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Nalco Holding (NYSE:NLC)

Q3 2011 Earnings Call

November 02, 2011 10:00 am ET

Executives

Lisa Curran -

J. Erik Fyrwald - Chairman, Chief Executive Officer and President

Kathryn A. Mikells - Chief Financial Officer and Executive Vice President

Analysts

Abhiram Rajendran - Crédit Suisse AG, Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

David L. Rose - Wedbush Securities Inc., Research Division

Brian Drab - William Blair & Company L.L.C., Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

Laurence Alexander - Jefferies & Company, Inc., Research Division

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Operator

Good day, everyone and welcome to the Third 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 Vice President of 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 third quarter 2011 results. Speaking today will be Chairman and CEO, Erik Fyrwald; and Executive Vice President and CFO, Kathryn Mikells.

Most of the information 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 discussed in a joint proxy statement or prospectus included in the registration statement on Form F-4 that Ecolab filed with the SEC in connection with the merger which was declared effective by the SEC on October 28, 2011. On or about October 31, 2011, Nalco and Ecolab began mailing the definitive joint proxy statement prospectus to stockholders of record as of the close of business on October 11, 2011. We urge investors to read the registration statement and joint proxy statement/prospectus and any other relevant documents filed with the SEC because they contain important information about Nalco, Ecolab and the proposed merger.

Our statement describing the risks associated with 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 Generally Accepted Accounting Principles. Management believes that the presentation of non-GAAP measures, such as operating earnings, adjusted operating earnings, EBITDA, adjusted EBITDA and adjusted EPS provides investors with additional insight into the ongoing performance of operations. Provided schedules reconciling all non-GAAP measures used in our third quarter earnings to the closest GAAP equivalent have been provided as attachments to our earnings release.

After comments from Erik and Kathryn, we'll open the call up to questions. In order to allow for as many participants as possible to ask questions, we will restrict participants to 1 question with a clarification follow up, if necessary. We will then ask that participants re-queue in order to ask additional questions. As previously announced, Nalco has established the date for a special meeting of its stockholders to consider and vote upon a proposal to adopt the previously announced agreement and plan of merger dated July 19, 2011, among Nalco, Ecolab Inc. and Sustainability Partners Corporation, a wholly-owned subsidiary of Ecolab. Stockholders will also vote on a nonbinding advisory proposal to approve the compensation that may become payable to Nalco's named executive officers in connection with the completion of the merger. Nalco stockholders of record at the close of business on Tuesday, October 11, 2011, will be entitled to notice of this special meeting and to vote at the special meeting. The meeting will be held on November 30, 2011, at 10 a.m. Central Standard Time at Nalco's corporate offices, 1601 West Diehl Road, Naperville, Illinois. The merger agreement is subject to customary, regulatory and stockholder approval. Nalco and Ecolab have submitted notifications of the merger with competition authorities in the U.S., European Union, Australia, Canada, China, Columbia, Mexico, Russia, South Korea and Turkey. To date, clearances have been received without imposed conditions from the U.S., Australia, Canada, Mexico, Russia, South Korea and Turkey. Please note that in Erik's and Kathryn's comments, unless stated otherwise, all references to year-over-year financial results will exclude the impact on third quarter 2010 from approximately $19 million in sales associated with the onetime oil dispersant sales associated with the Gulf of Mexico response. While this impact is not included in our definition of adjusted results, we believe excluding it in our discussions of results provides you with the best comparable to understand underlying business performance. With these administrative items out of the way, I will hand the call over to Erik.

J. Erik Fyrwald

Thanks, Lisa, and good morning. Nalco reported third quarter record sales of $1.3 billion, up 17% from the same period last year. We told you earlier this year that price would cover cost by the end of the third quarter and we delivered. These record results include a 5% price improvement, 9% volume growth and a favorable currency lift of 4%. The impact from acquisitions and divestitures was an unfavorable 1%, reflecting the divestitures of non-core businesses that we told you about at the beginning of the year.

I am pleased that we achieved double-digit organic revenue growth in both our Water and in Energy businesses and in all regions in the quarter. BRIC+ sales continued strong, up 21%. Third quarter adjusted EBITDA was $208 million, a year-over-year increase of 13%. Organic adjusted EBITDA grew 14%. Importantly, adjusted EBITDA margin increased 170 basis points sequentially, as our sales teams executed further pricing gains in the face of continued headwinds from raw materials and freight costs.

