Executives
Mike Bushman - Division VP, Communications and IR
J. Erik Fyrwald - Chairman, President and CEO
Bradley J. Bell - EVP, CFO and Treasurer
Analysts
David Begleiter - Deutsche Bank
Jeffrey Zekauskas - JPMorgan
Prashant Juvekar - Citigroup
Michael Harrison - First Analyst Corp.
Laurence Alexander - Jefferies & Company
Chris Shaw - UBS
Mark Gulley - Soleil - Gulley & Associates
Amy Zhang - Goldman Sachs
Nalco Holding Company (NLC) Q2 FY08 Earnings Call July 30, 2008 10:00 AM ET
Operator
Good day, everyone, and welcome to the Nalco Holding Company Investor Call. This call is being recorded. At this time I would like to turn the call over the Division Vice President for Communications and Investor Relations at Nalco, Mr. Mike Bushman. Please go ahead.
Mike Bushman - Division Vice President, Communications and Investor Relations
Thank you, Rebecca. Good morning and thank you for joining us for our second quarter 2008 conference call. 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 statement 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 risks is available in our 10-K.
The information discussed today will include data that does not conform to Generally Accepted Accounting Principles. Management believes the presentation of non-GAAP measure such as adjusted EBITDA, free cash flow and adjustments to net income provide investors with additional insight into the ongoing performance of our operations. When necessary, accompanying schedule 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 to questions. In order to allow for as many participants as possible to ask questions, we will restrict participants to one question with a clarification follow-up, if necessary. We will then ask that participant re-queue in order to ask additional questions.
So, we will start with Mr. Fyrwald.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Thanks, Mike. Good morning and thank you for joining us. Half way into a year challenged by rapidly rising product and freight costs and slowing global economies, Nelco is delivering continued strong revenue growth and good progress on the pricing front. But we need to strengthen our operating cost productivity efforts, which we are doing, and as we look at our plans for the second half of the year, we continue to target delivering 8% adjusted EBITDA growth for the full year. Now that's said good news and says a lot about the strength of the Nalco business model.
In my comments this morning I will focus on three key elements of our business: revenue growth, progress on our six top priorities, and our actions to strengthen operating expense discipline. Then I will highlight recent M&A activity and our expectations for the rest of 2008. Brad will then talk in detail about the results.
Sales continued to grow rapidly, up 9.8% in the second quarter nominally and 5.7% organically. Regionally, organic growth continues to be led by North America, up 8.8%, followed by Latin America at 8%, Asia-Pacific at 7.4%, and Europe, Africa Middle East, we call EAME, down 1.3%.
I'll talk about segment results in discussing our six priorities for 2008, but continue to be pleased with the strong growth opportunities that we've been delivering on and that are ahead of us.
So, let's review how we're doing on our top six priorities that we discussed at the end of the first quarter. First, on price capture, we are moving in the right direction. Gross earnings improved 8.8%, in large part because we did a very good job gaining $29 million in price against $36 million in higher product and freight costs so that sales growth cascaded to gross earnings growth.
Year-to-date, our price cost gap stands at $12 million with the second quarter GAAP being somewhat better than the traditional one quarter lag that company has seen in the past. Mary Kay Kaufmann, who moves to Chief Marketing Officer in a few weeks, is leading a corporate-wide price initiative to support the businesses and this has improved our performance from past efforts.
However, we remain concerned and focused on driving price. We continue to assume ongoing cost increases that we need to cover with incremental pricing. So, while we're making good progress, we're nowhere near being comfortable and we'll keep driving forward.
Secondly, on turning Europe around, we made progress in I&IS and have work remaining and energy and paper. I&IS Europe turned 5.8% organic growth in the second quarter, up substantially from first quarter results. The I&IS business in Western Europe was flat organically and the merging markets unit that includes Russia, the Middle East, Eastern Europe and North Africa, grew at a very high rate.
We continue to see progress being made in increasing time our sales engineers spend in front of customers and in new account penetration, and expect to meet our stated objective of delivering positive organic growth for total Europe by year-end.
On an overall basis, Europe organic growth was down 1.3% in the second quarter, but this was good sequential improvement after being down 4.2% organically in the first quarter.
Third, in terms of investing in BRIC+ countries, we are focusing our investment efforts on markets with the fastest, most profitable long-term growth potential, including Brazil, Russia, India, China, the Middle East, West Africa and the Caspian region.
In China, we added our 500th employee in June. We have increased headcount in Asia and in energy by about 200 people so far this year with the largest increase occurring in China. We are investing in BRIC+ to drive growth aggressively going forward.
Number four; Energy Services growth continue at a rapid pace of 10.9% organic growth. Very high growth rates continue in ADOMITE and in oil field businesses that include the tar sands, Gulf of Mexico, West Africa, and the US Heartland [ph]. Downstream businesses continue to grow, but slowed from the double-digit organic growth rates enjoyed in some recent quarters.
Operating expenses were added in energy at a pace faster than revenue in the second quarter. Some of this was hiring for key projects that will start up in the coming months. Now, looking ahead, I am confident that earnings growth in Energy Services will come back strong double-digit performance in the second half and for the full year, as we realize price gains, new business, and benefit from increased focus on cost productivity.
Fifth, I&IS delivered strong sequential sales improvement, up 6.2% organically in the second quarter after being up only 2.3% in the first quarter. Europe played a key role in the improvement with its 5.8% organic growth after being down 0.8% in the first quarter.
