2010 earnings outlook. For the quarter ended September 30, diluted earnings per share were $0.42 on net earnings of $59 million. That's more than double the year ago of $0.20. Adjusted EPS was $0.42 compared to the $0.31 in the prior year third-quarter, after adding back unusual items. The soft spot of our results was that adjusted EBITDA was up only 3% to $196 million compared with the $190 million in the third quarter of 2009, as the beneficial impacts of increased sales and the productivity gains this quarter were largely offset by continued aggressive growth investments and raw material cost headwinds versus the year-ago period.

As we continue recovering from the global economic recession and execute our strategy, we were able to deliver solid revenue growth and generate good cash flow from operations while setting the stage through growth investments for sustainable, profitable growth.

So let me give you some highlights of key elements of that strategy. Our investments in growth platforms are paying off. For example, BRIC+ market's continued sales growth at better than 40%. 3D TRASAR automation unit sales continued to be strong with year-to-date global unit sales for cooling and boiling systems both over 60%. And we have increased the rate of adoption of Nalco 360 remote monitoring by over 50%.

We continue to ramp up sales, technology capability and support in growth areas. Year-to-date, we've added over 700 new employees, with the majority in BRIC+ markets and the overwhelming majority in Asia.

Also we have completed our India headquarters move from Calcutta to the more strategic location of Pune. On August 26 we opened a new corporate office and research and development facility in Pune that serves as the headquarter for sales, marketing and supply chain operations for Nalco India, and will be one of our major hubs for Water and Energy technology innovation. Its immediate focus is to provide technical support to our energy upstream and downstream customers throughout the eastern hemisphere, including the Asia-Pacific region, the Caspian, Middle East and West Africa. The Pune center will also focus on water applications research by leveraging leading edge research done in our Naperville center in order to develop water sustainability solutions for our India and global customers. The center will be an integral part of our innovation network, and will collaborate, not only with Nalco Laboratories of Naperville and Sugarland in the United States, but also with our Shanghai innovation center. And we continue to increase our global technology spend investment.

Also earlier this month, we co-sponsored a global water stewardship forum in Chicago, along with the World Wildlife Fund that brought together sustainability and business leaders from large NGOs and global companies to drive water use best practices.

We also completed the acquisition of an engineering company that complements our TIORCO business model, which focuses on providing comprehensive enhanced oil recovery solutions to our customers. Now less sexy, but also important, we are in the middle of a project to centralize our Europe operations, with the move of our senior leadership to offices outside of Geneva, Switzerland. We expect this to finalize by the end of the first quarter of 2011, and should start to see some savings benefit in the second half of 2011. This will help our continued efforts to streamline internal operations to better support growth.

Now moving back to third quarter performance, we realized the second-highest third quarter revenues in the company's history. Sales increased 14% to $1.09 billion, with double-digit organic growth rates delivered by all three segments. This demonstrates how our investments in growth platforms like BRIC+ innovation are delivering against our stated target to double our historical sales growth rate to 6% to 8% in 2011.

Now looking at each segment. Energy Services grew 18%. Our Adomite Drilling Support business, which is largely impacted by natural gas drilling, was up over 70%. Oilfield Services, now the largest component of the Energy Services segment, delivered 26% growth. Paper Services grew 11%, lead by a 21% increase in Asia. And Paper sales in Europe have continued to rebound, with a 6% growth this quarter. In Water Services, sales grew 10%, reflecting robust volume growth and strengthening market positions.

We also delivered organic sales growth in all regions. Third quarter organic revenues grew 17% in North America, 12% in Asia, 9% in Latin America and 8% in Europe, Africa and Middle East. Year-to-date total revenues increased 14% or 11% organically to $3.1 billion. Organic sales in Energy, Paper and Water were up 18%, 9% and 7%, respectively, in the first nine months of the year. North American Mobitex sales were down 59% year-to-date due to U.S. regulatory uncertainty, which depressed North America Water Services organic sales by 260 basis points for the same period.

Now looking at year-to-date sales, excluding disbursements, total company organic sales were up 8%, and Energy Services were up 9%. Although very pleased with our revenue growth, I would have liked to have seen stronger EBITDA growth this quarter, given our long-term target of 20% EBITDA margin as compared to the 18% we realized this period. This is the result of increased raw material costs, aggressive growth investment that will pay off in 2011 and beyond, a negative from Mobitec and insufficient productivity and price gains to offset these challenges. That said, if you exclude the raw material headwind, our adjusted EBITDA margins would have been at about our 20% goal. And I can tell you that our leadership team is focused on continuing to drive aggressive revenue growth while increasing EBITDA margins going forward.