Adjusted operating earnings of $172 million improved 17% or 19% organically and demonstrate the customer benefits of our best-in-class sales and service expertise and innovation that allow us to bring tremendous value, and share in those benefits with customers through price. Adjusted EPS in the quarter was $0.53, up 33% compared to $0.40 in the same period last year. These strong earnings results reflect volume and price gains in all segments and in all regions.

Now I'll talk about how each of our segments performed. Water Services sales were $520 million -- $521 million, up 12% or 11% organically. Global sales were led by double-digit growth in Mining and in the Light, Food & Beverage and Manufacturing end-markets. Our Light and Heavy industry organic sales grew 7% and 5%, respectively. Direct contribution improved 15% over prior year, driven by volume growth and pricing gains with the best performance here in the Americas. Direct contribution margin increased 40 basis points globally and by 210 basis points in the Americas year-over-year, reflecting strong pricing gains in operating expense management, partially offset by the costs from substantial hires last year in our BRIC+ markets as we accelerate growth investments in those important growth areas. Direct contribution margin increased 270 basis points sequentially, driven by continued progress with pricing. Energy Services continued to deliver outstanding performance, sales were $510 million, a year-over-year increase of 25%. Organic growth was 21% led by substantial growth in enhanced oil recovery and double-digit performance upstream and downstream.

Direct contribution margin was down 90 basis points year-over-year, reflecting an unfavorable mix change, which included the continued stoppage of high-margin business in Libya, but that's business we expect to pick up again in 2012 as energy production is beginning to start back up in Libya.

Operating expenses were also impacted by Libya as we recorded at $1.2 million bad debt reserve, a situation the entire industry faced in the third quarter. We also began incurring expenses related to preparing for a brand-new $500 million 5-year contract win in the North American shale market, which started up the initial phase earlier this week and will ramp up over the next 18 months. Energy Services direct contribution margin increased 110 basis points sequentially, reflecting further pricing gains. Paper Services sales were $219 million. This represents a year-over-year reported growth of 13%, or 9% organically, led by double-digit growth in the Americas. Direct contribution margin declined 90 basis points from prior year, reflecting primarily raw material and freight headwinds. Direct contribution margin improved sequentially by 120 basis points with our pricing gains.

Now before moving to our guidance, I want to stress how pleased I am that we continue to build growth momentum well ahead of market growth as we head into the fourth quarter. And while we are strengthening our market position, we are also delivering on price at the same time. We've achieved robust organic sales growth year-to-date of 12% and organic adjusted operating earnings growth of 10% and are on pace to see a return to historic adjusted EBITDA margins in the fourth quarter as we described earlier.

So to reiterate, we covered cost with price in the quarter and we will do this again in the fourth quarter. Based on our strong pricing efforts and with where input costs are today, we now expect to end the year with price covering raw material and freight cost increases for the year.

On a cumulative basis, we expect to cover the significant raw material and freight cost increases that started to rise in 2010 within the first half of 2012. I'm very proud of what this leadership team has accomplished. We put in place the right growth strategy several years ago, and it's playing out as we expected because we are executing well.

Turning now to the outlook for the year. We see continued robust growth across our businesses and regions and therefore are raising our full year 2011 guidance for adjusted EBITDA and adjusted EPS based on year-to-date results and our expectations for the remainder of the year. We now expect adjusted EBITDA of $745 million, up from our prior guidance of $740 million. We expect adjusted EPS of $1.75, up from our prior guidance of $1.70 and we have reduced our adjusted effective tax rate outlook for the year by 1 point to 33%.

So let me finish by saying that I'm excited by the momentum we keep building as we approach the close of the merger with Ecolab in the fourth quarter. Our teams have been making great progress with integration planning and are ready to take full advantage of the significant cost and revenue synergies we will create with this powerful combination. With that, I'll turn it over to Kathryn for more details on the financials. Kathryn?

