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OM Group, Inc. (NYSE:OMG)

Business Update Call

January 22, 2013 10:00 AM ET

Executives

Joe Scaminace - CEO

Chris Hix - CFO

Rob Pierce - VP, Finance

Analysts

Kevin Hocevar - Northcoast Research

Mike Harris - First Analysis Markets

Chris Kapsch - Topeka Capital Markets

Andrew Dunn – KeyBanc Capital Markets

Operator

Good morning and welcome to OM Group’s Conference Call. Information presented on the call may include forward-looking statements that are subject to uncertainties, risks and factors which are difficult to predict. Actual results could differ materially from those expressed or implied. A more complete disclosure regarding forward-looking statements can be found at the bottom of OM Group’s Press Release or in their Form 10-K and applies to this call.

I now turn the call over to Mr. Joe Scaminace, Chairman and Chief Executive Officer of OM Group.

Joe Scaminace

Good morning, everyone, and thank you for joining us on this call this morning. Today, I am joined by Chris Hix, our CFO and Rob Pierce, VP of Finance, whose responsibilities include Investor Relations.

We are very excited to announce that we have entered into agreements to sell our advance materials cobalt business. This is a major step in realizing our vision to move away from commodity businesses to higher value-added businesses. This is the strategy that we have been consistently articulating and executing on since I joined the company back in 2005 and today’s announcement is a watershed moment in the history of the OM Group.

You can see our standard Safe Harbor disclosures on slide two, so let’s get right into the details on slide three. The sale of our cobalt business is the final step in our planned strategic exit of legacy commodity businesses.

Upon my arrival at OMG seven years ago, we had two businesses, cobalt and nickel, which were both tied to commodity metal prices. These were good businesses with great hardworking people, but the volatile earnings and unpredictability did not put us in control of our own destiny.

Our profitability was largely driven by metal prices, over which we had little control. The result was a business profile that was impossible to predict and not a firm foundation for a long term shareholder value creation.

We divested the nickel business in 2007 and with today’s announcement; we have completely existed our legacy commodity businesses and created a new company. This new company now concentrates on business in which we will grow sales and profits by developing solutions to meet complex applications and demanding customer requirements.

These businesses are driven by technology and innovation. Our superior technology will help fuel growth into new markets globally and new applications. We now posses a business model where we will be rewarded for the value that we deliver to our customers. As a result, we are now in control of our destiny and are developing a more predictable and sustaining earnings profile.

Our future is very bright. We are well positioned with a strong balance sheet to execute our strategy of both organic growth and synergistic acquisitions in our existing platforms.

We also have ample capacity for other capital deployment options, including substantial debt repayment and the $50 million share repurchase program that we also announced today.

Slide 4 is a very powerful depiction of all of the moves that we have made to make our strategic vision a reality. This shows the timeline from the sale of the nickel business in 2007 through today’s announcement of our cobalt exit.

As you could see, we have successfully utilized the proceeds from our nickel sales in 2007, along with the existing cash flows and leverage to make acquisitions that align with our strategy for long-term shareholder value creation.

Slide 7 provides a strategic overview of the new OM Group. We will continue to focus first and foremost on organic growth, continuing to develop and commercialize new products and expanding our geographic reach. We will also maintain our commitment to operational excellence and to a culture of continuous improvement. We will continue to work for higher margins and working capital efficiency.

And speaking of improvement, we will continue to focus on increased financial discipline throughout our organization to generate better returns. This is particularly important as we manage through what is shaping up to be a challenging start to 2013.

Even though we remained acquisitive, we are well positioned with the platforms that we currently have. Each of our three platforms have multiple opportunities to also create value via synergistic deals. The targeted outcomes of our strategy are first growing sales greater than 5% annually over the course of a normal business cycle, increasing profits faster than sales through our operating leverage; thirdly, generating free cash flow to fund our growth strategy; fourth, improving returns with strong financial discipline and acquiring synergistic businesses to further build value.

At this time, I will turn the call over to Chris Hix to walk us through the details of today’s announcement.

Chris Hix

Thanks Joe and good morning everyone. Slide 6 outlines the sale of our Advance Material’s business. We are selling the downstream business including our Kokkola refinery to a JV whose participants include Freeport-McMoRan, Lundin Mining and Gécamines. Gécamines is a 20% owner in our Congolese, which is known as GTL. Total cash consideration for the downstream business is $325 million at time of close with the potential for up to another $110 million over the next three years based on sales levels of the business.

This transaction structure captures today’s fair value for the business and preserves our share of the value upside if cobalt market conditions improve within the next 36 months. In addition to selling the downstream business, we also entered into an agreement to exit the upstream business by transferring our equity interest in GTL to our JV partners, effectively ending our presence in the Congo. The transaction should close before the end of April 2013, subject to regulatory approvals and other customary conditions.

Slide 7, includes a few other highlights. For two years OM Group will act as a supply in intermediary between GTL and the buyer of the downstream business. We also expect for 12 months to continue to act as the downstream businesses U.S distributor. Both of these arrangements were negotiated by the parties to facilitate an orderly transition. We expect minimal profit and cash flow impacts from these arrangements.

Slide 8 updates our cash and debt positions at the end of December. Our already strong balance sheet will become exceptionally fortified with the proceeds from the sale. Following the close of the transactions, we plan to use our cash to substantially repay our debt. Going forward we will have a fortress balance sheet with the financial capacity and flexibility that execute all facets of our strategy, including organic growth, synergistic acquisitions and share repurchases under the newly announced program.

Slide 9 highlights the key points of our new share repurchase program. This program has become possible because of the more predictable portfolio of businesses and strong liquidity we expect following the exit of our Advance Materials business. The board is authorized repurchase of up to $50 million of our common shares, which is about 7% of our total outstanding share at Friday’s price.

We intend to execute this program from time to time and we’ll update you each quarter on developments. This program is among many steps the company has been taking over the last few years to achieve its primary goal to create long term shareholder value.

And I’ll now turn the call back over to Joe for further discussion of our growth plans and other opportunities.

Joe Scaminace

Thanks Chris. Turning to slide 10, this shows the composition of the new OM group. Think of us now as a technology based industrial growth company. We feel confident that all three of our strategic platforms have organic and strategic growth paths to create value for our shareholders.

Slide 11 shows the attractive end markets where we have positioned the company through our strategic actions over the past several years. Our principal markets general industrial, automotive systems, and electronic devices are expected to grow above GDP over the long term with each underpinned by solid secular drivers and we’re also well positioned in newer applications such as medical, aerospace, and renewable energy, all having significant growth potential.

Slide 12 outlines the organic paths for each of our businesses. They are developing and commercializing new technologies and products to increase market share; two, extending our geographic reach into new markets with attractive global growth trends like we did with Borchers, expanding our sales and marketing for us to create and capture new customers.

You need to know that OM Group is global but opportunities exist within each of our businesses for profitable expansion into new geographic markets. For example, Magnetic Technologies has solid opportunities for growth into North America and Asia and Specialty Chemicals is strong in China and Taiwan but opportunities also exist in other Asian countries.

With respect to our geographic sales mix, Europe currently represents roughly half of our sale base, due primarily to the 2011 acquisition VAC. Over the long haul that percentage is expected to go down as we grow each of our businesses into new areas and acquire synergistic businesses to balance our exposure. We take a long term view and we recognize that regions can strengthen and weaken throughout the course of the business cycle.

Slides 13, 14, and 15 show examples of our new products and technologies. Slide 13 highlights our strong participation in the electrification of the vehicle, which has been a key driver in the performance of VAC since the acquisition. With the electrification of the vehicle, the key factor is not necessarily the number of autos being built, but rather the rate of adoption for new technology that is being added to each car.

As shown in the diagram, many VAC products are used throughout the vehicle. VAC products are critical to the performance of (inaudible) systems, electrical power assisted stirring, exhaust gas recirculation for lower remissions, and fuel injectors, just to name a few.

Slide 14 shows two emerging applications and our Battery Technology businesses. The company is Power Pyramid offering us use for alternative energy storage. It uses our innovation, our technology and our knowhow along with the proprietary blend of chemistries and algorithms to offer efficient energy storage. We successfully demonstrated this product offering in mid-2012, and in fact received our first order in the last quarter of 2012.

Aircraft starting battery systems represent a new commercial aerospace opportunity for battery technologies. What makes our technology superior is the combination of packaging, thermal management and fire prevention technique. We have a battery management system that makes our batteries safer than anything else on the market. We’ve also successfully tested our battery internally, using standards that comply with the requirements of RTCA/DO3-11, which is the FAA’s adopted performance standard for lithium ion batteries, which includes a requirement for fire containment.

In our Specialty Chemicals business as shown on slide 15, we continue to develop and commercialize new products and technologies. The best example is our Borchi OXY product lines which serve both the coatings and composites markets.

Earlier this year, we entered into an exclusive partnership with AkzoNobel to distribute our Borchi OXY-Cure accelerators to the composite industry. And in electronic chemicals we continue to identify products and applications to aid in a growing demand for miniaturization and performance of consumer electronics.

Slide 16 lists our key acquisition criteria. We are absolutely committed to disciplined deployment of capital to build out our businesses and ultimately create value for our shareholders.

Slide 17 demonstrates how our leadership and synergistic acquisitions can in fact create value. Back in 2006, the advanced organic piece of our specialty chemical business was mostly a commodity metal organics player with markets growing below GDP, low margins, low growth and low returns. It also had lots of bricks and mortar but little technology.

Through a series of leadership actions as outlined on slide 17, including the acquisition of Borchers we transformed this business. Today it participates global end markets growing above GDP, it focuses on value added solutions for our customers, driven by technology and innovation and it has significantly higher margins and returns.

Moving onto slide 18 upon the close of the cobalt sale, as Chris mentioned we will have in fact a fortress balance sheet with a capacity and flexibility to execute our strategy. We also have the resources to fund our growth plans and the management team and associates to deliver on our objectives in the long term.

At the same time in the short term, macroeconomic conditions remain weak in certain end markets, especially in Europe. We see challenges ahead in 2013, particularly in the first half of the year. As a result we have developed and have begun implanting programs to improve our cost structure.

We have also taken appropriate steps to reduce discretionary spending and optimize capital spending where possible. We are confident that the actions we’re taking now will create short term financial benefits and improve our long term cost structure.

Wrapping up on slide 19, you see the pillars of our strategy as discussed throughout this call. We are really excited about today’s announcements and are very confident about our ability to create and unlock value for this company and our shareholders.

Before I close, I want to sincerely thank the leadership team and associates of the OM Group who have made our vision a reality. Thank you again for your participation in today’s call, all your support and we look forward to keeping you updated on our progress throughout 2013.

At this time, I will open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Kevin Hocevar with Northcoast Research. Your line is open.

Kevin Hocevar - Northcoast Research

The first question I have is in terms of earn out, the $110 million earn out, I am assuming that this still has a lot to do with the price of cobalt. So to get to the $110 million, how much would the price of cobalt have to rise from current levels and what might that earn out be if cobalt stays around where it’s at today.

Joe Scaminace

Well, Kevin I would say it’s little more complicated than that and it’s going to be a factor of the volume in the business, as well as premiums or spreads and in addition to that the underlying price of cobalt. So rather than speculating or where that will end up, I think it’s fair to say that at today’s volume and price levels, we would struggle to achieve the earn out, but that’s the point of it, is to capture the upside as the markets improve.

Kevin Hocevar - Northcoast Research

And then in terms of the debt that you are looking to pay down, I believe in the 10-K it mentions that if certain assets are sold, that you have to pay down a certain principal amount. So did that apply to these cobalt assets and could you give us an idea of how much debt might be pay down.

Joe Scaminace

Just to be clear, we intend to use the proceeds from the sale of this, in addition to the cash that we have on hand to reduce our debt levels and that will meet any requirements that the banks might have under our current credit agreement, but we are doing that primarily to create the fortress balance sheet and to give us that flexibility going forward.

In terms of how debt we will pay down, that depends at the time of close how much cash we have on hand, what our cash flow performance is between now and close et cetera, but you can imagine that we will be paying down, as we say a substantial portion of that debt.

Kevin Hocevar - Northcoast Research

Okay, and then in terms of the remaining Advance Materials segment, it looks like there will be just a small U.S. portion, you will distribute the products and then GTL remain for about two years though. Could you give us an idea of what that might mean to revenue and I know you mentioned that the profits will be minimal, but should we expect low single, maybe a mid-single digit type margins on whatever the remaining revenue will be?

Joe Scaminace

Yes, and just to be clear we’re only acting as the U.S. distributor for the business for a year and then we expect to transition completely out of that. So it’s really more to facilitate an orderly transition of the business. We are not remaining in the cobalt business in any way, shape or form, with the exception of just the two year supply agreement between GTL and Kokkola, where we act as an intermediary and then the one year agreement acting as the distributor. And again we expect minimal profits in cash flow. These agreements were negotiated to largely be back-to-back and so we are really talking very de-minimis profit or cash flow impacts.

Operator

Your next question comes from the Mike Harrison with First Analysis Markets. Your line is open.

Mike Harris - First Analysis Markets

Joe, could you talk a little bit about how this transaction came about, maybe walk us through the timeline and what other options are you had been exploring?

Joe Scaminace

Our goal and whenever we’re on an investor call or with our investors, we’ve always talked about articulating a strategy where we’ve been attempting to minimize the exposure and a volatility of this business model. So, I can tell you that we made an exhaustive effort to comb the globe for potential buyers and in fact engaged in multiple discussions with multiple buyers and multiple geographies, including China, Europe and the United States and I will tell you that the most logical buyer emerged and we were able to conclude the transaction with this logical buyer.

Mike Harris - First Analysis Markets

And how did you think about valuation for what we would consider pretty unique set of assets in the global mining and kind of medal processing industry, and also what was, can you give us a ballpark of what the trailing 12 month EBITDA was for the business that’s been sold?

Joe Scaminace

Yeah. I won’t go on to the EBITDA but I will tell you that Mike, every step along the way, it was always about fair value. That was the overriding principle, the overriding goal. Obviously like any good company you’re going to look at every single possible valuation model, from DCF to comparable transactions but it all boils down to what would be the fairest value that we could bring to the table to basically reward our shareholders in a shareholder friendly way.

Mike Harris - First Analysis Markets

And is the Big Hill also part of the divestiture? Obviously that’s a component of the GTL joint venture, but did the rights transfer on a change a control like this?

Joe Scaminace

Well, we are completely existing at the conclusion of the transaction and we would be completely existing the Congo and so we’ll have no further interaction or rights with respect to any inactivity there, whether it’s access to the Big Hill, smelting operations anything else. We’re completely exiting that business and our joint venture partners will have total ownership of that.

Mike Harris - First Analysis Markets

And are there stranded costs associated with the Advanced Materials business and can you maybe talk about how much EPS dilution we should expect in the first year following the divestiture?

Joe Scaminace

Yeah. I think we’re not prepared at this point to comment on projections for 2013 or final results for 2012. So, I think we’ll have to update on February 19th with respect to our results for ‘12 and further definition around our outlook for 2013.

Mike Harris - First Analysis Markets

In terms of the stranded costs though, surely there are corporate costs associated with this business, is that there?

Joe Scaminace

Yeah, I think we’ve had pretty good alignment between our cost and the businesses themselves. As you know these businesses operated largely with all of their cost self-contained with very little allocation of cost coming from the corporate office. So we don’t expect there to be significant or material stranded costs as you call them or stranded assets; and sorry no stranded assets.

Mike Harris - First Analysis Markets

Okay; last question for me, clearly you were sourcing some of your cobalt chemicals for specially chemicals and for Magnetic Technologies internally and using the Advanced Materials business to provide raw materials for those businesses. Can you maybe discuss how this transaction could impact those businesses, in terms of supply security or profitability?

Joe Scaminace

Well, just to be clear the VAC business sourcing cobalt, not in fine powder form and really had limited relationships with the Advanced Materials business. So we don’t expect here to be any interaction between this transaction and the VAC business going forward. In the case of the Advanced Organics business, there can continue and we anticipated at least for some period of time, there could continue to be a supply arrangement between the advanced materials business and our advanced organics business, but then that also gives them the ability at some point to source product from any vendor, including the advanced material business.

Operator

Your next question comes from Chris Kapsch with Topeka Capital Markets. Your line is open.

Chris Kapsch - Topeka Capital Markets

Just a quick question on the transaction. Can you talk about maybe I missed this, the tax implications? I am assuming there is no tax leakage. Is that a correct assumption?

Joe Scaminace

Until we have completed the accounting for the transaction, including consideration of any value for the contingent consideration, it’s tough for us to answer to that question. I think it’s difficult for us at this point in time to envision that there would be tax leakage, but I think to be fair we have got to get through that complete calculation and then we can update folks closer to the time of close on that.

Chris Kapsch - Topeka Capital Markets

Is there the potential that there would actually some loss carry forward resulting from this or?

Joe Scaminace

Yeah, there is the potential for loss on that, loss carry forward as you would say, but again we have got to get through that calculation and we are not prepared update on that today.

Chris Kapsch - Topeka Capital Markets

Got you. And then just following up on the notion of stranded costs, sort of I think what the prior question was getting at; is there enough opportunity to reduce some corporate costs that were sort of supporting this cobalt enterprise?

Joe Scaminace

I think from our vantage point, we are taking, as Jo said, because of the business conditions, we are taking a fairly comprehensive look across the enterprise, at the cost structure and I’d say that we look at the corporate costs and everything else in light of that and not necessarily in light of this transaction.

Chris Kapsch - Topeka Capital Markets

Got you. And on the current headwinds, is there any way to dimensionlize, kind of order of magnitude what those headwinds are, sort of on a sequential basis for the pro forma portfolio looking forward, at least near term?

Joe Scaminace

We are not in a good position today but we certainly will be on February 19th to provide a more comprehensive update in terms of the Q4 performance and expectations with 2013. We understand qualitatively and that’s why we felt it was important to communicate that we do see some headwinds, as you say in the business today.

Chris Kapsch - Topeka Capital Markets

Got you and then I understand the like the fortress balance sheet going forward and the intent to look at synergistic acquisitions, that makes sense. I’m just wondering sort of order of magnitude, what sort of potential opportunities you might be seeing in the pipeline and I’m assuming, is it right to assume that you are not really looking for another leg to the portfolio but really more something to smallish complimentary acquisitions; is that fair?

Joe Scaminace

It’s very fair Chris. I will tell you that we have our business leaders, clearly focused on organic growth as their number one priority right now to take what we believe is a very good product line and find growth opportunities in their markets, expand their geographic markets and reduce costs where possible to make that happen and we’re focused on improving our margins, but to your point about the deal pipeline, clearly we feel like our platforms right now are ample platforms to take this industrial growth company into the future with it, and we are clearly focused on deals that have either market adjacencies, cost reduction opportunities and real synergies that are definable and where one of our champions could make those happen and add value to the company.

Chris Kapsch - Topeka Capital Markets

Do you think that something complimentary, VAC is the most likely target for acquisitions or any other remaining pro forma businesses likely as well?

Joe Scaminace

Well, I think all of our businesses right now are kicking the tires on some synergistic transactions. Clearly, I think if you look back at the story I told in my comments about where advanced organics took European company and globalized Borchers and brought that technology through their distribution channels, I mean clearly there is an opportunity for VAC to be able to do that. But, I would say yeah, they would be certainly in our sights but battery technologies and specialty chemicals also are looking at opportunities.

Chris Kapsch - Topeka Capital Markets

Got you. Are there any opportunities as compiling as behind back here in stock currently at sort of the pro forma multiple?

Joe Scaminace

The good news with the strategy…

Chris Kapsch - Topeka Capital Markets

That was a rhetorical question by the way.

Joe Scaminace

Yeah. Well the good news is we’re pursuing both, so.

Operator

Your next question comes from Andrew Dunn with KeyBanc Capital Markets. Your line is open.

Andrew Dunn – KeyBanc Capital Markets

Just, of course I’m not asking you to really project out but just as I look to kind of understand the moving parts here, assuming end markets, Europe kind of remains the same going forward. But you’re going to try to maybe shift up your geographical mix a little bit from Europe as you mentioned, you’re looking at some potential acquisitions and taking costs out of the business moving through the year. So kind of on an all things equal basis, with those factors you would kind of look for performance to improve moving through end of 2013. Yeah?

Joe Scaminace

Yeah. We’re looking at potentially, as I indicated in my comments, the next couple quarters are the headwinds that we’ve been referring to and we’re anticipating and actually hopeful for a stabilization within Europe. There are some very soft signs right now that that may be occurring, but we don’t know how sustainable it is. But over the long term absolutely we’re looking to grow this business.

Andrew Dunn – KeyBanc Capital Markets

Okay. Any chance I could get you guys to give a little more specific breakdown at your pro forma geographic mix?

Joe Scaminace

Yeah. Why don’t we have Rob call you after the call and we can give a lot more specifics on that.

Rob Pierce

Yes, we’ve published some stats on that previously and pro forma, the European mix is I believe over 50% and then you’ve got Asia and North America that are split with the balance.

Andrew Dunn – KeyBanc Capital Markets

Got you. And then lastly just kind of with the cash you’re going to get from this you look at, is the dividend still something that potentially on the table, as you talked about before or is that kind of taking you backseat now to bolt ons and debt pay down et cetera.

Joe Scaminace

Well with this watershed event I just want all of you to know that we’ll continue to evaluate all options around the table for the deployment of our capital but clearly we’re all about growth now. We’re an industrial growth company, but we we’ll continue to evaluate every option that’s on the table.

Okay, there being no more questions, let me just at this time just thank all of you for your interest in OM Group and just realize that we are really excited about this watershed moment. The new OM Group going forward will be very positive and we’re absolutely focused on creating shareholder value. Thank you and have a great day.

Operator

This concludes today’s conference call. You may now disconnect.

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