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Nalco Holding (NYSE:NLC)

Q2 2011 Earnings Call

August 03, 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

Rosemarie Morbelli - Gabelli & Company, Inc.

Manav Gupta - Goldman Sachs Group Inc.

Michael Harrison - First Analysis Securities Corporation

Jeffrey Zekauskas - JP Morgan Chase & Co

David Rose - Wedbush Securities Inc.

Laurence Alexander - Jefferies & Company, Inc.

Unknown Analyst -

P.J. Juvekar - Citigroup Inc

Operator

Good day, everyone, and welcome to the Second 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 VP of Investor Relations of Nalco, Ms. Lisa Curran. Please go ahead, ma'am.

Lisa Curran

Thank you, Alan. Good morning, and thank you for joining us for our conference call to discuss second 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 and include statements regarding the merger of Nalco and Ecolab. There are a number of risks and uncertainties that could cause actual results to differ materially. These risks, as well as other risks associated with the merger, will be more fully discussed in the joint proxy statement/prospectus that will be included in the registration statement on Form F-4 that Ecolab will file with the SEC in connection with the merger. We urge investors to read the registration statement and joint proxy statement/prospectus and any other relevant documents when they become available. Our statement describing the risks associated with the forward-looking information and additional information regarding the merger is in our press release, which may also be found at www.nalco.com. For further background on risks and uncertainties applicable to the respective businesses of Nalco and Ecolab, see the respective annual report on Form 10-K and the company's other public filings with the SEC. This call is for informational purposes only and does not constitute an offer to sell or the solicitation of an offer to buy any securities.

The information discussed today will include data that does not conform to the 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 schedules reconciling all non-GAAP measures used in our second 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. In order to follow for -- sorry, 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. Importantly, please note that in Erik and Kathryn's comments, unless stated otherwise, all references to year-over-year financial results will exclude the impact on second quarter 2010 from approximately $70 million in sales associated with the Gulf of Mexico response.

With those administrative items out of the way, I will hand the call over to Erik.

J. Fyrwald

Thanks, Lisa, and good morning. As you know, on July 20, we announced an agreement to merge with Ecolab. This transaction delivered substantial value to our shareholders through an immediate premium to Nalco share price, as well as the opportunity to participate in what I believe is substantial upside potential of the combined company. Many customers have been asking for this partnership as they recognize both companies' commitment to world-class service, innovation and delivering customer value. We share business models with high percentages of recurring revenue. We are not capital intensive and we price for value. And we are both well positioned to benefit from favorable macro trends like water scarcity and quality and ever-increasing demand for energy and water around the world and a growing, more prosperous middle class that highly values and will pay for cleaning and sanitization excellence. We are confident that our sound strategy and strong momentum, as reflected in the second quarter results we reported today, along with the combined enterprises' strong financial resources and significant cost and revenue synergies will help us deliver accelerated growth, improved profitability and better earnings consistency.

When we announced our agreement to merge with Ecolab, we also provided preliminary results for the second quarter and raised our guidance for the full year. This morning, we'll review the second quarter results and our raised guidance in more detail. Let me say that I am very pleased with the quarter and especially the strong sales growth outperforming the market in all businesses and solid pricing gains.

Nalco reported record second quarter sales of $1.2 billion, up 16% from the same period last year. Consistent with our previously stated #1 focus of increasing prices, these strong results include a 3% price improvement, 8% volume growth and favorable currency impact of 5%. And I am pleased that we achieved double-digit organic revenue growth across all segments in the quarter. BRIC+ sales, which make up 18% of total company sales, increased 14% year-over-year, when you exclude onetime sales and sales in Egypt and Libya given the geopolitical impacts there.

Second quarter adjusted EBITDA was $175 million, a year-over-year increase of 13%. And importantly, adjusted EBITDA margin increased 100 basis points sequentially as our sales teams executed well, increasing price in the face of continued headwinds from raw material and freight costs. Adjusted EPS in the quarter was $0.47 compared to $0.21 in the same period last year. Including the $0.20 associated with the 2010 Gulf response sales, prior EPS was $0.41. Now there are a number of items impacting our effective tax rate this quarter and for the full year. Kathryn will walk you through this later in the call.

