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Nalco Holding (NYSE:NLC)

Q4 2010 Earnings Call

February 02, 2011 10:00 am ET

Executives

Lisa Curran -

Kathryn Mikells - Chief Financial Officer and Executive Vice President

J. Fyrwald - Chairman, Chief Executive Officer and President

Analysts

Richard Eastman - Robert W. Baird & Co. Incorporated

Mark Gulley - Soleil Securities Group, Inc.

Jeffrey Zekauskas - JP Morgan Chase & Co

Chip Moore - Canaccord Adams

Robert Koort - Goldman Sachs Group Inc.

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 Fourth Quarter 2010 Earnings Call hosted by Nalco Company. [Operator Instructions] At this time, I'd like to turn the call over to the division Vice President for Investor Relations of Nalco, Ms. Lisa Curran. Please go ahead.

Lisa Curran

Thank you, James. And good morning from snowy Chicago-land. And thank you for joining us for our conference call to discuss fourth quarter and full year 2010 results. Speaking today will be Chairman and CEO, Erik Fyrwald; and our new Executive Vice President and CFO, Kathryn Mikells. Given the winter storm, the three of us are all calling in remote locations and so hopefully we'll maintain our connections.

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 be also 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 earnings reports to the closest GAAP equivalent have been provided as attachments to our earnings release.

After comments from Erik and Kathryn, we will open the call up 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 that participants re-queue in order to ask additional questions.

With that, we'll start with Erik.

J. Fyrwald

Thank you, Lisa. And good morning. In the fourth quarter, Nalco reported our highest revenue in any quarter ever at $1.12 billion. That's an 11% increase over prior year and surpassing the prior year record quarter from 2008. And for the full year 2010, we reported record sales of $4.25 billion, a 13% increase over 2009 and an 11% organic growth rate.

We are beating pre-financial crisis results, which demonstrates the strength of our business and that our growth strategy is working. We are executing well against nearly every aspect of our strategy and growing faster than our historical growth rate of 3% to 4% per year. Let me quickly update you on the key strategy elements we have laid out in the past.

First of all, in our BRIC+ markets, we achieved a full year record growth rate for these geographies of over 30%, reaching over $700 million in sales. In December, we formed a Nalco majority-owned JV with LUKOIL to produce and sell our energy products and services to LUKOIL and other energy companies in Siberia, Russia. This will accelerate our growth in this very important Russian energy market.

3D TRASAR automation unit sales continued to be strong. Year-to-date global sales growth rates for cooling and boiling, 3D TRASAR systems were both over 60%, with an all-time record 4,500 new units placed. And we've maintained a fast rate of adoption of our Nalco 360 remote monitoring with installations exceeding the 3D TRASAR unit sales pace as we convert previously installed 3D units and put in 3D units with new customers including the Nalco 360 remote monitoring.

Our Europe, Middle East and Africa region continues to make very good progress. Our senior team there is strong, we have and continue to reduce costs, we stopped market share decline and have improved our position in the Caspian, South Africa and Russia. And we're stepping up growth investments in the Middle East. Our Enhanced Oil Recovery business just posted record results in December and delivered a full year sales increase of 65% year-over-year.

In Air Protection, we did start to see some success with the $5 million to Nalco PAK project in Poland that we announced last week. And we also have some key additional projects in the pipeline for potential 2011 close. I'm not satisfied with the progress in this business but it is encouraging to start to see improvement. Lastly, we are stepping up our capability and business in shale gas.

Now moving to productivity, which is becoming an important capability across Nalco. We exceeded our target of $100 million in savings for a second consecutive year by achieving $122 million in cost reductions. Working capital management progressed as well as we reduced inventory by 2 1/2 days, building on solid gains in 2009. So overall, I feel that we have made very good progress with both our strategy and execution.

Now one area we are behind is pricing. We did not recover the increased cost of raw materials, which escalated in the fourth quarter. We are stepping up our efforts and have made a number of price increase announcements since December that cover our end markets and global footprint. We've had reasonable reception from our customers and believe we can make very good progress in the first half of the year towards covering our cost increases. Our commitment to our customers continues to be that we will consistently bring them total cost of operation savings that make Nalco by far their best option.

To support our accelerated business growth, we invested $54 million more in net CapEx in 2010 than in 2009. Even with this, we ended the year with strong free cash flow of $185 million, which was aided by the onetime disbursement sale. We continue to see many attractive growth opportunities that will require OpEx investments for more service engineers and support and increased R&D and more CapEx for manufacturing facilities to serve BRIC+ markets and for high-value equipment that we lease to customers like 3D TRASAR, Enhanced Oil Recovery feed systems and other specialty equipment. Before I provide you with our 2011 guidance, I'd like to spend a few more minutes highlighting our growth investments at work.