For the full year 2010, we are increasing our adjusted EBITDA and adjusted EPS outlooks to exceed $740 million and $1.50 per share, and that's up from $735 million and $1.40 per share, respectively. Our target for free cash flow remains to exceed $150 million.

And now I'll turn it over to Brad, who will provide you with specifics on the financials. Brad?

Bradley Bell

Erik has just given you a good walkthrough of the various businesses performance in the quarter. So let me fill in some additional color and then we'll quickly get to your questions.

As you saw, adjusted EBITDA was up $6 million versus last year's third quarter, in line with our expectations that less than we would have preferred given the strong sales growth. Elements of the change include first, some pressure on gross profits as our gross profit margin of 44.7% was down from last year's 47.2% when pricing, relative to raw material costs, had been fully recovered. We've seen some recent raw material moves and have taken pricing actions that are appropriate in this economy, balancing business volume considerations in the margin decision. Year-to-date, our gross profit margin is now just 10 basis points higher versus prior year.

Next is the OpEx build out that Erik addressed. Remember that growth for us requires the hiring and training of sales and service engineers, literally one to two years ahead of their becoming fully productive in the field, and we're continuing to see attractive opportunities for growth in key markets for us around the world. Administrative costs are shown to be sharply lower this quarter versus a year ago, but remember that the third quarter of 2009 included a $21 million pension settlement loss as we had an acceleration of near-term retirements in advance of discontinuing lump-sum payouts from the U.S. defined benefit plan. Without revisiting all that detail, that charge represented a pro rata portion of unamortized actuarial losses, was non-cash in nature and we removed its effect in computing adjusted EBITDA last year.

So in the quarter just ended, administrative costs were $56 million, about flat to last year adjusted for the pension charge I just mentioned, and down sequentially from the $67 million reported in Q2 of this year, primarily because of a reduction to incentive compensation accruals. For Q4, we expect something more like the Q2 figure.

Our productivity gains, measured as structural cost reductions, amounted to $29 million in the quarter, down slightly from last year's $31 million. Last year's third quarter also included a good portion of the almost $40 million in one-time cost savings for the year, known not to be recurring in nature but implemented by our employees as we worked out of the weak economic environment. Year-to-date, we have achieved a $92 million structural cost reduction this year, and are confident of achieving our $100 million target for the full 12 months.

Moving to taxes, our effective tax rate in the quarter was just a touch over 38%, a market improvement as compared to the 45.3% of last year's third quarter when we were plagued by restructuring charges in countries requiring valuation allowances against deferred tax assets. We expect full utilization of deferred tax assets going forward and continued rate declines as those valuation allowances, come off with improved European profitability. For the full year 2010, we expect the tax rate of 36% to 37% on an adjusted basis.

Next, free cash flow amounted to $66 million in the quarter, lead by very solid cash earnings in bringing the year-to-date figure to $111 million. As noted, we are holding to our guidance of at least $150 million for the full year, expecting another good quarter of cash earnings and an absolute reduction in both accounts receivable and investments in inventory.

I'll close with a couple of comments in our debt position coming in the fourth quarter, and then we'll go to your questions. Net debt at September 30 was $2.67 billion and amounted to 3.7x trailing 12 months adjusted EBITDA. At the end of the quarter, we retired the remaining $100.5 million outstanding balance under the old Term Loan B arranged back in 2003 and otherwise due this coming November.

Additionally, the $750 million Term Loan B arranged last May was repackaged, taking the form of a new $650 million Term Loan B issued at 99.5% of par due October 2017, with pricing of LIBOR plus 300 basis points in a 1.5% LIBOR floor. Additionally, a $100 million addition to our Term Loan C due November of 2016 issued at 95.5% of par, with pricing of LIBOR plus 175 basis points and no LIBOR floor. The improved terms in these facilities have the effect of reducing our interest expense by $17 million on an annual basis, beginning essentially with the quarter we are now in.

Finally, I'll just remind those on the line that this year's third quarter 10-Q is the last one I'll sign and will be stepping into retirement once we've properly transitioned the finance helm to Kathy Mikells. I would just say I've enjoyed were to be the past seven years and look forward to hearing your questions, and, of course, the company's answers from the other end of the phone line in the fourth quarter earnings conference call.

