Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

OM Group, Inc. (NYSE:OMG)

Q4 2009 Earnings Call Transcript

February 25, 2010 10:00 am ET

Executives

Troy Dewar – IR

Joe Scaminace – Chairman and CEO

Ken Haber – CFO

Steve Dunmead – VP and General Manager, Specialties

Greg Griffith – VP, Strategic Planning, Development and IR

Analysts

Saul Ludwig – KeyBanc Capital Markets

Mike Harrison – First Analysis Securities

Rosemarie Morbelli – Ingalls & Snyder

Chris Hatch [ph]

Operator

Good morning. My name is Tracy, and I will be your conference operator today. At this time I would like to welcome everyone to the fourth quarter 2009 year end results conference call. (Operator instructions) Mr. Dewar, you may begin your conference.

Troy Dewar

Thank you Tracy. Good morning, everyone and welcome to our review of OM Group's 2009 fourth quarter results. Joining me this morning are Joe Scaminace, Chairman and Chief Executive Officer; Ken Haber, Chief Financial Officer; Steve Dunmead, Vice-President and General Manager Specialties; and Greg Griffith, Vice-President Strategic Planning Development and Investor Relations.

The copy of the press release was issued earlier this morning, as well as the presentation materials that accompany our discussion can be found on the investor relations' portion of our website at investor.OMGI.com. As a reminder, comments made this morning by any of the participants on the call may include forward-looking statements based upon specific assumptions and subjects to uncertainties 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 our press release or in our Form 10-K and applies to this call. At this time I will turn the call over to Joe Scaminace.

Joe Scaminace

Thank you, Troy, and good morning, everyone. Before I turn the call over to Ken Haber, I would like to share my perspective on 2009 and also look ahead to 2010. Like many global companies we faced difficult business conditions last year. While these challenges tested our ability to grow, we were able to create momentum for our company by aggressively managing the things within our control.

This momentum took many forms. For example, volumes grew in the fourth quarter as end market demand improved and businesses replenished their inventories. All of our business units achieved higher volumes in the second half of the year compared with the first half. This was particularly true in our electronic technologies business where volumes in electronic chemicals were up 31%. Additionally volumes in Ultra Pure Chemicals increased 14%. These volumes, coupled with improving cobalt price, resulted in sequential revenue growth in the fourth quarter and in the second half of the year.

Improving cobalt supply demand fundamentals contributed to an average cobalt price in the second half of the year that was 28% higher than the first half. As a result, our second half revenues were 21% higher than those recorded in the first half of the year. Operating profit rebounded nicely. While margins were pressured in the first half of the year by a drop in volume, and falling cobalt prices, we saw double digit operating margins in the second half of the year, excluding restructuring charges.

These margin improvements were certainly helped by our profit enhancement initiatives and cost reductions. Also despite the macro-economic challenges, cash from operations continued to be a positive story. Cash provided by operations in the second half of 2009 was up 45% from the first half of the year. We generated positive cash flow from operations for the last seven quarters. This is a real testament to our working capital management and operational excellence initiatives.

So, in 2009 we were able to protect our margins and optimize our cash flow from operations. And we did this without sacrificing the quality of our products or our ability to satisfy our customer's needs. I'm very proud of the effort made by all of our associates at every level of this organization to identify these opportunities but more importantly to act on them.

As I look ahead at 2010, I'm confident in our ability to manage what's in our control. Even in the face of continuing uncertainty about the strength and duration of the economic recovery. Therefore, we will continue to be vigilant in maintaining a low and variable cost structure during what will likely be a slow recovery in end market demand throughout the remainder of this year.

Our lower cost structure will help us maintain our margins and our overall financial strength, particularly our ability to self-fund growth through strong free cash flow. There is no doubt that we were severely tested in 2009. And we still came through this with positive profit after some of our adjustments and strong cash flow. I'm optimistic that our results going forward will be stronger as these conditions improve.

My enthusiasm for 2010 and beyond is also a result of our recently announced acquisition of EaglePicher Technologies. This well-known company is a manufacturer and designer of batteries, battery systems, and energetic devices. Let me share a few thoughts with you about this acquisition. First, as you know we have been working diligently over the last several years to transform OM Group's business model and focus on two growth platforms, electronic chemicals and portable power. This acquisition will accelerate this transformation by giving us a bird's eye view of the latest developments in portable power and more specifically lithium ion batteries.

Gaining in end market perspective brings us a view-point that will allow us to advance our development of battery materials and technologies with the uniquely integrated supply chain. Second, EaglePicher adds to our business portfolio a longstanding market leader in several stable markets such as defense and aerospace. In addition to this, they participate in high growth markets with very strong growth potential in medical and alternative energy.

EaglePicher is a profitable company with a good base business, a record of growing earnings that are not subject to commodity prices. Also, the company brings broad R&D and technical expertise in battery chemistries, which will be critical to our growth in battery and battery material applications. They offer differentiated and specialized products and they are recognized as leaders in the markets they serve.

By collaborating with our Advanced Materials battery business we will be able to offer differentiated solutions to the portable power industry. EaglePicher is the right fit for OM Group. It's profitable, it is growing and they have leadership positions in attractive end markets. Now let me be clear on an important point for all of you to consider. This addition does not complete our transformation. It certainly is a meaningful step in the right direction. We will build upon this profitable company through product innovations and additional acquisitions. I will now turn the call over to Ken Haber to walk you through the details of our financial performance.