Technology and innovation. We had key 2010 launches that each delivered millions of dollars in sales in year one. Let me cover a few of them. Our Apex program for paint detackification launched with automotive manufacturers around the world. This technology helps clean up water and recovers paint from paint booths in an environmentally friendly way.

We launched our potash dust control program offering which is a greener solution for dust management in potash mines. FillerTEK, a fiber substitution program for paper that reduces pulp costs had a very aggressive launch. Brake Easy [ph] (16:58), friction reduction technology for shale and gas markets is now commercial as well as mercury, MERCONTROL mercury abatement program for the removal of mercury in boilers. Our seawater treatment program for use in cooling towers launched. And finally, also, our wax disbursements and hydrogen sulfide scavengers for the oil sands markets. These exciting technologies, along with our services, are helping our customers increase production and lower costs in environmentally friendly ways.

Turning to M&A. In August, we further expanded our enhanced oil recovery capabilities with the acquisition of FabTech. FabTech is a leader in custom-designed facilities for the application of tertiary chemical floods and also has extensive expertise in water injection and water disposal systems. Now operated with TIORCO by a single leadership team under the name of the Nalco FabTech and leveraging Nalco water treatment expertise, this completes a one-stop shop enhanced oil recovery solution package for oil companies all around the world. And it is being very much appreciated by our customers.

I'm proud of these 2010 accomplishments and also how we responded to the demand for dispersants to help reduce environmental impact of the oil spill crisis in the Gulf of Mexico in the second and third quarters of 2010. Although this diverted our attention temporarily from some other repeatable growth opportunities, it was the right thing to do. Looking back on 2010, it was another step in our working hard to establish a track record of delivering what we say we will achieve as we strengthen the company for a high-growth future.

Moving to 2011. We are looking to deliver another very successful year. We will continue significant investment in people and plants in BRIC+ geographies and increasingly in specialty customer equipment including 3D TRASAR and other differentiated technologies. This will keep EBITDA margins in the 17% range as we make these aggressive investments for future growth. If we see less growth opportunity in the future, we will reduce our rate of growth investment, which will help increase our margins towards 20%. But I think the key for us is that we will keep investing in attractive growth opportunities at a level that allows us to drive for 10% per year EBITDA growth going forward.

Now before giving you our 2011 guidance, I think it will help if I give you a backdrop to our targets. Starting with our Water Services business. Our Water Services team has accelerated our growth rate in industrial water treatment by adding resources in BRIC+ geographies and adding a broader solution capability to our portfolio with more specialty equipment for water pretreatment as we build on our Crossbow acquisition capability, adding this to our services and chemical additives offerings.

Although small at this time, the specialty equipment business will be lower gross margin than our traditional business but will still result in very attractive returns as part of an integrated systems offering. We will work to offset increasing raw material cost this year in the Water Services business through price actions described earlier and through productivity savings.

We will continue strong penetration of our 3D TRASAR technologies into the market and we expect to deliver revenue growth in Water Services that are in-line with our corporate goal of 6% to 8% revenue growth.

Moving to our Paper Services segment. We expect European markets to remain soft, North America to be up slightly and for continued solid industry growth in Latin America and Asia. Given our people investments in BRIC+ and our exciting new technologies like OxiPRO, we also expect this business to achieve a mid-single-digit growth rate in 2011.

For Energy Services we expect sales growth to be towards the upper end of our corporate goal of 6% to 8% revenue growth with flattish margins. We are hiring engineers to support new contract wins in our expanding footprint of business. Like Water Services, we will invest more CapEx in the business and continue our focus on cost and working capital productivity.

We are taking strong pricing actions to recover cost-of-goods-sold inflation projected for 2011 and unrecovered in 2010. We expect some stabilization and recovery in downstream but the market will continue to be challenged and further closures and asset sales are expected in North America and Europe over time.

In our Upstream business, we expect some market share growth with super majors with new CapEx coming online. In our Adomite business, we will see strong growth from shale gas including new greener technologies for frac-ing and our enhanced oil recovery market looks very promising again as the small-base business moves from technology start up to much more of a sales execution model. In Europe, our Switzerland-based centralized structure is scheduled to start up in the second quarter and should show benefits from the second half of the year.

So to summarize our outlook for 2011, we are targeting to meet our stated goal of 6% to 8% organic sales growth, excluding divestitures. We are taking out the 2010 impact of oil spill dispersants and our recent divestitures to create profit growth rates on an apples-to-apples basis. And with this, we are striving to deliver an adjusted EBITDA increase of roughly 10%, with expected EBITDA of roughly $735 million and an adjusted EPS growth rate of roughly 17% to about $1.65 per share.