Pacific I&IS led the way with 12.6% growth, Latin America matched Europe's growth, and North America was up 4.3% organically in I&IS. So, overall good progress that now needs to be sustained for the long term.
Finally, we're also making progress in our sixth priority, speeding technology commercialization. A few examples; we expanded development evaluation trials for 3D TRASAR technology for boilers being conducted with customers globally, so we accelerate the pace at which we globally commercialize this technology later in the year.
We're also starting to close the gaps between our sales successes in North America and other regions with 3D TRASAR technology for cooling water.
In Europe, we are reallocating personnel to establish a technical resource center for 3D TRASAR technology that will increase sales support for the technology.
Nalco Mobotec closed $26 million worth of new business in the first six months of the year and is well on its way to surpassing our stated goal of $30 million in sales for this year, while building a very strong project pipeline in North America, Europe and China to sustain growth in 2009 and beyond.
Technology commercialization process improvements will be on Mary Kay's agenda in her new CMO role and she will work closely with Mani Ramesh to shorten the product development cycle times and strengthen the launches to more quickly create value from our very strong technology base.
So in general, we are delivering solid revenue and price increase results given the rapid run up in raw material and freight costs. And given expectation for continued escalation, price capture remains our number one priority for the year.
Second quarter operating earnings were essentially flat versus prior year results on a company-wide basis as operating expense investments temporarily grew faster than our productivity efforts could support. Now since joining Nalco, I placed a very strong emphasis on accelerating our profitable growth initiatives and BRIC+ countries, Energy Services and Nalco Mobotec among other key areas.
I believe we have done a good job of investing wisely and aggressively in these areas and will see the benefit and continued high growth in the second half of 2008 and into 2009 and beyond. However, despite talk about productivity efforts, I have not put as much priority on speeding up cost savings as we have in speeding up growth and capturing price.
Year-to-date our cost savings stand at $36 million against our annual goal of $75 million. Reasonable progress, but not good enough to offset the additional investments being made in growth. Therefore I am personally stepping up the attention I pay to cost savings and operating expense management, and have increased my focus and that of my leadership team on initiating the productivity improvements we need to fund our growth efforts. As an example, effective July 1st, we put in place a number of hiring and spend-related policies that should begin to pay off in the third quarter and be fully effective by year-end. I will work with the leadership team to make sure we do a better job here to help pay for the aggressive growth investments that we know will pay off and we will continue to make.
Now, a few comments on recent M&A activity. In the second quarter, we acquired TIORCO, a player in the enhanced oil recovery engineering business. Now, as we approach going commercial with our BrightWater oil uplift improvement technology, TIORCO provides the complementary engineering expertise that we need to be fully successful in this exciting area.
Combining engineering and chemistry capability provides the same type of bundled business model that Nalco uses throughout our operations, allowing us to tailor offerings to individual reservoir requirements.
Also, last week we announced the sale of finishing technologies, the transaction that we believe made good sense for Nalco and for Rockwood Holdings, which will acquire the business. We did not have the market position in this business to succeed long term and Rockwood is building a solid market presence here. And at $75 million, the sale met our financial objectives and will allow us to focus our resources on energy, water, process optimization and air pollution control services and technologies.
Now while discussing M&A, I want to clarify our view of the paper market. Nalco brings significant value to our paper customers through process optimization and water treatment services and technology. We have attractive new technologies that we've launched in recent months and years that enable us to have reasonable margins and we have a good pipeline that will bring more value to this industry going forward. Also, we see very strong growth opportunities in BRIC countries, especially China and India, and that are now lining up the right resources to go after those opportunities.
However, we are concerned about the industry challenges, particularly in Western Europe and North America, and believe that some consolidation is likely. As stated before, we are assessing our options to improve our position over the next year, and by the second quarter of 2009 hope to have a view as to what our path forward will be in paper.
Now in addition to portfolio moves to put Nalco in the right markets, it's very important to have the right people in the right roles. Along these lines, I am very pleased that we have been able to recruit a strong leader in Dave Flitman, from his position as President of Allegheny Power to run our Industrial and Institutional Services division. I believe that Dave will complement our strong leadership team well and will be here in a few weeks.
I am also pleased that Mary Kay Kaufmann will lead a number of cross-divisional efforts as Chief Marketing Officer and that Lou Loosbrock will head up business development.
Finally, let me talk about expectations for the remainder of 2008. If raw material and freight costs stabilize in the next month or two, we continue to target to deliver our previously communicated adjusted EBITDA gross of about 8% from synfuel-adjusted 2007 results of $707 million. The timing of closing our Finishing Technologies sales could modestly detract from our ability to achieve this expectation, but not enough to establish a different goal. In addition, we continue to believe that we can achieve our free cash flow goal in the high $200 million range this year.
And finally, our earnings per share is expected to exceed our original 35% improvement goal by the amount of the expected gain on the sale of Finishing Technologies.
So, with those comments, let me turn the call over to Brad Bell. Brad?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Thank you, Erik. As you saw in our release, adjusted EBITDA used to determine compliance with the company's debt covenants increased 1.5% to $175.7 million from prior year period results of $173.1 million that exclude a now ended waste coal agglomeration or synfuel business. With that synfuel business included, adjusted EBITDA was $179.9 million in the second quarter of 2007.