Operator, we're ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc

Erik, you've done a lot of re-structuring in Europe with the self implementation, your back office in Budapest, this new Geneva headquarters. With all that, how do margins in Europe compare with the U.S. in Water Services?

Bradley Bell

Our Water margins in Europe are improving. We like the margin profile across all three businesses in Europe and this last round of restructuring that we're taking for the charges which have already been provided. But this re-organization and relocation to Switzerland really gives us a much simplified business model that is pretty much standard across every country. And with that, we can centralize additional back office activity and strip a large number of costs out of this.

J. Fyrwald

What this will do, PJ, is to allow us to continue the have the margins that have today and build on those. But be more aggressive in the marketplace. I believe it will free our leadership up to focus on driving growth. And so the rebound we're starting to see will continue going forward.

P.J. Juvekar - Citigroup Inc

And can you just give us a quick update on China? How many people do you have there on now? And you wanted to go after local business, local companies. How are you tracking on that?

J. Fyrwald

We're now up to 700 employees in China. Our Shanghai headquarters that we opened up about a year ago is doing extremely well in terms of re-positioning us in the country, because it's not only an attractive draw for new employees, it's a great place to motivate our existing employees, a great training center, a great technology center, to bring customers in and has repositioned us very, very well in the country. Our hiring of Ying Yae, who's Chairman of Nalco for Greater China. As we've talked about in the past, really improves our ability to interact not only with the Beijing government, but also with stat-owned enterprises that drive a lot of the economy in China. And that has resulted in a number of very attractive projects. It's starting to come in, bring in new business. So I feel very good about our overall situation in China. We're attracting great talent. The number of people that we've hired in the last two and a half years is about 350 people and very high quality. And we ask them why they joined Nalco, we hear from 93% of them that the number one reason they joined Nalco is they want to make a difference to the environmental challenges in China. And they believe that we are and can make a difference and that they can be part of that. So I feel great about China and the opportunity for us there.

Operator

And we'll go to our next question from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc.

Two questions, first, where's the current gap between your pricing actions this year and raw material inflation? How do you expect it to finish the year?

J. Fyrwald

We have a gap. I do not expect to close that full gap this year. And there's a couple of reasons for that. One is that the continued very weak economic conditions in Western Europe and North America are just making it tougher to drive pricing. Specifically, as an example, in downstream, the low margins for our customers, both in North America and Western Europe, the closing of facilities, has created a challenging pricing environment. Having said that, I do expect us to take actions that will improve our EBITDA margin going forward by focusing on price, making sure that we are articulating to our customers very clearly the value that we're bringing them and total cost reduction by driving the new technologies that we're driving, not just 3D TRASAR, but also a number of other new technologies that are increasing in value, including the Enhanced Oil Recovery that we've talked about but others as well. And driving productivity, continuing to drive productivity, both our get set projects, but also as we look at the growth rates of headcount that we've been having, having the people that we've hired and trained become more productive. And looking forward, how do we keep driving the growth with a less aggressive ramp up of headcount. Put all that together and I believe that we will increase our margins into next year. But I can't tell you for sure how long it will take us to re-capture fully the raw material increases with price. However, the raw material increases this year are far less than they were in the last increase cycle.

Laurence Alexander - Jefferies & Company, Inc.

And secondly, could you quantify, or even just give a rough swag at the current sales value of 3D TRASAR in the 360 remote monitoring programs?

J. Fyrwald

I think it's very difficult to put a specific number on it, but the way I would describe it is we've now got about 14,000 units out there. So 14,000 cooling towers, boilers and now some reverse osmosis units with 3D TRASAR for all the customers where we're using 3D TRASAR, it's making them stickier. It's creating a higher value with them that we can benefit by delivering more cost savings to them, which, with our pricing activities, we work to share with them. But also lowering our attrition rates significantly. And as we look at our margins with 3D TRASAR customers, they are higher than our margins for non-3D TRASAR customers. So I won't give you a specific number for just those, but I would say that the customers that are using or were using 3D TRASAR and increasingly, we're adding to that the Nalco 360 remote monitoring, we are adding more value, we're seeing less attrition and we're seeing higher margins.

Operator

And we'll go to our next question from John McNulty with Credit Suisse.