On a normalized basis, before divestitures and onetime items, we expect free cash flow to be roughly $175 million even though we will be investing heavily in CapEx to realize our strong growth needs. And we are targeting an effective tax rate of approximately 35%. Our intent is to achieve these results while we continue to invest aggressively for 2012 and beyond with CapEx of about $200 million to expand manufacturing capabilities in BRIC+ countries and as we increase investment in customer automation and other high-value specialty equipment.

We will also continue to invest in OpEx with additional hires, mostly in the BRIC+ geographies, of sales engineers, support staff and more researchers in India and China. We see tremendous opportunity for attractive growth and we will keep going for it.

With those comments, let me turn the call over to Kathryn to discuss our 2010 results in more detail. Kathryn?

Kathryn Mikells

Thanks, Erik. And good morning to everyone joining the call today. As Erik said, 2010 was a very strong year for Nalco. Successful execution of our growth strategy is clearly reflected in our record revenue for the quarter. Fourth quarter sales of $1.12 billion were up 11% versus a year ago or 10% on an organic basis. Notwithstanding organic growth in every region, our adjusted EBITDA was $189 million compared to $190 million in 2009 as over 50% of our full-year raw material cost increases hit us in the fourth quarter.

Erik talked to you about the actions that we're taking to recover price. We know this will be a theme throughout 2011 and is a key focus for our entire leadership team. Adjusted EPS nearly doubled to $0.56 reflecting a $10 million reduction in interest expense and a significantly lower tax rate year-over-year. In contrast to last year when we had a high tax rate due to valuation allowances, this quarter, our tax rate dropped as we harvested foreign tax credits and benefited from the legislative reinstatement of the R&D credit.

Moving to the segments. Energy Services realized 12% organic growth for the quarter and record sales in December, driving a strong global upstream market. A good recovery in the downstream market and record Adomite and break water sales.

Fourth quarter direct contribution margins declined 160 basis points, reflecting raw material headwinds and competitive contract price concessions that were partly offset by productivity and gain sharing. Additionally, Energy services had some expansion and operating expenses as they started up new contracts in Russia, Angola and the Caspian.

Water Services organic sales increased 8% in the quarter with heavy markets led by primary metals and chemicals growing at twice the global rate of light markets. Higher sales in low-margin end markets, steep increases in raw material cost and higher operating expenses all contributed to a 200 basis point decline in direct contribution margins.

Paper Services organic sales increased 8% in the fourth quarter, with more than 20% growth in Asia-Pacific. Direct contribution margins declined 330 basis points, reflecting raw material cost increases. And as you may recall, a very high margin last year that we noted would be challenging to sustain.

And now, for a brief look at organic sales by geography for the fourth quarter. We realized the following organic growth rates: 14% in Asia; 14% in North America; 2% in Latin America; and 2% in Europe Africa, and the Middle East. In Asia Pacific, paper sales grew at the highest rate at over 20%, albeit off the smallest revenue base of our three segments.

Water Services, the largest of the segments within the region, also had double-digit growth with mining and primary metals taking the lead. Energy Services grew at a high single-digit rate in North America. Water Services showed robust high-teen growth with primary metals, mining, chemical and power end markets all especially strong, indicating recovery in these end-use markets as well as our continued focus on leveraging our service and technology strength to take market share.

Energy Services also had double-digit growth with upstream markets taking the lead. Paper Services grew at a mid- to high single-digit rate. Looking at Latin America, Water Services grew at a low single-digit rate, mainly driven by heavy market. Energy Services and Paper Services grew at mid- to high single-digit and mid-teen rates, respectively.

We'll wrap up our fourth quarter regional sales review with look at EMEA, where Water Services declined by about 2% and again mining, chemical and primary metals had the highest growth rate. Energy Services grew nicely at mid-teen levels, driven by upstream market growth. Paper Services was roughly flat to the quarter. Free cash flow was $74 million in the fourth quarter, $36 million lower than last year.

As Erik mentioned, we increased our full-year capital investment in the business by almost $55 million versus 2009, with about $25 million of that increase coming in the fourth quarter.

Turning now from the fourth quarter to full year 2010. Our sales increased 13% to $4.25 billion. Excluding onetime dispersants sales, revenue increased to $4.16 billion. Adjusted EBITDA of $747 million was also up 13% compared to the year-ago period with a little over half of the $90 million year-over-year gain attributable to onetime dispersants sales.

Adjusted EBITDA, excluding the onetime sales, aligns closely with the guidance we provided you last February. Adjusted EBITDA margin was flat year-over-year at 17.6% as pricing and productivity gains were offset by nearly a $175 million headwind from the combination of higher operating expenses and raw material cost increases.

Free cash flow for the year of $185 million included a modest working capital base improvement and $30 million to $35 million of one-time benefit from sales of dispersants. Strong free cash flow enabled us to reduce net debt by $73 million. The effective tax rate for the year was 32% on an adjusted basis, roughly 400 basis points lower than expected last quarter due to the fourth quarter tax benefit that I mentioned earlier.