An unusually favorable tax rate in the quarter brought a modest decline in year-over-year pre-tax income to a net income gain of 5.7% to $44.2 million from the prior year results of $41.8 million. Earnings per share in the second quarter was up 10.7% to $0.31 from $0.28 in the prior year period, while having back the impact of non-cash amortization to earnings per share brings adjusted EPS to $0.38 from $0.35 in the year earlier quarter.
During the quarter, the we passed the profitability threshold here in the United States that allowed us to more fully recognize foreign tax credit carryforwards generated in previous years. Foreign taxes paid can be recognized as credits against U.S. tax liabilities rather than only as deductions against U.S. taxable income. The impact of this treatment is shown in the quarter, and results from improvement in U.S. profitability and changes in our global ownership structure.
The effective tax rate in the quarter was 16.4% versus 24% in the prior year period. We expect our effective tax rate for the year to average out at about 27 to 28%, and is expected to be about 30% on a going forward basis.
Price actions to offset rising material and freight costs in the quarter were impressive, but not complete, and combined with the rising level of operating expenses prompted the modest pre-tax earnings decline. Operating expense management will remain key area of focus over the balance of the year and into 2009, as Erik has already mentioned. Controls include limiting both the pace of new employee hires in established geographies and the use of outside services.
We are also taking steps to increase the management visibility of controllable expenses such as travel, entertainment, and training. On their own, these tools will not sell [ph] operating expense timing or control with the heightened visibility from its better portfolio spend management in support of key growth objectives.
Turning to cash flow, I have to say we drove excellent performance in the quarter. Free cash flow amounted to $26 million despite semi-annual bond interest payments in the period, an increase of $41 million over the results for the same period of last year. Very solid improvements in our days sales outstanding and small gains in payables management did much to mitigate our build an inventory and added to a higher level of cash earnings in the period.
The inventory build was partially due to higher raw material costs flowing into our inventory. Keep in mind, we operate on LIFO only in the U.S. So the biggest part of the second quarter cost surge flowed to our P&L in the U.S., but not fully in other regions. This is part of the reason why we expect continued aggressive cost increases to show in the third quarter.
In addition to higher raw material costs, we have consciously added inventory to deal with business growth in emerging geographies with shortages on a few select raw materials, and this protection against the impacts of potential labor disruption in West Coast ports.
Those who have followed us will recognize that we also have a normal inventory build ahead of heavier July and August cooling water sales. We expect inventory adds related to the seasonal builds, protection against labor disruption, and raw material shortages to we unwound over time, but some portion of the quarter's inventory build is likely to be sustained if business growth and high raw material costs hold.
Also contributing to free cash flow gains was a level of pension funding up to $10 million less than that in the second quarter of 2007, while a higher level of capital expenditures, including those our Nanjing, China plant increased cash out flows.
Year-to-date, free cash flow stands at $68.7 million, up $49.2 million if compared to results for the first half of last year. We have further improvements to make in receivables performance before we achieve our year-end goal of 66 days. So, we will have additional challenges in the second half as we deal with the additional price increases and surcharges that have been enacted for energy and freight costs. Issue is that prompt invoice is not immediately recognized as appropriate when they arrive in a customer's hands. Nonetheless, we continue to believe we can deliver free cash flow for the full year in the high $200 million range.
Additional cash flow, albeit outside of the definition of free cash, should arise in the third quarter as we close on the sale of our FTG business that Erik addressed earlier. Because of our historic net operating losses in the U.S., there is no cash tax obligation in the $75 million of proceeds. While our credit agreements pose some technical limitations on the use of proceeds, aiming at capital expenditures and debt reductions, this cash adds to the pool of funding all outlays, including bolt-on acquisitions and share repurchase. In addition, it's likely we will step up the funding of our pension plan.
Since Board authorization last year, we have purchased 6 million shares at a purchase price of just over $138 million. Of that total, we have bought 639,000 shares in the second quarter, all in the second half of June. The second quarter cash flow statements shows the cash impacts of settling some shares bought at the end of the first quarter and excluding cash that will come out of the third quarter for some shares bought at the end of Q2. Cash uses in the second quarter included paying off $27.9 million in notes that came due in May.
Returning to the income statement, adjusted EBITDA through the first six month of the year amounted to $341.3 million, a 4.9% gain over a year earlier results of $325.4 million that exclude synfuel impacts. The divestiture of FTG and the acquisition of the smaller TIORCO led to a slight reduction in EBITDA for the second half, but not so much that it prompts a change to our 2008 goal of 8% growth, a goal we continue to believe is deliverable provided we do not experience another round of cost increases beyond what we see today.
Year-to-date earnings per share of $0.51 are up 24% from a year ago level. The sale of FTG should add approximately $0.29, which would be additive to our targets of delivering a 35% increase in diluted earnings per share in 2008, as compared to the $0.88 earned in 2007.
Before turning to Q&A, I also want to draw your attention to a couple of additional cash elements of interest to shareholders. As a reminder, our senior discount notes covert to cash pay next February. At 9% interest on what would then be about $460 million in principal, this would be about $38 million greater cash use in 2009 than in 2008 if our debt structure remains set as at present.
