Executives
Mike Bushman - Division VP for Communications and IR
J. Erik Fyrwald - Chairman, President and CEO
Bradley J. Bell - EVP, CFO and Treasurer
Analysts
Jeffrey Zekauskas - JP Morgan
PJ Juvekar - Citigroup
David Begleiter - Deutsche Bank
Michael Harrison - First Analysis Group
Laurence Alexander - Jefferies
Chris Shaw - UBS
Mark Gulley - Soleil Securities
Brian Drab - William Blair & Company
Richard Eastman - Robert W. Baird
Robert Koort - Goldman Sachs
Nalco Holding Co. (NLC) Q1 FY08 Earnings Call April 30, 2008 10:00 AM ET
Operator
Good day everyone and welcome to the First Quarter 2008 Earnings Call hosted by Nalco Company. This call is being recorded.
At this time, I'd like to turn the call over to the Division Vice President for Communications and Investor Relations for Nalco. Mr. Mike Bushman, please go ahead sir.
Mike Bushman - Division Vice President for Communications and Investor Relations
Thank you, Kath. Good morning and thank you for joining us for our conference call to discuss first quarter 2008 results. Joining us today are Chairman, President and CEO, Erik Fyrwald; and Executive Vice President and CFO, Brad Bell.
Some of the information discussed today constitutes forward-looking statements that are subject to certain risks and uncertainties. Our statements describing the risks associated with forward-looking information is found on our website and on our press release, which may also be found at www.nalco.com. Further background on our risk is available in our 10-K.
The information discussed today will include data that does not conform to generally accepted accounting principles, management believe the presentation of non-GAAP measures such as adjusted EBITDA, free cash flow and adjustments in net earnings provide investors with addition insight into the ongoing performance of our operations. When necessary, accompanying schedules for reconciliation of such non-GAAP measures to the closest GAAP equivalent have been provided as attachments to our earnings release.
After comments from Mr. Fyrwald and Mr. Bell, we will open the call for questions. In order to allow for as many participants as possible to ask questions, we will restrict participants to one question with a clarification follow-up, if necessary. We will then ask the participant to re-queue in order to ask additional questions.
We will start with Mr. Fyrwald.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Thanks, Mike. Well, good morning and thank you all for joining us today. As this is my first quarterly conference call since joining Nalco in February, I'll focus my comments on my perspective of the business at this point. I'll also discuss our priorities for the remainder of the year and our plans to strengthen the businesses this year and going forward. Then I'll ask Brad Bell to go through first quarter results in greater detail. On future calls we'll have different division presidents join us, so you can hear more detailed perspectives on the individual end markets and geographies that make up Nalco.
Now, I've spent the last to months traveling the world, meeting with my senior management team, Nalco leaders in each region and our sales teams around the world. I visited many customers and a number of Nalco's sites and my initial conclusion from this time is that we have fantastic growth opportunities across our company, both in our target markets of water, process and energy services and in emerging geographies such a China, India, Russia, the Middle East, the Caspian and Brazil and with our great new technologies that are commercial and we are ramping up such as 3D TRASAR, Nalco Mobotec and our oil fields services deepwater technologies as well as with our near term technology pipeline that's coming through to commercialization.
However, we have some execution issues we must address to realize our first full growth potential. So, with both near and mid-term performance in mind, and both opportunities and challenges, let me lay out for you the six priorities my leadership team is focused on for 2008. First, we must capture price to at least cover cost increases. At 9.9% revenue growth, of which 5.5% was organic, our first quarter global sales increase provided a solid start to 2008. However, we must more aggressively push price increases and in the first quarter we ran $6 million behind in price capture with $17 million and achieved price increase against $23 million in higher product and freight cost. We need to cover this gap as we go forward.
Second, we have to get Europe turned around. We just finished the top level management team changes needed to make this happen. The team has been led since mid-year 2007 by David Johnson, who is European and understands the region very well. David and his team are taking actions to clearly lay out our market priorities and free up sales time so we can earn more business from existing customers and win over new customers. Now, David and his team have direct accountability to deliver growth and the authority to make the changes needed.
As an example of some of the actions, David's team recently identified needs for and worked with our global functional leaders to rapidly move some key IT supply chain and other order-to-cash process experts from our global group in North America to Europe to focus on improving our back office support systems there. Now, I believe we now have the talent focus and execution in place to get Europe back to positive organic growth by the end of the year, and turn around all of Europe Africa and the Middle East into a growth engine going forward from there.
Third, we need to enhance growth in Asia and several other emerging geographies, where we are growing today but have further growth opportunity. And we now have clear internal strategic alignment the what behind what I will call a brick plus strategy, that will focus a greater portion of resources including sales, marketing, research and other resources on emerging market economies such as China, India, Russia, Brazil, the Middle East, the Caspian and West Africa.
Now as an example of the changes we are making here, in the first quarter, we increased our employee count in Asia, mostly in China sales by 43 people. We'll train them well and expect them to contribute positively to earnings within one year. And we are similarly ramping up across these geographies. We are also having our industry experts from North America increase their travel to the high-growth geographies to train our local talent and support their efforts to win new business.