Capital expenditures were $155 million this year of which about 60% range went towards infrastructure and about 40% towards customer-related capital. We anticipate that CapEx needs in 2011 will be roughly $200 million to maintain infrastructure, to support business growth including BRIC+ needs and for strategy initiatives.

As you know, we executed two significant refinancings last quarter. The combination of our strong business performance and favorable debt markets enabled us to secure better rates, reducing our annual interest payment by about $38 million a year with $34 million of that incremental benefit coming in 2011.

We also recently announced the sale of two non-strategic businesses. We intend to use the proceeds from these divestitures to de-lever by repaying the remaining $200 million of 9% senior discount notes that are outstanding. With the repayment of the remaining senior discount notes, we have moved out our debt powers and have very little debt coming due before 2016.

In terms of expectations for 2011 free cash flow, the onetime tax of roughly $50 million related to the gain on sale from our divestitures will be reflected in operating cash flow. The impact of the divestitures and a few other onetime items results in an expected 2011 free cash flow of roughly $85 million.

We provided additional details in the investor supplement that we 8-K-ed at the same time as our press release last night. In closing, we feel good about the gains we made in 2010 and, adjusting for onetime items, expect strong profit growth in 2011 as we continue to execute our growth strategy.

With that, I'll turn the call over to our operator, James, so he can open up the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question today from Brian Drab with William Blair.

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

First question, just on the EPS buildup in the supplement to the press release. For 2011 adjusted EPS guidance, you stated roughly $1.65. When I look at that buildup, I don't see a line item that indicates the impact from major refinancings that you did in October and December. And I'm wondering if I'm just missing that or if that hasn't been taken into account here? Because I would estimate you're going to save $0.15 to $0.20 in EPS related to reduced interest expense associated with those refinancings.

Kathryn Mikells

I'm happy to take that. So overall you're correct in terms of roughly the interest savings. It's taking into consideration in the line item and the supplement that we called 2011 organic EPS growth. Overall that takes into consideration that the growth that we had mentioned in terms in EBITDA year-over-year, offsetting that is an expected increase in depreciation expense. We had mentioned that we're continuing to increase investment in the business in 2010. Our capital expenditures had increased in year-over-year, they are going to continue the increase so we're seeing a little higher depreciation expense. We're also guiding to a little higher tax rate than we experienced last year. And we're expecting a little bit of an increase in terms of below-the-line entities that we don't have majority control over. And so those are some of the other items that ultimately net into that 2011 organic EPS growth of $0.22 to $0.26.

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

Could you give us a little more detail regarding the tax rate in the quarter and the 14% rate? Why was it so low? I may have missed that if you got into that in your prepared remarks.

Kathryn Mikells

It really was driven by two items. We were in a position to take advantage and harvest some foreign tax credits. And we also had a change in law that occurred in the quarter and reinstatements of the R&D credits. And so those two items both fell in the quarter and reduced our tax rate significantly.

Operator

Next we'll hear from P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc

It seems that raw material prices should be more easily passed through in the energy market given that your customers are involved in energy and, I understand, the raw materials? And you mentioned that some competitive action in that segment, so are you going after volumes at the expense of price and energy?

J. Fyrwald

No, we are not going after volumes by reducing price in energy. We are continuing to strengthen our market position around the world in energy by adding value, bringing value to customers. But yes, a good chunk of our Energy business is open book model, as we've talked about before. And those costs will flow through, there's just a lag of time. And we are moving on price increases across the Energy segment around the world. So we will start to see those in the first and second quarters of this year and expect to be back on track here.

P.J. Juvekar - Citigroup Inc

And just quickly on the tax rate based on the previous answer, you're expecting tax rate to go up in 2011 compared to 2010. Kathryn, where could this long-term tax rate could go and when do you think that will happen?

Kathryn Mikells

We're continuing to look at what we can do structurally to bring down our tax rate. Overall the tax rate that we're guiding to is roughly 35%, with a couple of points under what our federal plus state tax rate would be, reflecting clearly that we are doing other things that we can do to get our tax rate down. But that will continue to be a focus of ours long term.

P.J. Juvekar - Citigroup Inc

Do you see a structural shift in the tax rate to maybe 30% or lower at some point?

Kathryn Mikells

Too early to tell. It's something that we continue to work on. And we'll work on that and obviously this year and in the outgoing years. But right now, that's our best guidance at the moment.

J. Fyrwald

But clearly we have efforts to find ways around the world to reduce our tax rate.

Operator

We'll move on to our next question from Laurence Alexander with Jefferies & Company.

Laurence Alexander - Jefferies & Company, Inc.

