Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Nalco Holding (NYSE:NLC)

Q1 2011 Earnings Call

April 27, 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

Ryan Connors - Janney Montgomery Scott LLC

Richard Eastman - Robert W. Baird & Co. Incorporated

Christopher Shaw - Monness, Crespi, Hardt & Co., Inc.

Jeremy Hellman - Singular Research

Lucy Watson - Jefferies & Company, Inc.

Mark Gulley - Soleil Securities Group, Inc.

Richard Hoss - Roth Capital Partners, LLC

Manav Gupta - Goldman Sachs Group Inc.

David Begleiter - Deutsche Bank AG

Bill Hoffman - RBC Capital Markets, LLC

Michael Harrison - First Analysis Securities Corporation

Jeffrey Zekauskas - JP Morgan Chase & Co

John McNulty - Crédit Suisse AG

David Rose - Wedbush Securities Inc.

Christopher Shaw - UBS Investment Bank

John Quealy - Canaccord Genuity

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

Edlain Rodriguez - Gleacher & Company, Inc.

P.J. Juvekar - Citigroup Inc

Operator

Good day, everyone. And welcome to the First Quarter 2011 Earnings Call hosted by Nalco Company. This call is being recorded. At this time, I would like to turn the call over to the division Vice President for Communications and Investor Relations of Nalco, Ms. Lisa Curran. Please go ahead, ma'am.

Lisa Curran

Good morning. And thank you for joining us for our conference call to discuss first quarter 2011 results. Speaking today will be Chairman and CEO, Erik Fyrwald; and Executive Vice President and CFO, Kathryn Mikells.

Most 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 our risks is also 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 provides investors with additional insight into the ongoing performance of our operations.

Accompanying schedule for reconciliation of all non-GAAP measures used in our first quarter earnings to the closest GAAP equivalent have been provided as attachments to our earnings release.

After comments from Erik and Kathryn, we will open the call up to questions. [Operator Instructions] With those administrative items out of the way, I will hand the call over to Erik.

J. Fyrwald

Thanks, Lisa, and good morning. Nalco reported record first quarter sales of $1.1 billion. This is an 11% increase or 9% increase on organic basis over the same period last year. These strong top line results primarily reflect an increase in volume, and we are also making progress on increasing price. BRIC+ sales continued to outperform, growing 19% to $195 million, led by China's growth of over 30%. And while I'm pleased with our top line performance, it is clear, going forward, that we must improve the bottom line. I am confident that our actions underway will do that.

Adjusted EBITDA of $148 million, compared to 2010's first quarter adjusted EBITDA of $164 million, and reflects a 1% price increase, offsetting only about 40% of the raw material and freight cost increases within the quarter, as raw materials continued to rapidly escalate since the fourth quarter. Adjusted EPS of $0.26 per share, compared to $0.31 in 2010. Kathryn will provide you the details on the adjustments.

Since I gave 2011 guidance on our February call, crude oil prices have increased to $25 per barrel, a 21% increase on West Texas Intermediate crude and propylene is up $0.14 per pound or a 19% increase to an all-time record high. As you may recall, last quarter I said we expected to have our pricing covering raw material costs on a run rate basis by the end of the second quarter, assuming raw material price stability. Given the further rapid and dramatic increase since then, we now expect it will take until the end of the third quarter to get prices covering raw materials on a run rate basis assuming no further cost inflation. Given the heightened importance of our pricing actions in this environment, I thought I would provide more color on where we are to-date.

We have been negotiating prices at all accounts. We are selling a valued service that reduces customers' total cost of operation better than their other options. So we are working hard to demonstrate this to customers with data, as we explain our new pricing and finalize timing of increases at each account. Of course, this also requires working through existing contract obligations.

As an indicator of our progress, in the critical North American Water and Process Services business, where we saw the largest drop in first quarter margin dollar earnings, we have now actioned over 75% of increases to get us to cover our raw material cost increases on a run rate basis by the end of the third quarter. The rest of the actions are underway.

In addition to negotiating price increases, we executed productivity efforts resulting in $25 million of cost savings in the quarter, which included procurement, demand planning, our global order-to-cash process and other productivity projects. While this is a good start, we expect this number to increase throughout the year as we drive to exceed our $100 million annual target to support margin gain. We are also making sure that the $15 million per quarter investment in about 900 new hires last year pays off by getting these people properly trained and productive as soon as possible. And as previously communicated, we have scaled back our hiring rate for 2011 as we do this.

Now proceeding to our segments. Energy Services delivered very strong growth with a 16% increase in sales to $421 million. America's upstream markets led the growth as our focus strategy to invest in new oil and gas production is paying off. As energy costs rise, Nalco's unique expertise to support oil and gas production increases in value as energy customers pursue these harder-to-reach resources.

We saw impressive new account growth in North America shale gas, continued success in CapEx deepwater areas of the Gulf of Mexico and West Africa, as well as strong oil-sands sales. Our Energy Services outlook includes continued strong double-digit sales growth in upstream and enhanced oil recovery and single-digit growth in downstream markets.