As I mentioned earlier, price has been a key focus for us and our sales team has continued to negotiate price increases across our accounts. I'm pleased to report that we're making solid progress and remain on track to fully offset raw materials and freight headwinds on a run rate basis by the end of the third quarter. In addition to implementing price increases, we continue to support our margins through productivity improvements. These actions resulted in $26 million of cost savings this quarter and we remain on track to achieve our $100 million annual target. But now I'd like to discuss how each of our segments performed.

As I mentioned earlier, all grew revenue by double digits over prior year. And while higher raw material costs caused direct contribution margins to be down versus last year, pricing gains, which were strongest in North America, enabled global sequential direct contribution margin growth of 50 basis points. Paper Services sales were $211 million. This represents year-over-year growth of 17% or 11% on an organic basis, reflecting volume and price growth led by double-digit growth in the Americas. This reflects strong market share growth in North America as a result of enthusiastic market adoption of our new technologies like PARETO and OxiPRO. Latin America benefited from favorable comps due to the Chilean earthquake in 2010. Organic paper sales grew an impressive 17% in China, and direct contribution margin improved sequentially by 30 basis points globally and by 220 basis points in the Americas.

Water Services sales were $489 million, up 14% or 11% organically. Organic sales grew by double digits across all regions. Global sales were led by double digit growth in Food & Beverage and Mining end markets. Heavy industry organic sales grew 12%, while light industry grew 3%, reflecting volume and price growth. Direct contribution margin increased sequentially by 150 basis points globally and by 330 basis points in the Americas.

Energy Services continued to deliver strong performance. Sales were $476 million, a year-over-year increase of 17%. And that's 11% organically, led by substantial growth in Adomite and enhanced oil recovery and double-digit downstream sales growth. Upstream Oilfield Chemical sales were up high-single digits, excluding the Middle East sale for a new startup unit that we referenced last year. Now this was achieved despite Libya's sanctions and slow recovery in Egypt's sales. These strong results reflect volume and price growth and market share growth across all segments. Direct contribution margin was down 60 basis points sequentially, reflecting an unfavorable mix change, which included the stoppage of high margin business in Libya. Direct contribution margin in the Americas increased sequentially by 110 basis points and we expect Energy Services global margins to expand in the third quarter as additional significant price increases became effective July 1.

Now before moving to our guidance, I want to reiterate how pleased I am with our strong volume growth and pricing gains this quarter. However, I'm disappointed with the earnings decline in EMEA. The underperformance there reflects the poor economic conditions in Europe, our being behind where we want to be in pricing in paper and energy for the quarter and a stoppage of very high margin upstream business in Libya that I mentioned earlier. Having said that, we now have important pricing agreements in place and have earned new Energy Services business. And therefore, I fully expect to return to earnings growth in the second half of the year for EMEA.

Turning to the outlook for the year. As we indicated in our merger announcement 2 weeks ago, we have raised our full year 2011 guidance for adjusted EBITDA and adjusted EPS based on year-to-date results and our expectations for the second half. We now expect adjusted EBITDA of $740 million, up from our prior guidance of $735 million. And we expect adjusted EPS of $1.70, up from our prior guidance of $1.65. Our free cash flow guidance remains unchanged. So that's the data for the quarter and the outlook for the year.

Let me finish by saying that I am most excited by the momentum we are building. This leadership team has done a great job over the past 3 years, defining a clear strategy and making the investment even in the face of strong economic headwinds that have more than doubled our rate of top line growth. They have also been able to really get prices moving. When you combine this momentum strength with raw material costs that are starting to stabilize and our continued gains in productivity, we have begun a very positive trend in high growth and margin expansion that we should carry forward for the second half of this year and into 2012. Also, this team has significantly strengthened our ability to execute. So it's with this backdrop that we head towards our merger with Ecolab later this year. We are ready to take this on and continue to build on our momentum while we add to that the significant cost and revenue synergies we will create from the combination.

So with that, I will turn it over to Kathryn.