Second, some time during 2009, we expect SUEZ to have exhausted profit sharing reimbursement obligation to us. From a cash standpoint in 2009, however, we would expect to recoup the profit sharing payments we make in 2009 for 2008 performance, leaving the cash generating capacity in 2009 unaffected, but meaning we would have a hurdle on cash generation going into 2010.
With those comments, let's move to your questions. Rebecca?
Question And Answer
Operator
Ladies and gentlemen, the question-and-answer session will be conducted electronically. [Operator Instructions] And from Deutsche Bank, we will hear David Begleiter.
David Begleiter - Deutsche Bank
Thank you. Can you just give us the... for Finishing Technologies the EBITDA and sales of that business that was sold?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Finishing... this is Brad. Finishing Technologies was above $50 million their earnings... sales, I'm sorry. We wish, we wouldn't have sold. $50 million of sales. I think I'll leave it to Rockwood to comment on profitability as they bring this in. Here it was modestly behind what we would typically enjoy for I&IS in our company. I think they'll do a nice job with this business.
David Begleiter - Deutsche Bank
Who is [ph] just trying to adjust for you '08 guidance, Brad, it'll be helpful to get what you had, what this business was running at historically or last 12 months?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
I think it's just easier to go back to Erik's comments about our goal for the year being unchanged. We'll lose a little bit of ongoing EBITDA with the sale of FTG. We'll tick something up for TIORCO, the net is closing up to be a push in our mind.
David Begleiter - Deutsche Bank
And then just on paper, are you likely to be a buyer or a seller of paper assets? And why does it take till Q2 of next year to make decision on what to do?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well, at this point, as I said in the last earnings call, we're evaluating all strategic options. We think we've got some very good technology that will continue to be of value and some additional coming through the pipeline. So we don't have a specific comment on what our plans are today. But we'll be filling you in over the next year.
David Begleiter - Deutsche Bank
Thank you.
Operator
From JPMorgan we will hear from Jeff Zekauskas.
Jeffrey Zekauskas - JPMorgan
Hi, good morning.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning, Jeff.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Jeff.
Jeffrey Zekauskas - JPMorgan
I guess looking across your results, they were more volatile than one would have expected. I&IS seemed to be better and energy seemed to worse and paper seemed to be worse. Is this kind of quarterly volatility in your opinion sort of natural to the business, or do you think that some of the operating returns that we saw this quarter can be trended out later in the year?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Jeff, this is Brad. I think you have three different drivers affecting these businesses. I&IS saw a nice important, they play across a broad landscape of end marketplaces. We are encouraged by the turnaround that they showed in the European sphere, in the growth in emerging markets. If you look at energy, their driver set is much, much different, and I think while their results were down, you saw a nice top line growth, you saw a good price attainments, and we are investing for pay-offs that we will start to see as early as the second half of this year.
Paper, kind of coming back to the prior question, a troubled marketplace for Western Europe and for North America, which is a good part of our footprint. I think these drivers are different, we are making improvements in the paper business. We've have had some nice gains in the Asian sphere for this business. We're trying to right-size expense spending to go with it as the industry goes through a trouble time.
So, I guess I hesitate to call that volatility in our results, you've got nice improvements coming out of two sides of the house. We continue to struggle with paper, but on the other hand, while it may not match the margins of the other two businesses, it's doing well in its space and we think there are ways to enhance this. There is a variety of options to consider for us and that's why Erik has kind of singled that it's going to take a little bit of time to get this optimized in our hands.
Jeffrey Zekauskas - JPMorgan
Okay.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Let me just add to that, Jeff, that looking forward on energy, we do believe that we will fully recoup the cost increases with price and that significant prices are coming through in the third quarter, that new business will come on in second half and that we will increase our emphasize on cost control. So we are confident that for the year... for the second half and for the year, we will deliver strong double-digit earnings growth in energy with obviously very strong double-digit revenue growth.
We also see in paper that we've got a number of new accounts that we've won in Asia that will start up over the second half and look for some improvement in a few areas in paper, and in addition, across the company increased emphasis on OpEx control, which was the one area that I feel like we did not deliver appropriately in the second quarter.
Jeffrey Zekauskas - JPMorgan
Okay. That's helpful. If I may follow-up with a clarification. Your tax rate looks like it will be about, order of magnitude, 300 basis points lower than maybe what you thought it would have been three month ago, at least as I understand it. Your earnings growth forecast for the year though hasn't changed. So, is there some offset that one has to take into account or all things being equal, what's leading you to keep your earnings guidance where it is even though the tax rate is coming down?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I think... this is Brad once again. I think the tax element is certainly a bit of a help for us. I think the bigger vagarity that we see right now is what's going to happen in the cost sphere. So we'll take the help from the tax rate. We are not through seeing cost increases come out this business. It's beyond just oil price element, you see it in the inorganic. I think we don't have a better number in mind than what we have previously signaled around EBITDA, and around earnings per share enhanced by the FTG piece. And to the extent we get a better bead on that over the course of the year, we'll keep you updated.
Jeffrey Zekauskas - JPMorgan
Okay, good. Thank you.
Operator
And from Citi we'll hear from PJ Juvekar.
Prashant Juvekar - Citigroup
Yes, hi, good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, PJ.