Kathryn A. Mikells

Thanks, Erik. Our third quarter results continued to demonstrate our growth strategy is working, with volume gains and pricing traction enabling strong bottom line results and solid sequential margin improvement. Sequentially, sales increased 7%, driven by 5% volume growth and 2% pricing gains. Top line growth and tight expense control enabled a $40 million or 31% increase in adjusted operating earnings compared to the second quarter, and a 250 basis point expansion of adjusted operating margin to 13.7%. Compared to the second quarter, adjusted EBITDA of $208 million increased 19% and adjusted EBITDA margin of 16.6% expanded 170 basis points as pricing gains drove significant progress towards restoring our margin to historical levels.

As Erik mentioned earlier, on a year-over-year basis, adjusted operating earnings increased $25 million or 17% and adjusted EBITDA of $208 million was up 13%, with adjusted EBITDA margins of 16.6% only about 50 basis points below prior year and adjusted operating margin about flat to prior year.

I'd note that admin expense, excluding $4.6 million of merger-related costs, increased by almost 16% for the quarter versus prior year, but was up only 8% on a year-to-date basis. We mentioned on our call this time last year that we reduced incentive accruals due to a decision to exclude Gulf sales from our incentive metrics, creating a $7 million year-over-year headwind this quarter in admin expense.

Below the operating line, reduced interest expense enabled even stronger growth in pretax earnings. Pretax earnings increased by $41 million to $121 million versus the $80 million pretax income in the prior-year period. The strong improvement in pretax income year-over-year was driven by $33 million higher reported operating earnings and $12 million lower interest expense, due to the de-leveraging and refinancing last year at significantly lower interest rates. Pretax margin improved 220 basis points compared to prior year. The adjusted effective tax rate in the second quarter was 35.4% and as Erik mentioned, we reduced our full year 2011 adjusted tax rate guidance from 34% to 33%, reflecting better full year visibility on profit mix.

In summary, this was a very strong quarter characterized by good volume growth and full price recovery. We expect our top line momentum to continue into the fourth quarter with the pricing gains we achieved enabling a further modest sequential and year-over-year adjusted EBITDA margin improvement, supporting our expectations that our adjusted EBITDA margins 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 to Anna.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Ryan Connors with Janney Montgomery Scott.

Ryan M. Connors - Janney Montgomery Scott LLC, Research Division

Erik, I wonder if you could touch on the competitive dynamics as the business combination with Ecolab approaches and specifically, wanted to get your thoughts on the GE Water, Diversity alliance. I mean, obviously on the surface, given the timing, it looks like a direct competitive response to the merger. So I'd be interested to get your thoughts on that alliance and what you think it means for the competitive dynamics going forward.

J. Erik Fyrwald

Sure. A few thoughts about this. First of all, I think that, that response helps validate the benefits of putting water and cleaning and sanitization solutions together. I think customers have value for that. I think it makes a lot of sense and I think this is further validation of that. Second point would be that my experience is that collaborations like this are much easier to do within a company where the goals are aligned versus an alliance across 2 companies. And I'd also add that we have had an alliance with Diversity in the past and all I'll say is that I like our chances together with Ecolab to create the strongest value proposition for the customer. We're both #1 and I think we'll be even stronger. In fact, I've had the chance to visit a number of customers in the Food & Beverage industry and Institutional with Ecolab reps and with our reps and I can tell you that the customers are very, very excited about what we can bring together. So I'm very pleased about our coming together and I'm very pleased about our chances relative to our competition.

Operator

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

Brian Drab - William Blair & Company L.L.C., Research Division

Just wanted to ask a couple of questions here. Was this the first time that you mentioned that $500 million win in the shale market?

J. Erik Fyrwald

Yes, it was.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. And if I heard correctly, that was $500 million over 5 years so $100 million a year. I mean, is this something that could add 2 points to the top line annually over the next 5 years?

J. Erik Fyrwald

Yes. It will start off slower, it will build up over 18 months and then from then on, it will be about the same level of revenue through the 5 years. So yes, it'll significantly enhance our growth rate.

Brian Drab - William Blair & Company L.L.C., Research Division

Okay. And that's just 1 win. Are there any other wins that are on a smaller scale that will also be contributing?

J. Erik Fyrwald

Well, I've recently spent time out in the shale region and I got to tell you, there's a lot of enthusiasm with our customers about the opportunity and a lot of investment going in from our customers and we've been building up our capabilities. So I am optimistic and confident that we will continue to strengthen our position in this very fast-growing market. So it is very important to our future growth.