Paper Services sales increased 11% to $197 million, reflecting continued strong double-digit growth in Asia Pacific. Nalco is well-positioned as higher energy costs further incent customers to purchase our total cost of operations, differentiated offerings like metrics, PARETO and FillerTEK.

Our outlook for Paper points to continued strength in tissue and in board and packaging with a especially strong growth in China, where sustainability and environmental image are becoming increasingly important to our customers. Now because of these dynamics, we expect near-term Paper Services sales growth above our previously communicated longer-term segment growth outlook of about 4% to 5%.

Water Services sales increased 7% to $443 million, led by double-digit growth in the Americas, reflecting strong growth in mining and both the chemical and power-heavy markets. Our Water Services outlook includes continued strong North America heavy-markets sales performance and robust growth in our food and beverage segments, which supports our outlook of high single-digit sales growth.

Taking a look at the full year for all of Nalco. We continue to forecast adjusted EBITDA and adjusted EPS of $735 million and roughly $1.65 per share, respectively. We are committed to achieving these earnings targets and I am confident we will get there. We will use all our available tools, including getting the pricing gains to cover cost inflation and taking more aggressive productivity actions, particularly in Europe and North America. We have included in our outlook the favorable impact from the streamlining of European operations from the regional centralization project that went live April 1. Business disruptions from geopolitical events in North and West Africa and the Middle East and natural disasters in Japan, Australia and New Zealand had a negative impact on first quarter direct contribution earnings of about $3 million. While the impacts here will continue to be felt through the year, we expect to fully offset these in other regions.

So now let me turn it over to Kathryn. Kathryn?

Kathryn Mikells

Thanks, Erik. While our bottom line results were disappointing for the quarter, we're pleased with our growth in volume and we'll continue to take the actions needed to deliver on our full year guidance, with pricing actions picking up momentum as we progress through the second quarter.

Cost inflation drove a 41.8% gross margin, 350 basis points less than prior year as cost of goods sold increased 18% year-over-year far outpacing our top line growth. The decline in operating margin was not as severe. Excluding the $136 million pretax gain from the sale of our 2 non-core businesses, operating margins fell 250 basis points to 10.4% as we slowed selling, research and admin investments.

Reported EBITDA was $280 million in the first quarter, excluding the gain on divestitures, restructuring expense and other unusual items, adjusted EBITDA was $148 million, $16 million lower than prior periods, reflecting strong volume but only modest pricing gains, compared to the sharply rising raw material and freight costs, which continued to escalate throughout the quarter. As a reminder, our prior period results include roughly $5 million of EBITDA associated with the divested businesses.

Net earnings of $117 million reflect an $84 million after-tax gain on the divestitures, adding $0.60 to our diluted earnings per share of $0.84. This compares to $25 million of net earnings or $0.18 per share in the prior period. Adjusted earnings per share was $0.26 for the quarter and that compared to $0.31 in 2010.

Elimination of the gain we recognized associated with the divestitures is the largest adjustment that we're making to this quarter's numbers. We also had a small adjustment to eliminate restructuring charges and debt extinguishment costs. You can find the details for all of the adjustments in this quarter and in the prior period in the attachments to our earnings release.

Free cash flow was negative in the quarter due to seasonality of cash flows with a higher outflow compared to the prior year due to lower cash earnings, higher profit-sharing and incentive payments and increased capital expenditures, partially offset by a modest improvement in working capital.

Capital expenditures were $37 million in the quarter, an increase of $10 million compared to the prior year period, driven by supply chain projects and growth in customer equipment like our 3D TRASAR technology. During the quarter, we applied the proceeds from our 2 divestitures to redeem the remaining $200 million of our senior discount notes, which otherwise would have been due in February of 2014. With the pay down of the discount notes, our most significant debt maturities have now been pushback to 2016 and beyond. Additionally, we reduced net debt by $210 million compared to this time last year.

We expect 2011 free cash flow of $175 million, excluding the impact from the divestitures and excess rise in profit-sharing of $35 million, compared to prior year. Including these items, we

expect reported free cash flow of $85 million, consistent with the guidance that we provided last quarter. The effective tax rate in the quarter was 37.5% and our adjusted effective tax rate was 35%. We continue to expect our adjusted effective tax rate to be approximately 35% for the year.

This quarter was marked by volatility. We experienced escalating oil and raw material costs and the repercussions from political instability and natural disasters. Nonetheless, the advantaged position we enjoy in the marketplace enabled strong volume growth. We're continuing to take actions to demonstrate our price leadership and recapture escalating raw material costs as we move through the year, with full recapture now expected at the end of the third quarter. We're also progressing on our productivity commitments, and we will continue to take the actions needed in order to deliver on our full year earnings guidance.

And with that, we'll move to your questions, and I'll turn the line back over to Jessica.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Edlain Rodriguez with Gleacher & Company.

Edlain Rodriguez - Gleacher & Company, Inc.

Erik, quick question. I mean, in terms of the segments, like are there segments where you think you can recover cost faster than Q3?