John McNulty - Crédit Suisse AG

Quick question. In your release, and you highlighted I guess in the call a little bit as well, you talked about incremental competitive pressures and that was one of the things that was keeping pressures on the margins. Can you speak to kind of where those competitive pressures are regionally, if you're seeing it in the BRIC+ areas or if it's more just kind of in the slower, more standard areas like Europe and the U.S.? And also in terms of the types of products that you might be seeing those pressures on?

J. Fyrwald

So first of all, the way I would say it is there's lot of competitive pressures and there always will be. I think we're doing very well versus our competitors in earning, winning new business based on value, not on pricing. And I think that's a good part of why our revenue growth is so strong. However, when you look at the macro base business, there's a lot of pressure on pricing because of the challenging economic conditions in Europe and North America. Our customers, very sophisticated purchasing people. Companies are looking at how do they reduce costs. So they're putting pressures in all their suppliers, not uniquely to water treatment, certainly. How we are dealing with that is making sure that we're delivering the maximum value we can deliver, quantifying that value and being able to discuss with customers how we're sharing that value them and how choosing Nalco, working with Nalco is better than other options. So there will always be plenty of, for example, chemistry suppliers that will come in with low-cost chemical products that could be used in the applications that we sell to. But our response to that is with our service capability, our 3D TRASAR automation and our chemical additives, that combination, we can provide you a lower total cost of operation, assure you asset integrity, assure you that your water usage continues to decline and that you're world class in environmental sustainability from both a water standpoint and from an energy standpoint with your heating and cooling systems. So you put all that together, and I think we have a very compelling value proposition. But the macro dynamic is that companies that are extremely challenged on profitability are trying hard to do anything they can to reduce their costs. So we're trying to become more of a solution to that problem versus a problem to that problem by bringing them more value. But it's a challenging environment. So let me just give you, again, some specific examples of where there's a particular challenge. North America and Western Europe, downstream oil refining. The industries continue to be challenged, a number of units have shut down. There will likely be some more shutdown of units in Europe as new capacity comes on in other parts of the world. And so refiners are pressured and are putting subsequent pressure on all their suppliers, including water treatment and service and process service suppliers like us. Again, we're responding to that with value and showing how we can help solve with our capability but net-net, the competitive dynamics are challenging. Other examples would be, in other large industries, large buyers are trying to push price reductions, and we are continuing to work with them in terms of looking at how we can help meet their cost challenges without dealing specifically with the price issue. So I think we will work our way through this. I would just say that a very challenging market, and you see it across industries.

Operator

Our next question comes from Rick Hoss with Roth Capital Partners.

Richard Hoss - Roth Capital Partners, LLC

As far as China goes, are you in any of the major SOEs at this point? I know it's sort of a philosophy behind or one of them behind hiring Ying Yeh?

Bradley Bell

Absolutely. We're in a number of SOEs today, whether it's Bow Steel, Capital Steel, ChemChina, a whole host of SOEs and a significantly increased number from where we were two years ago. And our pipeline is strengthening with existing SOEs where we sell today, but also penetrating more SOEs in the coming months and years. So we're making progress, never satisfied with where we are but we're making good progress.

Richard Hoss - Roth Capital Partners, LLC

But I think the last report was that an 8% to 10% market share. Is that growing or is that stable?

J. Fyrwald

It's growing, we are growing faster than even the high-growth China economy, but it's still small relative to the opportunity. So we see opportunity, not only to grow with the economy in China, but also to strengthen our market position. When you think about the challenges of China, very rapid industrial growth, a lot of heavy industry that's very water-intensive, we can help customers grow their industrial base, using less water and less energy, which is very, very important, not only to their cost position, but actually to their ability to run their plants. And that's very attractive.

Operator

And our next question comes from Robert Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc.

Erik, your company is by nature not that capital intensive, but I know your asset base in the emerging markets is quite a bit smaller than the developed market. So you talked about hiring both. What are the needs in terms of asset buildup in those emerging markets regions? And then can you give us some profile of where you would stand now on return on capital and the BRICs areas versus non-BRIC and what that path might look like?

J. Fyrwald

First of all, let me say that we're not going to compromise our return on capital expectations. But with the high rates of growth there we're seeing, with the need to supply product, especially blended products throughout these high-growth regions, we will need to build more blend plants. And as we increase our growth rates or as we keep growing aggressively, we're going to need some more of the reaction plant manufacturing capability as well in some of these regions. So the answer is that we will say with this increased growth rate an increased rate of capital expenditure. We'll give you more color on that when we talk about 2011 next quarter. But I think it will be very high return and I think it will be very reasonable, given the accelerated growth rate that we're delivering and expect for the future.