Operator

And our next question comes from David Begleiter with Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Erik, can you comment on Q4 volumes? Are you seeing some normal seasonality, any de-stocking and how much will it be down versus Q3?

J. Erik Fyrwald

Well, we're seeing continued -- very strong volume growth. We're not seeing any fall off in our business. Our new account rate is growing. We've added a lot of new accounts recently. I've talked about the shale win but there are others across Energy, Water and Paper. Our attrition rates are declining. We're doing a better job serving our customers. So we're not seeing any fall off in our business, but we are hearing mixed signals about the uncertainty with the economies especially in North America and Europe. And so we're monitoring that, trying to see what develops. We have heard some indications of slowing of the steel industry for example in Europe. But overall, our business is strong, the momentum continues to build. I think we're strengthening our market position and I feel very good about the future.

David L. Begleiter - Deutsche Bank AG, Research Division

And just on raws, what percent of the raw material and freight costs did you cover in Q3? You mentioned a cumulative catch-up on that comment.

J. Erik Fyrwald

Yes. So we covered all the raw material increases and logistics increases within the third quarter and we started to gain on the full year. So by the end of the fourth quarter, we will have covered all the raw materials and logistics costs that we incurred in 2011 within the calendar year 2011 for price. But if you look back into 2010, there was some raw materials that we were not able to fully cover in 2010. So our point is that by midyear of 2012, we will have gone back and covered all of those with the pricing gains that we continue to make. Is that clear, David?

David L. Begleiter - Deutsche Bank AG, Research Division

Very clear, yes.

Operator

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

Michael J. Harrison - First Analysis Securities Corporation, Research Division

I had a question for you on the paper side. It sounds like the Americas were the strongest geographic driver in that business. Can you walk through some of the details on what you're seeing in each geography, particularly what you're seeing in terms of the pricing environment, where it's strongest, where it's weakest globally?

J. Erik Fyrwald

Yes. So the paper environment is not much different than what we've talked about before. Relatively flat industry in North America, some continued decline in Europe but continued strong growth in Asia and Latin America. The strength of our business in North America was less a market phenomenon and more about our strengthening our market position by finding new technology. Our OxiPRO, our PARETO and other technologies are being well accepted in the marketplace, are creating value for our customers and are enhancing our ability to bring value and we're sharing in that value, which is helping our pricing. So that's why you're seeing a growth in North America. Now I think there's continued ability for us to drive these technologies not only in North America but around the world and the way I see it going forward is continued.

[Audio Gap]

Michael J. Harrison - First Analysis Securities Corporation, Research Division

On the FillerTEK product, I know that increasing the filler content of paper is sort of the holy grail of papermaking. Can you just give us some sense on how you expect that to ramp and maybe what it could contribute longer term in terms of the growth of your business in paper?

J. Erik Fyrwald

So FillerTEK is a very, very strong technology that we've recently launched. We've been very successful with it with the accounts that we've gone to with it. It's reduced their costs substantially, kept their quality without any diminution of their qualities. So it reduced their cost at the same quality and as a technology, that's really picking up in the marketplace as well. I'm very bullish about it. The customers that we've worked with, with FillerTEK so far have been very pleased. It's enabled us to enhance our position with those customers and I see that continuing. But I do look at it as one other technology in our bag of technologies that are bringing great value to the paper industry and allowing us to grow ahead of the market and improve our margins.

Operator

And our next question comes from Rosemarie Morbelli with Gabelli & Company.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Just follow up on the FillerTEK, is it -- is that particular technology used by paper mills only if they already use PCC or can paper mills not using PCC use it as well?

J. Erik Fyrwald

I think it applies to any paper mill that's making a certain type of paper product, whether they use PCC or not, as far as I understand. I can get you more details about the technology but it's used I think across uncoated paper mills so that it is broadly applicable. But, Rosemarie, we can follow-up with more details, if you'd like, on what we've talked about publicly about this great technology.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Yes, that would be really helpful. And if I may, on the raw material cost side, you are expecting to catch up with your 2010 raw material cost increases, but it looks as though the trend for raw material cost is going down. Do you think you can still catch up with those costs or will that put a little -- well, bring a little difficulty in terms of getting more from your customers?