Now we grew first quarter sales by robust 11% in North America. And that tells me that our capabilities are strong, we just need to more rapidly get them to the faster growing economies of the world to strengthen total Nalco growth.
Fourth, we must continue to drive high growth in the very attractive energy services business. Steve Taylor and his leadership team have us on a great track, they delivered 13.6% organic growth in the first quarter, and they have grown energy services to a substantial business for us, are consistently delivering strong sales and earnings growth, and are putting in place the plan, people and technologies to continue to drive strong improvements. And we'll continue to aggressively increase resources in this business to drive growth in both upstream and downstream with existing and new technologies.
Fifth, we need to accelerate growth in our Industrial and Institutional Services division which we call I&IS, which was off to a slow start in the first quarter at 2.3% organic growths. The technology will play a key role here, as we expand 3D TRASAR to more geographies in applications and facilitate the rapid spread of Nalco Mobotec to power and then to other customers.
We also have some high growth industries within I&IS that deserve more focus and we'll redirect resources to these markets together with our efforts to improve our focus on high growth geographies. Generating growth in I&IS Europe will be a key piece of moving this segments organic growth rate to a higher level. As with the rest of water treatment operations outside of Europe, are in pretty good shape, so we've got to get Europe on track.
Two examples of progress we did make in I&IS in the first quarter. Our focus on the food and beverage segment paid off and we grew double-digit organically everywhere in this segment except Europe. Also, Nalco Mobotec made very good progress in the first quarter and is said to deliver at least $30 million in sales this year and we have got sizable new projects and development, including a number of which are in contract negotiations right now that put us on track to deliver the growth we expect in 2008 and will help drive rapid growth in 2009 and beyond.
And finally, sixth, we have to speed up technology commercialization and ramp up across the businesses and regions. We have great new technologies to leverage such as PARETO optimization technology and EXTRA WHITE brightness enhancer for paper, new deepwater applications and Clean n Cor technology which delivers pipeline efficiency and corrosion protection in energy, 3D TRASAR technology that we have commercialized and penetrated largely in water-cooling, now we are driving into boilers and Nalco Mobotec. These will be our initial focus efforts in I&IS and they will expand more broadly across Nalco. But across our technology portfolio, we need to make bigger bets on the research side and combine that with faster, better supported commercialization. We've got great opportunity there.
And to help make sure technology development is well resourced and on track to deliver value to our customers and to Nalco, our R&D Vice President, Mani Ramesh and our senior business leaders are driving a quarterly update process for each of the top 10 projects. And I look forward to these updates very much and to interacting with our strong talented as driving this high margin important growth and to accelerate in that going forward.
Now to help fund the growth investments that I have been talking about, the Nalco leadership team is also committed to driving productivity and stepping that up to help fund the faster growth. And we'll discuss in more detail what our plans are here on future calls.
Now the most important factor to success of a company is its people. I am very encouraged by the quality of the leadership and talent across Nalco, including our very professional sales engineers, who in many cases live with our customers every day to profitably serve them. And I work closely with the leadership team to make sure we continuously improve getting the right people in the right jobs, train them well, and giving them the tools they need to succeed and drive the growth of Nalco.
Now, given its size of the opportunity set, and our capabilities and potential to deliver value to our customers, through cost savings for them and sustainability improvements by helping them reduce water usage, reduce energy usage, and air emissions and brining new technologies to energy to enhance and get more energy out of the ground, with all these opportunities we are asking ourselves as a management team how do we step up the growth rate and our margins. Doing this, will require us to focus more resources on the highest priority opportunities to develop clear plans and to execute more effectively and consistently.
I believe in the last few months we've taken the first steps toward this. This also requires our being very open amongst the Nalco leadership about our problems, so we address then head on and resolve them. Our issues in Europe are an example, and I think we are starting to head in the right direction there, but we'll keep you updated as we move forward.
We've got great potential to strengthen this company's performance and increase its value. But simply, knowing that growth potential exists is easy. Now we have to deliver on this potential over time and demonstrate to you our ability to increase profitable growth at Nalco.
With these introductory comments, let me turn it over to Brad to review the first quarter numbers in detail. Brad?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Thanks, Erik and good morning. Nalco generated $1 billion in the first quarter 2008 sales. That was up 9.9% from that year earlier, $909 million. This growth consisted of 5.7% of currency benefits, a negative 1.3% acquisition and perimeter adjustment and 5.5% organic growth. Acquisition perimeter is the net of results from Nalco Mobotec added this year offset by the synfuel business that ended with a December 31st, 2007 tax code expiration.
In the quarter, Nalco Mobotec sales were $6.3 million and the business added slightly to adjusted EBITDA. Adjusted EBITDA, which is used to determine compliance of the company's debt covenants increased 8.7% to $165.6 million from prior year results of $152.3 million that exclude the now ended waste coal agglomeration or synfuel business. With that synfuel business included, adjusted EBITDA was $158 million in the first quarter of last year, which means the as reported nominal gain in adjusted EBITDA was 4.8%.
As has been the case recently, revenue growth was led by Energy Services with an organic increase of 13.6%. Oil field and downstream businesses both grew at double-digit organic rates. Growth was strongest in North America and continued strong domestic demand and through export sales through out West African operations.
Sales in Europe declined on lower sales in mature markets. Direct contribution rose $13.4 million and margins in the business improved 60 basis points to 21.7%, although a portion of this improvement was likely due to product costs captured in the other segments, which I will discuss in a minute.
Organic growth in Industrial and Institutional Services or I&IS amounted to 2.3%. Broad growth in Asia Pacific and Latin America and gains in North America led by the food and beverage and power businesses were blended somewhat by a modest weakness in the Europe, Africa and Middle East or EMEA region. I&IS direct contribution margins dropped 210 basis points with negative mix and volume impacts including the loss of the synfuel business. Direct contribution dollars dropped by $4.1 million including a decline of $5.7 million from the discontinuation of synfuel.
Paper services grew 1.4% organically, with modest sales improvement everywhere except EMEA. Direct contribution increased $2 million on flat margins. Other segment sales dipped 7.7% organically in the quarter. I would like to bring your attention to the fact that results in India and Japan that are previously been included in the other segments are now being reported as part of the three primary end market segments. Restated segment results on this basis for 2007 are provided in attachment 9 to our earnings release. Remaining revenues in the other segments are the small amount of sales outside of our three reporting segments and are largely can be municipal, resale and a modest amount of tolling for others.
Other segment negative direct contribution is mainly comprised of $23 million in structural supply chain, customer service and other cross segments support group costs and $6 million in raw material costs not yet allocated to the business units.
Regionally, organic sales grew strongest in North America, at 11%, Asia Pacific sales increased 7.7% followed by a 4.2% improvement in Latin America and a decline in EMEA of 4.2%. The European dip was primarily driven by declining business in mature energy markets, with paper and I&IS merely flat.
As Erik mentioned, the primary challenge in the quarter was that our price increases was $6 million or so less than costs, even as we have been working to speed the capture of price in rising cost environments. More positively, operating expenses were under better control in the first quarter than it has been in recent experience, with a 1.1% organic increase in selling, administrative and research expense. We have put in place, under Erik's leadership, more rigorous disciplines on tracking and managing operating and admin expenses, including more extensive mid-period reviews with our business unit leaders.
First quarter net income increased 49% to $29.2 million from the prior year results of $19.6 million. A lower tax rate in the quarter contributed to our earnings improvement. A rate of 30.6% benefited from one-time tax reductions that are required to be reported fully in the quarter, and for the year we still expect our tax rate to be in the 33% to 34% range with cash tax expectations at about $100 million.
Diluted earnings per share gained 53.8% to $0.20 per share from $0.13 in the first quarter of 2007. The impact of share repurchase activity was essentially neutral. After tax amortization of intangibles amounted to $0.06 per share in the quarter, compared to $0.07 per share in the prior year period on a diluted basis.
Free cash flow defined as cash from operations less capital expenditures and minority interest charges, was $42.8 million in the first quarter. In the prior year period, free cash flow totaled $34.9 million. Most of the net difference resulted from lower pension contributions this year than in the prior year quarter.
Working capital was not a source of cash in the quarter. Our day sales outstanding increased very slightly as modest improvements in bringing down DSO in North America and Europe was offset by higher DSO in Latin America and Asia.
Inventory levels grew modestly, as we generally have our first quarter inventory build ahead of our summer cooling water season. Uses of free cash flow during the quarter included debt reduction in the form of required term loan A amortization and the pay off of revolving credit balances outstanding at year end. The small Brazilian acquisition, our dividend and the purchase of 350,000 share of our stock at an average cost of approximately $21.70, an additional 400,000 shares of stock repurchased at the end of March and April and will be reflected in our second quarter cash flow statements.
We were restricted from share repurchase activity during much of the quarter with the combination of earnings reports and pending news of Erik joining us as CEO. Going forward, the continuing priorities for free cash flow, our strategic acquisitions such as Mobotec and Veranum and share repurchase. Debt reduction beyond such mandatory requirements is the $28 million maturity in Q2, are not of primary interest as we remain comfortable with the degree of leverage in this very stable cash generating business.
We are reiterating our performance projections for the year expecting to grow adjusted EBITDA at an 8% pace from synfuel removed base of $707 million last year. Diluted EPS on a GAAP basis is projected to improve 35% before giving effect to the benefit of share repurchase. Product and freight costs are a key issue in projecting our performance for the year. As you know, a late in the year rapid increase in product costs will be particularly troublesome for us because of our typical one quarter lag in capturing price. We continue to work toward narrowing that one quarter time gap.
Despite the rapid change in crude oil prices since we last provided guidance, we still expect the organic impact of product and freight cost changes to increase only slightly from the $100 million range we projected. However, if recent surges in underlying commodity costs were to continue with this pace, our $100 million estimate would be in jeopardy. Price capture will then become an even larger factor in delivering our expected results for the year.
Finally, we continue to believe free cash flow will end in the year in the high $200 million range. Capital expenditures are still projected to be about $120 million this year and pension funding is expected to be about $20 million above expense levels. In all, we had a reasonable start to the year, but still see a number of opportunities to further improve.
With that, let me turn it back to you Kath and we'll go to questions from our listeners.
Question And Answer
Operator
Thank you, gentlemen. [Operator Instructions]. And we'll take our first question from Jeff Zekauskas with JP Morgan.
Jeffrey Zekauskas - JP Morgan
Hi, good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Jeff.
Jeffrey Zekauskas - JP Morgan
In terms of the 2.3% organic sales growth in I&IS, is that with the synfuels business factored out or is it with it factored in, that is was the underlying rate of organic growth higher but was obscured by synfuels or is 2.3 the organic growth rate?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Jeff the 2.3 is the true organic, so it's like-for-like year-over-year and again one of the big impacts on organic growth for I&IS continues to be Europe, which was essentially flat and then...
Jeffrey Zekauskas - JP Morgan
Okay. And then as my follow-up clarification, if in general your organic revenues are up $50 million, 5.5% and prices 17, then the remaining volume growth is about $33 million. And energy was up in total revenues by $52 million, so does that mean that volumes in paper and in I&IS were down year-over-year in the quarter?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Remember, your pricing there, we don't count it growth here, I just crack it. They just covered our cost activity. So, you've got to repeat the last part of your question through as I got side tracked, I apologize.
Jeffrey Zekauskas - JP Morgan
I apologize. What you did said that the price capture for the entire company gained $70 million, so that's the price effect for the company. The remaining volume exclusive of currency growth would be $33 million and since energy in its entirety, which does include currency was up $52 million, it seems to me that volume growth in I&IS and in paper must be negative. Is that true or is that not true, that is exclusive of currency and acquisition?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, you've got some mix differences around the globe, but I&IS and paper were essentially flat, most of their uptick was price in nature.
Jeffrey Zekauskas - JP Morgan
Okay, Thank you very much.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
With growth achieved in North America, Latin America and Asia, but slight decline in Europe.
Jeffrey Zekauskas - JP Morgan
Okay, good.
Operator
Thank you and we will go on to PJ Juvekar with Citi.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Hello PJ.
PJ Juvekar - Citigroup
Good morning Erik, good morning Brad. I have a question on Europe. So far your issues in Europe were related to cost cutting, back office integration, but now it seems that those issues are spilling over onto the revenue side and your revenues were down. If you look at volumes of other chemical or industrial companies in Europe, they were up. So, the fact that your revenue were down, is that a company specific issue, can you just talk a little bit more about what's causing this decline in Europe?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes, PJ. This is Erik, I'll start and Brad can chime in as he'd like. Our issues in Europe are very much related to challenges in the back office caused by a number of initiatives that were intended to drive productivity. which they will over time but the net effect for now was reducing percent of time sales people are spending with customers. So our sales people are not out... have not been out selling like they need to be. So we are fixing the back office situation, we are getting the order management situation resolved, so that our sales people can be out calling on customers, getting more business with existing customers and pursuing new customer opportunities. We are monitoring how much time our people are spending with customers, we are setting goals, we are brining over capability to get things streamlined in the back office and I am confident with all the plans that I've been through and I've been over there with our people and visited customers and with many of our sales people and our leadership, I am confident that we are getting on the right track, and will be back to positive organic growth, growing with and hopefully above the market rates by the end of this year.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I would only add to that, it's really been our consistent massage. PJ, we have spoken about this back office issues, but go back and look at comments we made through last year, it was really plaguing us in the areas of new business capture. Europe continues to have nice margins, we just haven't been able grow that business and the issues had been the complicating factors brought to that region.
PJ Juvekar - Citigroup
Okay.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
The other comment I'd make is that we have strengthened the leadership in Europe. So in addition to fixing the back office, which they are doing, we've got David Johnson over there, a European, very strong leader, knows Nalco, know the resources globally and how to access them and he has assembled a leadership team that is significantly stronger. He recently made some changes there that I think position us well to have a team that can figure out what are the top priority opportunities, tap into the resources that we have in Europe but also globally and pursue those more aggressively. So getting the back office fixed, so our sales reps spend their time selling, but also the leadership deployment in the right direction and get them the right resources to take full advantage of that sales time is starting to happen and we will see a turnaround in Europe this year.
PJ Juvekar - Citigroup
Okay. And Erik, another quick question for you. In your top six priorities, you did not mention paper; fixing or selling or anything about paper. So, if you can make a high level strategic comment on that. Thank you.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well, our paper business is important to us today from our revenue size and earning size standpoint. We continue to work aggressively on productivity opportunities in paper. We have some technologies that either have been recently commercialized or are just becoming commercialized, but I think an improved margins and paper, but clearly we have got a industry growth challenge in North America and Western Europe. We also though have a great market growth opportunity in Asia and I was in Asia with Brad last... the week before last, and saw first hand about the incredible growth in new paper operations in China, in India and some other geographies and I think we can capture growth there. Long-term, we are looking at paper and we have got to make sure that we can realize the ability to drive earnings and cash growth with that business and we are looking at how to do that.
Operator
Thank you. And we'll go on to David Begleiter with Deutsche Bank.
David Begleiter - Deutsche Bank
Thank you. Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning David.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Hi, David.
David Begleiter - Deutsche Bank
Erik, also on paper, when you say long-term, is again joint ventures have been proposed in the past for your business. Is long-term, three years, is it 12 months to decide the ultimate structure of the paper business, give some timing around that thought?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
I can't give you a specific date, but all I can tell you is that digging in, trying to understand it, we have got people that understand our business and the paper industry very well and looking at the global growth opportunities and what technologies we have today and coming, and we'll make decisions about paper over the next year or two and figure out what to do to optimize the opportunity for Nalco.
David Begleiter - Deutsche Bank
And just a clear clarification on the emerging markets, did Nalco under invest in the emerging markets over the past few years?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Absolutely. As I come in here and I see a company that grew in the first quarter 11% organically in North America, I don't know... you see more companies than I do, I don't think there are many industrial companies that grew 11% organically in North America in the first quarter. That tells me we've got lots of capability and as I look at our capability in North America, whether its technology, supply chain, sales capability, go out with customers and see how important we are critical partner to them, I am convinced that we've got the capability that if we ramp it up in these emerging markets, our growth opportunity is tremendous and is not lower margin, our margins in Asia are at or above our global margins.
We have very good margins in these emerging economies, we just need to ramp up the people, the capability not only in sales and marketing, but the technology and the infrastructure to make this happen, that's doable. That's... this is not rocket science, this is blocking and tackling, getting the horse power on the ground to make it happen and we have got the base capability to build from, we just need to add to it aggressively. And you are going to hear a lot more about that in the coming quarters, of how we are ramping that. The other great thing is, we get the right people as we get them hired and trained, it's a year before they start returning well over their cost, so it's a very, very attractive return. We can do it, we are going to do it and you are going to hear a lot more about it.
David Begleiter - Deutsche Bank
Thank you very much.
Operator
Thank you. And we'll go on to Mike Harrison with First Analysis.
Michael Harrison - First Analysis Group
Hi, good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Hello, Mike.
Michael Harrison - First Analysis Group
Looking at the segment direct contribution numbers, this $6.5 million shortfall in pricing versus raw materials you see that's not yet allocated among the B segment, that's some thing that you plan to allocate at some later point and can you may be give us a ballpark of how that shortfall impacted each segment in the quarter?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I think to explain our process for you Mike, this is the $6 million that I referenced in my comments. Our centralized procurement group will realize procurement variances, if you will, and we roll new raw material cost standards to the businesses each month. When you go through a period such as we just came through in the first quarter with sharply rising raw, there is that one month lag factor which accumulated to $6 million still in supply chain and that pushed to the three segments.
Starting in the second quarter, we've been doing these cost rolls now with a little bit of an anticipatory event in there so that we... the businesses see that in their margins on day one because in those businesses is the only place we can go for price capture to set this up. So over the balance of the year, all of that cost will be directly into the businesses and we'll actually move that $6 million across to them. I decoughing a number to try and tell you how much apply to each segment, the way we are doing this going forward is far more scientific, it's transaction by transaction. But it's got again, the biggest cost move so far have been in North America, I can say that. But the $6 million will find its way out and that will be a less of a factor in other in the go forward.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well, Mike, let me just add to that that as I went through the six priorities for the leadership team for the crust of 2008, price was right at the top, extremely important to us. We are putting in better managing processes to ensure that not only did the businesses see the cost increases coming ahead of time so that they can factor that into their pricing actions, but we're digging into the specific pricing actions by business and monitoring and tracking the progress there. So, this is very important for us not only to get the numbers into the businesses so that they understand what's happening, but what's coming and that we are dealing with that as aggressively as we can.
Michael Harrison - First Analysis Group
Well, I definitely understand the importance of getting pricing. It just strikes me that the sort of a component of gross margin here has been excluded from the direct contribution numbers in that. I was just trying to get a better sense, could you say it's roughly evenly spread among the three segments. Was the impact, I would assume it's largest in paper, is that accurate?
Unidentified Company Representative
If you are going to try and allocate something, you might do it off of revenues, Mike and you wouldn't be to far a field. A different business is used, different technology. Now the issue is that each of our business segments is not fully staffed with their own procurement organization buying for themselves. We have a shared supply chain which is why it's captured in the center. It's always in the company's gross margin but getting it to the businesses has been this one month lag, soon to be a zero lag if you will.
Michael Harrison - First Analysis Group
And if I could just sneak in one more, if you feel like you've been under investing in emerging markets, kind of curious why greater investment in emerging markets wouldn't be included in your plans for cash rather than share buybacks? Could you talk about that a little bit?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
It is. And remember, our definition of free cash is P&L after CapEx et cetera. For us to grow in expanding markets, in emerging markets, it's a people cost. It goes right into OpEx, it's not capital spending per se. So, clearly, our first priority continues to be to fund growth in these important parts of the world. It's... as Erik says, it's kind of a no bringer, it is taking what we already know how to do anyway abroad. One of our issues historically has been our greatest centers of expertise have been far too North American centric and we need to get technology and capability and resources out of the United States and more quickly to the bigger market opportunities where they exist.
David Begleiter - Deutsche Bank
All right. Thanks very much.
Operator
Thank you. [Operator Instructions]. And we will now go to Laurence Alexander with Jefferies.
Laurence Alexander - Jefferies
Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Laurence.
Laurence Alexander - Jefferies
I guess first question is on I&IS. Can you give a little bit of granularity or visibility on what you are seeing in terms of the trends within I&IS and particularly whether particular parts of I&IS have both scale and the growth rate to possibly be split off the way energy and paper have been within say the next three to five years?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well, I don't think that there is any segment in I&IS that we cannot grow. I think all segments in I&IS have significant growth opportunities. We talked about the issues in Europe, we are going to turn that around. I would say for the rest of the world and the various segment, we have different levels of growth opportunity and we need to make sure that we resource according to that, but when you think about 3D TRASAR for example and how that automation significantly advantages us versus the competition in cooling water control by automating the monitoring of the cooling water process, allowing us to add the additives that enhance that process optimally is a fantastic advantage and a fantastic benefit to our customers.
The ability to penetrate our existing customers with that and obtain new customers with technology is very important. The ability to expand that technology to boilers is just starting and a big growth opportunity for us and will enhance our overall I&IS business in each of the segments and then going beyond that, we have talked about Nalco Mobotec and what that does to get us onto the fire side of the boiler, optimize boilers and get involved with the air control, the air pollution control, expanding our portfolio of offering and that ability to sell more to our existing customers and sell new technologies that are advantaged to new customers, I think we have got lots of growth opportunity in I&IS, with those capabilities and you add to that the emerging economy opportunities that we are going to increase our resourcing for this division and the segments within it, all have significant growth opportunity.
Laurence Alexander - Jefferies
And then just to follow-up on that last point, when you look at the infrastructure in the emerging market for educating the sales force, do you think that you have enough infrastructure or is there going to be an initial period where the return on investment is lower and then as you build out the infrastructure then the return on investment accelerate in the out years?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
There are few places where we need more infrastructure. For example in Russia, where early on in Russia, we need to strengthen our infrastructure there. But when I visited China and other countries Singapore and other parts of Asia and other areas, we have the basis to build from. So, our adds of resources for the most part will be fairly quick to start to return and I am talking about within a year-to-year and a half. We have the training capabilities on the ground in Asia and in other emerging economies and we have great capability here in Naperville to bring people into Naperville, and to Sugarland for energy, train them and then get the map back out to the regions and we have experts here in Naperville and in Sugarland that travel out to the regions to train. So, when I look at that total combination, I think we can ramp up fairly rapidly and have quick returns.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Laurence, just to be clear, internally when we spent time talking about the infrastructure, typically we are talking about people and don't think we meant that in a capital expenditure sense, a word in your own. Erik's right, the one place we might need to add some capital is in Russia with the expansion opportunity there, but bear in mind for us, the new blend facility for example is 3 to $5 million; we don't have mega outlays to get a footprint on the ground for production capacity. That's largely behind us with the Nanjing start-up later this year. So, our infrastructure idea is walks around on two legs and that's the piece we need to add. And in some cases, simply redeploy from North America.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
We do to in addition to the sales and marketing, enhance our technology capability in Asia, particularly in China and we have a technical center in Suzhou that we will... we will build from or expand. So we have that capability. In manufacturing, we've got sites around the world, I think we will need to enhance Russia, but our Nanjing plant that will come on later this year will strengthen our capability to supply very effectively into the China market and across Asia. So I think we are in good shape, but we will strengthen through the year.
Laurence Alexander - Jefferies
Thank you.
Operator
Thank you. And we'll go on to Chris Shaw with UBS.
Chris Shaw - UBS
Hi, good morning.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning.
Chris Shaw - UBS
If at all could you break out what sort of organic growth in North American I&IS was? I know it was up, but any specifics there?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes, it was up a couple of percent, not... the growth rates that we expect, but that it was up.
Chris Shaw - UBS
In that regard, I mean is... was there something specific end market or I mean how generally kind of view that business when you guys characterize as offensive and just trying to get some I guess color on what was the... I guess weak areas that are in North America?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
The strong area was in food and beverage and power. Mobotec is enhancing our ability to drive power, but I would say across the board we are looking at how do we accelerate growth and how do we do that with driving 3D TRASAR in the boilers, how do we do with Mobotec and how do we do with other capabilities that we've got to bring customers cost savings, reduce water usage, reduce energy usage and air pollution control, so it was lower than we want going forward and we are taking action to accelerate growth.
Chris Shaw - UBS
Okay. And then on the alternate channels, can you... you haven't mentioned that all, I mean what is the... how was it and what's the plan forward, anything changing there?
Unidentified Company Representative
Really, no change Chris, we've only got 16 hubs in the water serve market, it's North American models still and it will continue to be a North American model so we've got the way we like it. We've good evidence that it enhances the margin, it enhances the attrition of customers in North America, we are still playing with it in those hubs and making some refinements, but really staying the course we mentioned for 2007.
Chris Shaw - UBS
Okay, great thank you.
Operator
Thank you. We will take our next question from Mark Gulley with Soleil Securities.
Unidentified Company Representative
Hello, Mark.
Mark Gulley - Soleil Securities
Good morning, guys. Erik, I certainly got a sense of a greater sense of urgency with respect to your six priorities, but I didn't hear a whole lot things that were new and wanted to probe on one thing. With respect to pricing, are there any efforts out there where you can get more automatic contractual pass through of raw material costs and so your sales force is not continually bogged down with negotiating these things with customers and can do what they are trying to do and what they are educated to so, so more and more contractual pass through automatic stuff.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well we are absolutely looking at the contracts we have and the contracts that are being negotiated and every other approach to getting prices up and that is absolutely one area that we are looking at and how do we get more discipline in that regard. So the answer is yes and that's a good point.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
We have some of that today in markets you probably are aware, we've got probably about every revenue model you can think of given the variety of industries and size of players we serve, but again as Erik pointed out, we are a service business and we want to get paid for our service rendering and not be the guy protecting our customers from raw material costs.
Mark Gulley - Soleil Securities
Right. And can you give us a feel at all where that stands right now, what percent of your customers might be on pass through? And Erik, given the fact with that was at top of your priority list, do you have a goal as to where you might be able to get that to?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
I am not sure we can give you a number in terms of percentage and we've also have to look behind that number to see how frequently you have reset et cetera, so, we'll look at that.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes.
Mark Gulley - Soleil Securities
Thanks guys.
Operator
Thank you. And we'll go on to Phil Mariatt [ph] with ABS advisors.
Unidentified Analyst
Thanks, good morning. I just wanted to talk little bit about working capital. Days sales outstanding on the receivable side is continuing to grow. It's up substantially over the last couple of years and I'm wondering given the investments that you guys have made in systems presumably to improve that, when do we see working capital become a... start to improve? And just related to that I am wondering, I am not sure I've heard your thoughts about what working capital will be due to the free cash flow this year? Thanks.
Unidentified Company Representative
Okay. Well, this year is a short answer to your question, we've got an extension of DSO by about six days compared to year end 2006 and the reason I said 2006 is that was before we rolled out an upgraded version of SAP that included something called NBT in there, Nalco Business Transformation. And clearly, the idea was to get a better graph around invoice accuracy et cetera in tracking. I think the difference is a good part of 6 days belongs to the change, but not all of it.
We are growing more rapidly in other parts of the world, returns tended to be longer but even looking inside those regions; we've got some work to do to get this thing back on the course where we expected it. We have that commitment internally with our segment in the region management, we've got that commitment would our Board of Directors, we saw progress in North America, we saw progress in Europe, not enough as yet, we saw some deterioration in Asia and Latin America that's been worked. So this is a regular topic and free cash is right there just behind pricing when it comes talking to our leadership.
Unidentified Analyst
Have you given guidance for what working capital will be at the source for use give or take for the year?
Unidentified Company Representative
I think all we said so far that it will be a source of cash in 2008. We did not separately quantify that. And I think really the issue is largely receivables. I think payables are generally well behaved, I think the inventory moves are that you are seeing are generally following seasonal and actually our days investment in inventory is below the levels of a year ago so this is really a receivable focused issue.
Unidentified Analyst
Is it reasonable to think of receivables getting... becoming... getting to a point that's better than 66 days, I mean once upon a time you were at 60 days or 61 days, a couple of in ''04 the end of '04 so.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
The intent with NBT was to get that 66 day number down, but again bear in mind that when you step into parts of the year when you step into parts of Latin America, when you step into parts of Asia, by industry norms receivable terms can be longer and we seem to make sure that we are getting that in our margins in these parts of the world. So, we are compensated for that. So the melted number is a tough one to make out, too many conclusions from, but I'll tell you that region by region, we have got some work to do to get Asia and get Latin America on better performance levels.
Unidentified Analyst
Okay, thanks. Just one last thing, FX what was the contribution from FX to revenues. I don't know that was specifically laid out in...?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Okay. Our overall revenues were nominally up $99 million. The organic piece ex-currency and adjusting for synfuels were up $50 million. We said currency was a 5.7% contribution to top line.
Unidentified Analyst
Okay. Thanks.
Operator
Thank you. And we will take our next question from Brian Drab with William Blair.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Hello Brian.
Brian Drab - William Blair & Company
Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning.
Brian Drab - William Blair & Company
Most things have been asked already, but just couple of house keeping items. On the synfuel business, direct contribution in first quarter '07 was $5.7 million. Could you tell us what the revenue contribution was, with an idea on ongoing contribution margin in I&IS?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, just over $18 million in Q1 of last year.