Prashant Juvekar - Citigroup
Your end of the year results declined in Europe. How much of that decline was due to what's going on in North Sea, and do you see Europe to continue to decline in energy?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
PJ, this is Brad, good morning. We lost some North Sea business in the second half of last year, which makes the year-over-year comparisons a little difficult to last properly. We don't expect continued declines. We're encouraged by the opportunities in the broader EAME space that includes Russia, the Middle East et cetera. We are actively going after those. It's more the piece that's fell out that we are overlapping [ph] now to make to the tough comparison. North Sea was more immature marketplace, and quite frankly, we just didn't take it at the margins at which it could have been kept.
Prashant Juvekar - Citigroup
Okay. And then secondly, as your European integration continues, your Budapest office, when that happens and the sales people spend more time on the front lines, when do you begin to see the impact on the organic growth in Europe?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
I think it's what we started to see in the second quarter, some benefit from that, especially in I&IS. We have seen and we're tracking very closely the time spent in front of customers by our sales force that has started to trend up significantly, not fully recovering what we lost, but headed in the right direction quickly. And we have started to see new account penetration sales trending up also. So we expect those to continue to favorably move in the second half and are on track for by the end of the year to see positive total organic growth in Europe.
I think the second quarter was a validation of that in I&IS. The paper market continues to be challenging. So we are continuing to work through that, but energy, as Brad said, was affected by some very low margin business that we lost in the second half of last year, as those year-over-year comparisons get... we get past those. We will also see a tick up in energy. So I think we are making progress obviously with a negative organic growth rate for Europe in the second quarter, we are not satisfied, but we will head in the right direction and we will get there through the second half of the year.
Prashant Juvekar - Citigroup
So are you suggesting that maybe second quarter was infliction point in Europe?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
I think it was a good step progress towards where we need to be for I&IS. And I think we continue to make progress in some areas that benefit energy and paper, but we're not where we need to be yet.
Prashant Juvekar - Citigroup
Okay. Thank you.
Operator
From First Analysis, we will hear from Mr. Mike Harrison.
Michael Harrison - First Analyst Corp.
Hi, good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Mike.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning, Mike.
Michael Harrison - First Analyst Corp.
In the context of the sale of Finishing Technologies to Rockwood, can you talk about how you are viewing your portfolio businesses overall and to what extant may be we could see some more divestitures in the coming quarters? And then also may be comment on what you're seeing in the acquisition pipeline?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes, let me start hare and Brad can add in. We are committed to winning where we want to focus in energy, water, process optimization, and air pollution control now with Mobotec. Both combination of services and technologies... product technologies, they are differentiated. And that's where we are going to focusing our efforts. FTG did not really fit in that... in any of those categories. We have 1% share. It was a reasonable margin business, but a much better fit to drive growth with Rockwood.
As I you look across our portfolio, yes, there are some areas that we need to continue to look at. I have already described that we are going to... we are evaluating what the right way to strengthen our paper business is, but clearly our expenditures for acquisitions are going to be targeted largely at energy and water and process optimization technologies like Mobotec that really add to our offering portfolio, but energy and water will be top priorities for our acquisition arena. And we announced TIORCO and we are looking at other opportunities, but don't have anything to add to that today.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
I think Erik covered that well, Mike. I think the only thing... a comment I would add in response to your question is that there is a lot more activities spent on looking for good thoughtful strategic acquisitions in the bolt-on space than there is looking around for things to tell. This is a good portfolio.
Michael Harrison - First Analyst Corp.
And then if I could, on the paper side, obviously you are expecting some top line improvement with this new business in Asia. Should we expect to see some improvement from a margin standpoint as well with that new Asian paper business or I guess, how do the margins in Asia compare to the paper margin in other geographies?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
You have a very different paper marketplace in Asia than you have in other spaces, very much healthier customer base for one. We're also bringing out new technologies which will enhance margins every place we play. And quite frankly, we were having to get pretty thoughtful about what business we're going to continue and at what rates of acceptable margins to continue, which has forced a good rethink, a lot of operating discipline in North America and in Western Europe. We like the paper space in the emerging markets of the world.
Michael Harrison - First Analyst Corp.
Alright, thanks very much.
Operator
Moving on, we will hear from Laurence Alexander with Jefferies & Company.
Laurence Alexander - Jefferies & Company
Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Laurence.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning, Laurence.
Laurence Alexander - Jefferies & Company
With the new staffing that you've brought on this year and that you expect to bring on in the back half, what is the drag that you're seeing on this year's EBITDA?
Unidentified Company Representative
What was the staffing cost --
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
What is the drag on this year's EBITDA to year-to-date?
Laurence Alexander - Jefferies & Company
For the full year, I mean, what's the internal cost of bringing on these people and training them.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Our headcount is roughly 200 people in the energy and Asia space alone we are up a little more than 300 as a company year-to-date, as we address market opportunities. I guess, I haven't priced that out separately.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
But a significant part of that, we're trying to... some of that is trained people that will begin to pay for themselves in a fairly short period of time. Many of the people will be trained or are in training that will really begin to pay towards the end of next year and beyond.
Laurence Alexander - Jefferies & Company
And, I guess secondly with the incremental growth in Europe, are the margins comparable to the Nalco average or are you seeing any shift as you drive... as you try and drive the growth rates a little bit faster?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
They are it's good or better in terms of the spaces we are looking into and we're driving the whole EAME space more than ideal, profitable growth in bottom line improvement rather than just chasing top line. This is one of the reasons we had the disciplines around business that continued in the second half of the year... last year.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
And part of our placing discipline is to go after new business with the new prices.