J. Erik Fyrwald

Well, so far, we've seen the raw materials start to moderate. There are some raw materials that have declined like propylene and others that have stayed the same and some that have gone up. But I would say overall, what we're seeing is a moderation in the increase of raw materials. There's so much uncertainty going forward and I can't tell you if raw materials are going to come down or go back up or stay about where they are. But our assumption is that they could go any direction. We're continuing to work on pricing and our belief is that with any scenario that we can foresee, that by the end of the first half of 2012, we will have covered all the raw material increases when you look back to when they started increasing in 2010. So I can't tell you exactly how that's going to play out, but I can tell you that we're out there in the marketplace making sure that we cover the raws in any situation.

Kathryn A. Mikells

And we had talked earlier this year, obviously, in the first quarter, we saw our margins very much under pressure as we put our pricing actions in place and if you look historically, we always tend to follow that pattern. But if raw material prices start to abate, historically, we also follow the pattern that we're able to hold on to price for a period of time. So we're pretty confident in our expectation of fully covering those raw material cumulative cost increases in the first half of next year.

J. Erik Fyrwald

In any scenario.

Operator

And our next question comes from John McNulty with Crédit Suisse.

Abhiram Rajendran - Crédit Suisse AG, Research Division

This is Abhi Rajendran calling in for John McNulty. Quick question on the Ecolab integration. So your integration team has been working on a review of opportunities for a couple of months now and at Ecolab's Investor Day, you talked about roughly $75 million in synergy opportunities by 2013 or so. Do you have any updates to this? And also, could you talk a little bit about some of the cross-selling and adjacent growth opportunities you see, say, looking out to the middle of the decade?

J. Erik Fyrwald

Yes. So we're not changing our numbers at all but what I can tell you is that we -- as the integration teams dig in both on the cost side and the revenue side, not only are we getting more specific about the opportunities and defining them and the plans to make them happen, but we're seeing more opportunities than we expected. So I think that you'll be pleased with our ability to hit the numbers that we've talked about publicly. I think you'll be pleased with the timing of the beginning of starting to see gains. And I'm very confident of what's going to happen there. On the cross-selling opportunities, again, I had mentioned before that I've been out with some customers, with our reps, with Ecolab reps. I can tell you that now we're getting very specific about what accounts we go to first. The energy, the enthusiasm and our sales force and Ecolab sales force to get the deal closed and get out there and open doors for each other, both directions, is very high, particularly in Food & Beverage and Institutional. And the concepts that we're developing around solutions, what we can bring to add value to the customers is getting very clear, very exciting to people that we're ready to go out there and provide them. Of course, with the Hart-Scott-Rodino and the SEC approvals, we're able to get into more specifics about what we can do together. And what I'll say is the enthusiasm is building and we'll be ready to go later this year when we close.

Abhiram Rajendran - Crédit Suisse AG, Research Division

Great. And then just a quick follow-up if I may. In Water Services, you mentioned accelerated spending in the BRIC+ regions. Could you maybe quantify the costs associated with this, what this translates to in terms of number of people and also, maybe how much more ramping you may need to do to rightsize the business for the available opportunities in these markets?

J. Erik Fyrwald

Well, the big cost we talked about occurred last year when we hired 900 people. We increased our headcount by 900. I think that that's flowing through now and we're seeing some of those cost increases, the year-over-year and we're just starting to see in the marketplace, the benefit of that ramp up in cost as people get trained, as they get ready to go out and have an impact in the marketplace. This year, we're continuing to increase our headcount but at a pace more aligned with our growth rate and you'll see that, I think, naturally going through the P&L and we'll be able to handle that without the spike that we saw last year. So the way I would put it is the step up in investment that we made last year was a very well done, was smart to do and advances the growth opportunity. We now have those people getting trained and are seeing the growth opportunities and it's paying off now and will continue to pay off going forward. So we won't hire at the 900 per year rate, but I think we talked about this year, about somewhere around half of that 400 or so, and that's the rate that we're on that will allow us to continue to drive revenue growth.

Operator

[Operator Instructions] And we'll now take our next question from Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc., Research Division

Just wanted to ask on Energy Services, have you seen any shift in competitor behavior, particularly by Champion? And also, with your new products in the shale applications, to what degree is this say, step change versus competing products or do you see several products going after the same markets already?

J. Erik Fyrwald

We haven't seen any significant change in the competitive dynamics. We've talked in the past about our heavy focus on CapEx, working with customers well before the production starts, that continues to be successful. We continue to win a very high percentage of the new production. The shale play, both oil and gas is still -- it's been around for a number of years in the gas area, but it's accelerated tremendously with horizontal drilling and I think it's -- there's a lot of opportunity out there, it's still early on. There's a lot more growth to come. We're making sure that our technologies and services are a good fit there and give us the kind of competitive advantage we've got in another areas. So we're investing both in service capability out in the field as well as technologies to support that service. And I'm very optimistic about our ability to compete with a differentiated offering there as well as we have with deep, ultra deep, the oil sands where we've been very successful, enhanced oil recovery where we're being very successful and growing rapidly. And I am very, very pleased with the strength that we have across our Energy Services portfolio and our ability to continue to build on that strength, differentiate and win in these important high-growth markets.

Operator

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

Robert Koort - Goldman Sachs Group Inc., Research Division

I see the margin improvement sequentially in all segments. A few questions on the shale project, are your products more customized towards gas-based shale drilling or you also handle oil-based shale drilling?

J. Erik Fyrwald

We handle both and we see great opportunity in both.

Robert Koort - Goldman Sachs Group Inc., Research Division

And this $500 million project, is it more of gas-based or it's also oil-based?

J. Erik Fyrwald

It's more gas-based upfront but my assumption is that over time, it'll be significant oil as well.

Robert Koort - Goldman Sachs Group Inc., Research Division

And the second question is in the downstream segment, in the second quarter, you reported very strong sales growth in the Energy Services in the downstream segment. Is it directly relating to the strong refining cycle we are seeing or what's driving it?

J. Erik Fyrwald

Some of it's the improved refining cycle, some of it's pricing and that pricing goes along with more technology that we're bringing to the marketplace. We're bringing 3D TRASAR technology. We're bringing chemical technology that helps customers deal with opportunity crudes, more difficult to handle crudes and we're advancing a number of technologies to bring more value to the customer that enables us to save them money, which we're sharing with -- on pricing. And that's also helping us gain market position. So it's market position, market growth plus better technology and service that we're getting through price.

Robert Koort - Goldman Sachs Group Inc., Research Division

And one last question. On the raw material front, we're seeing raw material prices collapse pretty dramatically. Let's say propylene down 30% from the highs. My question is, are you holding back to a point where you're running low on your inventories so that this -- you can get a better pricing as they collapse more or are you buying as you need it?

J. Erik Fyrwald

We're buying as we need it and there are a whole basket of things that we buy. We're not going to short our customers. We've got -- we've built up high customer service delivery levels and we're going to make sure that we can continue that. At the kind of growth rates that we're seeing, we have to make sure that we're able to support that growth rate and don't lose business because of that. And then frankly, we don't buy propylene specifically, we buy a lot of other products that are derivatives of propylene. So our raw material costs have not come down that significantly. When you look overall, there have been some costs going up. Net-net our raw materials are moderating and we hope that there's some decline going forward but we can't count on that.

Operator

And our next question comes from Richard Eastman with Robert W. Baird.

Richard C. Eastman - Robert W. Baird & Co. Incorporated, Research Division

Just a quick question. Again, just circling back to the gross profit margin. I would have thought that perhaps your consolidated gross margin would have been a bit higher here given the price covered raw and logistics costs. Was there anything in the mix that maybe influenced that number negatively? And then the second question would be, are you still comfortable with your calendar '11 free cash flow target that you tossed out?

J. Erik Fyrwald

So I'll take the first question first. The mix, yes, there has been a mix that shifts to a lower gross margin but equal DC margin. So our Energy Services OFC business for example is growing very, very rapidly. Our Adomite business is growing very rapidly. They have lower gross margins but lower cost per dollar to service those businesses per dollar of sales. So the net is our DC margin as you saw sequentially is growing. Our EBITDA margin is growing. Our operating income margin is growing and the business is very, very attractive. On the second question around free cash flow, we have not changed our outlook for the year and that continues to be as previously stated.

Operator

And our next question comes from David Rose with Wedbush Securities.