Bradley Bell

Maybe just to add a little bit to that, Bob, to register, have a lot of chemical company followers on the phone. For us at blends facility, you can launch it in a new country for $3 million or $4 million or $5 million. These don't come in the large slugs that some of you may be used to following traditional industry. I'm always duly bound to remind folks we're a service company, first and foremost. We recently don't forget opened a whole new Nanjing facility, which is very fully-featured and that entire project was $27 million, including rationary chemistry. This is a little different scale. I think your opening line, Bob, we're not particularly capital intensive. For us, it's more about the people.

Robert Koort - Goldman Sachs Group Inc.

And then in Europe, the consolidation into it and of course, the savings there come from elimination of redundancies or how do you get the benefits there?

Bradley Bell

We do a lot more with a single company style model as opposed to having a country by country deployment with varying procedures and processes for getting things done. It involves more tolling of products for the parent's company in Europe and you basically have the operating arms and legs country by country that are so standardized you can do a lot of that work from a central location.

J. Fyrwald

And today, we have a lot of our senior management in Europe enlighten the Netherlands, but we also have other spread throughout Europe. So we're bringing them all together, they'll work together as a unit. So it gives us a lot of opportunity to streamline the management processes, the back office continue to streamline that, and better focus on driving growth. And Switzerland is a great place to locate our European headquarters as well.

Operator

And we'll go to our next question from David Rose with Wedbush Securities.

David Rose - Wedbush Securities Inc.

On the margin side, as we look into your expectations to get 200 basis points improvement, how does that break down from productivity initiatives versus margin improvement on improved pricing? And then secondly, a question on goodwill. Your goodwill increased $100 million over Q2. Can you explain that?

J. Fyrwald

I'll talk to the margin and Brad will talk to the goodwill. On the margin, I can't give you a specific breakdown but what I can tell you that both price and productivity will play into our drive to holding and build on our margins today and work towards our goal of 20% EBITDA. We got opportunity in both places. On the pricing side, we are bringing lots of value to our customers, sharing in that value is something they understand. And the more we quantify it, the better we train our people, the more opportunity there is there. Our new technology, we've talked a lot about 3D TRASAR, but we've got other great technologies. Our Enhanced Oil Recovery business is small but growing very, very nicely. In the Oil Sands, we have chemical programs that remove bad actors that allow for better transportation and processing of the heavy oils, doing very, very well with very attractive margins and our Mining business, we have some new dust control agent technologies that's very attractive margins in high-growth. We are seeing opportunity for greener chemicals, phosphate-free products for water treatment, formaldehyde-free paint recovery products for automotive, a number of technologies that we're launching, and we've been increasing the R&D spending in the last few years, the pipeline's not only filling up, but also we're starting to launch more products. And that will help pricing and margins. And then the productivity, we'll see what we can do with that. We've demonstrated with get set that we have a good productivity system. We just need to get that more broadly deployed and ramped up and be able to realize our growth with a leveraged back office support, and even in the marketplace with more productivity and in how we service the customers. And with all that put together, I am confident that we will see some margin improvement in 2011, but that will continue out beyond 2011.

Bradley Bell

On the goodwill question, it might be the easiest comparisons to look at the earnings release we just issued. You'll see that goodwill is up about $48 million from the end of the year. We got a couple of acquisitions this year, and early in the year, we acquired the stake in North Africa. A good portion of that was allocated in goodwill. Individually, these are not relatively large. In April we completed the purchase of ResChem. In the third quarter just ended, we acquired this company called FabTech or Fabrication Technologies Inc. and that, by itself, is about $20 million. And there's a small item correction for some purchase accounting that went between deferred tax assets and goodwill.

David Rose - Wedbush Securities Inc.

I was just looking at the second quarter, you're taking the second quarter and comparing to the press release. It was $100 million rather than $40 million. So it's actually a little bit higher than that. SO it sort of a little bit higher than that.

So it sort of caught me by surprise.

Bradley Bell

Foreign exchange movement in there too because a fair amount of our goodwill is a portion around the world.

J. Fyrwald

By the way, our South Africa investment re-launch, of Nalco in South Africa is going very well.

Operator

And our next question comes from the line of Mike Harrison with First Analysis.