Brian Drab - William Blair & Company
$18 million. And I know this was very high margin business not... hardly any costs associated with it. Do you think that the absence of synfuel had a material effect on gross margin decline in the quarter?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Well, we had adjusted for that in the organic... certainly it a... it was an okay gross margin business. It had no OpEx attached to it. High margin at the bottom line more because of the lack of infrastructure required to run this house.
Brian Drab - William Blair & Company
Okay. So, roughly what was gross margin for synfuel?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
It was a kin to the other businesses.
Brian Drab - William Blair & Company
Okay, all right. And then I just wanted to ask in the energy segment, obviously organic growth was very strong, was this really broad-based demand or did you have some specific large orders that came through and what type of organic growth would you expect for the rest for the year in this segment?
Unidentified Company Representative
Well, it was broad-based growth, it was both downstream and upstream and reflects our good position with our customers, it reflects our technologies which are very good and it includes existing business, but it also includes new CapEx and we had a lot of focus on CapEx, the new both oil fields also the downstream refinering capacity that's coming on Asia and because of that and continued CapEx coming on, we see continued strong growth outlook for our Energy Services business.
Brian Drab - William Blair & Company
Okay.
Unidentified Company Representative
And we are looking at ways to add to our offering and we'll be talking more about that in future.
Brian Drab - William Blair & Company
Okay, thank you very much.
Operator
Thank you. And next we'll hear from Richard Eastman with Robert Baird.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Hello, Richard.
Richard Eastman - Robert W. Baird
Back to the I&IS contribution margin, when I look at that number being down 210 basis points, my estimate would be it may be synfuels was 30 bps of that and we presumably got some price and you commented that perhaps two months of the raw material cost... negative cost variances in that number, but what accounts for the other 100 and call it, 80 basis points of decrease year-over-year and how does that look for the balance of the year?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
So you've got mix shifts in here a bit and again, Europe is the soft spot in I&IS. We talked bout strength in North America, most notably when we talked about food and beverage, we talked about power et cetera, I think if we get Europe turned around you are going to see better numbers coming out of I&IS overall largely because of Europe and also because of increased focus in growing this business and getting price to offset this cost.
Richard Eastman - Robert W. Baird
So despite the fact the volumes were up in the U.S. and I think you said Asia in I&IS again that the softer volumes in Europe overcame that as well as any price increase you guys... so the I&IS margin is very dependent, more dependent on getting Europe turned than it is on realizing price capture there?
Unidentified Company Representative
I would up it's more, let's say, it's an equal factor in getting this business performing the way we would like for to be, it's price and it's going to be getting Europe volume activity.
Unidentified Company Representative
Both are important, we've got to do both.
Richard Eastman - Robert W. Baird
Okay, all right.
Unidentified Company Representative
Europe is too big a piece of our portfolio to...
Richard Eastman - Robert W. Baird
How big is Europe as a portion of I&IS, is it 40% or...
Unidentified Company Representative
The mix is pretty similar to the mix of the overall businesses around the world, we radically different profile in the European region.
Richard Eastman - Robert W. Baird
Okay. A and then just as a follow up question on the margin line, when I look at the three businesses and I look at the contribution margin in each of the business, for '08 as you kind of reiterating guidance and kind of GAAP guidance, what assumptions do you have and there fore the direct contribution margin year-over-year for each of the three segments by the time as the year end falls we capture price, we should see a turn in Europe, do you expect margins to be higher in all three segments at the end of the year?
Unidentified Company Representative
I would say modestly, but again as you... if you only cover costs, your margin by definition will come down because you are not adding at the gross margin kind of rates and with the kind of cost to run ups we have seen and might even expect given the oil prices where they are, covering costs is our bogie, but that will deliver the kind of guidance that we put up.
Richard Eastman - Robert W. Baird
Okay, thank you.
Unidentified Company Representative
We have surpassed our... so let's just take one last question and then we'll close.
Operator
Thank you. And let's take our final question from Robert Koort with Goldman Sachs.
Robert Koort - Goldman Sachs
Thank you, good morning. I've got a fire alarm drill going on so hopefully I can get this question before you hear the alarm and then... no, maybe not, I'll backup sorry.
Unidentified Company Representative
No problem.
Unidentified Company Representative
Why don't we go ahead and close that.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Appreciate you all joining our call this morning, we appreciate your questions. I just want to close by saying that after 60 days here I can tell you that we've got a great growth opportunity in Nalco. We have to do some things better around execution. We've got to get the price up and cover our costs. We've got to turn around Europe and some of the other things we've talked about, but as I look at the opportunity for us to more broadly drive our technology both to grow our revenue and our margins and our ability to drive faster growth in emerging markets that we talked about and I know from all my experience that we can do this. I just see Nalco is having a great opportunity for the future and we look forward to talking to you more and updating you on our progress.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Thank you.
Operator
And thank you, ladies and gentleman. This does conclude today's presentation. We thank you for your participation and have a great afternoon.
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