Laurence Alexander - Jefferies & Company
Okay. An finally on EOR, are you seeing this as a significant incremental opportunity or is it more just sort of layering into your existing growth profile?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
We see EOR as a significant growth opportunity and we will discuss more, describe more about the opportunity by the Investor Day, which is September 5th.
Laurence Alexander - Jefferies & Company
Okay, thank you.
Operator
From UBS, we will hear from Chris Shaw.
Chris Shaw - UBS
Hi, good morning. How're you doing?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Hi, Chris.
Chris Shaw - UBS
So the extra standing in energy, could you remind me what the projects... those upcoming projects are? Is it EOR, but is it more than that?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
It's more than that, it's new OpEx both offshore and downstream. It's bringing on people for specific new account opportunities. It's bringing on people for geographic opportunities in BRIC+, going after new opportunities to start those new opportunities. It was also travel with the price increases, we're spending a lot of time with our customers, which is absolutely the right thing to do. And we have some consulting services that helped us better clarify our strategy going forward.
So it's a number of areas that will help growth both in the second half of this year, but set us up for stronger growth in '09 and '010 and beyond in a number of areas, which I think was invested very wisely. On the other hand, across the company, what we are saying is that we need to do a better job of redeploying resources to these growth opportunities and tightening the belt around OpEx control to make sure that we are traveling for internal meetings that aren't necessary or other kinds of things to lower the spend that isn't adding to the profitable growth so that we can continue to invest aggressively in the profitable growth.
I think we did a good job of investing for growth. We didn't do enough in saving the money in other places to help that investment.
Chris Shaw - UBS
So, it's mostly a people expense, not a, like, a technology and R&D, anything like that?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Right, it was people expense, but including people that are driving the technology into these growth geographies and accounts.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
People in training.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
People in training.
Chris Shaw - UBS
Okay. Could you... your 75 million in cost cutting goal, was that still intact for the year then?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes. We are committed to that and we are stepping up efforts to go after that more aggressively than we did in the first half.
Chris Shaw - UBS
And then I think Brad mentioned the LIFO accounting so that you are sort of up-to-date on the cost in the U.S., but I guess outside of U.S. you are not LIFO. So we would expect ramp up... continuing escalation in raw material cost in the third quarter for the international stuff?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes. And I don't think we're through seeing cost increases here in North America either for that matter. But you're correct. Very few companies are LIFO abroad. And if you look at our business portfolio, it's better than half outside the United States. So, it's a factor for us to keep in mind.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
We're trying to be very realistic in our assumptions of what the cost increases could be so that our price increase efforts reflect that.
Chris Shaw - UBS
Okay. And then finally, on the paper business, have you hired a banker or anything yet to look at other opportunities outside of fixing it or --?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
No comment, but no.
Chris Shaw - UBS
Okay. Thanks a lot. Guys.
Operator
From Soleil Securities, we'll hear from Mark Gulley.
Mark Gulley - Soleil - Gulley & Associates
Good morning, guys. Got a couple of questions. First of all, Erik, with respect to Mary Kay and her CMO role, it sounds a little reminiscent at DuPont where I believe that that corporate-wide marketing person was very successful.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Agreed.
Mark Gulley - Soleil - Gulley & Associates
Price increases through and do [ph] some other things. So, is one of the reasons you're doing this your positive experience at DuPont?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Absolutely. And what we did was while Mary Kay was running a piece of I&IS, we had her focus across the company on supporting the price increase efforts and she created a team with representatives from every unit. She was off to a great start with that and we want to do more of that in pricing. But also, that leverage across the company as our travel around the world and Nalco, I see pockets of just incredible strength in sales and marketing. And I see other areas that could leverage those pockets and we're going to do a better job of leveraging that.
I also think that there are number of areas to explore where she can create value.
She know our company, she knows our customers, she knows our sales organization, she's highly respected and will be able to leverage that across the company versus just in one unit. So the answer is yes, I was very pleased with what David Bills was able to do in DuPont and I am confident that Mary Kay will have a similar and very big impact at Nalco across the company.
Mark Gulley - Soleil - Gulley & Associates
It sounds like she would be a key speaker on September 5th.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes.
Mark Gulley - Soleil - Gulley & Associates
Brad I had a question for you on free cash flow.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Sure.
Mark Gulley - Soleil - Gulley & Associates
We are not asking you to forecast free cash flow for next year, just want to confirm the fact that a big vital come out of that with respect to paper going to cash pay. Would that be correct?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I think I made a comment about the size of that being roughly $38 million of pre-tax interest expense that would be a subtraction from free cash. But we will offset that with growth in the business. I think we've gotten working capital back to a better place. Our CapEx should be in a modestly better place with the bulk of the spending for Nanjing behind us. I am not trying to telegraph that we're going to have a different trajectory in front of us.
Mark Gulley - Soleil - Gulley & Associates
Is it fair to say that free cash flow could still be in the high 200s next year as well, or is that --?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
only for '09 guidance just yet, but as a business, this portfolio generates significant cash flow.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
And that's not going to slow down in '09.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
That's not going to change.