David L. Rose - Wedbush Securities Inc., Research Division

I have 2 quick questions if I may. The first is on the gas shale -- gas and oil shale contract. How much of that is related to green chemistries? I mean, is this part of your green chemistry initiative, one. Is it recovery? I'm assuming there is a part recovery and how much of it is, if any, water treatment on the produced water side? And then lastly, if you can talk about the acquisition opportunities set that you see in front of you post-closure?

J. Erik Fyrwald

So starting off with your question about the gas and oil shale contract. It's a very attractive contract for us. It's a very important business. It involves certainly some of our greening products. We continue to come out with products that are performance, high-performance and greener. It does involve some water treatment. Obviously, that's part of the value that we bring to that marketplace and we'll continue to build out that portfolio of technologies going forward for the oil and gas shale. In terms of acquisitions, we see continued opportunities to do bolt-on acquisitions as we've done in the past. With the strong balance sheet that Ecolab brings to the combination, we'll be able to execute on more of those. I think we've had a good record of very attractive bolt-ons that we've been able to lever with our global sales force, whether it's the Crossbow Water pretreatment acquisition that we did in Water Services that we've done. Not only have been able to grow that nicely, but we've done other similar bolt-ons in other geographies. Or our TIORCO enhanced oil recovery and FabTech enhanced oil recovery equipment, bolt-ons that we did in Energy Services that have played out extremely well, now that we've got a leading Enhanced Oil Recovery capability, which has tremendous growth opportunities. And we're starting to deliver on that. We see those types of bolt-on opportunities in our Water and Energy Services business that we will be able to do more of after the close of the deal with Ecolab.

David L. Rose - Wedbush Securities Inc., Research Division

So I'm assuming within 1 quarter or 2, you should be able to execute on a couple bolt-on acquisitions.

J. Erik Fyrwald

You will see some bolt-on acquisitions in 2012.

Operator

And we'll now take a follow-up from Rosemarie Morbelli with Gabelli.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Erik, you talked about the slowdown in the steel industry in Europe. Could you touch -- even though may not be affecting you fully, could you touch on the effect to your business?

J. Erik Fyrwald

Yes, Rosemarie. So again, we're not seeing any falloff in our business. It continues very strong. I think that's important to put out there first because we're continuing to grow with the markets. We put a lot more of our resources in the BRIC+ markets. They're still continuing to grow nicely. We're expanding our market share and we're bringing more value to the marketplace. So I think that's important upfront. However, we are seeing indications of future slowdown in areas like steel in Europe. Steel is in the low-single digits in terms of what part of our business it is in Europe, so that's not a big area of exposure for us. But I think it is an indication that there could be challenges ahead there. The paper industry in Europe -- talked about it before, that's an area that hasn't been growing for us. We don't expect that to grow for us, but we're overcoming that with fast growth in paper and Latin America, North America and Asia-Pacific with our new technologies, but I think we can hold our own in Europe through this economic challenge period. So I would say that steel and paper would be examples. I think there will be continued shift of refining from capacity from Europe to the Middle East and other areas where they start up new world-class facilities. Our view is that we plan to be there with the new capacity and at least capture our same share, if not more. So we see that not as a negative, but as a potential opportunity for us. But those will be the biggest areas that I would look to now that could be softening. But our position is that we're going to drive our business. We're going to go out there with increased value on our services and technology. With the Ecolab combination that opens up more opportunity in the Food & Beverage and Institutional for offerings from both companies. And with all that, we think that there's more opportunities for growth, not less, for our company.

Operator

And it appears there are no further questions.

J. Erik Fyrwald

Well, great. Then let me close by saying that first of all, I thank you for joining us for what I hope was a helpful discussion of, what we feel, a very strong quarter and a momentum that continues to build. We continue to build on our volume growth, taking a stronger position in the marketplace. Our pricing growth, as we talked about, material costs have started to abate. And as you've mentioned that in some areas that they're starting to decline. All of that's attractive to us, continuing to build our momentum. As this will likely be Nalco's last call as a stand-alone public company, I feel great about the strength of our leadership team, our clear focus on big opportunities that really make a difference, and the performance and momentum we are bringing to the combination with Ecolab. I'll tell you this combination will only make us stronger. And we look forward to the exciting times ahead and hope that you will continue to join us on this new journey. Thank you very much.

Operator

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

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