Kathryn Mikells

Thanks, Erik. Our second quarter results are further evidence that our growth strategy is working, and we're pleased with the strong efforts of our sales force that enabled solid sequential margin improvement, along with continued strong growth in volume and market share. Sequentially, sales increased 11%, driven by 7% volume growth and 2% pricing gain. Operating expenses, excluding unusual or onetime expenses, as well as the onetime gain on divestitures that took place in the first quarter, grew 10% sequentially, enabling a 70 basis point expansion of operating margin to 11.2%.

Adjusted operating earnings of $131 million increased $19 million or 17% compared to the first quarter, driven by volume and pricing gains, as well as more moderate growth in selling, admin and research expenses.

Similarly, adjusted EBITDA of $175 million increased 18% compared to the first quarter and adjusted EBITDA margin of 14.9% expanded 100 basis points as pricing gains drove significant progress towards restoring our margins to historical levels. Below the operating line, reduced interest expense and lower other expenses enabled even stronger growth in pretax earnings. Excluding the same items I mentioned previously, as well as the first quarter's loss on early debt extinguishment, adjusted pretax earnings increased 41% from the first quarter to $85.2 million and pretax margin expanded 150 basis points to 7.2%.

On a year-over-year basis, adjusted operating earnings increased $19 million or 17%. And adjusted EBITDA of $175 million was up 13%, with adjusted EBITDA margin of 14.9%, only about 30 basis points below prior year. Adjusted pretax income of $85 million was over 50% higher versus the $56 million adjusted pretax income in the prior period. The strong improvement in pretax income year-over-year was driven by $19 million higher operating earnings and $11 million lower interest expense due to the deleveraging and refinancing last year at significantly lower rates. Adjusted pretax margin of 7.2% improved 170 basis points compared to prior year.

As Erik said, adjusted EPS was $0.47 compared to $0.21 per share in the prior year period, reflecting the previously discussed growth in operating earnings and reduced expense, as well as a significantly lower tax rate, which I'll discuss in a second. Including the net earnings generated by the Gulf response sales, prior period adjusted EPS was $0.41. The adjusted effective tax rate in the second quarter was 21.5%. This low rate reflects the release of a portion of the valuation allowance against certain foreign deferred tax assets and the associated accrual of tax reserves through uncertain tax positions. You'll recall that we foreshadowed these discrete items in our first quarter 10-Q. With these discrete items behind us, we’ve reduced our full year 2011 adjusted tax rate guidance from 35% to 34%. If we had used our full year 2011 adjusted effective tax rate, our adjusted EPS for this quarter would be $0.40 or $0.04 above consensus.

Free cash flow was negative in the quarter, reflecting higher receivables and inventory driven by our strong 11% sequential sales increase. Receivable and inventory days were fairly consistent with our first quarter results. We have a number of initiatives underway, including further automating and globalizing supply chain, that are expected to improve our days outstanding and working capital in the second half of the year. By year end, we expect to see about a 4-day reduction in inventory days and about a 5-day reduction in receivable days. And we're on track to hit our full year free cash flow and other financial guidance.

In summary, this was a very strong quarter, characterized by good volume growth and continued progress on pricing. We expect our top line momentum to continue into the second half of the year with further pricing and productivity gains enabling even greater sequential adjusted EBITDA margin improvement and supporting our expectation that our adjusted EBITDA margin will have fully recovered to historical levels in the fourth quarter.

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

Question-and-Answer Session

Operator

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

P.J. Juvekar - Citigroup Inc

On what percentage of your customers have you raised prices? Because I know some customers had annual contracts, particularly in Asia. Have you been able to renegotiate shorter-term contracts?

J. Fyrwald

Yes, we're making good progress across the board with all of our customers. And what I would say is we've got agreements in place with over 75% of our customers, and that number is moving up. And in cases where we had longer-term contracts, we've been able to go back and work through those with our customers in a win-win way.

Kathryn Mikells

And if we break that down between kind of Energy Services and WPS, at this point, in terms of what we're expecting in pricing increases, WPS has between 90% and 95% of their pricing increases actioned at this point, and Energy Services is at about 80% of their pricing actions already in place today.

J. Fyrwald

So we got 3% price increase in the second quarter and we'll continue to build on that in the third quarter. And we've got some good increases already kicking in, in July and we'll move forward through the quarter. So we're in a good spot, P.J., and very confident of the commitments that we've made.