Michael Harrison - First Analysis

I wanted to revisit this idea of seeing additional competitive pressures. First of all, I was curious if you could give a sense of where you're seeing this additional competition coming from? Is it from anyone big or is it from smaller regional guys? And then second of all, you mentioned that your customers are getting more sophisticated on purchasing, which I would agree with. But I do still think that you guys have the advantage in terms of understanding what's best for their assets, what's best in terms on the engineering of the water treatment service that you're providing. And I'm curious if maybe rather than what you would typically do, which is let the customer go ahead, buy the cheap chemical and they'll be back eventually, are you guys actually playing into this competitive pressure or the sophisticated purchasers by sacrificing some of your pricing or your value proposition in order to gain volume, your organic growth numbers might suggest that something like that is going on right now.

J. Fyrwald

First of all, let me be very clear, that's not what's happening. Our new business that we're capturing is very attractive margins. What's happening is the competitive dynamics that I was talking about is across the base business, and it has nothing to do with our competitors strengthening. It's much more to do with just the economic dynamics, which are causing many companies to have challenges and to push harder on getting price reductions or cost reductions. You're absolutely right and that even with the purchasing's increased sophistication, we can be a solution to their problem versus a creator of their problem, not with price, but with the value that we bring. And what we're doing increasingly is obviously, we interact with purchasing with all of our customers. But with the combination of technology and total cost savings opportunities and the environmental benefits that we can bring, we're playing to, in addition to the purchasing people and playing to their need to help reduce costs, not necessarily by price, we're getting to the business leadership and the corporate leadership around, not only can we help address your cost challenges, but we can help address your environmental challenges. And that's across businesses. Specifically on the Energy Services side, with harder to find oil, deep, ultra deep, heavy oils, the more challenging the oil is, the more the customer is going to rely on our service capability and technologies with confidence to be able to help them meet their needs, and the amount of costs that we represent to the amount of risk that they take if what we bring is not successful makes us very attractive and makes the value discussion very doable to put on the table. So I'm trying to describe the macro economic dynamics are very challenging for many of our customers. That results in a hard push. But I believe that we are well-positioned to work our way through that. And I agree with you that if a customer is going to buy only on price of the chemical, then we'll be glad to see them go with somebody else. And then hopefully, win them back later when they see that the real opportunity is the total value we bring, which I can tell you that the preponderance of customers see, because I believe we are strengthening our market position, we're not losing our market position.

Operator

And our next question comes from Brian Drab with William Blair.

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

Just another question on gross margin. Going from the second quarter 2010 to the third quarter, did the pressure in gross margin come more from higher raw material costs or from a more challenging pricing environment? Because my understanding from following some of these key raw materials that you used in your processes is that you actually have had a good pullback in some of the commodities like polyethylene and polypropylene and things like that. So could you give us a little color if it is on the cost side specifically, where is it coming from and which was a bigger factor, cost or price?

J. Fyrwald

It's definitely on the cost side, and we were not able to cover the raw material cost increase with pricing in the quarter. But you're right in that there have been some raws that did come up and we saw that those flow through in the third quarter, but there's also been some weakness in raw costing that we've seen in some areas too. So we do not expect the same kind of increase in raw costs that we saw on the third quarter to happen in the fourth quarter.

Bradley Bell

You don't feel a little different to in timing, in terms of the price in which we're procuring new raws and the cycle through inventory until they show up in cost of goods sold.

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

I understand that particularly because your international business operates on FIFO, correct? And it might take some time to see those pullback to show in the gross margin line?

Bradley Bell

Right.

Unidentified Analyst

One then just one follow-up question to the second question on Mobotec. In China, you began a program, I believe, early or maybe mid-2009 with a few systems in place. Can you update us on progress of Mobotec in China?

J. Fyrwald

In China, we had three projects that we talked about. Those projects have been successful. They've demonstrated the technology. The technology works. We have not been able to translate those yet into new closed projects. We do have an attractive pipeline of projects. We have recently moved to try to strengthen our commercial operations there and better communicate the successes that we've had to other potential customers. So I don't have anything to report today. But in China and similarly in Europe, where we've also successfully demonstrated the technology and where we believe the demand is also there, we have an attractive pipeline as well, but we have not been able to close the major projects, major from our standpoint. But we will update you through 2011. We expect to close a number of projects in 2011. But we haven't done it yet, and I'm anxious for that to happen. But what I can tell you is that technology is working and it provides the customer the ability to meet regulatory standards at much lower costs than other alternatives. So we've got a value proposition, now we just need to close some deals.