Ken Haber

Thank you, Joe, and good morning to everyone listening. I will begin with a review of the company's fourth quarter 2009 results followed by a review of the full year results. Please refer to the presentation materials from our website and turn to page three and four.

Revenue fell 19% to $241 million in the fourth quarter compared with $297 million last year. The key driver for this was the decrease in Advanced Materials pricing, which was impacted by the lower average cobalt price. Slightly lower volume sales in Advanced Materials were offset by higher combined volume sales in Specialty Chemicals, especially in the electronic chemicals end market of printed circuit boards and memory disks.

Excluding the inventory charge of $27 million and goodwill impairment charge of $9 million from last year's fourth quarter results, operating profit would have been a loss of $10 million compared to $29 million profit in the fourth quarter of this year. Improved margins in Advanced Materials due to lower raw material fee costs combined with improved end market demand and favorable pricing in Specialty Chemicals, along with profit enhancements contributed to the turnaround in profitability.

Income tax expense in this year's fourth quarter was $14 million, including discreet tax items totaling $6 million. These discreet items relate primarily to repatriation of foreign earnings and tax matters in the DRC related to the GTL joint venture. Excluding the discreet tax items, the effective tax rate for the quarter would have been 30%. 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 loss from discontinued operations and the special items listed, income from continuing operations for the current quarter as adjusted was $20 million or $0.66 per diluted share. This compares to the $46 million loss or $1.51 per diluted share in the fourth quarter of 2008.

On page seven and continuing on page eight are the fourth quarter 2009 operating results for the Advanced Materials segment. Compared to the fourth quarter of 2008, lower selling prices of $51 million accounted for the majority of the decrease and net sales. Total unit volume was up 3% driven by increased demand in all end markets except for powder metallurgy, which was down 17%. The largest end market, battery materials was up 4%. Chemicals was up 19% and ceramic was up 57% on a small base.

As you can see from the waterfall on page seven, the key drivers for the year-over-year improvement of $42 million, including the $20 million inventory charge are the favorable impact of lower raw material, fee cost, profit enhancement initiatives and lower process base material costs. These were partially offset by foreign currency and other items.

Fourth quarter net sales were up 5% from the third quarter primarily due slightly higher selling prices offset somewhat by a decline in total volume. Compared to the third quarter of this year combined volume was down 5%. Excluding metal resale and copper byproduct sales volumes were up 5% with powder metallurgy up 25%, and battery materials up 2%.

On page nine and continuing on page 10 are the fourth quarter 2009 operating results for the specialty chemical segment. Year-over-year increase in sales was primarily due to the strong demand in electronic chemicals end markets of printed circuit boards and memory disks. Electronic chemical sales were up $9 million on increased unit volume of over 47% from a weak prior year quarter with the two largest end markets memory disk up 100% and apprentice printed circuit boards up 17%. This revenue growth was offset by lower sales in the advanced organics end markets of coatings and chemicals and lower pricing in the Photomasks business.

As you can see from the waterfall on page nine, including the $7 million inventory charge and the goodwill impairment charge of $9 million recorded in the prior year quarter, the key drivers for the year-over-year improvement of $30 million were favorable volume and pricing and the benefit from the profit enhancement initiatives and reduced spending.

Fourth quarter sales were flat from the third quarter of 2009 due to stronger volume demand in electronic chemicals up 14% and Ultra Pure Chemicals up 2% that was offset by seasonally lower demand in specific end markets served by advanced organics. On page 11 is a summary of selected financial data and metrics for the quarter shown. The company finished the year with $355 million of cash on hand as the company continued to generate positive cash flow for the seventh consecutive quarter.

During the fourth quarter of this year operating activities provided $61 million of cash bringing the year-to-date total to $165 million. Majority of the increase in the current quarter cash was due to EBITDA of $42 million and net reduction in working capital of $17 million. The reduction in net working capital in the current quarter was due to a $39 million increase in payables and a $2 million decrease in receivables offset by a $24 million increase in inventories.

During the current quarter networking capital days decreased by 13 days. Most of this was related to an increase in payable days of seven days due in part to timing of scheduled payments. Inventories were down eight days and receivables were up two days reflecting the sequential increase in sales. This completes the review of the fourth quarter 2009 results.

Turning now to the full year results and beginning with the consolidated results for 2009, as shown on pages 14 and 15. Net sales decreased $865 million or 50% of which 83% of that decline occurred in the Advanced Materials segment totaling $720 million. Volume declines in both segments of the company driven by weak end market demand and customer destocking contributed $230 million to the reduction in sales. The largest single contributor to the lower net sales was $400 million decrease in selling prices in the Advanced Materials segment related to the lower average cobalt reference price in 2009 versus 2008.

As you can see from the operating profit waterfall on page 15, the consequences of lower prices totaling $156 million, almost all of it occurring in the Advanced Materials segment was the biggest reason for the decline in 2009 profits. The impact from lower volumes totaling $89 million was partially offset by the profit enhancement initiatives that were implemented by our people and lower spending across all the businesses and functions of the company.

Income tax expense for 2009 was $21 million, including discreet tax items totaling $10 million. The discreet items relate to those matters that were previously reported in the first three quarters of this year, along with the fourth quarter items totaling $6 million that I mentioned in my earlier remarks. Excluding the discreet tax items, the effective tax rate for the year would have been 28% based on a pre-tax income adjusted for impairment charges that are not deductible for taxes.

On page 16 is the reconciliation of the company's non-GAAP reporting of net income and income from continuing operations attributable to the company for the years 2009 and 2008. Excluding the income from discontinued operations and the special items listed, income from continuing operations for 2009 as adjusted was $32 million or $1.06 per diluted share. This compares to the $99 million or $3.26 per diluted share for 2008.

