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OM Group, Inc. (NYSE:OMG)

Q3 2009 Earnings Call Transcript

November 05, 2009 10:00 ET

Executives

Joseph M. Scaminace - Chairman and Chief Executive Officer

Kenneth Haber - Chief Financial Officer

Stephen D. Dunmead - Vice President and General Manager, Specialties Group

Gregory J. Griffith - Vice President, Strategic Planning, Development and Investor Relations

Troy Dewar - Director of Investor Relations

Analysts

Michael Harrison - First Analysis

Rosemarie Morbelli - Ingalls & Snyder

Saul Ludwig - KeyBanc Capital Markets

Operator

Good morning. My name is Sheena and I will be your conference operator today. At this time I like to welcome everyone to the Third Quarter 2009 Results Conference Call. All lines have been placed on mute to prevent any background. After the speaker’s remarks there will be a question and answer session. (Operator Instructions) Thank you, Mr. Dewar, you may begin our conference.

Troy Dewar

Thank you Sheena and good morning everyone. Welcome to our review of OM Group’s 2009 third quarter results. Joined me this morning are Joe Scaminace, Chairman and Chief Executive Officer, Ken Haber, Chief Financial Officer, Steve Dunmead, Vice President and General Manager of Specialties and Greg Griffith, Vice President of Strategic Planning Development and Investor Relations

The copy of the press release we issued earlier this morning as well as the presentation material that accompany our discussion can found on the Investor Relations portion of our website at investor.omgi.com. As a comments made this morning by any of the participants on the call may include forward-looking statements based upon specific assumptions and subject to uncertainties and factors which are difficult to predict. Actual results could differ materially from those express or implied. A more complete disclosure, regarding forward-looking statements can be found at the bottom of our press release or in our Form 10-K, and apply to this call.

At this time I will turn the call over to Joe Scaminace.

Joseph M. Scaminace

Thank you Troy, and good morning everyone. Last year at this time we entered a major global economic decline. This downturn affect to all markets and all region. And led to drastically lower top line and bottom line performance for our company. Now a year later, there are indications that the worst is over. In the case of OM Group many of our end markets are seeing sequential growth. This growth is occurring in battery, semi conductor, printed circuit board and memory disk. As driven impart by inventory restocking we are also seeing positive trends in underlying demand.

Customer orders are certainly running than we expected in the first half of this year and we experience in the first half of this year. And while this may be a sign that we are entering a gradual economic recovery, there still enough mix data to keep us from getting overly optimistic in the near term. For example there is evidence that end market demand is still slow in automotive, construction and industrial production. In addition some of the some increase in demand is attributable to the unprecedented stimulus by governments around the globe, this may not be sustainable.

In addition to improving trends in end market demand we also experienced benefit from a positive trend in the cobalt reference price. Since bottoming at the end of 2008 the cobalt reference price has risen steadily throughout 2009. And now the most recent quote is just under $20 per pound. This up tick has provided some benefit on a sequential basis. Throughout the year we’ve discussed the actions we’ve taken to address this downturn. We moved early, quickly and decisively to enhance profits by reducing cost dramatically and managing cash. These measures contributed to stronger third quarter results and we are seeing the benefits of our actions.

The next step in our profit enhancement program is already well underway. We are today announcing restructuring action in the advanced organic business. This specialty chemical business serve several markets, including the tire market, the coatings market and various chemical end markets.

All of our customers in these markets have been hit hard during the recent economic downturn, especially our tire customers. Additionally, the coating sector is facing challenges from legislative and regulatory action as well as decreased customer demand. These factors have contributed to global overcapacity for the products we supply to these markets.

Additionally, new competitors have entered the rubber adhesion promoter product line creating additional oversupply. And as a result there has been a meaningful decrease in both demand and profitability in these markets. There is one other factor which contributed to our decision. End market demand is shifting away from our European manufacturing footprint and moving toward Asia. We therefore determined that now is the time to reduce our capacity, realign our operations and get more cost out. These restructuring actions demonstrate our results to act quickly and substantially to improve our cost structure.

I’m proud of the hard work our employees have shown during this difficult period. Taking cost out is never easy, but our actions are essential to meeting the challenges we face in this difficult operating environment. And in tough calls are certainly essential to delivering the type of performance that we’ve reported this morning.

Excluding restructuring charges, the specialty chemical segment achieved year-over-year growth in operating profits. It’s worth noting that today we are as strong financially that at any time in our company’s history. We are debt free and have more than $300 million in cash on hand. We generated positive cash flow in every quarter since the downturn, including the the last quarter of 2008 all the way to the last quarter.

In addition to our $300 million in cash on hand, we have additional liquidity through two revolvers. Our lower cost structure and liquidity gives us the strength and flexibility that are essential during these uncertain times. Our financial strength enables us to remain active and focused on implementing our long range growth strategy and as we have stated many times this strategy involves acquiring attractably valued assets that would allow us to further diversify our revenue and income stream, while reducing the volatility in our earnings created by metal price fluctuations.