J. Fyrwald

Well, we will begin to cover costs more -- we have 1% price increase in the first quarter. We will build on that in the second quarter and what I'm saying is, across the company, for the full company, by the end of the third quarter, we will be on a price run rate that's greater than our raw material cost inflation. So the answer is, yes, there are certain segments and certain geographies that will move faster that we can get prices up faster that will flow through earlier, and we'll see more of that in the second quarter. But we'll build across the company through the second quarter and third quarter.

Operator

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

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

First of all, thank you for the enhancements you've made to the press release, particularly the resolution we have on geography in terms of margins and sales and the other enhancements. That's very helpful. I guess since I only have one question, let me just ask about revenue growth. Erik, if you adjust for the divestitures that you made earlier this year, the two divestitures and the impact from the oil spill revenue that you earned from the oil spill sales over dispersant last year, what should we expect in terms of revenue growth run rate going forward for the balance of this year?

J. Fyrwald

Sorry, Brian, let me just say that, I would expect that for the full year, we'll be at the high end of our 6% to 8% goal range.

Kathryn Mikells

And I was just going to comment that we had previously provided information about how much the divested businesses were adding to sales, that's roughly $70 million. So just in terms of adjusting 2010 that disclosure is out there.

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

Okay. So just to be clear for the full year then, Erik, you said at the high end of the 6% to 8% range after making those adjustments?

J. Fyrwald

Yes. After making those adjustments high end of the 6% to 8% range, I would add to that any pricing gains.

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

Okay. Understood. So after strong performance, if you adjust for, if you make those adjustments that I'm talking about, your organic growth in the first quarter was actually about 11%. So I'm wondering, is there any reason for us to expect a slowdown or a lower year-over-year growth rate then? The back half of the year, I guess, the answer to that is, yes, maybe modestly?

J. Fyrwald

We don't see any slowdown in the global economy, but there's a lot of uncertainty out there, put it that way. So we believe that given any reasonable scenario, that we will deliver at the high end of that 6% to 8% goal range.

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

Okay. Okay. Thank you very much.

Operator

We'll take our next question from John McNulty with Crédit Suisse.

John McNulty - Crédit Suisse AG

Just a question regarding the guidance. So you've got some incremental raw material headwinds and some incremental geopolitical headwinds, and yet you've maintained the guidance. So I guess I'm wondering, what's gotten better than what you were necessarily expecting so that you could be maintaining that guidance?

J. Fyrwald

Well, it's clear understanding of the progress that we're making. We made a lot of progress in pricing in the first quarter. We saw only 1% of that in the results for the first quarter, but a lot of that effort will show up in the second and third quarter. So we got a lot of agreements with a lot of customers around price increases that are coming due April 1, May 1, June 1. In that time period between now and the end of the third quarter, that gives us that confidence that we'll recover that. Plus, we've got our aggressive productivity projects, and we know where they stand. So we put all that together and that gives us confidence, strong confidence, that we'll be able to deliver the $735 million EBITDA for the full year.

John McNulty - Crédit Suisse AG

Okay. Great. Thanks a lot.

Operator

We'll take our next question from Jeff Zekauskas with JP Morgan.

Jeffrey Zekauskas - JP Morgan Chase & Co

In your tax rate guidance for the year, the tax rate was guided to 35%, which I think is about a percentage point higher than last year. And in addition, in 2010, you're uncertain tax positions, I think, grew by $15.2 million. So I would have thought that your tax rate would really be meaningfully lower this year, so why should it be higher?

Kathryn Mikells

Last year, we benefited from utilization of certain foreign tax credits, specifically in the fourth quarter that brought our tax rate down a little bit, and we're not forecasting that same utilization this year and that's the biggest reason for the differential.

Jeffrey Zekauskas - JP Morgan Chase & Co

So to follow-up, can you just broadly explain why your tax rate is as high as it is, given how diversified your operations are and how sort of consistent your EBITDA margins are across the geographies?

Kathryn Mikells

Yes. I mean, if we look across geographies, obviously, here in the U.S., we're subject to a 35% statutory rate and you can add loosely a couple of points on that to also take into consideration state and local taxes. We, as we mentioned in our prepared remarks, have been reorganizing in Europe. Prior to that reorganization, we had an overall, I'll call it, one day of tax rate in excess of 25% in Europe. In Asia Pacific, in Latin America, especially Asia Pacific, we struggle not quite as much with the statutory tax rate but certainly with a fair amount of withholding taxes and nondeductible expenses that drive up our effective tax rate even higher. So in Asia Pacific, our effective tax rate has been even higher than what we'd experienced here in the U.S. Over the long term, we're clearly looking to make changes in our overall operation in order to seek to bring our tax rate down, but that gives you a little bit of a flavor for our data set. And then the last thing that I would mention is historically, we have had a need for repatriation in order to service our debt. That need is also being reduced as we both pay down our debt and refinance our debt at a lower rate. But that gives you a little bit of picture for the tax pattern that we have.

Jeffrey Zekauskas - JP Morgan Chase & Co

Thank you very much.

Operator

We'll go next to P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc

Many other service companies have contractual pass-throughs in their contracts, pricing pass-throughs. So are you able to incentivize your salespeople to write such contracts or maybe convert existing contracts to such pass-throughs?