On pages 18 and 19 are the 2009 operating results for the Advanced Materials segment. Besides the impact of lower prices on net sales, the volume impact was driven by lower demand in all key end markets, battery materials was down 11%, chemicals was down 6%, and powder metallurgy was down 55%. As you can see from the operating profit waterfall, the profit enhancement initiatives, lower spending and the 2008 inventory charge at $21 million offset the impact from lower volumes. However, there was no way that we were able to offset the huge impact of lower pricing totaling $157 million.

On pages 20 and 21 are the 2009 operating results for the specialty chemical segment. The key drivers behind the $108 million volume impact on net sales was advanced organics and electronic chemicals, which experienced declines of 25% and 20% respectively. Excluding the goodwill impairment charges from both years and restructuring charges related to the advanced organics business, this segment recorded $4 million increase in their operating profit. This was a result again of the successful implementation of profit enhancement initiatives, and controlling spending throughout the year. This completes the review of the 2009 results.

I will now turn it over to Steve. Thank you.

Steve Dunmead

Thanks, Ken. First I'll make some comments regarding the cobalt market. During the fourth quarter the cobalt market strengthened somewhat with overall demand estimated to be up 5% versus Q3, but still down approximately 10% versus the prior year. Cobalt prices ranged from $15 to $20 a pound with the quarterly average of $18.35 trending to the highest point in 2009.

The strength in the market was a combination of a modest increase in demand coupled with continued limited availability. Cobalt prices continued to strengthen at the start of 2010 increasing to approximately $20 to $25 a pound in late January. Since then, prices have drifted lower and currently stand at approximately $18.50 a pound. Supply from new projects in the DRC continues to slowly materialize. The market anticipates a few large projects bringing additional supply in the second half of 2010.

Demand has improved versus 2009, but consumers are still cautious. As we have noted over the past 12 months, the cobalt market has historically operated on various grades on forms of metal. The market is very tight in those forms used in super alloy, magnet and chemical applications. After years of discussions and speculation, cobalt began trading on the LME on Monday. This move has brought significant interest from nontraditional market participants. It is yet to be seen, however, if this will translate into actual purchases.

It is clear, however that the trading on the LME will dominate the cobalt conversation over the coming months. Before I make any specific remarks about our key end markets, I want to make a couple of general comments. Volumes in our markets were down between 10% and 20% versus the prior year. For the fourth quarter in general we held on to the market improvements that we have seen in the second and third quarters. We are cautiously optimistic about the demand outlook for the first half of 2010.

The degree of visibility is certainly improved over the past six months but does not extend yet into the second half of 2010. Customers remain cautious as the wounds from excess inventory in 2009 won't soon be forgotten. Now I would like to cover some of the key end use markets impacting our Advanced Materials segment. Overall non-resale cobalt volumes held on to the gains made in Q3 and were essentially flat versus the prior quarter and the prior year. Based upon current market conditions we expect first half volumes to be up approximately 8% to 10% from 2009 levels.

The battery materials market held on to the Q3 gains as result of improved demand for consumer electronics and hybrid electric vehicles. In addition, we continue to see substitution of lower cobalt containing chemistries in some applications. Due to timing of shipments, Q4 cobalt sales ended this market were down approximately 8% versus a strong Q4 '08. Looking forward, we expect to see a modest 3% to 5% increase in cobalt volume as we continue to make market penetration with our cobalt and mixed metal precursors and our solid position in performance enhancing cobalt additives for nickel metal hydrate HEV batteries.

The powder metallurgy market continued to recover with volumes up approximately 25% sequentially. Tool producers who have reduced stocks at very low levels have been placing rush orders as they bring idle plants back online and furloughed operators back to work. Looking forward first half volumes are expected to be up approximately 70% to 80% versus the 2009 average, but still approximately 25% off of the peak in 2008.

During the fourth quarter, the chemical market continued to be our strongest performing sector within Advanced Materials. Cobalt sales were essentially flat versus the strong Q3 and up 26% versus the prior year. The main driver for Q4 was petrochemical processing catalyst changeovers. Looking forward a modest 3% to 5% improvement in overall cobalt volume over a solid 2009 is expected with the drivers being hydrodesulfurization in gas to liquid.

Now for a few comments on the key markets impacting our Specialty Chemicals segment. The general consensus is that there is limited further downside in the housing and construction markets with some signs of gradual improvement. In the fourth quarter, volumes of our coatings and chemicals products serving these markets were down approximately 14% year-over-year and essentially flat versus the third quarter. These markets should see some seasonal upturn in the first half 2010 of approximately 5%.

It should be noted however, that there is still significant uncertainty regarding the timing of any recovery in commercial construction. Global demand for tires have stabilized at new levels well below those seen in 2007. As we have said previously, this is being driven by decreased new car sales, miles driven and commercial truck traffic. On a relative basis the strength in this market is coming out of Asia due to the production shifts and regional growth.

Sales volumes into this market were up approximately 70% versus a very weak Q4 '08, but were down approximately 9% versus Q3. We expect to see continued slow recovery in this market. The recovery in the semiconductor market, which began in Q2, continued into the fourth quarter. The overall market ended the year with volumes down approximately 9% versus 2008, far better than the dire predictions earlier in the year. Our sales for the UPC business were essentially flat year-over-year and up 2% sequentially.