Operator

Our next question comes from John Quealy from Canaccord.

John Quealy - Canaccord Genuity

First question, with regard to the accelerated headcount, can you just summarize for us again where and how much we should expect accelerated hiring? And if you could, is there a way to quantify what the realtime operating margin drag has been for that?

J. Fyrwald

We can't quantify exactly the drag because we've been hiring now for a few years aggressively. It's resulted in -- been a significant contributor to the growth rate that you're seeing now. Two quarters of 40% growth in BRIC+ is partly related to obviously the growing economies there but also to our strengthening market position. So first point is that it is paying off. We've told you that we've hired 700 people year-to-date increase from last year. What I can tell is that our rate of hiring going forward will be significantly less than that. We'll continue to increase headcount. But now we're looking at, okay, we have significantly increased headcount, let's make sure that we're adding what we need to do to be successful at new accounts, but let's keep working on getting more productivity out of our back office, our administrative functions. And as we get more 3D TRASAR out there, how do we get more efficient in our services model? When we have 3D TRASAR running at 14,000 accounts, many of those with remote monitoring 24/7, how do we translate that into more efficient servicing of the accounts? And we're learning how to do that and so we'll see some more productivity there. So I can't give you a specific number, John, but what I can tell you is that I believe that we'll be able to continue a high growth rate, revenue growth rate, with less hiring increases as we figure out how to do things more productively.

John Quealy - Canaccord Genuity

My follow up, with regard to Paper in China or Asia, I should say, up over 20% in the quarter, can you comment on that contribution margin? Did it keep pace with that growth or was it acceptable for you in the quarter?

Bradley Bell

This is Brad. It was acceptable to us in the quarter. And a lot of it has to do with the mix of what we're selling and to whom, unlike Western Europe and North America, the Paper business is a very attractive market point for us in Asia and in China in particular.

J. Fyrwald

I was just in China three weeks ago and visited several paper mills. And I got to tell a couple of things. One is we've got a very good team there, it's a very good service capability that they learned from our North America and Europe colleagues and really have some very good capability on the ground, very good relationships with the major paper companies at senior levels. We had meetings with top management, and it was interesting that the top management was very interested in the success that they've had with our technology. So they're adopting our latest technologies, including brand-new technologies that we've just recently launched and launched them early in China. So we're seeing that technology adoption, good relationships with senior management who want to use us, not only for our technology and cost, but also because they're very interested in environmental sustainability. So we bring them less water use, less energy use, they like that very much too. So as a result of that, we're selling value and we're getting attractive margins and very high growth. So we're very excited about the Paper business in Asia.

Operator

And our next question comes from Mark Gulley with Soleil Securities.

Mark Gulley - Soleil Securities Group, Inc.

Brad, if you were hanging around, what kind of tax rate might you achieve? And would some of that come from with the discussion we had this morning with respect to consolidating operations in Europe?

Bradley Bell

You got a mix across Europe to be sure. I don't want to confuse what's going to happen to the global tax rate because, again, we continue to repatriate cash earnings from around the globe back home. So does something like this helps? It helps on the tax line, sure, but the primary driver for the European move is really a simplification of the model and making it standard across Europe. And with that, we're really going to drive EBITDA margins to a better point, and there was a nice, beautiful spot in Europe already. And Europe is not a problem for us.

J. Fyrwald

And Switzerland is a good location.

Mark Gulley - Soleil Securities Group, Inc.

And then secondly, I got this feeling in talking about the results of the quarter this year, Erik, that when you think about it, you got a bit of a windfall, if you will, from the BP issue. Although I'm sure you don't think of it that way. Are you using that windfall to add to infrastructure, to add to sales force and all of that? And if so, if that premise is correct, with the absence of that windfall next year, are you going to be able to continue growth going forward without that tailwind?

J. Fyrwald

First of all, we're not looking at it as an opportunity to take that money and invest it. We're looking at the investment opportunity and investment returns totally separate from the BP oil spill dispersion situation. So take that completely separate. And what I would say is we are looking at the growth investment and very hard at what the returns are going to be for that growth investment, and we like what we see. We like the fact that it's starting to kick in. We like the returns, but we still believe that to get the margins where we want them, we got to do it more productively. So we are going to do that. The oil spill dispersion happened, its past, it's gone, and we don't expect and we hope to not repeat that.