Could you elaborate a little bit more on the strategic rationale around the divestiture and what percentage of sales you might class by businesses that could also be in that category of possibly being divested over the next two years?

J. Fyrwald

Yes. The two businesses that we divested, one was called NALFLEET, which was a marine business, which was very small for us. And we did not have critical mass of a total solution set. So we believe that, that business is in better hands with a company that has a broader offering to marine customers. The other divestiture was our personal care business. Certainly not core at all, there was no leverage with our industrial water treatment or Energy Services business. So we were not putting in the R&D or the effort, I would say, to continue to grow that business at attractive levels. So it was a distraction, not a core business, both of those. And we have divested them at, I believe, very reasonable levels. And I look at this as completing our need to divest of non-core businesses. I look at the rest of our businesses, as very good strategic fit. And we'll grow from here and our M&A activity now will focus on acquisitions.

Laurence Alexander - Jefferies & Company, Inc.

And then just a follow-up on one of the prior questions about the operation leverage or how much of the EBITDA improvement is being offset by agents below the line. Are those factors that were listed, are those likely to continue in 2012 and 2013? Or do you see this as a one-time challenge and then as the new businesses and the growth rates improve, you should get more EBITDA leverage flow through to the earnings?

Kathryn Mikells

The one thing that I would mention that I expect to continue is we're seeing depreciation increase year-over-year. And as a result of our increased investments in the business in order to support growth and especially our growth strategy in BRIC+ markets, I would expect that to continue. In terms of the tax rate overall and the change year-over-year, no I would not expect that to continue. And in fact, as Erik and I both pointed to, that is going to be certainly a focus of ours long term in terms of structurally what different things we can do with the business in order to drive that tax rate down further. But those other two items, will be as I mentioned.

J. Fyrwald

And just let me build on that. So we see lots of very attractive growth rates, equally attractive businesses we've had in the past, lots more for us before to get. The challenge is, we want to grow it at very aggressive levels so we're investing the OpEx and the CapEx to make sure that that happens. So that investment for the future, as we hire and train people that can continue to grow the business in 2012, '13 and beyond as we expand manufacturing footprint around the world in these BRIC+ geographies. And as we start to sell more specialty equipment, 3D TRASAR, FabTech and other on a lease basis, our CapEx and OpEx are increasing for that future growth. But the base business that we're getting is equally attractive to what we've had in the past. So I don't see any diminution in the attractiveness of the business. It's the investment for future growth that is putting some pressure on our margins. But certainly the business that we're winning is very, very attractive.

Kathryn Mikells

And one last thing that I would mention in terms of interest expense. Obviously, we just completed a number of refinancings that are giving us a lot of interest expense savings year-over-year. Our continued de-levering will also continue to just naturally reduce our interest expense as you look out into the future.

Laurence Alexander - Jefferies & Company, Inc.

But maybe if I can just -- one clarification on that. If you run the math on that, do you expect your EBIT growth to be at least equal to your sales growth in 2012, 2013 and beyond or do you think you're going to this drag effect for several years?

J. Fyrwald

It should be in line with the revenue growth. So we're saying now for 2011 is 6% to 8% revenue growth and 10% EBITDA growth. And I think that's a model that we want to continue to drive going forward.

Operator

Next we'll hear from John McNulty from Crédit

Suisse.

John McNulty - Crédit Suisse AG

A quick question on the cash flows. When I look at your net earnings, it looks like you took in about $196 million. Your free cash was $185 million. For such a low capital-intensity business, I'm a little bit surprised at the cash flow conversion that we're seeing and it doesn't seem to be keeping up with what you've done in past years like '07 and '06. I'm wondering if there's something different going on there and how we should think about cash flow conversion going forward.

Kathryn Mikells

We increased our capital investment year-over-year, we mentioned we spent $155 million in capital year-over-year. We're intending on spending a little bit more than that in 2011, as we mentioned. But fundamentally, there isn't any other big moving parts going on.

J. Fyrwald

I do think 2009 was an exceptionally strong free cash flow year, so I think you have to look at it over several years as well, especially as you look at working capital.

John McNulty - Crédit Suisse AG

I mean that's fair enough, but I guess when I look at '06 and '07, clearly you were earning less and yet you were generating much more free cash even then. I mean '09, obviously, everyone generated a ton of cash. I know you've had some issues with cash conversion in the past and it looked like those were fixed. And I'm wondering I guess do you think they are fixed? Is there more work to be done there?

Kathryn Mikells

Overall really, the only thing that you're seeing, I think, going on differently is we're at a point in our BRIC+ strategy where we need to make a little bit more investment in the supply chain in order to move funding plans kind of closer to where we're now gaining critical momentum in terms of customer base. But overall, the company is going to continue to generate very strong free cash flow. And as you saw in our Investor Supplement, we have a couple of onetime things going on this year. But absent those, we would have normalized free cash flow of closer to $175 million.