We held on to the gains that we have seen in Asia and saw steady improvement in Europe and the US. Industry experts are currently calling for growth in the 12% to 15% range for 2010. For the electronic chemicals related markets, Q4 continued to build on the momentum that we have seen in Q2 and Q3. Overall volumes of electronic plating chemicals were up 47% versus the prior year and up 14% sequentially.

Hard disk drive shipments were reported to be up 5% versus Q3. Our sales into this market were up 100% year-over-year and up 24% versus Q3 due to share gains and increased capacity utilization by our key customers. While the overall market is expected to be essentially flat versus Q4, our volumes are expected to be up approximately 10%.

The printed circuit board market held on to the improvements seen over the past two quarters. Overall volumes were up 17% year-over-year and essentially flat versus Q3. Industry analysts are calling for a 7% to 10% increase in overall PCB volume in 2010. Due to strength coming from Chinese LCD and notebook PC manufacturers, we expect to see a much less significant normal seasonal downturn in Q1.

Our overall outlook for the first half of 2010 is for demand to be up approximately 8% to 10% versus the Q4 levels. At this point I would like to turn the call back over to Joe Scaminace.

Joe Scaminace

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

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Saul Ludwig.

Saul Ludwig - KeyBanc Capital Markets

Good morning. Great fourth quarter. Congratulations. Steve, when you look at the outlook for batteries and then you talk about lower cobalt containing materials, what would you say the outlook -- maybe you said this and I didn't get it down straight. What was the outlook for the total market growth for let's say battery material. And then because of the lower cobalt containing product what would be the outlook for cobalt demand?

Steve Dunmead

The overall battery market, if you looked at cell unit volume of cell growth is probably going to be in that 10% to 12% to 14% range. And I think I said in my comments that we were expecting a modest increase in cobalt volume into that market of on the range of 3% to 5%.

Saul Ludwig - KeyBanc Capital Markets

And that considers. When you use the lower cobalt containing materials, is the product efficacy the same or does the user of the lower cobalt contain mixtures, yet less efficacy?

Steve Dunmead

It depends on the application, Saul. In some cases straight lithium cobalt dioxide is the preferred cathode material. In other cases where maybe they are balancing rechargeability and safety a mixed metal containing say nickel, and manganese and cobalt might be preferred. As we stated before, we are participating in that mixed metal chemistries also.

Joe Scaminace

So, the one thing that I will tell you, from everything that we could glean, is that the cobalt contained in the newer higher end products clearly are continuing to grow. For example, the new notebooks out there, these net books, the new phones that require significant powering, are continuing to use greater amounts of cobalt. And generally speaking the lower end-type applications are probably formulating more away from the higher cobalt contents. Still using some, but I think that's really what we were referring to on that basis.

Saul Ludwig - KeyBanc Capital Markets

Okay. Can you talk about the cost savings that you achieved from your, you know your management actions to reduce your cost structure?

Steve Dunmead

Sure. I mean…

Saul Ludwig - KeyBanc Capital Markets

Did it fall into cost to goods sold? Or did it fall under SG&A and into which business segments?

Steve Dunmead

It impacted all of the segments. I think a majority of it came, you would see it in our cost of goods sold. A lot of the cost initiatives and lower spending occurred in our operations factories. I would say it probably was the majority of it.

Saul Ludwig - KeyBanc Capital Markets

Mostly in cost of goods sold?

Steve Dunmead

Mostly cost of goods sold. Our corporate spending year-over-year was down $10 million. That included, we reported in an earlier quarter the cancellation of or termination of post retirement. So, that was a one-time benefit that we recorded in that $10 million which was about $4.5 million. The rest was lower expenses related to compensation.

Saul Ludwig - KeyBanc Capital Markets

And what was the total magnitude of the cost reductions in the fourth quarter?

Steve Dunmead

It was in the operation -- in the fourth quarter it was about $11 million, $11 million, $12 million.

Saul Ludwig - KeyBanc Capital Markets

And did that come in advanced materials or electronic chemicals?

Steve Dunmead

It came in both.

Saul Ludwig - KeyBanc Capital Markets

And then…

Steve Dunmead

Definitely both.

Saul Ludwig - KeyBanc Capital Markets

And what's going to be the impact of Big Hill shut down in the first quarter for a couple of months?

Steve Dunmead

From what perspective, Saul?

Saul Ludwig - KeyBanc Capital Markets

Financial perspective.

Steve Dunmead

I'll let Ken answer that. From an operational perspective we believe that first of all the shut down has already started. It started on the tenth of February. The roof is already off of the furnace and they are starting the sidewall demolition. So things are moving along according to schedule. Ken, do you want to comment on the?

Ken Haber

Yes, I think that and certainly Steve said, there is additional cost that would be period costs associated with that. And so we are now estimated about a $2 million operating loss. It will also depend somewhat on what the receipts are that will show up in coco [ph]. Because again their revenue is driven off of actual receipts at coco, not their production. So, it will be in that range, I suspect.

Saul Ludwig - KeyBanc Capital Markets

Two million operating loss at the Big Hill pre-tax for their --

Ken Haber

Pre-tax first quarter.

Saul Ludwig - KeyBanc Capital Markets

Got you. Thank you very much guys.

Ken Haber

You're welcome.

Operator

Your next question comes from the line of Mike Harrison.

Mike Harrison - First Analysis Securities

Hi, good morning.

Ken Haber

Good morning.

Mike Harrison - First Analysis Securities

Joe, you talked to the past about looking for an acquisition in the course of this transformation process that would move you up the value chain in the battery market. Presumably I guess I was at least thinking that would mean sort of slightly up the value chain from sort of the beginning point where you are now. You go and do this EaglePitcher deal. It basically takes you to the end of the value chain versus where your cobalt materials kind of operate now, and really no operational synergies to speak of. Can you just help me understand why this was the right deal for OM Group in terms of creating value for your shareholders?

Joe Scaminace

Yes, absolutely. We could definitely do that. First of all, you know when we looked at all of the opportunities that were out there and the opportunities quite frankly that we passed on because we had been combing the earth, basically, trying to look at transformation type opportunities. And when the EaglePitcher opportunity came before us, we looked at it from a lot of different screens.

First of all this whole idea of portable power you know, and electronic chemicals was our space. So your question is, okay, when you look in portable power why did you guys take such a bold move to the end of the channel? Well, first of all let me just more generally I will tell you that the EaglePitcher deal from a general standpoint absolutely was the right size. I mean this was not any kind of bet the company transaction for us. We had the liquidity. We had the availability of this property to take a hard look at it.

When we went down to Joplin, Missouri, on the first trip we were immediately struck by their technical expertise of the players at EaglePitcher with respect to understanding the specialty side of lithium ion batteries. And you know Mike when you look at what's going on out there right now, one of the presentations that we actually heard from Eagle was that when you look at the whole electric vehicle market and HEV market that there is a strong belief that's going to be commoditized very, very quickly.

Eagle's business is very specialized. However, they understand that technology at the end of the channel. With all this money being poured into lithium ion capacity, chemical capacity, this does not get us into that. This keeps us very specialized. So, even though there are not a lot of operational synergies along the classic line, where you would say, okay, what are the cost reduction synergies? What are the overhead consolidations? What are the market adjacencies? There are none.

The major advantage to Eagle the way we saw it was to get this view of what these chemistries are looking like at the end of the channel in an effort to try and feedback into our advanced material business. As a matter of fact, we have a series of meetings scheduled with our advanced materials people and Eagle technology technicians in an effort to try and get us to understand what's happening with these materials. So that's what we see as a real advantage. And we see it filling out our whole portable power platform.

Mike Harrison - First Analysis Securities

So you view it as really facilitating your attempts to move into the mix metal precursors eventually? Or are these -- or a lot of the EaglePitcher technologies still using a lot of cobalt based precursors?

Joe Scaminace

Well they are using cathode material in a lot of their applications that they are buying right now. But Mike, you have to look at it. You know, a company like ours could have gone out and did a multimillion dollar think tank investment. A lot of companies are doing that right now. When you look at, take a look at a lot of the companies out there right now even some that have market caps and look at their earnings.

This is a company that has a base load of profit. This company has real customers. They make real shipments. They are making materials for lithium ion battery customers out there. So having that, having that ability to have a profitable business, having the R&D capabilities of this helps us drive the technology of our overall company.

Mike Harrison - First Analysis Securities

All right. I appreciate the additional color there, Joe. Steve, you had mentioned the beginning of cobalt trading on the LME. Historically you have not hedged cobalt prices in large part because the instruments simply weren't there. Is it possible we could see OM Group start doing some hedging now there is a market available?

Steve Dunmead

Well, I guess two or three comments there Mike. The first is we have historically hedged some cobalt. As you said the instruments weren't widely available, but if you go back into 2008 and maybe early in 2009 we did some small hedging for selected customers. Certainly we will evaluate it. You know today the amount of trading that has gone on over the course of the first three days was about 150 tons. So, it's not huge. It's not like we're going to go out and do a 15 month forward contract on 10,000 tons a year. But certainly for selected customers or where we see opportunities to protect margin, if the volumes are there, certainly we will look at it.

Mike Harrison - First Analysis Securities

And then you had noticed last quarter mentioned a pick up in the catalyst business. Has that pick up and sustained or has it fallen off a little bit? I know that a lot of refiners are hurting right now and if you could give me insight there.

Steve Dunmead

Yes. I think that as I said in my prepared remarks, that we ended up holding on to what we saw in Q3. So our sales into that chemical and catalyst market for advanced materials was essentially flat, and really it was catalyst changeovers at the refiners that has been driving that. Does that answer your question?

Mike Harrison - First Analysis Securities

Yes. Clearly, semi con was an early cycle recovery this time. Was curious, Steve, what gives you confidence on further sequential improvement in Q1, and have you seen that through the first month or two of the first quarter?

Steve Dunmead

Yes, we've certainly seen things hold on to what we saw in Q4 as we started the year, which gives us some confidence, because normally if you look at not just the semi con market but the PCB market and memory disk markets all of those what Joe refers to as electronic technologies businesses, those typically with Chinese New Year and after the buildup for Christmas and back to school Q1 typically is down. And at least the things that we are seeing and also hearing from the people that follow the markets is that significance of that dip is not going to be the same or maybe nonexistent in 2010.

Mike Harrison - First Analysis Securities

Got it, all right. Last question I have for now. You noted, Ken, I believe noted lower pricing in the Photomasks business, and I was curious to get some more detail on that.

Ken Haber

I think it's just a reflection Mike of us protecting our market share and volume at different customers. I think there's, the whole market is still depressed as far as no new mass design. So it's really just being very protective of our current market share and in some selected areas trying to go after more volume where we think we can be successful.

Steve Dunmead

Mike, in the Photomasks business, we have gone from everyone being scared to spend capital to quite honestly the operating utilizations in the existing fabs is so high now that there is sort of, it has gone from not developing new devices because everyone is scared to spend the money to not having the capacity to do the new devices. And, so -- but from our standpoint we think that we got the cost structure in line to live with where we are right now until the market does recover.

Mike Harrison - First Analysis Securities

All right. Thanks very much guys.

Ken Haber

Thank you.

Operator

Your next question comes from Rosemarie Morbelli.

Rosemarie Morbelli - Ingalls & Snyder

Good morning, all. Following up on the Photomasks question, it sounds as though you are going after volume in order to fill up your manufacturing facilities. Are we going to see some margin decline based on that particular tact and is that a long term way of looking at it? Or are you kind of adjusting with the way the market is currently?

Ken Haber

First off my comment was that most of our pricing is related to protecting our volume and our market share with all of our key customers and it's very selectively going after customers that we think we can gain some, and that also we've adjusted our cost structure going into that his year to reflect that there is going to be a very -- there won't be a lot of growth in this market this year in 2010. So we've adjusted that. So we believe that our margins will be protected from that perspective.

Steve Dunmead

And in grand scheme of things, Rosemarie, it is a small portion of the Specialty Chemicals segment.

Rosemarie Morbelli - Ingalls & Snyder

Are you sharing with us the size of Photomasks business?

Ken Haber

No, we don't -- we would show that in the 10-K and Q. I think we break out the percentages of total sales of the segment.

Rosemarie Morbelli - Ingalls & Snyder

Okay. That is helpful. Thank you.

Ken Haber

It's available in the K.

Rosemarie Morbelli - Ingalls & Snyder

Okay. Looking at EaglePitcher, revenues were about $126 million in 2009. Could you share with us the growth rate of the last several years that that top line has experienced for that business?

Steve Dunmead

I think over the last four or five years it's been growing steadily. I don't remember the numbers right off hand. I don't know if Greg does. But it is probably in the high single digit. I think that they did see some retraction in 2009 from 2008 related to a couple of projects for defense. But that was timing differences.

Greg Griffith

Yes, they saw a peak in '08 as a buildup in surge associated with the war and then a drop off. But, typically their growth in their base business of aerospace and defense as Ken indicated would be in that you know high single digit kind of range.

Ken Haber

You know, let me answer the question a little differently in terms of you know, and even going back to Mike Harrison's question. With respect to the base load to this business where they have seen profitable base load in defense and aerospace, where we see future growth, and again this doesn't address synergistic issues as much as it does growth issues but we do see the whole idea of alternative energy and more specifically medical technology as an avenue of growth for this business.

For example, EaglePitcher participates in selling batteries currently into the market for deep brain stimulation better known as neuromodulation. And there are at the leading edge with major customers out there, which are basically helping mitigate the effects of things like Parkinson's disease. So we see growth in those areas.

Rosemarie Morbelli - Ingalls & Snyder

Okay, and what was the operating income for that particular business in ’09?

Steve Dunmead

In '09 I think the EBITDA was somewhere in that $18 million to $20 million. That was the EBITDA.

Rosemarie Morbelli - Ingalls & Snyder

For the full year?

Steve Dunmead

For their full year and their full year was a fiscal. Their fiscal year end was November 2009.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And you are going to put them on your calendar year?

Steve Dunmead

Yes. They will be reported their first month of results or first two months of the year will be reported in our first quarter. So, February and March will be the first two months.

Rosemarie Morbelli - Ingalls & Snyder

Is there any particular seasonality to that business both on the revenue side and on the EBITDA side?

Steve Dunmead

No. There is no real seasonality. Remember, most of their businesses are on contract, as contract. And they operate on a percentage of completion basis for reporting purposes. So it's really driven more by delivery of batteries and the predescribed payments relative to those specific projects.

Rosemarie Morbelli - Ingalls & Snyder

And, if you look at the contracts going out, are they long-term contracts? Are they one year and what do you see, you know, you have no visibility in a lot of your businesses? Do you have because of the nature of this business do you have more visibility in what are you looking at?

Steve Dunmead

Yeah. We have certainly contracts can range from a year to where they will be renewals of long-term programs. Again, a lot of their -- in their defense they have, their contracts are with regards to very long term defense projects. So, though they are contracts are renewed each year, they are really tied to long term programs, defense programs and the same would be true I think to some degree, lesser degree in their aerospace.

And as far as visibility, you know, again, most of their contracts I think are renewed near the end of the year end, fiscal year end. So, again, I think they have a very good handle and a view of what their revenue is going to be at least in those two end markets, aerospace and defense for this year.

Rosemarie Morbelli - Ingalls & Snyder

And those markets dependent on the multiple wars that we are fighting out there. In other words, if there was some kind of a miracle, and we are no longer fighting to the degree or at least to the -- with the intensity that we are now, does their business come down substantially or it is not really dependent on that?

Ken Haber

You know, I can answer that by saying that I think it's the other way. That there are what are called war surges. It's what we've heard from the EaglePitcher people. But basically when you look at this whole idea of the technology that's going into their defense business, they are at the leading edge of many of the current and future missile programs that are out there.

In particular a lot of these defense batteries, you know, I just use the term like the patriot missile battery defense system is participated in. So, it is not a matter of if conflicts lessen, that their business gets downsized dramatically. But it has to do with the technology that they are developing. It has to do with the programs that they are on. And we think that there is a reasonably good base load here in defense that we can utilize to launch into other platforms.

Rosemarie Morbelli - Ingalls & Snyder

That is very expensive. -- I'm sorry, helpful. I was looking at my note. Just one quick question, interest expense, what is the chance of transaction and how much cash did you use versus the revolving credit facility?

Steve Dunmead

We drew down our current revolver by $94 million. And the remainder was in cash, about -- and so we paid $172 million. So $94 million of that was paid through drawdown of our revolver and the rest was by cash. The current revolver was negotiated five years ago. So the pricing on that is not market right now. We were paying right now, but we are paying right now three quarters of a percent or 75 basis points on that revolver. So, on an annual run rate that would be probably less than $700,000 a year in interest expense.

Rosemarie Morbelli - Ingalls & Snyder

Okay. So, that doesn't make that much of a difference.

Steve Dunmead

No. But just do want to make a note that our current revolver does expire at the end of this year. And so we are in the process of looking at replacing that revolver here in the near future.

Rosemarie Morbelli - Ingalls & Snyder

So, you are --

Steve Dunmead

And that will replace -- and that revolver will be in expanded capacity and will reflect more market pricing.

Rosemarie Morbelli - Ingalls & Snyder

Okay, thanks a lot.

Steve Dunmead

Thank you.

Operator

Your next question comes from Saul Ludwig.

Saul Ludwig - KeyBanc Capital Markets

Thanks. Steve, just a thought with the new cobalt capacity coming on whether it be the Centaur [ph] project or because there is one or two others, do those projects have with them cobalt refining where they are going to take the concentrate and actually convert it into cobalt or is the refining of that byproduct material going to be done by others and are you in the loop on that? We hear about all of the cobalt capacity, but it has to be refined. Could you address that question of where this new capacity is going to get refined?

Steve Dunmead

Yes, Saul. Today most of these new projects that are coming on-line, and I have to back off of that and say some of these projects including some of the ones you mentioned historically have been talked about since I started looking at the cobalt market eight years ago. And, so it is in the Congo. And political things change and it's harder to get something started up than you ever think. But most of those projects today are going to be bringing what we would refer to as refinery feed to the market. And, are we in the loop? Yes, we were in the loop.

Saul Ludwig - KeyBanc Capital Markets

So in other words, the potential cobalt supply from the new projects and you alluded to the fact that you thought there would be some additional capacity in the second half of this year. Who is doing that refining, I mean…

Steve Dunmead

I don't think I would speculate on that. I think it's the existing players in the market. And truthfully, if you look at this up-tick in higher grade refinery feeds that are coming out of the Congo, in some cases it is simply replaced low-grade handpicked materials that we talked about as heterogeneous [ph] before. And so, in some cases it would be more like a substitution in an end market.

Ken Haber

You bring up a good point, Saul. Does that answer your question?

Steve Dunmead

Hello, did we lose the call. Did we lose the call?

Operator

I believe Mr. Ludwig's line disconnected. I will proceed with the next question and that comes from Chris Hatch [ph].

Chris Hatch

Yes. Hi. Looking at the evolution of cathode chemistries for the lithium ion battery application, obviously you guys are a player, important player in cobalt oxide precursors, and I assume that you built confidence in mixed metal, cobalt containing mixed metal oxides. I'm just wondering if you currently sell or plan to sell materials for the manganese spinel or iron phosphate chemistries.

Steve Dunmead

Chris, this is Steve Dunmead. Certainly we have development programs in place. I think it's a bit early to say whether or not we are going to get large in those chemistries because truthfully there is not a lot of volume in them today. But certainly we have development programs in place both internally and with key customers.

Chris Hatch

Right. And on the mixed metal side, do you feel like your sort of presence in market share for those materials is comparable to where you are in cobalt oxide?

Steve Dunmead

No, I don't believe it's comparable. I think it's less but certainly growing.

Chris Hatch

Okay. How important is it the fact that you are -- your competence in cobalt as it relates to mixed metal oxide sort of market development?

Steve Dunmead

Could you rephrase that?

Chris Hatch

Well the fact that I mean your confidence obviously in cobalt oxide is that important in terms of establishing yourself as a supplier precursors for mixed metal oxides that contain cobalt.

Steve Dunmead

Absolutely. It's key, because as Joe talked about, EaglePitcher looking at it from the end sort of end of the specialized part of that value chain, anything that you understand about what makes a good precursor or good cathode material whether it's particle sized, chemistry control, additives that go in, all of those things are key, and I think that's part of what Joe was trying to talk about, about looking at the technical expertise associated with a variety of different chemistries and understanding then how we pull those two things together and get more out of battery materials also.

Ken Haber

See, there is all kind of formulations out there Chris that, you know, there hasn't really been a chip down even with respect to electric vehicles or HEV yet. So what is really great about our position right now is that we are not remaining tentative for a purpose. We are remaining tentative for a purpose here because we are developing the capability to go with whatever direction the market takes for specific applications. And Chris, you know, let me just welcome you back to OM Group. We're glad to have you back on the calls again from a little bit of an absence. So, it's great to hear your voice and thanks for being back with us.

Chris Hatch

Thanks for that. I had a follow-up though, just looking at the supply chain, this application for electric drive vehicles. It looks as though there will be a greater level of integration vis-à-vis the consumer electronics lithium ion batteries supply chain. And I'm just wondering if looking down the road if you think that will affect your business model with either customers backward integrating or suppliers forward integrating. How do you see that playing out as this -- the electric drive vehicle market sort of develops and grows?

Steve Dunmead

Chris, while you were absent from OMG, as all that DOE money was being divvied out over the course of the past 12 months, we did talk in a few conference calls about the fact that as Joe said we weren't ready to put down a chip on a specific chemistry, but however without violating any confidentiality agreements we are working with at least three of those supply chains today.