P.J. Juvekar - Citigroup Inc

And just quickly on Asia, you hired those 600 sales people. Are you ahead of your expectations in terms of sales? And what was the impact of hiring in the quarter?

J. Fyrwald

We are very confident that those hires are going to pay off. The training is going very, very well. The people that had some prior experience are already out in the field. The people that were new to water -- or to our businesses have begun working with experts in the field. And it's going to pay off. We already are seeing very strong growth in Asia Pacific. And you heard about paper specifically at 17% growth in China in the quarter, and I expect that to continue in terms of across-the-board very, very strong growth rates. Last quarter, we said $50 million in OpEx was the carry-forward headwind. We'll have a very good return on that. And I'll tell you, if you have a chance, if you're over in Asia, stop by our operations in China, India or any place and see the enthusiasm in these new sales reps. They're very excited to be part of Nalco. They're very excited to be making a difference in the environment and to be adding value with customers and growing our business profitably.

Operator

Our next question comes from Jeff Zekauskas with JPMorgan.

Jeffrey Zekauskas - JP Morgan Chase & Co

In the earnings release, you call out in your expectations for the year $35 million in higher rent and profiteering costs. Is that a quasi-onetime item that won't recur for the consolidated entity next year?

Kathryn Mikells

Yes, this is Kathryn. And specifically on the rent, we have a lease here in Naperville. And obviously, for income statement purposes, that's a straight line. We have a relatively large payment this year. It's about $18 million higher on a year-over-year basis. On a going-forward basis, that payment is stable at $12.5 million. So that's very much a onetime item. From profit sharing, which was an impact in the first quarter in terms of overall cash flow, we ended up paying about 9.5% in profit-sharing, we would target to pay closer to 6.5%. So again, we view that as a onetime item.

Jeffrey Zekauskas - JP Morgan Chase & Co

Okay. And then for my second question. You said that your average prices went up about 3% in the quarter. Which were the segments or the geographies where the price increase was higher than 3%? And which were the segments and geographies where the price was lower than 3%?

J. Fyrwald

North America was clearly the leader, and that's a combination of very good sales force capabilities, we've been working on it longer, and very strong success, including with new technologies that we've launched. The Europe and the Asia increases were less but are building.

Operator

Our next question comes from Ryan Connors with Janney Montgomery Scott.

Ryan Connors - Janney Montgomery Scott LLC

I wanted to touch on the merger for a minute here, Erik, and you made the interesting comment in your prepared remarks there that customers have been asking for this business combination. I wonder if you can expand on that comment a little bit. And without naming names in terms of the customers, talk about which specific end markets you've been hearing that from and then what specific benefits those customers seek coming from the business combination?

J. Fyrwald

I would say particularly in the Food & Beverage and Institutional markets where Ecolab has a very, very strong position, a very strong market position, bringing a lot of value. Nalco brings a lot of value. We've got very high margins, very attractive business in those markets, but we just have a much smaller position. We’ve naturally, over the years, gravitated and focused more on the heavy businesses, the Energy Services business, but we've got a great business in Food & Beverage and Institutional. We're just much smaller. So the customers that know us, our capability and know the great value that Ecolab brings naturally believe that, that combination of the Ecolab sales force, what they bring in cleaning and sanitizing with the leading expertise in water treatment from Nalco is a great combination because in Food & Beverage especially, the water treatment is extremely important to what they do, both in terms of their process, water needs, in terms of their cleaning and sanitization and cleaning process, cleaning place processes. So huge value for Water Services, tremendous relationships with Ecolab, plugging into that, Nalco's outstanding service capability in water treatment, our 3D TRASAR technology, which makes that very efficient, is a great solution for the customer and can create tremendous growth opportunities for us. Institutional, similarly, we just have not put a big focus on that. We've got great service capability, great technology with 3D TRASAR, but we don't have the position that Ecolab has. And so those customers have also been asking for Ecolab to have stronger water capability and for Nalco to have a stronger sales capability, put them together and we've got the full package.

