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OMNOVA Solutions (NYSE:OMN)

Q1 2013 Earnings Call

April 03, 2013 11:00 am ET

Executives

Kevin M. McMullen - Chairman, Chief Executive Officer, President and Chairman of Executive Committee

Michael E. Hicks - Chief Financial Officer and Senior Vice President

Analysts

David L. Begleiter - Deutsche Bank AG, Research Division

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

Peter J. Cozzone - KeyBanc Capital Markets Inc., Research Division

Roger N. Spitz - BofA Merrill Lynch, Research Division

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Tom Spiro

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the OMNOVA Solutions First Quarter Earnings Discussion. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host, CEO, Mr. Kevin McMullen. Please go ahead.

Kevin M. McMullen

Good morning, and thank you for joining us for our conference call to discuss first quarter 2013 results. Joining me today is Mike Hicks, our Senior Vice President and Chief Financial Officer. I'd like to turn it over to Mike to make comments on forward-looking statements.

Michael E. Hicks

Thanks, Kevin. During this conference call, OMNOVA representatives may make forward-looking statements as encouraged by the Private Securities Litigation Reform Act of 1995. All statements in this conference call and in subsequent discussions with the company's management, other than historical information, are forward-looking statements.

These statements represent management's current judgment on expectations for future results and other matters. A variety of risk factors highlighted in the company's Form 10-K and in our most recent earnings release could cause business conditions and the company's actual results to differ materially from those expected by the company or expressed in the company's forward-looking statement.

In addition, certain financial measures referred to during this call are non-GAAP financial measures. For an explanation and reconciliation of these non-GAAP measures, see our most recent earnings release. Kevin?

Kevin M. McMullen

Thank you, Mike.

Typically, the first quarter, which begins in December, is seasonally the weakest for OMNOVA Solutions, and this proved to be the case in 2013. Though sales and profit were down year-over-year from an unusually strong first quarter in 2012, we were encouraged to see significantly improved results in February, following weakness in December and January. During the quarter, demand improved in oil and gas drilling chemicals and in other key global product lines, with strong and growing exposure to Asia, including chemicals for nonwovens, construction, paint, adhesives and transportation applications.

In addition, late quarter volumes increased in our Engineered Surfaces segment where laminate and coated fabric end users tied to the upswing in construction were particularly strong. Overall, volumes were down due to the continued recession in Europe, and as a result of a previously disclosed volume loss late last year in North American coated paper chemicals. However, we received new paper chemical commitments during the first quarter, which are expected to offset much of the lost volume with shipments beginning to ramp up in the second quarter.

Profit for engineered surfaces was impacted by inventory adjustments and onetime transitional costs related to the fiscal 2012 sale of Commercial Wallcovering. With those actions now completed in our 2013 first quarter, our refocused Engineered Surfaces business is much better positioned for improved margins and growth.

Also during the first quarter, we won new business in chemicals for nonwovens, in oil and gas drilling and in Laminates for kitchen and bath. We announced pricing actions and near completion of 2 exciting growth-oriented capital investments that are expected to ramp up in the second half of the year. The first is an expansion of specialty chemical capacity at our newest plant in Caojing, China, which supports our growth objectives in the region. The second is the repurposing of assets to align our capabilities with changing market needs by repurposing -- I mean, taking our existing capacity in manufacturing footprint and changing it to a different process or chemistry. For example, we have redirected some of our North American styrene butadiene capacity to the production of hollow plastic pigments, thus increasing our overall capacity utilization and supporting our expansion into new chemistries and new markets. Many of the actions we have taken are building on the fundamental improvements we have made to OMNOVA Solutions through globalization, diversification and expansion of our Specialty Chemicals business, and the repositioning of Engineered Surfaces to be a positive contributor to OMNOVA's financial performance.

I will provide more details later in this call on the many positive developments that are expected to build momentum for OMNOVA as the year progresses.

But first, I'd like to summarize our consolidated first quarter results as reported in our earnings release.

First quarter net sales were $251.7 million, down $24.2 million or 8.8% from the first quarter of last year. The year-over-year sales decline was driven by lower volumes of 7.1% and reduced pricing of 1.7%.