Mark Gulley - Soleil - Gulley & Associates
Right. Okay. And then finally, it sounds like you have hiring freeze in some parts of company here. You are obviously adding people in key growth initiatives you described several times, but is there a hiring freeze elsewhere?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Well, the way I would describe it is as a leadership team we are looking across the portfolio of markets and geographies and business, and saying... and functions, and saying where can we streamline more where maybe we don't have the same growth opportunities or we aren't world-class yet in certain functional activities, and how can we do that so that we are redeploying headcount to the growth opportunities. They may not be the same people if they don't have the right talent, but the concept is we want to reduce headcount positions in certain areas by streamlining so that we can help fund the growth in other places. And I think we have been funding the growth and we haven't done enough streamlining, and it's not just headcount, it's also OpEx discipline in general. And we are set up, we have been talking about it, we have been working on it, now I think we are going to be able to execute better on that side of the equation.
Mark Gulley - Soleil - Gulley & Associates
And a clarification, did you lose that business at North Sea to competition or was fields shut in?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Competition.
Mark Gulley - Soleil - Gulley & Associates
Okay. Thank you.
Operator
Alright. Next, we'll hear from John McNulty.
Unidentified Analyst
This is Eli Gep [ph] on behalf of, John. How are you?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning.
Unidentified Analyst
With regard to the margin decline in Energy Services, what was the split between the margin declines you did in that [ph] versus mix?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
I don't think we've gotten that granular in our releases. I think you got a fair amount of pre-investment for the go-forward period. And as we said earlier in the call, that's not a long lead time investment necessarily. We expect to reap the benefits of that beginning here in the third quarter. So, look for a very strong second half of the year coming out of energy as a result. It's more timing than anything else.
Unidentified Analyst
Okay. Well, on the mix side, what was driving the unfavorable mix impact?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Mainly price not exceeding the cost. And that's what we're focused on rectifying in the third quarter.
Unidentified Analyst
Okay. So, it's mainly the gap between cost and pricing, not necessarily higher sales of a lower margin product or lower sales of a higher margin product?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
That's correct.
Unidentified Analyst
Okay. And with regard to free cash flow, assuming you can hit the high $200 million range, how do you expect to redeploy the cash? Will it be higher rate of share buybacks, bolt-on acquisitions or what?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I think we have articulated earlier that demands on free cash flow, the top priority is the kind of logical technology expansions that could further enhance this portfolio and those don't necessarily have to be large areas of expenditure. We can hold in some nice things like a Mobotec. Beyond that, share repurchase remains. We have a dividend in place. And there is some debt that is scheduled for amortization that we certainly tend to.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
But as Brad said earlier, we are stepping up our efforts to look for attractive bolt-on acquisitions.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Right.
Unidentified Analyst
Okay, great, thank you.
Operator
And with Goldman Sachs we will hear from Amy Zhang.
Amy Zhang - Goldman Sachs
Good morning.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Good morning, Amy.
Amy Zhang - Goldman Sachs
Thanks for taking my questions. The first question regarding the raw materials cost trend. I think a lot of your raw materials are oil-based derivatives and in the history, if it's cost increase each year, obviously shows pretty strong correction with the oil price changes. But your $100 million cost inflation for this year seems to suggest the disruption to this historical trend. Can you just give me some color on that? What have been changed in the company over the past several years regarding the raw material procurement or a negotiation process with the suppliers that gives you confidence this $100 million raw materials cost inflation for the year is realistic?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Amy, if you go back to when we talked about first quarter results, you remember that we said we originally had a $100 million view in mind for raw materials and freight, and had concluded even then that number that was in our business plan would be woefully inadequate. So we signaled without giving a new number that that cost escalation would be much higher than $100 million. If anything the experience of the second quarter reinforces that view, we don't think we have seen the full extent of run-up yet. We have further increases in our own forecast for the second half of the year. And then that number is well north of $100 million. It moves wildly, we're seeing inorganics move, it's more than just oil price movements that drive this. But in excess of 50% higher would be a safe observation.
Amy Zhang - Goldman Sachs
Okay. And then just a follow-up question, can you just give some color, what would be the new target for this raw materials cost inflation for the year?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
I guess I tried to do that. I guess, it's well more than 50% higher than that $100 million mark. But you'd have to... we'd have to spend a lot of time talking about assumptions and linkages and what's happening in the inorganic space for you to make sense out of that. So just understand that we have had in our own mind a rate of increase well north of $100 million since the time we ended the first quarter. And we are gearing our productivity and gearing our pricing actions around that expectations there.
Amy Zhang - Goldman Sachs
Okay. My second question is related to energy business. Over the past several weeks we have seen some declining in oil prices. And assuming this trend could extend, the energy prices stabilizing into the second half of this year, what will be the impacts on our energy business?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
We believe that as long as energy is anywhere in the range that it is today, they are very favorable dynamics for us in terms of the value that we bring and helping energy companies get more energy out of the ground. So we see this range as, especially if prices stabilize as very favorable in terms of... as we get our prices to offset the cost. And anything above $100 oil continues to highly favor our technologies to get more energy out of the ground. And continues to have a lot of value for our customers for what we bring in terms of water and energy savings.
Amy Zhang - Goldman Sachs
Okay. And my last question is if we assume stable rise to energy or raw materials costs in the second half of '08, how sustainable do you think your aggressive pricing hikes could be? Are you going to give up some pricings gains in the second half?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Well, again, look at where we are year-to-date, we are 12 million behind. So, in fairness, we are still catching up on absolute costs without margin. Most of this is being done in a value pricing demonstration with our customers who understand the value we bring at higher cost levels. I don't think we're sitting here at the crest looking at the downside of slope any time real soon.