Bradley Bell

Mark, we do all of our metrics internally and even the budget planning next year are all taking, ignoring the dispersion impacts in the current year so that we don't get lulled into thinking there's something there won't be around.

Operator

And our next question comes from Ryan Connors with Janney Montgomery Scott.

Unidentified Analyst

I wanted to touch on some of the cyclical dynamics at play here and how they impact the trajectory of the top line? I know that during the downturn last year, you talked a lot about facility shutdowns being a significant factor, shutdowns by your customers in terms of the revenue decline, and now we're seeing a nice cyclical bump up in the revenue off of the trough. So do we interpret that as customer facilities coming back online, or is this just improved utilization rates at the customer facilities that operated throughout the downturn?

Bradley Bell

First of all, when customers reduce their utilization rate at a given site, for our water treatment business, it doesn't really affect how much our sales are. Now for our process side, it does relate, and paper often relates to the amount of production used. But bottom line is the utility of the plant, the rate at which a plant runs is not that strongly correlated to our sales. The start up facilities, our shutdown facilities, obviously, when our facilities shut down. We do not sell anything and when a facility starts up, we go from zero back to selling. And there's some of that benefit in what you're seeing. But overall, I think we're doing two things, we're growing with the market by investing in the high-growth markets; and secondly, we are strengthening our market position. I believe strongly that across the world, our target markets across our businesses this year, we will have strengthened our market position. So I think it's more about that and investing heavily and driving growth in the growth markets, the highest growth markets. That combination.

John Quealy - Canaccord Genuity

And you mentioned in your prepared remarks, regulatory uncertainty in the U.S. as a limiting factor on the results there. Can you maybe elaborate a bit on that and talk about your outlook for how that evolves from here?

Bradley Bell

Yes, first of all, that was specifically about Mobotec and Mobotec only. And that's related to -- what we bring in Mobotec is to coal-fired units, the ability to reduce NOx, SOx, mercury and particulates. With the U.S. uncertainty and regulatory, nobody is investing in new pollution control technologies even if we are lower cost than other alternatives. But that's starting to become clear what the future is, and we're starting to hear from customers that they're considering what to do, and our pipeline is starting to look like it's more a reasonable term between here and when some things could close. That's been a big headwind for us this year. I expect it to start to loosen in 2011. That's not the issue in Europe and China, the issue in those two countries are we just need to get customers to make decisions and close projects and get going. So the regulatory thing in the U.S. has been a big headwind, but I expect that to start to open up next year.

Operator

Our last question comes from Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

Just to maybe summarize, I just want to review one more time, the margin in direct contribution in Water and Paper, obviously, we were impacted by raw material costs, our pricing lags, but given where we stand today, pricing appears to be going in places especially in the water side, material costs have flattened out. On the Paper side, one of your competitors has talked about raising prices pretty aggressively in this fourth quarter. Is there any reason that we should assume that the contribution margin in Water and Paper don't, at least, stabilize, if not improve here in the fourth quarter and into next year off to this kind of call it the third quarter base?

Bradley Bell

I think that's a good assumption, Richard.

Richard Eastman - Robert W. Baird & Co. Incorporated

Just lastly, Erik, you talked about the BRIC countries, the growth rate there, the BRIC region, the growth rate there. Can you just give us an order of magnitude, say, for the third quarter? What percentage of revenue that you're rolling into that growth rate from the BRIC countries? How big are the BRIC countries from a revenue percentage standpoint?

J. Fyrwald

A little bit less than 20%. At 40%, they're growing -- they'll quickly become a bigger part of our company.

Okay. Well, thank you all for joining us. Let me make a couple of closing comments. First of all, just to summarize, we're very pleased with our revenue growth. We are focused on continuing to drive that revenue growth and sustainably deliver the 6% to 8% or more revenue growth that we've talked about in past calls. Secondly, we're pushing hard to increase margins, both through price discipline and productivity. And thirdly, we feel good about the future of Nalco. We're seeing additional, attractive growth opportunities, with an expanded business model, bringing more service capability to our customers. We've talked in the past about TIORCO and Crossbow acquisitions as good example of this. And I look forward to discussing more progress in this arena in coming quarters and how it can add to our profitable growth. But finally, let me close by saying that on behalf of the Nalco management team and the board, we'd like to thank Brad Bill for all he's done for the company over the last seven years to strengthen us, and we wish him all the best going forward. So thank you very much.

Operator

That concludes our call for today. Thank you for your participation.

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