J. Fyrwald

The answer is we do have some pass-throughs today and about 1/3 of our energy business has a pass-through model. But the answer is, yes, and we are taking fresh look -- as we get through the situation we're in today, we're taking a fresh look at our contract policies and plan to improve those in the future. But today, right now, we're focused on getting the prices up. I would say, though, that even companies that Ecolab, Praxair and Air Products are faced with inflationary challenges as we are. And in the first quarter, all 3 of those companies saw a 1% price increase. So when you have a high value service model, even with contractual pass-throughs, there is a lag period. And we want to improve the time on that lag period, but it is a challenge for all of us. But what I would say to you is, I'm very confident that we're going to get there. We've got a lot of data. We've got a very disciplined process. We look at the data very regularly, the updates on how we're doing by customer and we made a lot of progress in the first quarter. We're making more in the second quarter and we will get there by the third quarter. Having said that, we do need to keep working on how we get better for the future. So it's a great point.

Kathryn Mikells

And the last thing that I would just mention is when we go back and look at historical information, we understand that we faced the lag issue that we're discussing. The flip side of that is we tend to then hang on to pricing for a longer period of time when commodity costs ultimately start to adjust down. So, for us, it's really truly has been a timing issue. Historically, it isn't as if over the commodity cycle we don't end up ahead, but we certainly are in the part of that commodity cycle where we are behind.

P.J. Juvekar - Citigroup Inc

Thank you. And just as you hire these new salespeople, just on this incentive issue, how are you incentivizing them in terms of getting volumes versus pricing?

J. Fyrwald

We have changed our incentive system over the last few years to go from a revenue-base to a profit-base. So we're all clear on that. But we agree with you that providing better tools around contract development would be a logical next step. So we've made this step on the compensation system. Now we need to continue to provide better tools for our sales force.

P.J. Juvekar - Citigroup Inc

Thank you.

Operator

We'll take our next question from David Begleiter with Deutsche Bank.

David Begleiter - Deutsche Bank AG

Erik, could you quantify the actual price versus material GAAP in Q1? And also just on the last question, giving back any pricing when raws [raw materials] drop, any commitments you're having to make or even understandings that to get these price increases pushed through, if and when, propylene prices drop, crude drops, that there is some give-back on pricing?

J. Fyrwald

So the first part of the question, we had 1% price increase achieved in the first quarter. As I said, we achieved a lot more progress but that'll come in the second and third quarter results. That covered about 40% of our raw material escalation in the first quarter. And you saw that our cogs were up about 18% raw material driven. So we recovered partially but not nearly enough. And that's what we're going to get to by the third quarter.

David Begleiter - Deutsche Bank AG

And on the second part of the question?

J. Fyrwald

On the givebacks, I think what Catherine was alluding to is still absolutely the case. We suffer on the front end of the raw material escalation and the lag on our ability to get the prices up. We fully expect to have the same situation on the way down where the prices will go down slower than the raw material deflation when that occurs.

David Begleiter - Deutsche Bank AG

Prices will come down?

J. Fyrwald

Slower and have a lag versus the raw material deflation. So we expect to get what we lost on the front end and more on the back end.

David Begleiter - Deutsche Bank AG

Thank you.

Kathryn Mikells

Sorry, just to be clear. All the same reasons hold true for us in terms of why we have a lag on the other side of the commodity cycle as well. So we have contracts that we can't open up to change the price for a certain amount of time. That same situation will be in place at the other end of it. Even where we have some contracts that are indexed. They're only indexed in a quarter, right? And so we have a little bit of a lag there, too. All those same things will hold as we move to the other part of this commodity cycle. And again, historically, I think we very well demonstrated our ability to overall hang on to price for a little bit longer on the downside of the commodity cycle relative to the lag we've had historically on the upswing in the cycle.

David Begleiter - Deutsche Bank AG

Thank you.

Operator

Our next question comes from Robert Koort with Goldman Sachs.

Manav Gupta - Goldman Sachs Group Inc.

This is Manav. I have a small question on the margins of the Energy segment. And my understanding is that Water segment is more fragmented and the customers are smaller when you compare them to the Energy that you did with the bigger companies. And those companies are more open to contract renegotiations. So you mentioned the progress that you're making on the water front, what's the progress on the Energy segment? And also, to add to that, you mentioned that higher oil benefits you so 2011 will definitely see a higher oil price compared to 2010 and maybe a higher gas price because of the incremental demand, so could you actually see a year-over-year margin expansion in this segment in 2011?