Amy Zhang - Goldman Sachs
Okay. And what was your customers' reaction to your price hikes?
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes, I am sorry, we're going to have to move on to the next question.
Amy Zhang - Goldman Sachs
Okay, thank you.
Operator
From [indiscernible] you will hear from James LaSalle [ph]
Unidentified Analyst
Hi. Yes, actually just related to her last question, let's just say that we do continue to see a pullback in energy and related costs. Is there a stickiness to your surcharges and/or price increases that you think could hold through first half '09 or even further? Or do you think there is some chance for get backs?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
We are not seeing raw material cost declines at this juncture. I mean, oil has temporarily stabilized. And I guess I filled my tank the other day for nominally less than I did a week ago. But that is not translated into reduced costs for our raws. If anything, I think there is a lot of pent-up inflation still moving through economy that is broader than the oil space. So I think we're on the cost uptick trend for some period to come. We are moving prices with that expectation and recent experience that demonstrate that.
The surcharge piece is probably the only one that reacts to changes, but those are reinstituted for August 1, but not at July 30 levels. The conversations around the surcharge also start from a lower base. We would have to have significant declines in diesel and related freight costs, if energy costs before that would come off.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
On the other hand, if in the future there are declines in raw material costs, we will see a benefit from that for a period of time.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
We tend to hang onto to price increases longer on the way down recognizing we didn't get up as quickly.
Unidentified Analyst
Yes, exactly. My... that's actually the point of my question in that. If this trend does continue, let's say, it for the next 3 to 6 months, then you're looking at a pretty strong first half '09.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Which trend are you referring to?
Unidentified Analyst
Just lower energy and related costs.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, I am not sure that we see trend just yet, but...
Unidentified Analyst
Well, I just... I see a trend of 17% in the last two weeks and if that holds through for the next few months, again, I know it's difficult to extrapolate, but I am just saying with the extenuation of a trend, it's certainly possible that you could see some beneficial effects.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
I hope you're right. We could see that.
Unidentified Analyst
Thank you.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Thanks.
Operator
And next Canaccord Adam [ph], we'll hear from Mark Sidoski [ph].
Unidentified Analyst
Hi, good morning guys.
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Good morning.
Unidentified Analyst
Just wondering in light of the recent rejection in clean air instate rule, I'm wondering are you seeing any impact at Nalco Mobotec on sort of the general pollution control market and what that impact might be, if there is any?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Yes, the interstate rule has the potential to delay some kinds of projects in the marketplace, but we have the advantage with our technology of combustion efficiency being a big part of the value driver. So, you get the benefit of fuel savings, the air pollution control benefit goes with it. So our technology portfolio and what Nalco Mobotec has to offer works on an economic or an environmental driver. If you have both, it's obviously helpful. But we certainly have at least the economic driver and the environmental requirements in various regions of the world where we are selling. It's not just the U.S. business.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
We had a number of Chinese customers' partners here two weeks ago and they were talking about how the regulations not only are getting stiffer in China, but also the enforcement of those regulations. And they have very high value for Mobotec and believe that the growth opportunity for Mobotec in China, for example, is very, very big. So the question that you are asking is about the U.S. and yes, that may have some impact. We are not really seeing it with our customer who are moving forward. But I would say that in other parts of the world, the timelines are accelerating for the need to drive pollution... air pollution control.
Mike Bushman - Division Vice President, Communications and Investor Relations
We are at the hour. So if we have got one last question, we'll take that and then close.
Operator
We will take our last question from Bo Hur [ph] wit Banc of America Security.
Unidentified Analyst
Hi, guys. Sorry to come on late here. You may have already addressed this. I know you had mentioned that your whole co-note [ph] cash pay. Have you made any decisions on your plan side to recapitalize or take that out and what that's going to imply for your balance sheet?
Bradley J. Bell - Executive Vice President, Chief Financial Officer and Treasurer
Bo, this is Brad. We're always looking at that. I think we've seen some improvements in treasury markets. We also saw winding of spreads... always being shown and are looking at the take out premiums on some of this. And presently it doesn't pay to do anything grand in a wholesale fashion, but we've got some maturities late '09 and going into 2010, it's... probably you'll step up the pace of activity around there, but no decisions as yet.
Unidentified Analyst
That's it. Thank you very much guys.
Mike Bushman - Division Vice President, Communications and Investor Relations
Just a quick close down.
J. Erik Fyrwald - Chairman, President and Chief Executive Officer
Yes, let me just summarize here. In the second quarter, we are proud of the strong revenue growth. We feel like we made good progress on pricing although we're not where we need to be yet and that we fell short of our total year 8% EBITDA growth due largely to growth investments exceeding cost savings.
In the second half, we're going to keep driving revenue growth, we're going keep driving price increases, we are going to increase our emphasis on cost control to help pay for the growth investments and do that without taking away from future growth opportunities. And our commitment is to do all we can to deliver our targeted EBITDA growth rate of 8% while we continue to build the company for a stronger of in 2009 and beyond.
Thank you for joining us.
Operator
Ladies and gentlemen that does conclude today's presentation. We do thank everyone for your participation. And have a wonderful day.
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