I’ll now turn the call over to Ken Haber to walk you through the details of our financial performance.

Kenneth Haber

Thank you, Joe and good morning to everyone listening. My comments will cover the company’s third quarter 2009 consolidated results, as it compared to the second quarter of 2009 and the third quarter of last year. Starting on page three and page four of the presentation materials that appear on our website.

Revenue fell 48% to $235 million in the third quarter compared with $449 million last year. The same three drivers that impacted the severe drop in revenue in the second quarter, continued into the third quarter as compared to last year.

These were the decrease in advanced materials pricing, impacted by the drop in the cobalt reference price, lower volumes in nearly all end markets due to the global economic slowdown and a decrease in cobalt metal resale.

Both, lower pricing and volume totaling $60 million had the largest impact on the reduction in operating profit from the third quarter 2008. Offsetting this partially was the benefit from profit enhancements and lower spending totaling $23 million, lower process based material cost of $8 million and the loss on the cobalt forward purchase contract that was recorded in 2008. The other item that impacted the current quarter operating profit was an $11.9 million charge related to the restructuring of the company’s Advanced Organics business. Of this total 7.6 million is related to non-cash asset impairment charges. The balance has been accrued to cover future cash payments related to workforce reductions and facility related shutdown expenses.

Income tax expense in this year’s third quarter was $900,000 including discrete tax items netting to $1.2 million tax benefit. The benefit of $2.8 million related to amending prior tax year returns to claim additional foreign tax credits were offset by true ups to the filing of the prior year tax returns and the expected outcome of the 2008 DRC tax audit related to GTL operations. Excluding the net discrete tax benefit, the effective tax rate for the current quarter would have been 21%.

On page five is a reconciliation of the company’s non-GAAP reporting of net income and income from continuing operations attributable to the company for the period shown. Excluding the income from discontinued operations the restructuring charge and the other items listed, income from continuing operations for the current quarter as adjusted for special items was $80 million or $0.58 per diluted share. This compares to the $3 million loss or $0.11 per diluted share in the second quarter of 2009.

On page seven and continuing on page eight are third quarter 2009 operating results for the Advanced Materials segment. Compared to the third quarter of 2008 lower selling prices of $106 million and lower volume of $35 million accounted for the majority of the decrease in net sales. Total unit volume was down by 17% as all end markets were impacted by lower demand. The largest end market battery was down 9%, also chemical was down 5% and powder metallurgy was down 55%.

Third quarter sales were up 22% from the second quarter primarily due to higher selling prices and volume growth in the battery end market. Compared to the second quarter of this year combined volume was relatively flat as improvements in all major end markets were offset by lower metal resale and copper by-product sales. Powder mill metallurgy was up 46%, battery was up 30% and chemical was up 4%. As you can see from the waterfall on page seven the key drivers for the drop of $29 million in the third quarter operating profit compared to last year’s third quarter is due to the impact from the large drop in the cobalt reference price had on product selling prices totaling to $42 million. And the negative volume impact of $15 million. This was offset somewhat by three major factors.

Reductions in spending of $14 million related product profit enhancement initiatives and lower sales, lower spending due to sales’ volumes. Lower process based material cost of $8 million and the loss on the cobalt forward purchase contract that was recorded in 2008.

On page nine and continuing on page 10 are the third quarter 2009 operating results for the Speciality Chemicals segment. Lower unit sales in all end markets had the biggest impact related to the decrease in net sales to $33 million. The largest sales decreases occurred in the Advanced Organics down $25 million and Electronic Chemicals business down $4 million. The 23% volume drop in the Advanced Organics was primarily related to weak market demand in coatings, and chemicals.

Lower demand in memory disks and printed circuit boards were the key reason for the 13% volume drop in electronic and chemicals. As you can see from the waterfall on page 9 the biggest impact on the third quarter operating profit compared to the prior year quarter was the restructuring charge of $11.9 million which I mentioned earlier.

Excluding that charge, operating profit would have been $13.6 million or $4 million improvement over the prior year quarter due primarily to the profit enhancement initiatives and reduced spending related to lower volume, totaling $6 million.

Third quarter sales were up 9% from the second quarter of 2009 due to stronger volume demand in Electronic Chemicals up 8% and Ultra Pure Chemicals up 2%.

Advanced Organics volumes were down slightly as increased demand in tire was offset primarily by lower demand in coatings and additives.

On page 11 is the summary of selected financial data and metrics for the quarter shown. The company finished the quarter with $300 million of cash on hand as the company continues to generate positive cash flow throughout the time period of this global economic downturn. During the third quarter of this year operating activities provided $37 million of cash bringing the year-to-date total to $105 million.

The majority of the increase on the current quarter cash was due to EBITDA excluding the restructuring charge. The reduction in networking capital for the current quarter was due to an $18 million increase in payables and a $5 million decrease in inventories offset by $14 million increase in receivables.