Operator

Our next question comes from John Quealy with Canaccord.

Chip Moore - Canaccord Adams

It's Chip Moore for John. I was wondering if you can talk about your expectations for China's 12th Fifth-Year (sic) [Five-Year] Plan in March, both for the air pollution control business and just your broader Water business in general?

J. Fyrwald

Very – but I’m supportive of our capability. We expect the 12th Fifth-Year (sic) [Five-Year] Plan to speak to both air pollution control and NOx reduction right in our sweet spot for our Mobitex business, as well as a very high emphasis on water reduction. Not only the 12th Fifth-Year (sic) [Five-Year] Plan but everything we're hearing from Chinese officials and leading company leadership in China is that water continues to be a very high priority and will be an increasing priority going forward. And of course that fits right in with Nalco's capabilities. That's why we're seeing such strong growth in China today and expect that to continue that's why we're hiring more sales engineers, training sales engineers, adding more research capability in China and expect that the 12th Five-Year Plan to continue to support that growth. We see the same opportunity dynamics in India and have the same opportunity and are gearing up for that as well and delivering the growth today in India at very high rates and expect that to continue.

Operator

Next we'll hear from Bob Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc.

Erik, I wanted to explore some more detail on the raw materials. I know back in '05, '06, you guys suffered some spikes and it took quite a while to catch up. '08 I think you had something like $150 million of raw materials. So it seemed like by the end of '08 you were getting somewhere around 6% year-on-year pricing. So I'm wondering if you can size what you see as the headwind going into '11 and then in the guidance you've given around revenue growth, what is implied about pricing?

J. Fyrwald

In 2010, we saw about $73 million in headwinds from raw materials. More than half of that, most of it was in the fourth quarter and we see raw materials continuing to increase. If you go out and ask a lot of experts, there are a lot of different views of where it will go from here from -- it will continue to go up, it'll stay at these levels, or it may decline. So I can't tell you what's going to happen over time. All I can tell you is that we've been hit pretty hard by raw materials in the fourth quarter and 2010. We're expecting that to continue at least through the first half of this year. Could very well be beyond that. And so we're taking price actions to offset that. We're seeing reasonable receptivity with the customers. We're working through that and we expect to be on track at least by the end of the first half of this year but we'll make progress in the first quarter. I really don't know where raws are headed long-term. There's a lot of uncertainty in the world, a lot of volatility, but we have to assume that they're going to stay or increase from these levels and deal with it accordingly and that's what we're doing.

Robert Koort - Goldman Sachs Group Inc.

And with the PDQ teams, the approach you're taking to pricing now, can we expect to see a quicker closure of those leads and lags? And what kind of timeframe will we -- if we saw no more increases in raw materials from today, would you close the gap by the second quarter, you think?

J. Fyrwald

Yes, I think we would certainly work to try and close it by the end of the second quarter. What I would say is -- but it's different in different parts of the world and different industries. But overall, that target of getting caught up by the end of the second quarter on a run rate basis is an appropriate target. We're making some progress, we'll report more after the first quarter. But certainly, as Kathryn pointed out, a very high priority for the entire management team. Back in the fourth quarter, we were challenged by some very short raw materials which caused some problems of just getting material. And we weren't sure whether those shortages were going to continue but they have translated into the higher cost. And we're assuming that the cost will go up from here and are taking action.

Operator

David Rose with Wedbush Securities has our next question.

David Rose - Wedbush Securities Inc.

Can you give me a little bit more color on the productivity initiatives? What percentage of that offset will be redeployed in the business and how much should we expect to partially offset some of the margin pressure?

J. Fyrwald

The productivity efforts -- what I would say is that we're getting -- we got the low-hanging fruit in the first year that we deployed Get FIT as a program. Now what we're doing is we're increasing our capability to drive productivity. We've got more, we don't call them black belts but they're an equivalent, we call blue belts with kind of a six Sigma light approach. But we've got a number of blue belts certified today, we've got 35 in training. We've got more projects coming on all the time. And what I would say is our confidence is increasing that we can deliver $100 million or more in productivity savings every year. Now combination of offsetting cost increases. Some of it goes to the bottom line, some of it goes to investment. But it's all part of the total picture that's going to get us to 10% EBITDA growth target that we're working on.

David Rose - Wedbush Securities Inc.

If I may build on that, I'm assuming that the consolidation of the European operations is not part of these productivity initiatives, is that fair?

J. Fyrwald

It is part of it.

David Rose - Wedbush Securities Inc.

It is part of it. So we can't see anything incremental above and beyond that. That's all part of the $100 million?

J. Fyrwald

It's going to be part of achieving $100 million or more.