J. Fyrwald

First of all, the progress we're making on the Energy Services segment I would say is similar to the progress we're making on Water. As I have mentioned before, about 1/3 of our Energy Services business is a model that automatically passes through the cost increases with a lag period. But we're out increasing prices around the world and fully expect the Energy Services segment, like the Water segment and the whole company, to be where we need to be by the end of the third quarter in terms of covering the raw material escalation with pricing on a run rate basis. So we're making good progress. You'll see some more of it in the second quarter and then in the third quarter, by the end of the third quarter, we'll make that coverage. In terms of high oil prices, certainly benefit the demand for our Energy Services, what we offer, you see more oil production come online, you see harder-to-reach oil come online, shale with the oil sands the production, the Deepwater, the new CapEx, we're getting a significant share of. So that does benefit us from a growth opportunity standpoint. The challenge we have with higher oil prices is the period while the prices are rising and the lag period to get our prices to cover that raw material escalation. And for that period of time, that's the challenge for us. While there's a stable period even at higher oil prices, that's okay for us and then on the decline, we benefit. It's on that rising period that's a challenge for us that we're in right now.

Manav Gupta - Goldman Sachs Group Inc.

Thanks, guys.

Operator

We'll go next to Laurence Alexander with Jefferies & Company.

Lucy Watson - Jefferies & Company, Inc.

This is Lucy Watson on for Lawrence today. You mentioned in your prepared remarks that working capital was a benefit from a cash flow standpoint in Q1. I'm Just wondering if your working capital expectations for the full year have changed at all given the recent spike in raw materials. And as a follow-up to that, I guess if your working capital expectations have increased, is there an offset in cash flows that allowed you to maintain your free cash flow outlook?

Kathryn Mikells

Overall, our working capital hasn't really changed materially in terms of our expectations for the year. It's obviously going to be used as we're growing the company, but we are managing that use by trying to work down days and while that's not easy, I think we have kind of proven our ability to do that last year to continue to work down days modestly. And that's what we're focused on to offset what you point to, which is we'd expect our receivables and inventory naturally to climb a little bit as raw material prices increase, but we are seeking to offset that by managing days a little bit better.

Lucy Watson - Jefferies & Company, Inc.

Thank you.

Operator

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

Richard Hoss - Roth Capital Partners, LLC

On the gross margin, when you say fully captured by the third quarter I'm assuming that, that would be kind of a mid-cycle type of growth, which, correct me if I'm wrong, would be maybe around the 44% level?

Kathryn Mikells

Just in terms of where we expect to be in the margins, I guess I would point to, Erik, overall what Erik was suggesting in terms of our price recovery pattern. We would expect towards the second half of the year much stronger margins overall relative to the first half just given the trajectory of where we're at in pricing relative to what we achieved in the first quarter in terms of the 1% price increase we achieved. Over 60% of that was achieved in the March month. So that gives you a flavor for just the kind of pattern we're seeing in terms of the growing actions taking place. So we're certainly expecting a much stronger second half relative to first half.

Richard Hoss - Roth Capital Partners, LLC

Right. So I guess if I look at your historical fluctuation growth you kind of fluctuated between 42% and 46% and the reason I'm picking that 44% number is just sort of the fully reflected kind of all-else-being-equal type of number as you talked about is if commodities do roll off in the second half of the year, then you maintain, do you still have some of that lag I guess in pricing and then your gross would probably peak out at kind of 46% as you kind of chase the cycle. Is that correct?

Kathryn Mikells

Yes. That's very fair in terms of what our historical pattern is and we're obviously expecting that our gross margin is going to be stronger in the second half of the year relative to the first half.

Richard Hoss - Roth Capital Partners, LLC

Perfect. Thank you.

Operator

We'll go next to Ryan Connors with Janney Montgomery Scott.

Ryan Connors - Janney Montgomery Scott LLC

Great. Thank you. Just want to step away from the price cost issue for a minute and get an update on where we stand relative to a couple of the discreet growth opportunities. First one is, Erik, you mentioned in your prepared remarks you're seeing impressive new account growth in shale gas. Can you elaborate on that qualitatively and then maybe try to put some numbers around that for us? And then the other 1 that I just wanted to get an update on was Mobotec I know the EPA finally did publish their proposed utility macked [ph] rule in March. So can you update us on the opportunity there and in particular how the issuance of that proposed rule impacts your thoughts on timing in terms of that one?

J. Fyrwald

Yes, let's start with shale gas and we're seeing very impressive growth there. We put a lot more emphasis on the shale gas opportunity in the U.S. in the last 2 years, and we're starting to see that pay off, both in terms of our Adomite business and the drilling, as well as the frac-water cleanup and produced-water cleanup. We don't give specific numbers on that. I'll just tell you that the growth rate is very high for us, strong double-digit growth rate in shale gas. And we see lots more opportunity there in the U.S. and over time, in other parts of the world. So we want to build our capability in the U.S., learn how to continue to add more value in that application and then move it around the world as the opportunity presents itself. On Mobotec, what I would say is that we're encouraged by the progress in the regulatory situation in the U.S., it's still going to take us until, I think later in this year before that becomes clear, before it starts to impact our pipeline, which I would expect to start to pay off sometime next year and into 2013. So that's not a near-term significant opportunity for us. On the other hand, we are seeing our pipeline from Mobotec strengthen in Europe significantly and we hope to have in the next 6 months some announcements about progress on that pipeline that I can be more specific. But I would just say that it's getting more encouraging for the rest of this year for Europe to have something happen and I would say next year and into 2013 for the U.S.

Ryan Connors - Janney Montgomery Scott LLC

Super. Thank you.