For the current quarter networking capital days decreased by 16 days. Also this was related to decrease in inventory days of 13 due to the sequential increase in sales in the third quarter. The combined impact of lower cobalt and reduced sales volume on the advanced materials working capital levels was the primary reason for the increase of 14 days and networking capital days over the prior year quarter.

This completes the review of the third quarter 2009 results. I will now turn it over to Steve. Thank you.

Stephen D. Dunmead

Thanks, Ken. First I will make some comments regarding the cobalt market. During the third quarter the cobalt markets strengthened somewhat with overall demand estimated to be up 10 to 15% versus the second quarter but down approximately 15% versus the prior year.

Cobalt prices moved in a fairly narrow range throughout the third quarter with the average up approximately $3 a pound versus the second quarter. Strengthening during Q3 was driven by modest improvements in demand across almost all key market sectors. Since the end of the quarter, cobalt prices have strengthened significantly up approximately $5 a pound over the past few weeks. Increase in demand from both consumers and the trade coupled with tight supply of certain grades of metal contributed to the recent price runoff.

Supply from new projects in the DRC continues to be slow to materialize. Additionally, any further increases in demand could push prices up significantly in the near term due primarily to tightness in metal availability.

After years of discussion and speculation the LME currently plans to begin trading cobalt during the first quarter of 2010. This move has brought significant interest from nine traditional market participants. There are lots of questions that remain in the market about whether or not this interest will result in actual buying, but if it does this would provide additional sources of demand.

Before I make any specific comments about are our key end markets, I want to make a few general remarks. Volumes in our markets were down between 10 and 20% versus the prior year with the electronic chemicals applications performing at the better end of the range. As expected however we continue to see sequential improvement in most of our key markets. We’re cautiously optimistic about the demand outlook for the balance of the year and into early 2010. The degree of visibility has certainly improved over the past six months but customers remained cautious regarding firm orders in the first quarter. The ramifications from excess inventory in early 2009 won’t soon be forgot.

Now I would like to cover some of the key end markets impacting our Advance Material segment. We saw solid improvement in overall non-resale cobalt volumes which exceeded the second quarter by 18%. Based upon current market conditions we should see another modest improvement in the fourth quarter with sales volumes approaching the Q4 ’08 levels. Rechargeable battery market continues to recover as a result of growing demand from notebook and netbook computers. Overall battery demand in the fourth quarter is expected to exceed ’08 levels. Our cobalt sales into this market increased 19% versus the second quarter due to a combination of further penetration into China and Korea, increase precursor sales and normal seasonality. That being said, large battery producers continue to work out excess inventory that was nearly built 2009.

In addition we continue to see substitution of lower cobalt containing chemistries in some applications. Consequently cobalt consumption in this space is expected to be above the modest 3 to 5% in the near-term. As we discussed during the second quarter conference call, There’s been a great deal of present speculations regarding the future electric and hybrid electric vehicle market. The Department Of Energy awarded 2.4 billion in funding to promote the development of U.S. manufacturing of batteries and components for electric vehicles. We continue to work with multiple awardees regarding the battery material supply chains. We finally started to see some improve demand in hard metal and diamond tool applications with volume up approximately 45% sequentially. While large tool producers continue to see their orders down approximately 40% compared to last year. De-stocking seems to finally come to an end.

Looking forward we expect to see modest recovery in restocking that should result in demand improvement and another 10 to 15% in the near-term. The chemicals market was our best performance sector with an Advance Materials. Sales volumes were at the highest level since the first quarter of 2008 with the main driver being petrochemical processing catalyst. It appears that refineries that have been delaying catalyst changeovers have hit a point where this maintenance is required. This strength should continue in the coming quarters with demand expected at levels approximately 10% higher than the previous year.

Now for a few comments on our key markets impacting our Specialty Chemical Segment. The state of the global economy continues to be negatively impact housing and construction. Volumes of our product serving these markets were down approximately 24% year-over-year and essentially flat versus the second quarter. Overall expectations are for slow recovery in both of these markets with normal seasonal downturn in the fourth quarter. As Ken said, global demand for tires has slowed significantly due to decreases in new car sales, miles driven and commercial truck traffic. Overall demand however, continued to build on the improvement in the second quarter. Sales volumes into this market were down approximately 8% year-over-year and we’re up 9% versus the prior quarter.

Full year OEM tire sales are expected to be down approximately 25 to 35% versus 2008. Most analysts are predicting a very slow recovery in the OEM market, with estimates of four to five years before we get back to the 2007 levels.

For the electronics related markets, Q3 continue to build on the momentum that we saw in Q2, with overall volumes now being down eight to 10% versus 2008. For our electronic plating chemicals, overall volumes were down 11% versus a strong third quarter of 2008, but up 11% sequentially.

Hard disk drive shipments were reported to be up 16% versus the second quarter, with 22% growth in glass substrates and 7% growth in aluminum. Our sales into this market were down 11% year-over-year, but up 15% versus the second quarter due to a combination of share gains and increased capacity utilization by our key customers. The market expected to be essentially flat for the balance of the year.