Ryan Connors - Janney Montgomery Scott LLC

Okay. That’s very helpful. And then in terms of just a follow-up to that, again, on the merger. You've been very enthusiastic about the BRIC+ investments. And obviously, we're seeing the fruits of that here in the second quarter, in the Paper side in particular. So can you talk about the trajectory of that investment program post merger? In other words, philosophically, does Ecolab share your vision of expanding Nalco's business in those areas? Or do you think we'll sort of just sit steady where we are in terms of the investments that have already been made?

J. Fyrwald

I think Ecolab is very much supportive of our BRIC+ strategy. I think they very much want to tie into the progress that we've made. They're also making progress in those areas. I think we've invested more. But the combination will continue to invest in BRIC+, but we'll be able to spread the benefits more quickly over more customers and more sales. So I think that the profitability will be enhanced with the combination. So absolute support for it. We will continue to drive BRIC+ very aggressively, but you'll see better performance with the combination.

Operator

Our next question comes from Mike Harrison with First Analysis.

Michael Harrison - First Analysis Securities Corporation

I was hoping that I could get some more details on what kind of volume growth rates you're seeing right now in the paper market on a region-to-region basis. I know you provided the China number, as well as an Americas number. I was hoping maybe I could hear how North America and Latin America compared. And then also maybe get some comments on the competitive and pricing environment region-to-region in Paper?

J. Fyrwald

So first, let me say that I commented already that China growth was 17% in the quarter. We are seeing very, very strong growth in China, which is the fastest-growing market. But we are growing faster than the market there. So we're improving our position, and by the way, with very respectable margins. Behind that, North America and Latin America are growing strong double-digits in the quarter. And I think, over time, that will be mid-single digits, not quite that strong a growth. But we're seeing a surge in growth, not because of market growth, but because our technologies that we've recently launched have been very, very well-accepted and we're strengthening our market position with those. But over time, we expect single-digit growth in North America and Latin America. In Europe, that's where the growth has been slower, still positive growth for the quarter, but we expect that to be more flattish over time as the paper market in Europe is very challenged. In terms of pricing, I would say that North America -- the Americas pricing is the stronger, followed by Asia and then Europe, with many competitors and a weak marketplace, is the weakest from a pricing standpoint in the Paper business.

Michael Harrison - First Analysis Securities Corporation

And then in the past, it's generally been thought that your Paper business was too integrated with the Water business to be a potential divestiture candidate. I know that you undertook a strategic review. The decision was made to actually further integrate those businesses. But I was just hoping maybe you could revisit this idea of would it be possible to divest that business now? Or do you still see it as just having too many dis-synergies if you went that route?

J. Fyrwald

I don't think dis-synergies is an issue. I think what the issue is we've had a strategic review of it about 2 years ago because the performance wasn't that good. Subsequent to that strategic review, we have reduced cost. We've launched more technology. We've improved our business performance significantly. And now it's gone from a business that was really a drag on performance to a business that's doing very well. So the way I look at it is the Paper business is important to our company. There's a lot of Water technology, a lot of Water capability that helps you improve how you run the Paper business. And by the way, paper mills have cooling towers and they have boilers, so we also sell our traditional Water capabilities to the paper industry. And the way that the team has run that business has improved significantly, and my belief is that they’ll continue to improve that business and it will continue to be an attractive -- an increasingly attractive business for us also because in addition to new technologies, they focus very hard on the higher-growth, higher-margin segment of the paper industry like tissue and geographies like China and Brazil.

Operator

Our next question comes from Robert Koort with Goldman Sachs.

Manav Gupta - Goldman Sachs Group Inc.

This is Manav in for Robert today. Just a quick question. You experienced 100-basis point improvement in EBITDA margin in Q2 over Q1 despite the fact that raw materials were significantly higher in Q2 than Q1. Now that raw material prices are going down, will you actually have to give up some of your pricing gains? Or I mean, the broader question is, could this 100-basis point expand to 200 to 300 basis points in Q3 itself?

J. Fyrwald

We expect the EBITDA margin to continue to increase, and we feel very confident that we are on track to meet our previously stated commitment of exceeding 17% EBITDA margin by the end of the year. So the answer is yes, our prices will continue to increase. Raw materials are stabilizing. Now the peak raw material costs, we think, were in the second quarter. We never know what's going to happen going forward, but likely the peak could be in the second quarter from a cost standpoint. But that flows through the P&L through inventory in the third quarter. So we will likely see continued raw material escalation in the P&L in the third quarter, but we will fully offset that by price increases in the third quarter. And then as raw materials stabilize with the forecasted stabilization going forward, price increases continue, our margins will expand.

Manav Gupta - Goldman Sachs Group Inc.

And just one more question, you pointed out to a double-digit downstream sales growth in the Energy Services. Now in the past, we have seen very good performance on the Adomite and enhanced oil recovery. Is this double-digit downstream sales growth sustainable? And where did it come from?

J. Fyrwald

We do not expect double-digit downstream growth over time. But today, this year, we're having double-digit growth because of outstanding performance by our downstream team. They are strengthening our market position. They're doing that with technology and superior service. They're winning new business in places like China and the Middle East, where new capacity is coming online, and just doing an outstanding job servicing customers and getting price increases that we've earned through delivering value. So that combination has us at double digits this year. I would -- and also, the market has come back somewhat in markets like North America. I would expect going forward to have single-digit downstream growth as we continue to develop technology. But right now, the team is really getting out in the market and delivering double-digit strong growth performance.

Operator

Our next question comes from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc.

I guess 2 cultural questions or I guess from 2 different angles. I want to -- you've worked with different – with some very different sales forces over your career. And as you look at the Ecolab sales force and the Nalco sales force, what do you think they have to learn from each other specifically? That is, like, what can Nalco bring to Ecolab? Or similarly, what can Ecolab bring to the Nalco sales force?

J. Fyrwald

Laurence, I think there's a lot we can learn from each other. I think the Ecolab sales force, I’ll start with that, has a great record. We've got great respect for the Ecolab sales force. I think they have similar respect for us, where Nalco people have gone over to Ecolab, and there's been some of that. And there's been some Ecolab people that have come over to us over the years. Our people do very well there, and their people do very well here. So I think that culturally, there's a great fit. I think that's the first point. Second point is, we have great respect for Ecolab and how they manage key accounts, for one. They've been at it a long time. We've been at key account management for the last couple of years. I think we've gone from okay to good to very good. I think they're outstanding, and we can learn more from how they do key account management. And I think we can leverage between the 2 on particularly Food & Beverage where there's over $1 billion of opportunity for us. And they have very, very strong positions. I also think how they manage, how they sell to smaller customers, Institutional and even manufacturing or Food & Beverage smaller accounts, has just not been a strong focus for us. So we have very attractive margins but we haven't seen the kind of growth or the market position that we would like there. Ecolab has great market position there. They know how to sell to those customers very efficiently. We know how to service them very efficiently. So if we learn and tie in with their sales success, I think that will bring great revenue opportunities. In terms of what we can bring to Ecolab, I think the BRIC+ is top of the list. I think we've really invested hard. We've been very successful in the BRIC+ countries and there'll be opportunities there. I think second with larger industrial customers. We're very well positioned there. We know how to sell to those customers, and there will be some opportunities for Ecolab connecting into that. I think lastly, technology. We've got some great technology, for example, 3D TRASAR that Ecolab sees tremendous opportunity in what they do, for example, in the Food & Beverage industry in cleaning place and other opportunities to leverage 3D TRASAR into what the Ecolab sales force brings to their customers. On bio science, it's very important for us. We're very good at it but Ecolab has tremendous capability in bio science so there's going to be some opportunity there to leverage that capability for our sales force to bring even more value, in bio science is an example. And so those are just the initial thoughts based on early looks at this. I think we'll learn a lot more and see a lot more opportunities as we dig into this.

Laurence Alexander - Jefferies & Company, Inc.

And secondly, you've already supervised a fairly significant step-up in Nalco's growth investments, and Ecolab has made it clear that they feel that even the current plans are -- reflect a capital constraint and that you would have been -- that there were significant more growth investments that you could be doing if you had your druthers and had the flexibility, and they will give you the flexibility. Can you give a sense for what we should be looking at in terms of how much more of a step-up in CapEx, what the concomitant results into acceleration in sales growth might be and how you would think about the tradeoff between an acceleration in sales growth a few years out and margin drag? If you can give us a sense for how you -- what kind of plans you might already have on the table that you shelved because you just couldn't get to authorize it with Nalco on a standalone basis?

J. Fyrwald

Yes, so let me start by saying that the benefit here with the stronger balance sheet that we have covered that we really wanted to have is around M&A. So our OpEx investment growth will continue. But my belief is that together, we'll be able to make that more productive, and so quicker payback, higher-margin growth through OpEx investment and growth. On the M&A side, we have had -- we've done some M&A bolt-on moves. Two examples, TIORCO in enhanced oil recovery, Crossbow in water pretreatment, that have been tremendous successes. They've bolted into our companies. We've been able to globalize them, have very strong revenue and earnings with those acquisitions, and we've got a very strong pipeline in both Energy Services and Water, bolt-on acquisition opportunities that would further strengthen our leadership positions, expand our growth rate at very good profit margins and very good returns. We haven't been aggressive going after those because of our weak balance sheet. With this combination and a strong combined balance sheet, we'll be able to go after these very attractive M&A opportunities. So on the OpEx side, that investment in the CapEx side, I see just a continued investment but higher returns, higher payback for the combined companies. On M&A, I see us being able to be more aggressive.

Operator

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

Richard Eastman - Robert W. Baird & Co. Incorporated

Just a clarification, if you will. On the operating margin in Energy, when I look at that sequentially, you had mentioned some sequential decline due to the unfavorable mix in the Middle East. And if I add that back in, is the implication here that we did make progress on the operating margin in Energy from the price materials variance sequentially?

J. Fyrwald

Yes, we made some progress sequentially. But what I would say is that we're going to make more progress in the third and fourth quarters. We've had some price increases in the third quarter. We've won some very attractive new business. And as raw materials peak and have stabilized, it'll peak in the third quarter in terms of the P&L impact and start to stabilize from there, that price increase will expand the margins for Energy Services, and I think we will see a sequential improvement in the third quarter and further improvement in the fourth quarter.

Richard Eastman - Robert W. Baird & Co. Incorporated

Okay. Okay. And then also, is the shale gas growth that you're now experiencing, is that showing up in the Adomite growth rate?

J. Fyrwald

Yes, primarily in the Adomite growth rate in terms of the drilling. And then the ongoing production is in the OFC or Oilfield Chemicals business.

Richard Eastman - Robert W. Baird & Co. Incorporated

Okay. And then just lastly, you may have covered this, I may have missed this in the dialogue, but what was the net impact of the material cost increases, the variance there relative to price? I can kind of do the price math. It looked like maybe price added $30 million or so. What was the materials variance? What was the net impact?

J. Fyrwald

The raw materials was slightly higher cost than the price. So we did not quite cover the cost with price in the third -- in the second quarter, but we expect to do that in the third quarter and then obviously expand that in the fourth quarter with moderating raws and further increases in price.

Operator

Our next question comes from John McNulty with Crédit Suisse.

Unknown Analyst -

This is Avi Rajin [ph] calling in for John McNulty. Two quick questions. First, could you talk a little bit about freight costs and your outlook for these in the second half and how this might impact margins in Paper and the Energy business?

Kathryn Mikells

Overall, the freight cost increase we're seeing has a much more moderate impact than what we're seeing in raw materials. So we include it when we talk about raw materials. But at this point, on an ongoing basis, that impact is very, very small.

Unknown Analyst -

Okay, great. And then just as a follow-up. Just wanted to quickly clarify the tax rate. Since the full year guidance is 34% and the first half is roughly 27%, that means your second half tax rate comes in higher at roughly 38%. Is that the right way to think about it?

Kathryn Mikells

That's exactly the way to think about it. And that will enable us to hit the 34% full year guidance. We obviously guide to full year and not to quarters, but you're exactly correct on that.

Operator

[Operator Instructions] We'll now take our next question from Rosemarie Morbelli with Gabelli & Company.

Rosemarie Morbelli - Gabelli & Company, Inc.

Could you, Erik, talk a little bit about the long-term growth rate for your different businesses?

J. Fyrwald

Sure. We see Energy Services growing at 10%-type growth rate. We see our Water business growing at high single digits, 6% to 7% to 8% growth rate. And we see our Paper growing at lower single-digit growth rates, 2% to 4% growth rates. But that will be different by geography. The BRIC+ countries will be growing faster. The more mature markets, especially Europe, will be growing slower than those.

Rosemarie Morbelli - Gabelli & Company, Inc.

And just following up on the Paper side, you left out India from the growth in Paper, and there are quite a few mills coming on stream there or being expanded. Is that because you are not there yet? Or is there any particular reason that I am not thinking about? And then as a follow-up also, still on the Paper, there are still talks of paper mills shutting down in Europe while a lot of them have consolidated or gone out of the business or shut down lines in North America. The change has not been as pronounced in Europe, yet you are expecting flat Paper business as opposed to -- I would have expected it to come down. Could you elaborate on those 2 points?

J. Fyrwald

Sure. I'll start with India. And we are well positioned in India. We have not put the emphasis and the number of resources that we put in China because the China market is substantially bigger and growing very fast. India is a growth market for paper. We are growing in paper there. In fact, I was in India in January and I met with one of the largest paper company CEOs and he was telling us about how they were doubling their capacity at their largest mill, but they were not allowed to have any additional water. They were not allowed to use any additional water. So he was asking us how can we help them double their capacity with no additional water use. So not only is the industry growing in India and we're well positioned, but the water challenges, like in China, are tremendous. And therefore, what we bring advantages us versus other competitors.

Rosemarie Morbelli - Gabelli & Company, Inc.

Can they do it?

J. Fyrwald

No, not as well as we can.

Rosemarie Morbelli - Gabelli & Company, Inc.

No, I meant to double the capacity without adding any water.

J. Fyrwald

Well, we've got a whole team there working with them to do that. And they'll start up the plant later this year, and we'll be there with them to make sure that they can do it.

Rosemarie Morbelli - Gabelli & Company, Inc.

And in Europe?

J. Fyrwald

And in Europe, you're right, that there's been some contraction there. But on the other hand, we are bringing some new technology, some additional value with our services. So we think we can hold about flat performance in sales in Europe paper.

Operator

Our next question comes from David Rose with Wedbush Securities.

David Rose - Wedbush Securities Inc.

Just 2 quick questions. On the emerging markets, can you provide us a little bit in terms of the evolution throughout the quarter, the growth in these markets on the months?

J. Fyrwald

Oh, we saw the strongest growth in the third month of the quarter, but that's not atypical for us. I think your question, I think, is leading to have we seen a slowdown. And if that's the question that you're trying to get at, the answer is no. We have not seen any slowdown of our business in the emerging markets or, frankly, around the world for that matter because we're growing with the markets but we're also expanding our market position. And that's why we just completed a record growth rate year -- quarter for our company.

David Rose - Wedbush Securities Inc.

Okay. And Erik you had called out the anniversary of the Chilean earthquake as an easier comparison in Latin America. Are there difficult comparisons that we're facing that have not been called out previously that you see in the third quarter?

J. Fyrwald

No, not significant.

Operator

It appears there are no further questions at this time. Mr. Fyrwald, I'd like to turn the conference back over to you for additional or closing remarks, sir.

J. Fyrwald

Thanks. First of all, I want to thank everybody for joining us today. And before we end the call, I'd like to remind you of the 3 commitments we made on the last quarter's call that will allow us to achieve our EBITDA target for the year. First of all, we committed to driving strong top line growth and we delivered 16% revenue growth in the second quarter. Our growth strategy is sound. We are executing well, and that high growth rate will continue. Second, we committed to continuing to raise prices in order to recover raw material cost increases and support margin expansion. We made good progress on that front in the second quarter and are on track to fully offset current year raw material and freight headwinds on a run rate basis by the end of the third quarter. We are also on track for our full year productivity target. And finally, we committed to getting our quarterly adjusted EBITDA margin above 17% by year end and we're on track for that as well. So overall, our strategy is working. We're executing well. We're delivering on our commitments and our momentum continues to build. Thank you very much.

Operator

And that does conclude today's conference. Thank you for your participation.

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