David Rose - Wedbush Securities Inc.

And then lastly, to get a little bit more clarity on the personnel adds. Last conference call, you had mentioned the amount of people that you added in Asia and that we should see fewer headwinds as a result of fewer adds in Asia. Can you give us a little bit more color on the numbers just as a point of reference, just to refresh my mind?

J. Fyrwald

Last year, we increased our headcount by more than 800 people. Some of that was taking people that were contract workers and making them employees in some parts of the world where that made sense. But the way I look at it is we will not hire, we will not add 800 headcount in 2011, but we'll still add a significant increase in the BRIC+ countries. Many of these countries, the cost per headcount is not that great. So I do believe that while we'll see a significant increase in headcount, it'll be a measured level that will allow us, as part of the total package, to drive towards a 10% EBITDA growth.

Operator

Next we hear from Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

Erik, could you just maybe elaborate a bit on the shale gas opportunity? We had the acquisition in the summer. There's obviously much activity in that space industry-wide. But how quickly and how significant can that business grow and be for you? And will that entail any additional acquisitions on the service side or consulting side?

J. Fyrwald

The opportunity for us is both in the frac-ing fluids additives including some greener products that we brought to the marketplace, as well as the water, including the produced water, and handling that and being able to clean it up and have it returned to use. So there's very big opportunity for us. What I would say, is that we're out there today commercial. The business is in tens of millions and growing and I expect that to be more and more significant in the coming years. We won't give specific guidance but important business for us. And we're working on technology that's going to further help our customers deal with their frac-ing and water challenges. And you'll hear more about that in the coming quarters.

Richard Eastman - Robert W. Baird & Co. Incorporated

And then, just lastly, could you just break down for a second the Energy business as you look out into '11, calendar '11. You can give the expectation for growth over all. Do you expect, in the downstream portion of that business, does that business continue to rebound and show growth in calendar '11?

J. Fyrwald

Yes, I expect low growth with downstream. It will go back to growth but it'll be low single-digits. I expect the upstream Adomite and Enhanced Oil Recovery all to have double-digit growth. That's where the combination gets us to the high end of the 6% to 8% corporate goal.

Operator

Mark Gulley with Soleil Securities has the next question.

Mark Gulley - Soleil Securities Group, Inc.

For a long time, Nalco has had an aspirational goal of 20% EBITDA margins. Given the growth initiatives you talked about today, is it time to kind of just set that aside, push it aside and maybe come back to it when it's more achievable? It seems to be a fairly elusive goal at this junction.

J. Fyrwald

I think the way to look at it is that if we wanted to slow our growth down and invest less in the future growth, we could get to 20% EBITDA margins. I think that the better thing for creating value is to focus more on still having very attractive margins, in the 17% to 20% range. Even if it stays at 17%, if we can push the growth higher, deliver 10% EBITDA consistently as a target, EBITDA growth is a better value-creating way to look at it. So as long as we see very attractive growth opportunities push harder on the growth, but make sure that we have attractive EBITDA margins and get that 10% plus EBITDA growth is the way we're looking at it.

Mark Gulley - Soleil Securities Group, Inc.

And secondly, with [indiscernible] (58:31) the tone of business, have you [indiscernible] (58:36) in Water Services in the U.S., how is that looking to you right now? Perhaps we have a spread of growth here, maybe it's just a one-time thing. Any thoughts on the tone of business there please?

J. Fyrwald

Well, I think all around the world, there is interest in us expanding our capability and providing more automation capability. We started with 3D TRASAR for cooling towers, we've moved it to boilers. We're in market development for some additional applications. What I would say is that we see Water Services growth opportunity everywhere in the world, including in North America where we have the biggest part of our own capability to drive it. But at the same time, I've got to say that longer-term I see the BRIC+ growth opportunities as being consistently higher than the U.S. opportunity. So we'll continue, I think, to have very attractive growth rates and margins in the U.S., in North America but we will differentially add resources in the BRIC+ geographies because we see even higher growth opportunities there that will continue for many, many years to come. So yes, a continued attractive North American market. We're not going to back off in North America. But we're going to add more resources in the BRIC+ regions and grow that even faster.

Operator

Next, we hear from Jeff Zekauskas with JPMorgan.

Jeffrey Zekauskas - JP Morgan Chase & Co

Just a quick question again on taxes. When you look at your tax note, your foreign tax rate differential, it shows that your offshore rates are very, very low compared to your domestic rates. So can you just roughly tell us why your tax rate should be 35% for next year? What's the thing that pushes it up, is it the amortization expense? What's the factor and what you plan to do?

Kathryn Mikells

Overall, the tax pattern that pushes up our tax rate is to some extent our overall capital structure and the fact that we're highly levered here in the U.S., which is not the place from a profitability perspective that we tend to earn most of our profitability. So that's a structural issue that we continue to be kind of challenged at and look at. But we're certainly looking overseas and looking overseas in terms of lower tax rate countries and structurally, things that we can do in order to both consistently grow the business in a way that is efficient for the company and ultimately gain more efficiencies overall in terms of our tax rate. So that work continues to be underway. You saw it here in the fourth quarter that we were able to do some things that brought our tax rate down, which I think was very efficient and productive and we'll continue to look for those opportunities in the future.

Jeffrey Zekauskas - JP Morgan Chase & Co

Lastly with your $200 million in capital expenditures expected for this year. Are you building new facilities? And if you are, where are they and what components of the overall CapEx budget is that? Or is it not for new facilities?

J. Fyrwald

There are some new facilities. There are blending plants primarily in BRIC+ countries. So it's small plants that blend products in Russia, in the Middle East and other markets where it keeps us close to customers and allows us to be more efficient in our supply chain and strengthens our market position. So that's a key part of it, we have to expand some of our base chemistry capability, our latex and [ph] (1:02:41) units, reaction chemistry. And we are pushing harder on specialty high-value equipment with customers. So combination of 3D TRASAR plus our FabTech, enhanced oil recovery equipment for adding products there as well as our Crossbow acquisition for water pretreatment, getting more business like that as part of a full solution offering where the full solution offering is very attractive, helps us drive our growth rates and makes a lot of sense. What I would say though is that's a small piece today, we'll continue to rise over time. What we're facing right now is a couple of years of needs to expand our manufacturing capability and add these facilities in some of the BRIC+ markets. So we are seeing a spike for a couple of years before we have the capacity that we need then for growth for a number of years going forward.

Operator

Mike Harrison from First Analysis Securities.

Michael Harrison - First Analysis

I was wondering if you could give a little bit more detail on what regions or segments you're seeing the greatest pressure in terms of the pricing versus raw material? And specific to the raw material, is the pressure about equal across segments or are there areas where you're seeing a greater impact or lower impact from raw materials?

J. Fyrwald

First of all, I think we will make progress on this issue, on the pricing issue, across all segments, across all geographies. What I would say is in combination of the slower-growth geographies where customers are challenged, we're trying to work with them to make sure that the total cost of savings is helping them as we get the price increases that we need. So that's taking a bit of time but we're working through that. The other thing is there's some cultures in the world, even at some high-growth geographies, that very much reject price increases and it takes some time to work through them. But everybody's seeing the inflation in these high-growth markets and our people understand it, our customers understand it, and we're working through it. It's taking longer than I would have liked but we were absolutely committed to making it work and getting it across geographies and across segments. And we'll make progress in the first quarter, which we'll report to you and we'll make a lot of progress through the first half of the year.

Michael Harrison - First Analysis

And then just to clarify on the Energy Services segment margin, you had said to expect about flattish margin in 2011 versus 2010, that segment saw a benefit from the dispersant sales that didn't really include all of the costs associated with those dispersant. So the 23.4%, is that the type of number that you think we're going to be flattish at? Or is it going to be more of a 22%-type number x dispersants that we'd be flat from?

J. Fyrwald

It'll be more of the x dispersants that we're committing to.

Operator

That will conclude our question-and-answer session. I'll turn the conference over to Mr. Fyrwald for any additional closing comments.

J. Fyrwald

First of all, thanks everybody for joining us this morning. I just want to reiterate that I believe that we have an incredible growth opportunity ahead of us both for our Water Treatment, Industrial Water Treatment business and our Energy Services business. Over the last month, I've spent several weeks in India, in Russia. And every time I go to the BRIC+ markets, which is often, I get more and more of a sense of how challenging the water issues are and how challenging the energy issues are and how well the fit our capabilities are and how much customers want us to strengthen our capability in these markets locally to serve them and help them deal with these challenges. We are doing that, we are increasing our capability and therefore increasing my confidence in our ability to continue to drive high growth rates for many years to come.

Oil spills dispersants was a onetime distraction for the company. I think it was the right thing for us to do to serve that critical need. But we've moved on from that and are looking at driving businesses that allow us to continue to grow over time.

We've done a couple of divestitures recently, they're past us. We've now got the core of our business remaining that we can focus on and we will drive organic growth, plus continue to find and we've got a good stable pipeline of attractive bolt-on acquisitions. And that combination will allow us to, I believe, drive and deliver consistently the 6% to 8% revenue growth and drive towards a consistent 10%-plus EBITDA growth going forward.

So I'm pleased with the performance in 2010. I believe we've got another very strong year ahead of us in 2011. And we will also continue to build our strength for 2012, 2013 that I believe you'll be pleased with. So thank you, and have a good day.

Operator

This does conclude today's conference call. Thank you for your participation and have a nice day.

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