Printed circuit board market continued its recovery with most of the strength concentrated in Asia. Overall volumes were down approximately 7% year-over-year, but up 8% versus the second quarter. The sequential improvement was due to both the recovery and build-up for back-to-school and Christmas. For the fourth quarter we expect to see a slight decline in overall demand as some customers are beginning to talk about shutdowns over the holiday season.

The recovery in the semiconductor market began in the second quarter with Asia again leading the way. Our sales for the UPC business were down 9% year-over-year, but up 9% sequentially. We held on to the gains that we realized in Asia and saw substantial improvements in Europe versus a very weak first half of 2009.

Industry experts are calling for modest 3% improvement in demand in the fourth quarter. Most of our key customers are anticipating some softening in the first quarter as restocking comes to an end.

Photomask market is tied to capital spending and new device introductions in the semiconductor industry. Early in 2008 new devices weren’t being introduced because of the economic uncertainty and the need to conserve capital. Now the recovery and demand, coupled with the significant restructuring done in this industry in 2009 has resulted on fabs being too busy to work on new devices.

Our sales into the sector were down approximately 14% year-over-year, but up 2% sequentially.

At this point I’d like to turn the call back over to Joe Scaminace.

Joseph M. Scaminace

Thank you, Steve for your comments and Ken. At this time, let me turn the call over to the operator and we will be glad to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mike Harrison.

Michael Harrison - First Analysis

Hi, good morning.

Joseph M. Scaminace

Good morning, Mike.

Michael Harrison - First Analysis

Couple questions on batteries. Steve, you noted in your battery outlook that you expect to see a negative impact on demand related to substitution of lower cobalt containing materials. Obviously that’s a reference to some of the next generation lithium ion batteries that are using alternative cathode chemistries. But when we’ve talked about this previously, you seem to some extent to expect that that impact would be relatively small that the timing of it would be at least a few years off. And you also had highlighted it as an opportunity to move into other types of cathode materials, mixed metals is what you referred to. So I guess what I’m asking what should we make of this comment that you are making here today, is this substitution happening sooner than you anticipated, is it affecting a larger number of batteries? Are you getting less traction than you had hoped in terms of your own supply of mixed metal materials? Talk about that if you could?

Stephen D. Dunmead

Yes, part of the confusion may be that when I was talking about volume there I was talking about cobalt volumes. If you talked about total physical volume, the story is probably different because we are getting penetration in our mixed metal chemistries; as we have discussed before from our standpoint we are not sure that we really what the chemistries are because we know that the space is growing and that we want to continue to participate in it. And so the comments were simply that the overall battery market is going to be up but the combination of still some de-stocking happening at the lithium-ion battery producer level coupled with some fraction of substitution which I think is happening just about the way that we’d expected it to, ends up giving us about three to 5% increase in cobalt volume as opposed to growing at the same rate as the battery market is.

Joseph M. Scaminace

And Mike we are not worried about, you know, in terms of the cathode material that will be going into new battery applications, there is every indication that a lot of that cathode material will have cobalt contained in it. There are some technologies that are non-cobalt, you know iron phosphate for example, but you know in the current markets, you know, they all continue along with the same chemistry, I think we will continue to see you know when the market returns growth in portable electronics et cetera, and I think that’s probably combined with Steve’s answer hopefully filled that in for you.

Michael Harrison - First Analysis

Do you see like you are replacing what is being substituted out in some of the lower cobalt containing cathodes? Are you replacing that with mixed metal precursor sales?

Stephen D. Dunmead

Certainly if you look at total physical volume going out the door, the answer is yes.

Michael Harrison - First Analysis

Okay.

Stephen D. Dunmead

Probably more than just covering it.

Michael Harrison - First Analysis

And then I was also hoping that you could maybe remind us what the typical battery seasonality looks like around the holiday season and maybe how you expect – do you expect this year to be a typical year or do you expect this year to differ?

Stephen D. Dunmead

I’ll answer your last question first. I’m guessing that this year maybe slightly different than previous years because you got this inventory issue that we haven’t dealt with in most other years, typically, toward the end of the second quarter and in the third quarter, you’ve got a significant build up for back-to-school and Christmas. And so those are the strongest periods. If you took July-August in the third quarter, those are the strongest months of the quarter or of the year and then you do see some kind of a dip in the fourth quarter.

However, because we saw such weak demand early in the year, we are expecting that the volumes are going to hold pretty good in the fourth quarter in this particular market.

Michael Harrison - First Analysis

All right. And then I had a couple of questions around the specialty chemicals business and the much improved profitability there. In terms of the profitability, I know it sounds like the electronic chemical side of the business was better in terms of top line rebound but did the profitability reflect that as well, or was there improvement in the advanced organics profitability as well?

Kenneth Haber

No, that was driven – this is Ken, this is driven primarily from the electronic chemicals business certainly in the printed circuit board business certainly contributed to that part of the business relative to electronic chemicals.