Operator

We'll go next to David Rose with Wedbush Securities.

David Rose - Wedbush Securities Inc.

I had a couple of questions, if I may, the first on productivity initiatives. We've talked a lot about gross margin, if we can focus a little bit more on the SG&A side and look at some of the productivity initiatives that are left to bring down SG&A as a percentage of sales for the remainder of the year. Can you give us a little bit more color on what's left in sort of the bag of tricks?

J. Fyrwald

Sure. So one thing I think that's very important that I alluded to in my prepared remarks. We hired over 900 people last year, most of those in BRIC+ countries, most of those sales engineers, getting them fully trained, out in the marketplace, delivering business, growing the business, fully productive is a very high priority for us. So we've been spending the money to train them. We've been spending money to get them out there in the field, get them experience necessary for them to stand on their own feet to make that happen. That's very important. I mentioned that in North America and Europe that we're continuing to look at productivity opportunities, how we continue to streamline, how we can avoid the backfilling back office people when they depart. We're also looking at how do we manage travel and entertainment effectively. We've been getting a lot of new business, sending people around the world to service that business get it up and running successfully but looking at how do we control the travel and entertainment costs in a period of inflation for ticket prices so that's another area that we're working on. There are a number of areas that we expect will help us in the second half of the year, the last 3 quarters, and our goal is to get above our $100 million productivity target and with that. And you'll hear more as the year progresses.

David Rose - Wedbush Securities Inc.

You made significant progress in the first quarter on a year-over-year basis on SG&A. Are we likely to see something similar in the second quarter or I mean, at least some partial improvement?

J. Fyrwald

Well, I think what we'll see is some of these productivity projects paying off. The hiring that occurred last year will continue to be an investment that plays out through the year. We are growing fast so we are having to service those accounts so at this point, what I would say is that we have some productivity baked into the full year EBITDA. We're going to do what's necessary on the cost side to deliver the full year EBITDA growth.

David Rose - Wedbush Securities Inc.

Okay. Thank you. And then the last question regarding Asia, the numbers were lighter than Latin America. What impact did Japan have on that top line figure?

J. Fyrwald

Japan was about historical-type growth rates. That was not a big negative. But the Japan, Australia, we've got a few more mature markets that temper the growth that we see in the high-growth markets but overall, Asia growth was reflective of very high growth rate in the BRIC+ countries, in the high-growth markets with moderate growth in the more mature markets of Japan and Australia, where we have significant position.

Kathryn Mikells

And a big part of our presence in Japan is through a joint venture that we have there, that we consolidate where we're a 50% owner. And so well that impact may be a little bigger on the revenue side. It's pretty light in terms of the overall earnings impact.

David Rose - Wedbush Securities Inc.

So on the revenue side, was it 1% of Asia, 2%, what sort of top line impact did it have?

J. Fyrwald

Don't have that exactly but the size of Japan and Australia significantly lowered the total growth rate of Asia, let me just put it that way.

Kathryn Mikells

But the overall impact specifically was pretty nominal in overall Asian sales.

David Rose - Wedbush Securities Inc.

Sure.

J. Fyrwald

Of the disaster, yes. I think the important thing in Asia is, is that tempers the total growth rate of Asia with the 2 big economies that are slower growth. However, China where we put a lot of emphasis, a lot of investment had another great growth quarter of 30%.

David Rose - Wedbush Securities Inc.

And India?

J. Fyrwald

India growth rate was not as strong as China but continues to move forward.

David Rose - Wedbush Securities Inc.

Ballpark number?

J. Fyrwald

I don't have that handy, but we'll get back to you on that.

David Rose - Wedbush Securities Inc.

Okay. That's fine. Thank you very much.

Operator

Our next question comes from John Quealy with Canaccord Genuity.

John Quealy - Canaccord Genuity

Can you talk about -- you talked about the 900 FTEs added last year and you talked about a little bit of a margin drag as those folks get trained, billable and executed on projects. Can you talk about how much of the impact that was in the quarter or what you think it will be moving through the '11 time frame into '12?

J. Fyrwald

Yes, the cost of those 900 people are $15 million per quarter and then there's some travel and training expenses. So I look at that as an investment. It's a cost, but I look at it as an investment, a very good investment that will start to pay off later this year and certainly much more pay off for next year and beyond.

John Quealy - Canaccord Genuity

Thank you.

Operator

We'll go next to Jeremy Hellman with Divine Capital Markets.

Jeremy Hellman - Singular Research

Just to go back to the cost issue again, just to make sure I heard you correctly, when you talk about full recovery by Q3 that was assuming level costs. And if I heard you correct on that, just wanted to get a sense on what you underlie that with from a macroeconomic viewpoint? And also part to that with respect to your energy customers, do you have a firm idea of where they see all prices averaging through the year?

J. Fyrwald

Well, what the basis of that end of the third quarter full recovery is $120 per barrel oil or less, $0.86 per pound propylene or less, but in that range, we believe we will fully recover it. I mean, we hear all kinds of estimates of the oil prices will go down, the oil prices might go up, they might stay the same. I think at this point they've gone up a lot and our assumption is that they will likely stay the same but they could go up again. And we're preparing our sales force certainly for another potential escalation where they have to go out to our customers again and move the price further.