Gross profit in the first quarter of 2013 was down $11.9 million from the prior year. Gross profit margins were 19.5% due primarily to the lower volumes and resulting manufacturing absorption issues as compared to gross margins of 22.1% in the first quarter of 2012.

Adjusted income from continuing operations was $1.5 million or $0.03 per diluted share in the first quarter of 2013, compared to an unusually strong $10 million or $0.22 per diluted share in the first quarter of 2012.

Selling, general and administrative expense was $30.5 million in the first quarter of 2013, up $1 million from the same period last year. The year-over-year increase was due to higher outside services, health care and other employee costs.

Interest expense was $8.6 million in the 2013 first quarter, down $900,000 from the same period last year due primarily to the completed amortization in 2012 of an interest rate swap agreement.

Going forward, OMNOVA expects annual interest rate savings of approximately $2.4 million at current LIBOR rates as a result of the completion early in the second quarter of an amendment to our $195.5 million term loan credit facility. The floating rate pricing of this debt declined by 125 basis points to 4.25%, and the term was extended by 1 year to May 2018. The company will record a charge of approximately $1.5 million in the 2013 second quarter related to this transaction.

Income tax expense was $600,000, a 75% effective income tax rate for the first quarter of 2013, compared to income tax expense of $3.5 million or a 24.6% effective tax rate in the first quarter of 2012. The higher tax rate in the year's first quarter was primarily related to the lower pretax income. While the first quarter effective tax rate appears high at 75%, the company estimates its full year 2013 effective tax rate will be approximately 30% to 33%.

Cash tax payments in the U.S. over the next few years are expected to be minimal as the company has $116.8 million of U.S. federal net operating loss carryforwards, and $90 million of state and local tax net operating loss carryforwards with expiration dates between 2022 and 2032.

In the first quarter of 2013, OMNOVA maintained its strong liquidity position. Liquidity totaled $200 million, consisting of $122 million in cash, cash equivalents and restricted cash, and $78 million in available borrowing capacity under OMNOVA's U.S. revolving asset-based credit facility.

OMNOVA's trailing 12-month adjusted EBITDA as defined by our term loan credit agreement and presented in our earnings release financial tables was $97.4 million at the end of the first quarter.

Net debt as presented in our earnings release increased $26.9 million to $334.2 million during the quarter, due primarily to a seasonal increase in working capital.

Turning now to business segment results. You will recall that OMNOVA previously announced that the name of its former Decorative Products business segment has been changed to Engineered Surfaces. The new name reflects the improved portfolio and the importance of technology and innovation in driving the functional performance of our products, which, along with design, are key differentiators with our customers.

Engineered Surfaces sales in the first quarter were $60.5 million, a 5.2% increase or $3 million higher than the first quarter of 2012. We believe there were some prebuying by Coated Fabrics customers in the 2012 fourth quarter in anticipation of the manufacturing closure at our Columbus, Mississippi plant. Still, volumes were up in the first quarter in both the Coated Fabrics and Laminates product lines. Sales for the Laminates product line, which includes Performance Films, were $31.6 million in the first quarter, an increase of $2.3 million or 7.8%, from the prior year. Sales grew across most Laminate market segments led by flooring, kitchen and bath cabinets, and retail store fixtures.

Sales of Coated Fabrics were $28.9 million, an increase of $700,000 or 2.5% compared to the first quarter of 2012. Sales were up in our Asian Coated Fabrics business for products that go into transportation seating and accessory applications.

February marked the completion of transitional activities related to last year's divestiture of our Commercial Wallcovering business. Wallcovering production has been successfully transferred to the buyer, and Coated Fabrics products that had been produced in our Columbus, Mississippi plant have been transitioned to other more efficient OMNOVA manufacturing sites in the United States and Asia. The Coated Fabrics transition is expected to result in a much improved portfolio and better asset utilization in our Engineered Surfaces business going forward. These transitional activities contributed to the year-over-year decline in adjusted segment operating profit in Engineered Surfaces, which was $1.8 million in the 2012 first -- in the 2013 first quarter compared to $3 million last year.