Chris Hatch

Okay.

Steve Dunmead

So I don't believe that changes with respect to how we -- it's almost identical to how we participated in the consumer electronics part of the market.

Chris Hatch

Well, it just looks to me like what I'm getting at is some -- ultimately some of the customers may be more backward integrated. I just wonder if that's a dynamic that you think is going to be dramatically different than the existing sort of consumer electronics battery supply chain or if it's really business as usual.

Steve Dunmead

Certainly more integration. I think if you look at the overall supply chain there won't be as many separate steps in it. But I think that how forward or how backward integrated each one of those supply chains are. It will just determine where we participate, because we participated like three different points in that value chain today, or supply chain today.

Chris Hatch

Okay, thanks. And then just one follow-up, I think you said just looking at the balance sheet that working capital in the fourth quarter was up or inventories were up $24 million. Just wondering if that related to the sequential higher cobalt prices in the fourth quarter? Or were you building from inventory that had the Big Hill shut down?

Ken Haber

Chris, is this is Ken Haber. The majority of that increase in dollars was driven by the cobalt price increase in cobalt price during the quarter.

Chris Hatch

Okay. So you have sufficient inventories to supply your customers even though the Big Hill is going to be shut down for a couple of months.

Steve Dunmead

Yeah, we shouldn't have any problem.

Chris Hatch

Okay, thanks, guys.

Steve Dunmead

You're welcome.

Ken Haber

Thank you, Chris. Welcome back.

Operator

Your next question comes from Mike Harrison.

Mike Harrison - First Analysis Securities

Couple of more questions for you. Looking at the average cobalt price for the quarter, it was down about 12% year-over-year. But then the price component within advanced materials, $51 million that was down about 26%. Can you just help me understand that discrepancy there? Is it really just related to timing or mix?

Ken Haber

Some timing, some mix and it also is reflecting the raw material costs, too. That's a net impact. It's not just pricing on our selling. So, it's a net impact on operating profit which is a combination of both the sale price and our raw material feed cost.

Steve Dunmead

And Mike, this is Steve. You know, we’ve talked about at least when we were seeing rapid run-ups and rapid declines in the cobalt price we talked about the fact that there is some lag associated with our pricing. And, so sometimes using a quarterly average doesn't necessarily reflect what happens because that previous month or previous two months before that quarter may have impacted what our sales prices were.

Mike Harrison - First Analysis Securities

Understood. And then a couple of questions for Ken. Any update on the tax rate guidance for next year? I believe you had previously said something in the high 20s would be appropriate.

Ken Haber

Yeah, I think on my last call, in the third quarter call I had indicated a 25% to 30% range, and I would say that's what we are using going into this year. I probably would lean more towards the high end of that range at this moment at least for the quarter, the first quarter we are looking at and for the year.

Mike Harrison - First Analysis Securities

Is there any significant difference in the EaglePitcher tax rate versus your existing business?

Ken Haber

No. It won't have any significant impact on that rate.

Mike Harrison - First Analysis Securities

And then after you integrate the EaglePitcher acquisition, after we see a full quarter so I guess this is more of a second quarter and beyond run rate. What is D&A going to look like?

Ken Haber

Yes. I think as you said, Mike, the first quarter will only have two months. I think the second quarter and actually on a run rate, I think it's going to be around $14 million I think it is something in that range, $14 million to $15 million on an annual run rate.

Mike Harrison - First Analysis Securities

So not too significantly different from what you have been showing in recent quarters?

Ken Haber

Well, that's just for EPT. Your question was EPT.

Mike Harrison - First Analysis Securities

Okay, so that-

Ken Haber

That was an annual -- two things, one is you know as with buying the business we are going to have to -- we have an opening balance sheet. So there is going to be full re-valuation of all of the tangible assets and also intangibles. So there is going to be a significant amount of amortization that goes with the normal depreciation. So for again EPT, it is going to be around an annual run rate of about $14 million. I think on a full year, including our operation and I think that will be around $60 million. So you take the existing business of $46 million EPT will be around $14 million or $15 million. So, roughly about $60 million on an annual run rate.

Mike Harrison - First Analysis Securities

Got it. Okay. And then are you guys willing to offer any projections for first year EPS accretion for the EaglePitcher acquisition?

Steve Dunmead

I would say that it will be very immaterial to the first full year, up or down. We have to get these guys in compliance for you know a public company. You know, we bought this out of private equity, and so there are some things we need to do. But Ken's answer is right on.

Mike Harrison - First Analysis Securities

And presumably it gets significantly accretive in the second year then?

Steve Dunmead

It certainly contributes in the second and third years and out years.

Mike Harrison - First Analysis Securities

All right. Thanks very much.

Steve Dunmead

Thank you, Mike.

Ken Haber

Okay, well thank you, everybody. 2009 when you look back I have to say was a challenging year not just for us but for many companies. But in our case memorable for some of the progress that we made. We made tremendous strides in improving our cost structure and laying the foundation to emerge stronger as this economy recovers. Furthermore, we've improved our portfolio with the addition of EaglePitcher, while preserving our financial flexibility and our strong cash position to fund more future growth.

As I said before, I'm pleased with our progress but far from satisfied. We are going to continue to press forward to make OMG the great company we know we could be, and at this time I would just like to thank you all again for your time this morning and ongoing interest in the OM Group and we look forward to continuing to upgrade you on our progress.

Operator

Thank you for participating in today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: OM Group, Inc. Q4 2009 Earnings Call Transcript
This Transcript
All Transcripts