Jeremy Hellman - Singular Research

Okay. And if you could broadly characterize just your customers, what sort of hurdle rates for the oil they're figuring?

J. Fyrwald

Well, I think it's a wide range. But I think there are a lot of people that think that oil will stay about where it is as long as there's political uncertainty in the Middle East, North Africa and the global economy stays at a reasonable level.

Kathryn Mikells

And while it's pretty hard to predict, we obviously look at the forward curve and the futures market. And the forward curve isn't currently in steep contango as it has been at different points in the past. And so that's at least an indication of what the market viewpoint is currently.

Jeremy Hellman - Singular Research

Okay. Thanks.

Operator

We'll go next to Chris Shaw with Monness, Crespi.

Christopher Shaw - Monness, Crespi, Hardt & Co., Inc.

With all the talk about oil being up on the call and such, I'm just kind of with TIORCO. I haven't heard much from that. I would assume maybe activity up. What's the size of the business currently? And what kind of growth are you guys been seeing?

J. Fyrwald

The growth rates of TIORCO have been very strong. It's still a smaller business between $50 million and $100 million in sales, but we saw over 70% growth in the first quarter. We expect that business to continue at very high growth rates. We are seeing strong demand. The business has been more of a developmental business where we have to go out to a number of oil companies and demonstrate our capability, including with our fairly recently commercialized BrightWater technology. That demonstration of our capability, the ability to help them get more oil out of existing reservoirs is going very well and it's expanding our project pipeline significantly. So we think continued very high growth rates will happen for that business. We're very excited about that business.

Christopher Shaw - UBS Investment Bank

It was up 70% year-over-year, is that what you said?

J. Fyrwald

Yes.

Christopher Shaw - Monness, Crespi, Hardt & Co., Inc.

Great. Thank you.

Operator

Our next question comes from Mike Harrison with First Analysis.

Michael Harrison - First Analysis Securities Corporation

Looking at the Water Services business, can you give us a sense of the magnitude of the negative mix effect that you're seeing due to faster sales growth in the heavier industries versus lighter industries? Is it, for example, 100 basis points of the year-over-year margin decline that you saw in that segment?

J. Fyrwald

It's in that range maybe a little bit more than 100 basis points, but the good news is the heavy markets are growing. We're doing very well in them, but we are starting to see the light markets pick up some too. So we're not down on those, we're just doing very, very well in the heavy markets, particularly mining as an example doing very, very well. But we hope that the light markets continue to pick up and become a positive for us.

Michael Harrison - First Analysis Securities Corporation

Alright. And then if I could ask another one. On the upstream Energy business, you called out Gulf of Mexico Deepwater production as a source of strength, I was hoping that maybe you could just give us a sense of how your outlook for that business has changed since the Macondo incident. Is the Gulf still expected to be a long-term driver within energy or have you reduced your expectations a little bit?

J. Fyrwald

We think it's going to continue to be a long-term driver. We think that some of the projects obviously will be slowed down because the drilling was slowed down and delayed, but we still think that the Gulf of Mexico will be, over time, a driver of growth for us. But I'll tell you, we're seeing great growth around the world, our CapEx ratio, win ratio is well over 60% of the new oil production. We're very excited about continued growth in West Africa, the Caspian, off the coast of Brazil, all around the world. So while the Gulf is important to us, and will continue to be important to us, we're seeing a lot of growth elsewhere as well. So if it takes longer for some of the new CapEx to come on in the Gulf, I don't think that's going to materially impact our ability to continue to see very strong growth rate in our Energy Services business.

Michael Harrison - First Analysis Securities Corporation

Roughly, what portion of your upstream sales does the Gulf of Mexico account for?

J. Fyrwald

We haven't made that public, but it's a significant part, but it's not a majority part.

Michael Harrison - First Analysis Securities Corporation

Got it. Thank you very much.

Operator

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

Bill Hoffman - RBC Capital Markets, LLC

Erik, I just wonder if you could follow on the sort of prior questions for the Energy Services sector. I'm curious if you could maybe help us a little bit with regards to the natural gas frac-ing and also the Oil sands, like what you're seeing, maybe on a quarter-to-quarter basis, like are we seeing a significant volume ramp ups at this point in time? And how do you expect that to play out for the rest of the year?

J. Fyrwald

Growth rate there has been over 20%, so we are seeing significant volume growth. I expect that to continue only tempered by fairly low natural gas prices in North America relative to certainly oil prices. But as natural gas gets used in more applications because of the lower price, I think over time natural gas prices will firm. And we'll see continued aggressive development, environmentally sustainable development of the shale gas in the United States. But I also believe in this coming 3 to 5 years we'll start to see significant shale gas development in parts of Europe, parts of Asia, India, that will add to the opportunity.

Bill Hoffman - RBC Capital Markets, LLC

And then when you look at those businesses from a competitive standpoint, what share do you guys feel like you're taking in those markets at this point in time and do you think you'll be able to push that into these international opportunities as well?