Adjusted segment operating profit for the first quarter of 2013 included onetime cost of approximately $500,000 for the Columbus transition and $800,000 in lower LIFO and inventory valuation, $600,000 in transition costs at our Jeannette, Pennsylvania plant, as well as $500,000 in higher year-over-year health care cost.

There is significant activity around a number of new Coated Fabrics opportunities in automotive, mass transit and in health care seating applications. For example, production is ramping up on a new win with a major automotive manufacturer in China. As we enter the construction season, we are seeing increased sales of Laminates in the key housing applications, particularly kitchen and bath cabinets and flooring. In fact, one major cabinet customer has indicated that their volume with us this year should double to approximately $4 million from $2 million last year. We are well positioned with leading cabinet and flooring manufacturers with value-added functionality and performance in market-leading designs.

I have talked in the past about our surf(x) three-dimensional laminates, which demonstrate higher impact resistance than high pressure or thermally-fused laminates and enable rounded-edge profiles, and our harmony program that allows customers to value engineer their products by combining surf(x) three-dimensional laminates with our DURAMAX flat laminates and other products in the industry to match design and color across multiple surfacing materials on a single finished product, thereby lowering the customer's cost. Specialty acrylic laminates is a growing and exciting area for us, and during the quarter, we won new business with a major North American producer of decorative bath surround systems.

Turning now to Performance Chemicals. Sales were $191.2 million in the first quarter, down $27.2 million or 12.4% from the first quarter of last year. Volumes decreased 10.2% year-over-year. And pricing, which is linked to changes in raw material costing indices and 45% of chemicals, was down 2.2%.

Performance Chemicals generated $15.1 million in adjusted segment operating profit in the first quarter of 2013 compared to $25.7 million for the same period in 2012.

Sales of Specialty Chemicals were $123.9 million in the first quarter as compared to $131.9 million in the same period in 2012. Sales declines in Europe and India were partially offset by increased global sales of specialty polymers into oil and gas drilling applications, where we have introduced 3 exciting new products. Sales also increased in other key global product lines where we have strong and growing positions in Asia, including nonwovens, tire cord, antioxidants, tape and adhesives, and floor care.

During the quarter, a global nonwovens customer notified us that they anticipate significant increases in volume for hygiene applications due to strong growth in China and Latin America. We also won significant new business for nonwovens that will go into roofing and other construction applications where shipment is expected to begin ramping up in the second quarter.

At OMNOVA's newest plant in Caojing, China, we continue to make progress in obtaining customer approvals for specialty latex applications. A major construction project to further expand the types of specialty polymers we can produce at the site is nearing completion. This expansion will support our aggressive strategy to serve the fast-growing local Asian markets.

Sales of paper and carpet chemicals were $67.3 million in the first quarter of 2013 compared to $86.5 million in the first quarter of 2012. Volumes were down at both North American markets, where prolonged softness in industry demand has increased competitive activity. As previously disclosed, OMNOVA lost approximately 60 million pounds annualized to competitive activity in late 2012. We have now won new commitments in paper chemicals that we expect will significantly offset this volume loss with shipments beginning to ramp up in the second quarter of 2013.

The fastest-growing segment is paperboard for packaging, which represents a clear opportunity and is an area of particular focus. Our emphasis is on technologies that offer higher performance, higher strength and more sustainable product solutions, such as bio-based copolymer hybrids and other emulsion chemistries valued by our customers. We are nearing completion of a capital program that will provide new in-house capability for the production of hollow plastic pigment for paper, packaging and other specialty applications. Hollow plastic pigment technology provides opacity and gloss, and can reduce the need for costly ingredients such as titanium dioxide. The capacity to produce these specialty high-performance emulsion products was converted from existing North American styrene butadiene latex manufacturing capacity, or what we will refer to as repurposing, as part of OMNOVA's continuing strategy to adjust its manufacturing footprint to meet changing market needs. Significant customer conversions to OMNOVA-produced product and new account penetrations are expected for late in the second quarter.

In summary, the first quarter is seasonally our weakest because of the December holidays and the low construction activities due to poor weather. Throughout my comments today, I have highlighted a few of the reasons we feel confident and excited about our growth opportunities over the remainder of the year. To summarize those reasons, I would point out our expansion in the high-growth markets of Asia, where sales in the first quarter were up in most of the applications we serve there. We are seeing consistently solid results from key global product lines that we have targeted and invested in for growth, including chemicals for oil field, nonwovens, tire cord, and tape and adhesives. Our newest chemical plant in Caojing, China will provide us with greater regional manufacturing capabilities to support growth, particularly when the latest expansion comes online in the second half of this year. Likewise, our Engineered Surfaces business is continuing to build on our strong position in Asia in automotive and other transportation applications. We are leveraging these capabilities to expand further into a wide array of other markets in Asia that use Coated Fabrics, Laminates and Performance Films.

We are encouraged by the improved trend in key markets where we are well positioned, particularly the housing recovery, where we have seen a ramp up in construction in February and March. Likewise, demand for high-performance oil and gas drilling chemicals continues to grow globally; personal hygiene products are growing, particularly in developing regions; and the transportation markets remain robust. We are making exciting investments to support our growth objectives. The Caojing, China plant is one example and the repurposing of assets for the production of hollow plastic pigments is another. In addition, we have made targeted growth-oriented investments in new equipment at several sites aimed at further strengthening our capabilities and improving yields in productivity.

We have significant technology-driven new business wins. We are encouraged by the progress of our Engineered Surfaces business as evidenced by the increased volumes in the first quarter. Now with the improved portfolio and restructured manufacturing footprint in the Coated Fabrics manufacturing transition behind us, Engineered Surfaces is positioned to contribute with improved margins and greater profitable growth. And we have reduced our interest costs with the completion of an amendment to our term loan credit facility. While we believe in the potential of all these opportunities and actions, we also know that continued economic uncertainties in Europe, expectations of rising raw material costs during the year and general softness in some markets require us to take action to reduce cost. In last quarter's conference call, we announced that we expected approximately $8 million in savings for 2013 and our efforts are on track. Initial savings in the first quarter were masked by the low volumes but we still expect savings to ramp up throughout the year. Actions include: reduction in discretionary spending; process yield and productivity improvements through our Lean Six Sigma program; significant savings in annual global logistics spending as a result of a very focused initiative to streamline this important facet of our global business; and a significant reduction in energy cost companywide, with capital investments coming online for cogeneration, new energy-efficient boilers to power of our manufacturing plants and other energy-saving projects.

With these cost actions and the strong growth opportunities we are aggressively pursuing, we continue to expect full year 2013 adjusted income from continuing operations to exceed last year's performance. Mike and I would now be happy to answer any questions that you might have. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of David Begleiter, Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Kevin, the strength you saw in February, has that continued into the month of March as well?

Kevin M. McMullen

Yes, and what we've seen in March is a continuation of that. And as we said, we expect that to further increase as the year goes on.

David L. Begleiter - Deutsche Bank AG, Research Division

And, Kevin, in the Engineered Surfaces, how should we think about the sequential improvement in profit in that segment in Q2, given some of the one-off items we had in Q1?

Kevin M. McMullen

Yes. Certainly, we would expect Q2 to be stronger with the one-off items behind us in the restructuring of the Coated Fabrics business and the manufacturing shutdown in Columbus, and we expect more business volume gains as the year progresses as well. So I think Q2 will be an improvement and the second half will be an improvement from there.

David L. Begleiter - Deutsche Bank AG, Research Division

And lastly just on in paper chemical, as the new business ramps up in Q2, will there be much of a profit impact from that new business in Q2 or will it be more back half of the year?

Kevin M. McMullen

We'll get some improvement in Q2 and then the balance in the back half of the year, but we would expect certainly, some improvement in Q2.

Operator

And the next question comes from the line of Laurence Alexander, Jefferies.

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

This is Jeff Schnell in for Laurence. You guys called out India and Europe as weak. What end markets are driving that? Are they continuing to decline or are you seeing any sort of stabilization?

Kevin M. McMullen

Yes, I would say, in Europe, it's pretty broad-based in our Specialty Chemicals business. So coatings, specialty coatings, some of our antioxidant business areas in Europe in our specialties market were weak just based on general economic weakness in the European economy, I think. In India, in particular, it would be tire and automotive applications where we have specialty rubber businesses there, and they were weak in the quarter. I don't think we see anything there systematic. It was not a strong quarter, but there, I don't think it's a general economic issue. I think it was kind of a temporary weakness in the quarter.

Jeffrey Schnell - Jefferies & Company, Inc., Research Division

And on the new products in oil and gas, can you quantify the impact of those? And do you expect to have more products commercialize in 2013 or are they still in approval processes and the like?

Kevin M. McMullen

Yes, no. So we would expect certainly, benefit from these new products in 2013. We continued to develop more new products for the oil and gas industry. We are very excited about our position in this industry. It is an industry, as you know, that is growing rapidly, and we have a growing position on the heels of our winning technology in that industry. And they -- the areas that we are particularly focused in is the areas of highest growth, offshore deep-well drilling, where high pressure and high temperature are particularly critical operating conditions and our products tend to work extremely well in those conditions. And so we're excited about the industry overall and the new products we continue to develop to serve that industry.

Operator

Next question from the line of Peter Cozzone from KeyBanc Capital.

Peter J. Cozzone - KeyBanc Capital Markets Inc., Research Division

Kevin, for Performance Chemicals, in addition to the new business wins, are there other areas or initiatives in the back half of 2013 which might help you offset some of the year-over-year headwinds that you saw in the first quarter, and to some extent, 2Q here from an earnings standpoint? And I guess, can you grow these businesses despite the more challenging operating environment versus 2012?

Kevin M. McMullen

Yes. We certainly look to grow it going forward. Obviously, we have some challenges in the North American coated paper business. But as you note, as a smaller part of the portfolio today than it's been in the past as we've grown in other areas, and so that is a helpful thing, the growth in other areas. I think the new business wins that we have in coated paper and in other areas will help us see growth in the second half of the year. We continue to look at cost actions in that business and that's part of the $8 million that I talked about earlier, so we continue to focus on that. We continue to repurpose some of our North American SB assets to serve other growing markets, and the new capacity and capability coming online in China will be a big contributor in the second half and beyond as we continue to see exciting growth in the Asian markets. So I think all of those things will contribute to a stronger second half of the year, stronger earnings and stronger growth as well.

Peter J. Cozzone - KeyBanc Capital Markets Inc., Research Division

And then you noted a positive outlook for housing here and seen some benefit from that in your Engineered Surfaces business, when would you typically expect to see that improvement translate to some growth in carpet chemicals, or are there other issues at play here as far as substitution maybe in the carpet side?

Kevin M. McMullen

Yes. I mean, our understanding at least through the beginning part of the year from our carpet customers is they were not seeing year-over-year demand improvements for carpet. Regardless of what chemistries were being used in carpet, they were not seeing year-over-year demand increases. We would expect as housing improves that, that would drive sales increases in carpet overall and we would start to see benefits there, but we have not yet seen that. There has been some material substitution that has created some headwinds. But really, the biggest issue is demand overall for carpet, we haven't seen an improvement of that but would expect, as housing improves going forward that, that would start in the latter part of the year.

Peter J. Cozzone - KeyBanc Capital Markets Inc., Research Division

And then 2 quick questions for Mike. Can you provide some color on the raw material trends, specifically butadiene and what's your outlook there for the remainder of 2013?

Michael E. Hicks

Yes. Butadiene was down pretty significantly on a year-over-year basis. A lot of that gets reflected in the lower sales because of our index pricing but it averaged about $0.85 in the quarter. The rollover for the month of March and April is around $0.80, $0.85. Again, IHS or CMAI is forecasting it to get above $1 by year-end. But so far, we're seeing weak demand globally for things like tires, which has kept butadiene prices, again, lower than what we would've expected going into the year. Styrene was up about $0.15 year-over-year. Styrene spiked at the end of 2012 because of higher benzene costs and it's in the mid $0.70 range. We think that, that has peaked for the year and should come off of that modestly. I think we're forecasting it to drop to about $0.70 by year-end. Some of the other things like propylene and PVC, which we have less exposure to, we're seeing that we believe they probably have a little bit of room to go up from the levels we're at now, but nothing dramatic.

Peter J. Cozzone - KeyBanc Capital Markets Inc., Research Division

Okay. And then lastly, given the amended term loan facility, what's the current expectation for annual interest expense going forward?

Michael E. Hicks

We should be at about $8 million a quarter going forward, versus the $8.6 million we had in first quarter.

Operator

Next question from the line of Roger Spitz of Bank of America.

Roger N. Spitz - BofA Merrill Lynch, Research Division

In the Specialty Chemicals subsegment, can you provide the year-over-year volume and price percentage movements?

Michael E. Hicks

Volume was down about 4% in Specialty Chemicals, and that was all driven by Europe and India. In North America, we were flat to up a bit. The raws versus price, we don't disclose that but for the whole company, raws versus price was -- raws dropped $4.7 million, price was down 3 point -- I'm sorry, price was down $4.7 million, raws were down $3.8 million, so we took a small hit in there, but it was not a big impact in the Specialty segment.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Okay. And that $4.7 million and the $3.8 million, that was for the whole company, not for the Performance Chemicals or the Specialty Chemicals subsegment?

Michael E. Hicks

Correct.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Okay. And in terms of the [indiscernible] for the new business, it sounds like that's in paper. Now does that -- maybe you could just step it back a bit. The 60 million pounds, was that -- did you lose that in paper or carpet, could you remind us?

Michael E. Hicks

Paper.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Okay. And are you basically -- I'm assuming you're basically taking share from someone else, perhaps the guy who took share from you. Is that how to think about it as opposed to any new business opportunity?

Kevin M. McMullen

I think it's a combination of both. So some of it is sheer gain in standard paper, some of it is, as we ramp up our new hollow plastic pigment capability, we are winning new business not from same competitors but from other folks.

Roger N. Spitz - BofA Merrill Lynch, Research Division

So that volume, some of that volume gain or replacement, if you will, is from the hollow sphere stuff, not necessarily from SB Latex into paper?

Michael E. Hicks

Correct. Over half of it is.

Operator

And the next question from the line of Bill Hoffman of RBC.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Just a follow-on to the earlier question on recovery and some of the volumes in the paper markets. You talked about 60 million pounds, whatever, $12.5 million a quarter. Can you just talk to us like how you expect that to walk back into the business?

Michael E. Hicks

We would just get a portion of it, less than 25% of that, in the second quarter, Bill, because we have essentially, 8 different trialing locations, and we've been knocking those off here as we go and we're starting to make some shipment but we would expect to be at close to a full run rate on that by the end of June. So a good comparison versus the first half of the year, and, again, it's going to be ramping up. We'll get some benefit in Q2, a significant amount more in 3Q and full benefit in 4Q.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Okay. And then you also mentioned the sort of the cost absorption impact from that in the first quarter. As you're going to start to ramp back up again, will you sort of overproduce or bring the costs absorption hit back sooner?

Michael E. Hicks

Yes. We would expect to see that in Q3 once we're running at higher volume rates than we are right now.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Okay. The next question has to do with the nonwovens growth that you're talking about. Could you just help us sort of quantify maybe how we should think about that as either top line or an EBITDA impact as it rolls in through the year?

Michael E. Hicks

In total, the market has been growing low single digits on its own, but there has been some additional capacity that's been added by our customers, which should add 3 or 4 million pounds of annual volume at about $1 a pound. So, again, it's a nice piece of incremental business on a part of our portfolio that was growing already.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Okay. And then just with regards specifically to the Caojing facility, you said guys are running sort of 50% in the first quarter. How do you expect the ramp up that to go through this year?

Michael E. Hicks

Well, that 50% is on the tire cord adhesive only, and, again, we started that business up about 2 years ago. So again, to think we've had good progress in filling it, we still have room to grow and market share that we think we can capture in Asia. That will continue to grow through the year. The new piece that will be coming on, we'll be starting butadiene latex and we would be expecting to be able to start manufacturing product at the end of the third quarter and then should generate $3 million to $4 million of sales in the first quarter. After that, we have a ramp up requirement. We got customer trials. But going into 2013, we'll update you at the end of the third quarter where we think we're going end 2013 and going into 2014 on the SB Latex volume.

Bill Hoffman - RBC Capital Markets, LLC, Research Division

Okay. And then just last question, if I may. Capital spending target for the year, any change? It certainly look like you're off to kind of a slow start there.

Michael E. Hicks

It's about $33 million. We'll be spending more in the second half of the year, primarily in, I think, in some of our foreign operations.

Operator

[Operator Instructions] You have a question from the line of Tom Spiro of Spiro Capital.

Tom Spiro

Tom Spiro, Spiro Capital. Kevin, now that we've repurposed some of the North American SB Latex capacity, what's our utilization rate for what remains?

Kevin M. McMullen

Yes. We're probably in the 65% to 70% level. As you point out, we did repurpose some of our assets to our hollow plastic pigment production, so that's probably at the level we're at now. We continue to analyze that as we go forward and continue to look at our footprint as we go forward for similar actions we can take.

Tom Spiro

What's your sense of the industry as the utilization rate -- the North American industry's utilization rate?

Kevin M. McMullen

Yes, I would guess the industry is probably about the same, maybe a little lower, 60% to 65%.

Tom Spiro

And that would suggest that the pricing pressures that we've experienced that led to some business losses will continue.

Kevin M. McMullen

Well, that's a possibility, certainly. We continue to focus on products that are differentiated, that bring value to the marketplace, but there has been increased competitive activity, as you point out. I think it remains to be seen how competitors act going forward, but there is challenge in the North American marketplace from the standpoint of capacity.

Operator

And the next question is from the line of Rosemarie Morbelli of Gabelli & Co.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Just following up on the 60 million pounds that you have lost to competitive pressure and that you will more or less recover by year-end. First of all, will you be covering the whole 60 million pounds? And second of all, are you recovering it at a lower margin than what you have lost or are the new products offsetting the competitive pressure?

Kevin M. McMullen

So the first part of your question, we expect to recover all of that volume over the course of 2013, commitments that we have already received from our customers. We would expect that to be at approximately the same margin as what we had before, maybe a modest reduction but in the same area.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And if you look at -- I mean, if I understood properly, and I may not have, you are recovering some of that volume working with the paper industry but other volume is going to be recovered for new applications, am I correct?

Kevin M. McMullen

Well, the 60 million that we've been talking about would all come from paper and packaging. Part of that would come from our traditional SB Latex technology and part of it would come from this new technology called hollow plastic pigment that the initial markets we will serve with our new capability in hollow plastic pigment will be paper and packaging, so it will be the combined of those 2 that will offset that 60 million pounds.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

And the hollow plastic pigment, which allows your customers to use less of the expensive TiO2, does not carry higher margin?

Kevin M. McMullen

It does. That piece of it will, yes.

Rosemarie J. Morbelli - Gabelli & Company, Inc.

Okay. So between -- so what you are saying is that between the higher-margin in that particular category and then the, obviously, lower margin as we -- as you recover some business in the old category, it is the net of those 2 that is going to end up being similar to slightly lower margin?

Kevin M. McMullen

Yes.

Operator

And back to you, gentlemen.

Kevin M. McMullen

Okay. Thank you for calling in for our first quarter conference call, and I'll turn it over to the operator to give you information on the recording and we'll look forward to talking to you at the end of our second quarter.

Operator

Okay, thank you. And a digitized telephone replay is scheduled from April 3, 2013 at 1:00 p.m. Eastern until April 24, 2013, at 11:59 p.m. Eastern. Also, an audio replay will be available on the OMNOVA Solutions website at www.omnova.com until noon Eastern on April 24, 2013. And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive TeleConference service. You may now disconnect.

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