Michael Harrison - First Analysis

All right. And pricing in there was only a small negative this quarter in the Specialty Chemicals business, should we expect that number to go positive year-over-year in Q4, as you demand firming and may be some of your raw material cost beginning to increase?

Kenneth Haber

Yeah, I would say that we should expect to see that some firming can put a dollar amount on it, but I think directionally you are correct in thinking that way.

Michael Harrison - First Analysis

All right. And were there any restructuring benefits related to the Advanced Organics restructuring program you announced to date, were there any benefits in this quarter?

Kenneth Haber

No, no, we won’t start seeing the benefits until, our plan is to wind this all down and have it all pretty much shutdown by the end of the second quarter 2010. So the significant benefits will start to appear in the second half of 2010. Some maybe going into the first, second quarter of next year but certainly majority will be realized in the second half of the 2010.

Michael Harrison - First Analysis

And when you finish that, how much do you expect to save annually?

Kenneth Haber

Well we are projecting right now that on approximately about $10 million is what we would – on an annualized basis is what our spending would be in that regard, certainly – we certainly expect this to, when we are done with this restructuring again at the end of the second quarter of next year, on an annual basis the improving offering profit would be accretive, the question there is how much business we retain from this – with this shutdown of the Clayton facility.

Michael Harrison - First Analysis

All right, thanks very much.

Kenneth Haber

You’re welcome.

Operator

Your next question comes from Rosemarie Morbelli.

Rosemarie Morbelli - Ingalls & Snyder

That would be Morbelli. Good morning all. Most of my questions actually have been answered but I do have some additional ones. During last conference calls, you talked about looking at the small profit in Q3 is coupled with the $17.50. And the result this quarter’s are substantially better than my interpretation of small profit. Other than the low cost inventory, what surprised you during the quarter or did you expect it to be a strong?

Joseph M. Scaminace

Well I think the reference that you’re referring to in the second quarter is when I was asked that, what’s our expectation for third quarter, we said certainly we saw – we expected improvement in profits, I am not sure we referenced any metal price to be honest with you, I don’t – we usually don’t do that so, in that regard but we certainly – we were somewhat surprised by the strength in the volumes that – and some of the traction that occurred certainly the increase in the metal price and also the cost savings came in a little stronger than we anticipated in that regard.

Rosemarie Morbelli - Ingalls & Snyder

Can you put a number on the cost savings?

Joseph M. Scaminace

Well in the third quarter, from operations, it’s about $14 million combined and that’s between profit enhancements and what we are spending driven by our lower volume – and that’s a year-over-year number in that regard. And that’s from operations.

Rosemarie Morbelli - Ingalls & Snyder

Okay. So now with – let’s assume that the cobalt – let’s assume that the cobalt stays around $20 for the balance of the fourth quarter, this is more or less where it was last year and you lost $0.88. Do you – are your savings going to be higher than the $14 million you benefited from in the third quarter? And thus should we expect a sequential quarter now, more or less similar to the third quarter in terms of profits?

Joseph M. Scaminace

Well, let me talk about sequentially from – looking forward through the fourth quarter of this year. I think that there’s certainly more – it’s a story of two cities, actually, because if you look at advanced materials, the – given that the volumes will continue to stay at the recent levels and with the increase in the pricing that we’re seeing right now, and again we all know that can easily change the other way. But I would say that given the higher pricing on average for the fourth quarter, there’s certainly upward, more positive upward on the earnings than there is downward relative to advanced materials. So I would expect – we would expect to see an improvement in advanced materials earnings in the fourth quarter over the third quarter of this year.

Rosemarie Morbelli - Ingalls & Snyder

Okay, and in your other categories?

Joseph M. Scaminace

And then with regard to especially chemicals, certainly the volumes are usually seasonally traditionally lower, and so we would expect to see some decrease in their profits in the fourth quarter relative to the fourth quarter of this year.

As far as referring to last year, I think you have to remember there were some LCM charges that we took and also the price was on a decline throughout the fourth quarter of last year, where this year that’s not the case.

Rosemarie Morbelli - Ingalls & Snyder

Okay, right. So at this stage, how long of low-cost inventory – that’s right, you did adjust that inventory recently. How long of a supply of low cost inventory do you think you’ll have? Can it take you through two, three quarters? Is it only enough for the fourth quarter? Can you give a figure for that?

Joseph M. Scaminace

Well, first off, we didn’t take a charge recently. That was again an inventory charge that we took in the fourth quarter of last year. Second –

Rosemarie Morbelli - Ingalls & Snyder

I was referring to the mark-to-market.

Joseph M. Scaminace

That’s what I’m referring to, mark-to-market for lower cost to market for inventory, that charge was recorded in the fourth quarter of last year, relative to the significant drop in the metal prices. Our supply line, as we always said before, has always been somewhere in that 4 to 6 month period. So – and our costs are reflective of the current market pricing that we’ve seen over the last few quarters.

Stephen D. Dunmead

This is Steve. I think I would add that we’ve only seen a run – an increase over the course of the past three or four weeks in cobalt prices. So to refer to us having an inventory of low cost cobalt I think would be an error. If we’re sitting here three months from now and cobalt prices have continued to run up, we may be having that conversation. But I think it would be preliminary to have that conversation today.

Rosemarie Morbelli - Ingalls & Snyder

Okay, I appreciate that. And just one quick question, as you are taking capacity in advanced organic out of Europe, are you planning an increasing capacity in Asia or do you have enough to serve a growing market there?

Stephen D. Dunmead

This is Steve. Certainly we are looking at what the opportunities may be in Asia, and we’ve honestly been doing that for about a year. The problem is that we want to make sure that if we do anything in Asia that we are not just simply putting over capacity in Asia. And so at this point in time as you know all of our sales that are going into Asia out of the Advanced Organics business, which is mostly rubber adhesion promoters, it was either manufactured in the US and Franklin, Pennsylvania or out of the Clayton facility. And so we are looking at it, but there’s pretty high hurdle rate associated with whether or not we would be doing something in Advanced Organics in Asia at this point.

Joseph M. Scaminace

And really the other comment that I have made earlier is that the field has gotten pretty crowded in this rubber adhesion promoter market and there’s more competitors there. And we have actually we have switched over in the – with the weakness of the coatings markets in Advanced Organics our Borchers acquisition has afforded a different technology to go after more of the water borne technology. Part of the weakness in the coatings industry and which causes us restructuring was the decline in demand in addition to decline in demand for alkaline coatings or oil-based coatings. And that’s where a lot of our product line was going.

Rosemarie Morbelli - Ingalls & Snyder

Okay, thanks I appreciate it.

Operator

Your next question comes from the line of Saul Ludwig.

Saul Ludwig - KeyBanc Capital Markets

Hey good morning guys.

Joseph M. Scaminace

Good morning Saul.

Kenneth Haber

Good morning.

Saul Ludwig - KeyBanc Capital Markets

These are cost cuts that you benefited 14 million in advanced materials and what you say six or so in electronic chemicals, some of those are probably permanent eliminations of fixed costs and others maybe what we will call emergency tactical cost cuts, to what degree are those going to sort of come back where you reinstate salary increases, you reinstate hiring some positions that were maybe eliminated, there are travel issues. How do you see that going as we move through the fourth quarter and into next year? The sustainability of the cost cuts.

Kenneth Haber

Yeah, I would say that we believe that somewhere around 40% or so is sustainable in that regard, so the rest of it will come back as volumes pick up in that regard. Certainly we have worked very hard to get costs out of our operations so we are going to be very careful not to let things come back as quickly, but certainly we are not going to jeopardize our business and the opportunities to support the volume growth as it starts to come back. Also I just want to say that the numbers you quoted I think let me just clarify I think 14 million was in combined in operations from both segments and another six million of SG&A expense again from both segments so totaling about $20 million in the thirds quarter compared to the prior year quarter from both the segments contribute to this.

Saul Ludwig - KeyBanc Capital Markets

Got you. Ken, in the quarter a couple of numbers relative to GTL by itself on its books what were its pre-tax and tax effect? That’s one question. And then on OMG’s consolidated books how much of pre-tax earnings were taken in as income related to GTL operations but they get deferred before they hit your books?

Kenneth Haber

Okay, first to answer to first question Saul is operating profit was a loss of 300,000 in the quarter,they had some other expenses so total pre-tax income for the joint venture was $0.5 million. And then so their share of that was about 250,000 or so – 200,000 and then there were some discrete tax items that were also booked in the third quarter and heir share of that was about 250,000 or so 200,000 and there were discrete some tax – discrete tax items that were also booked in the third quarter. And their share of that was about another 200,000. So…..

Saul Ludwig - KeyBanc Capital Markets

What do you mean by their share? I just thought theirs is 100% of theirs. GTL as a total entity – in other words, the 0.5 million is GTL’s 100% pre-tax loss.

Kenneth Haber

Right. Right. And their share of that was 45%.

Saul Ludwig - KeyBanc Capital Markets

Right.

Kenneth Haber

Then 200,000 and there was tax expense, discrete tax expenses that were booked in the third quarter, their share of that was about 45% so additional 200,000 associate with the minority interest. So, 200,000 from operations and 200,000 of tax expense – tax discrete expense. Total is $400,000 that you see on our consolidated P&L attributed all to the minority interest.

Saul Ludwig - KeyBanc Capital Markets

400,000 minority interest. Got you. Okay. And then….

Kenneth Haber

As far as your second question, it was very minimal flow through at all.

Saul Ludwig - KeyBanc Capital Markets

I should be zero.

Kenneth Haber

Practically nothing – yes, you can call it zero.

Saul Ludwig - KeyBanc Capital Markets

Okay, is that like that it would be case going forward?

Kenneth Haber

Which case?

Saul Ludwig - KeyBanc Capital Markets

That it’s likely to be maybe some contributions or...?

Kenneth Haber

Yes. In the fourth quarter, yes.

Saul Ludwig - KeyBanc Capital Markets

Right. And then the next question I have is, will you look at your earnings improvement from the second quarter to the third quarter in advanced materials where you went up by about $11 million, right from five million to 16 million?

Kenneth Haber

Right.

Saul Ludwig - KeyBanc Capital Markets

If everything were the same – you didn’t have, your cost structure was the same and your volume was the same and the only thing that changed was cobalt price, moved up $3. How much of that 11 million would have been explained merely because cobalt price went up, I guess some portion of course relates to volume and operational excellence. What would have been the effect just because you got help from the cobalt price?

Kenneth Haber

Certainly there’s going to be a benefit. As we’ve always said, of course, again it’s going to depend on the movement of our raw material cost.

Saul Ludwig - KeyBanc Capital Markets

No, from the third to the fourth quarter.

Kenneth Haber

Third to fourth, okay. So, …

Saul Ludwig - KeyBanc Capital Markets

Second to third.

Kenneth Haber

Okay.

Saul Ludwig - KeyBanc Capital Markets

Everything is the same. In the third quarter, it’s the second only different being cobalt price.

Kenneth Haber

Three to four million approximately.

Saul Ludwig - KeyBanc Capital Markets

Okay. And then finally, the product that you’re taking out of Cokala does that mean that Cokala will now only be a cobalt producer rather than a product producer which had taken cobalt and upgraded it?

Stephen D. Dunmead

Saul, the only thing that we are shutting down in Cokala is the Advanced Organics specialty chemicals manufacturing and honestly it was a fairly small operation 10 or 12 people and so the impact on Cokala is going to minimum.

Joseph M. Scaminace

Yes, the vast – so the vast majority of Cokala business remain unchanged, the Advanced Organics production was taking place in a building onsite there that is basically shut down.

Saul Ludwig - KeyBanc Capital Markets

And then finally, I know it might be great to comment – it’s been a couple of years now, I try and put some of this cash to work to start to move toward the strategic direction that, Joe, you [indiscernible] and using the electronics business [indiscernible] to become more important for us and that segment. What’s the deal flow look now, what’s it’s like now? It looks like we see in general sense some more activity in the M&A area broadly speaking. Are you getting any warmer or how do you see the strategy playing out as we look through 2010?

Joseph M. Scaminace

Saul, let me start by answering that and then Greg could help drill down a little bit by filling some blanks. But let me start off by saying clearly, when you look at our financial strength right now and the cash we have on hand, we have become sort of a beacon therefore and banks and investment firms that are bringing a lot of ideas to the table to us.

Some of these ideas are very appropriate. Some of them probably are a little bit of a reach for us. But we continue to look at every one of them. And I would tell you that the deal flow is good. And we are out there picking the tires on numerous opportunities. But I will tell you that the gap between buyer and seller is still there.

And if I had to best describe the valuation gap, it’s that buyers like us are continuing to try to be as prudent as we can while balancing that against our strategic needs. And in our prudence, we like to look at last 12 month results, consider the fact that the level of business today could be the new normal. We don’t when we’ll go back to 2007 levels.

So when we are out there, we are asking a lot of questions and being very diligent. On the other hand the sellers are saying, well, wait a minute, you ought to look back at the five year results and the average EBITDA that we have experienced and pay us that kind of value.

So the deal flow – if you look at the deal flow around the world, it’s been low. But we are seeing signs where credit markets are freeing up, deal flow is freeing up. And we remain very active. And now I’ll let Greg fill in some of the blanks in terms of what else is going on here.

Gregory J. Griffith

Well, Joe, you didn’t leave many blanks to fill in. So I would only underscore that over that two year timeframe, Saul, that you referred to credit markets literally shut down and so there was a period there in which every opportunity in markets were receiving a different level of scrutiny.

I would say today with the uptick that we have seen in the third quarter and a more positive view for the second half of ’09 and some optimism leading into 2010 that the valuation gap that Joe just referred to is not narrowing, it’s widening.

And then lastly, there is always pressure on us to – for those deal that have been done, there was a high synergy component from a strategic standpoint and the things that we are looking at, we are still looking to find those opportunities that fit the strategy of which there are numerous opportunities to look at.

And then we also then measure the synergies against the fit of our strategy. And so we’ve got a lense that we look at that’s pretty rigorous. And so we just continue to drive our process with the kind of discipline that Joe has imposed on that process.

Saul Ludwig - KeyBanc Capital Markets

I think discipline – that’s great. I mean you shouldn’t compromise those at all. If another year goes by and you build a little more cash and let’s just say you haven’t been able to negotiate what you believe is a fair deal, what do you think doing with that cash, Joe?

Joseph M. Scaminace

I think we’re going to have to look at it at that time. I mean it’s very – it’d be very difficult for us to say right now what we’ll do a year from now given the cash. We’d – there’s a lot of variables between now and then. And there is a lot of bigger deals and smaller deals that we have always talked about bolt-ons. And certainly we are active on the bolt-on front. But it’s very difficult to say.

Gregory J. Griffith

Well, then there’s one more thing. So when you take a look at the year out, there’s a pretty significant credit cliff in that 2012 timeframe so that there’s also an expectation as a lot of the over leveraged portfolio companies consider their options relative to thatcliff. There’s also an expectation that the opportunities continue to increase, not diminish. And so that I think it would be premature at this juncture to look the year out and assume that we are not able to find the right deal because I think the opportunities continue to increase, not diminish.

Saul Ludwig - KeyBanc Capital Markets

And then finally I assume you would be planning for next year to use some of that cash and working capital to reassume particular if cobalt prices stay high. Should we assume you could use, I don’t know, 25, 50 million, $75 million in working capital next year?

Kenneth Haber

I can’t state specifically the dollars but certainly I would say listen, that is working capital would – we would use some of our cash to support the buildup in cash but also don’t forget if the prices are going to be rising, we are going to be generating stronger operating profit and that’s going tooffset that to some degree.

So, it’s going to be again a degree. It’s a question of how quickly the change in the metal price moves in that regard.

Saul Ludwig - KeyBanc Capital Markets

Okay, thank you very much, guys.

Joseph M. Scaminace

Thank you, Saul.

Gregory J. Griffith

Thanks, Saul.

Operator

Your next question comes from the line of Mike Harrison.

Michael Harrison - First Analysis

Hi, just a couple of additional ones for you. You gave some comments on powder metallurgy expectations for next quarter but I was wondering if you could comment at all on the longer-term health of your customers in that business. You mentioned less destocking. Do you have any sense of when the order patterns might return to some sense of normal?

Stephen D. Dunmead

Yeah, Mike, this is Steve. As I think I’ve said either in the first quarter conference call or probably the second that the – actually the length of time that this destocking went on quite honestly midway through the year surprised us because this market is so heavily tied to automotive mining and construction especially the automotive, I am not looking to return to the 2007 levels for a couple of years.

Joseph M. Scaminace

Mike, let me answer that because you asked about the health of the customers. With the exception of one of the large players, I think the structure of the industry is pretty strong. They could weather the storm and – there’re not a lot of big producers out there. There’s very large Swedish producer, there’s a North American producer and another one in Luxemburg. Again, I will tell you that these companies, their business is related to, as Steve says, to the strength of industrial production. So the answer to the question is that global industrial production wherever it occurs, because these are global companies and we’re supplying metallurgy on a much global basis, so you can’t look at U.S. industrial production only. As Chinese production picks up, as Australian mining operations pick up, as African mining operations pick up, we think that this business will get stronger. Right now it’s in trough because of automotive and industrial production being down.

Michael Harrison - First Analysis

All right, I appreciate the additional color there. I was wondering if maybe you could – can you do the same thing in terms of additional detail on what’s driving the refinery catalysts demand. It sounds like that’s really been a strong business for you.

Stephen D. Dunmead

Yes, as I said in my comments that I think that the strength that we have seen over the past couple of quarters has been driven by the fact that refineries are running and they are running at a pretty good clip. But secondly the recent strength is due to the fact that this maintenance they have been delaying, changing out the catalysts to conserve cash and you can’t continue to do that forever and they are now being forced to change out those catalysts and so we have seen a significant uptick in that amount of demand and as I said in my comments we are operating and that’s the only market I think that we are operating higher than we were at the beginning of 2008.

Michael Harrison - First Analysis

And do you have any sense for how long that could last, I mean obviously if it’s sort of pent-up demand this is probably more of a temporary phenomenon than something that’s going to be sustainable?

Stephen D. Dunmead

Certainly over the course of the next three quarters, we are looking at pretty strong performance in this business.

Michael Harrison - First Analysis

Okay. And then a couple of questions, just housekeeping related, the tax rate for next quarter in 2010, any guidance there?

Kenneth Haber

Well, I would say that – I would about 25%, the 30% would be the number I would be looking at for the third quarter again as we, I mean sorry the fourth quarter that will be for the full year then and again I have to, as usual which usually does happen we always chew that up in the fourth quarter for the full year tax effect and as I said before I think going into 2010 again is going to depend on the mix of profits relative to different tax jurisdictions decisions but from a starting point I would go with 25% plus or minus, you know, 5% or so. It can be volatile because of where our earnings are and the mix of those earnings.

Michael Harrison - First Analysis

I understand that but I appreciate that. All right, that’s it from me. Thanks guys.

Joseph M. Scaminace

Thanks Mike.

Stephen D. Dunmead

Thank you Mike.

Joseph M. Scaminace

Okay, I will close by just saying that today’s economic environment is much improved compared with earlier this year and we are excited because demand is firming somewhat and confidence is slowly returning. However, we are not yet lowering the alert flag and we are remaining vigilant and preserving our financial strength and our healthy balance sheet, both of which will be critical to our stability and ability to create steadily increasing value for our shareholders over the long term. So I want to thank all of you again for your time this morning and your ongoing interest in OEM group.

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Source: OM Group, Inc. Q3 2009 Earnings Call Transcript

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