J. Fyrwald

Yes, it's hard to calculate a share with something that's growing so fast and it's so early on. But I think that we'll earn our rightful share here and establish ourselves very well for the global business. On the Oil sands, I didn't comment on that yet about on the Oil sands. Oil sands is I think I'm bullish on the Oil sands because of the combination of high oil prices and relatively lower natural gas prices, which natural gas is a big component of the production cost on the Oil sands, especially with this ID [ph] process where you've got to use steam to enable them to flow. And then there's lots of water application there for us. That high oil price and lower natural gas price drives the opportunity for our customers and that's very attractive to them and a very good business to us. We've got a good market share position there and a high-growth market that I think will continue to grow nicely.

Bill Hoffman - RBC Capital Markets, LLC

And are they starting to ramp up more now with oil than where it is?

J. Fyrwald

Absolutely.

Bill Hoffman - RBC Capital Markets, LLC

Thank you.

Operator

Our next question comes from Mark Gulley with Soleil Securities.

Mark Gulley - Soleil Securities Group, Inc.

I have two questions. Eric, is 1 of the issues on pricing the demographics to your sales force. It would seem as if the average age is coming down since you're adding a lot of new people, particularly in the BRIC+ countries and maybe their experience with getting price increases is less than more senior people. So is demographics one of the issues here?

J. Fyrwald

Yes. I mean, it is one of the issues, and we have people that have not been through inflationary periods and have not had to be out raising prices. So we're doing a lot of training and we're doing a lot of role-playing. We're using more experienced sales people that have been through this. But absolutely it's a very good point you've got to get the sales force confident not only in the need to raise prices but also in their ability to go out and confidently handle what any customer is going to have increasingly good purchasing tactics, to push back, delay. And they've got to be able to help, stand up and work through that with our customers. So absolutely, demographics plays a part and we're training our people to work through that.

Mark Gulley - Soleil Securities Group, Inc.

You were a customer once. I'm sure you're pretty good at that role-playing. I want to follow up on EBITDA margin goal. Can you remind us what your EBITDA margin goal is? It seems like you kind of step back from this and how long it might take to achieve that long-term goal that you've talked about in the past?

J. Fyrwald

We are focused very much right now on getting back to and above 17%. And I am very confident that in the second half of this year, we will exceed our 17% goal to return to 17%. And as I've talked about in the last few quarters, our thinking from there is to drive aggressive top line growth with a 17%-plus type EBITDA margin.

Kathryn Mikells

Jessica, one more question please.

Operator

We'll take our final question from Richard Eastman with Robert W. Baird.

Richard Eastman - Robert W. Baird & Co. Incorporated

Yes. Erik, could you just circle back to the Water Services piece of the business and you addressed this a little bit earlier, certainly, the heavy portion of that business is very strong. Does the math suggests that the light portion of that business, the boiler, chiller business, including price, is that business up in terms of volume?

J. Fyrwald

Yes, it's up, but less than the heavy part of the business. And that's the reason for the mix challenge to our margins.

Richard Eastman - Robert W. Baird & Co. Incorporated

And there's not a chance that we're losing share there as we try to raise price or losing accounts? Is there a bigger churn there than there's been in the past?

J. Fyrwald

No. We monitor that very closely and we are not losing share. We are strengthening our market position globally in Water and there's not where we're going backwards.

Richard Eastman - Robert W. Baird & Co. Incorporated

Okay. And then just a follow-up, just in terms of revenue, when you talk about the second half end being up around the 6% to 8% type of sales growth that you expect. You were talking in volume? So if we're at 8% volume gains in the second half, which is what you're targeting, that's going to be compounded a bit by say, 3% price. So reported sales number is bigger than that, correct?

J. Fyrwald

Yes, we expect our reported sales number to be over that 6% to 8% range.

Richard Eastman - Robert W. Baird & Co. Incorporated

That's a volume number. Okay. Alright. Thank you.

J. Fyrwald

Okay. Well, I want to thank everybody for joining us today. Before I close, I'd like to announce 2 upcoming special investor teleconferences, given that our shareholder base is evolving to become more growth-oriented and also to provide an update for those of you who have followed us from some time. Steve Taylor, the President of Nalco Energy Services, will be hosting a teleconference on May 31; and Dave Flitman, the President of our Water and Process Services, will host a conference call on June 28. And watch out for more details from Lisa as they become available. I think it's very important for those 2 key leaders to very clearly tell you about the growth strategies and how they're developing and update you on pricing. Now I want to make sure that you take away 3 important commitments that we're making. One is that we will continue to drive strong top line growth. Our growth strategy is working. We're going to continue to execute it. Secondly, we will get the price up, as the service expertise and technology we are bringing to the market continues to increase the return on investment we uniquely deliver our customers, we will get our price up. Quarterly adjusted EBITDA margin will clearly exceed 17% as I talked about earlier in the second half and with those 3, we will deliver on our commitment of $735 million EBITDA for the full year. Thank you very much.

Operator

This does conclude today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Nalco Holding's CEO Discusses Q1 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts