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OM Group Inc. (NYSE:OMG)

Q1 2010 Earnings Call

May 07, 2010 10:00 am ET

Executives

Troy Dewar - IR

Joe Scaminace - Chairman and CEO

Ken Haber - CFO

Steve Dunmead - VP and GM, Specialties Group

Analysts

Mike Harrison - First Analysis

Rosemarie Morbelli - Ingalls & Snyder

Saul Ludwig - Northcoast Research

Mike Harrison - First Analysis

Chris Kapsch - BDR Research Group

Rosemarie Morbelli - Ingalls & Snyder

Presentation

Operator

Good morning. My name is [Durie] and I will be your conference operator today. At this time, I would like to welcome everyone to the first quarter 2010 results conference call. (Operator Instructions).

Thank you. I would now like to turn the call over to Mr. Troy Dewar. Sir, you may begin your conference.

Troy Dewar

Thank you, [Durie]. Good morning, everyone, and welcome to our review of OM Group's 2010 first 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.

A 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 on specific assumptions and subject 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. Today, we reported stronger first quarter results, reflecting a continuation of positive trends in our business. In addition to our cost reductions and cash generation, we experienced higher demand for our products and improved cobalt fundamentals. We also completed the acquisition of EaglePicher Technologies at the end of January. Revenue increased 58% from the first quarter of last year and 26% from the fourth quarter of 2009.

Operating profit of $32 million was a significant improvement from the $11 million loss last year. We were once again successful in generating positive cash flow from operations. At the end of the first quarter, our cash balance was $366 million. Coupled

with available liquidity from our new credit revolver, we are in a strong financial position to fund our growth initiatives.

This is an exciting time to be associated with OMG. Our focus on product innovation, organic growth and acquisitions is starting to pay off, and we're seeing evidence that our long term growth strategy is working. For example, our advanced materials unit supplies high quality cobalt to world markets. We continue to move up this channel with value added products such as mixed metal precursors, supporting new applications in rechargeable batteries. These actions move us up the supply channel and closer to our customers and closer to end markets. Within the electronic chemicals market, we're seeing strong end market demand. More importantly, we have the products and services to grow significantly in memory disk, printed circuit board and the very strong semiconductor accounts right now.

Finally, our battery technologies business offers differentiated products and solutions for energy storage. In EaglePicher, we have acquired broad technical expertise in batteries for the defense, aerospace and medical industries. Obviously, adding EaglePicher certainly gives us exposure to growth in the medical and alternative energy markets. Now, what may not be immediately obvious is the fact that this acquisition was not totally about pulling material forward in the supply chain and just selling more cobalt to EaglePicher. We were attracted to the idea of pulling technology and knowhow backward into the value chain. We can now leverage this knowhow in our battery and material business and become better specialty material suppliers.

Now you can begin to see that we are not just a commodity cobalt company supplying only cobalt to a growing world market. We provide specialized value added materials and technologies, which enable our customers to meet their product and process performance requirements.

The performance bars we've set for this company are high. And while we've made progress, we know that there is still much work to be done. Now, we still can't mitigate the swings in our earnings resulted from changes in cobalt prices. However, I remain confident that we are headed in the right direction to stabilize our results. With the momentum we've created and the continued performance of our great employees, we are well on our way to delivering on our strategy.

At this time, I'll ask Ken Haber to walk you through the details of our financial performance. Ken?

Ken Haber

Thank you, Joe, and good morning, everyone. Please refer to the presentation materials from our website and turn to page three. Revenue in the first quarter of 2010 increased 58% compared with the same period last year. Growing end market demand led to higher volumes in both advanced materials and specialty chemicals. Volumes grew in nearly all end markets - most notably, battery materials, powder metallurgy, printed circuit board, memory disk and tire.

In addition to volume growth, the advanced materials segment benefited from higher selling prices due to higher cobalt reference prices. Battery technologies, a new segment for us this quarter, reported revenue of $19 million, all due to the January 29th acquisition of EaglePicher Technologies. The results of this business are included in our results for the two months since the date of acquisition.

The first quarter operating profit of $32 million was significantly higher than the $11 million loss last year. This improvement is a demonstration of our ability to leverage revenue growth to the bottom line as a result of the lower cost structure created last year through our profit enhancement initiatives. Advanced materials operating profit was lifted by a combination of higher cobalt prices and an upward trend in average quarterly cobalt price. Battery technologies was a slight drag on operating profit, due primarily to purchase accounting adjustments related to acquired inventory and deferred revenue. Income from continuing operations was $22.5 million or $0.74 per diluted share. Other expense of $3.7 million is largely attributed to the impact of the strengthening US dollar on specific foreign currency cash balances.

Tax expense for the quarter of $4.3 million is net of discreet tax benefits totaling $4 million, primarily related to adjustment to prior year tax provisions. Excluding purchase accounting adjustments, the inventory and deferred revenue related to EaglePicher Technologies, restructuring charges and the discreet tax items, income from continuing operations was $21 million or $0.69 per diluted share. This compares with a loss of $3.9 million or $0.13 per diluted share in the first quarter of 2009.

Revenue in our advanced materials segment, shown on page five, grew 56% compared to the first quarter 2009 led by higher cobalt reference price and higher sales volumes. Excluding metal resell and byproduct sales, volumes rose 27% with strong growth in all end markets, particularly battery materials and powder metallurgic. Battery materials volumes were driven by increasing end market demand for laptops and cell phones. Powder metallurgy volumes were up as end market demand continues to recover from automotive and industrial applications along with customers restocking their supply chain.

Metal resell on copper byproduct grew on higher volumes and pricing. The average cobalt reference price for the first quarter of 2010 was $20.11 per pound, up 50% from the same period last year, while copper was $3.29 per pound, more than double

the average price during the first quarter of 2009. The key driver for the rise in operating profit compared with last year was the impact from changes in cobalt reference price on gross margin. Additionally, the segment benefited from higher sales volumes and lower cost structure than last year.

On pages seven and eight are the first quarter results for the specialty chemicals segment. Net sales grew 39% in the specialty chemicals segment with growth in every end market. With advanced organics, growth was led by economic recovery in the tire end market while coatings and chemicals benefited from seasonal upturn in construction.

In the electronic technologies businesses, markets were much stronger than a very weak 2009 first quarter, particularly memory disk and printed circuit board. Operating profit of $15.3 million improved significantly from a loss of $8 million from the same period last year. Last year's results included a charge of $3.3 million to adjust inventory to market values and net goodwill impairment charges of $2.6 million. Even excluding these 2009 items, results improved significantly due to the benefit of higher volumes and lower cost structure.

Please turn to pages nine and ten of the presentation. As was previously stated, battery technologies is a new reporting segment for us and consists of the recently acquired EaglePicher Technologies. The segment serves a variety of sectors in defense,

aerospace and medical. The defense market is driven primarily by government spending on missile programs for which our products are used to provide power for the auxiliary systems on the missile. Missile spending is expected to be stable throughout

2010.

In aerospace, demand is driven by satellites, used both in defense and commercial communication applications and by aircraft. The satellite market should see steady growth this year while aircraft is expected to recover from a depressed 2009.

Growth in medical should come from growth in cardiac rhythm management and narrow stimulation markets as well as market share growth for us as a relatively new player in this industry. Revenue for the segment for the two months since the date of acquisition was $18.6 million. A majority of the business within this segment is conducted under long term contracts. As a result, backlog is an important metric used to assess current business development as well as forecasting future business needs and performance. Backlog, which was $130 million at the end of the first quarter, represents the value of unfilled orders for which funding is contractually obligated by the customer and for which revenue has not been recognized.

The segment posted an operating loss of $1.5 million including $1.5 million of charges for purchase accounting adjustments related to inventory and deferred revenue. As we have stated previously, our expectation is that this segment will be relatively neutral to 2010 earnings due to one time acquisition cost, amortization expense for intangibles and interest expense.

On page 11 is a summary of financial metrics. At the end of the first quarter, our cash balance was $366 million, up nearly 34% from the first quarter 2009 and up slightly from the end of last year. During the quarter, we used $22 million of cash toward the purchase of EaglePicher Technologies and made a $10 million payment towards the outstanding balance on the new revolver.

Excluding the effect of EaglePicher Technologies acquisition, network and capital contributed positive cash flow of $11 million as inventories were reduced by $35 million, offset by an increase in accounts receivable of $26 million.

Finally, consolidated EBITDA from continuing operations was $145 million for the last 12 months, which is within our required debt covenants under the new $250 million revolver.

This completes my review of our first quarter 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 first quarter, the cobalt market continued to strengthen with overall demand estimated to be up approximately 6% versus the fourth quarter and up approximately 12% versus the prior year. As Ken previously mentioned, during the first quarter, cobalt prices ranged from $18 to $23 a pound, averaging $20.11 a pound, up approximately $2 versus the prior quarter. The strength in the market was a combination of a modest increase in demand coupled with continued limited availability.

During the quarter, spreads widened significantly, reflecting a shortage of grades used in super alloys, specifically Russian and high grade, and selective movement of other specific grades at lower prices. Cobalt prices continued to strengthen at the start of the second quarter and have now stabilized in the $21 to $23 range.

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. The timing for these projects and any new investments remains clouded somewhat by current pushes to increase import and export taxes and discussions regarding a potential ban on the export of concentrates.

The new LME contract has attracted moderate activity since it started trading in February. The real test, however, comes on May 21st, the date of the first cash settlement. This could bring about many interesting challenges in the coming months, including liquidity, grade imbalances and increased short term volatility.

Now, I would like to cover some of the key end use markets impacting our advanced material segment. Advanced materials had a strong first quarter with overall non-resell cobalt volumes up 9% sequentially and over 13% over Q1 '09. In the second quarter, volumes will be impacted by the normal seasonal slowdown for battery materials and our annual maintenance shutdown in [Cokala]. That being said, we expect 2010 volumes to be approximately 10% year-over-year.

Overall rechargeable battery sell shipment were reported to be approximately 15% year-over-year. This growth was offset by the usage of lower cobalt containing chemistries in some of the new lithium ion battery applications resulting in flat cobalt consumption in the market.4 Cobalt consumption is expected to pick up as applications such as electric powered automobiles and electric bikes gain critical mass. Consistent with the market, our first quarter cobalt sales were flat versus Q4 '09. Our precursor commercialization efforts remain focused on the strong demand for nickel cobalt manganese based cathode materials. Looking forward, cobalt volumes are expected to be flat in 2010 compared with 2009 with the second half volumes ramping up.

The powder metallurgy market bounced back much more than expected in the first quarter with volumes up 70% sequentially and up triple digits over Q1 '09. The strong performance was due to a combination of restocking of a grossly depleted supply

chain, share gains and increased demand for tooling from global end markets such as automotive, energy and mining. Looking forward, full year volumes are expected to double compared to 2009.

The chemical market continued to perform well in the first quarter with cobalt volume being up 6% both sequentially and over the first quarter of 2009. The main driver here was petrochemical processing catalyst. Thanks to a combination of increased global construction activity and share gains, cobalt volumes into the ceramics and pigments market were up 30% to 35% in both in the first quarter, both sequentially and over the first quarter of 2009. On a combined basis, we expect chemicals and ceramics markets to be up approximately 5 to 7% year-over-year.

Now for a few comments on the key markets impacting our specialty chemicals segment - we've started to see some pickup in the housing and construction markets, but non-residential construction continues to be soft. In the first quarter, volumes of our coatings and chemicals products serving these markets were up approximately 9% sequentially and up 7% versus the prior year. For 2010, we expect to see overall volume up a modest 3% to 5% with growth in our additive product lines more than offsetting the sluggish commodity paint dryer market.

The global tire market continues to recover slowly, but is still down from 2007 levels. Most of the growth is coming from Asia with European and North American markets continuing to be weak as miles driven and commercial fleet activity have only improved slightly.

Sales volumes into this market were up approximately 50% over a very weak first quarter of 2009 and up 19% sequentially, mostly due to timing. For the full year, due to a combination of the market recovery and the shutdown of the Clayton facility in June, we expect year-over-year volumes to be down approximately 8% to 10%.

The recovery in the semiconductor market, which began in mid 2009, continued into the first quarter with sales up 27% year-over-year and essentially flat versus the fourth quarter of 2009. We are starting to see some strength in the US and Europe, which were approximately six months behind Asia in the cycle. After two years of reduced capital spending in the semicon industry, market watchers are predicting a 50% increase in 2010, focused on adding capacity and finer line width capabilities.

Industry experts now feel that their previous growth estimates for the semiconductor market for 2010 of 12% to 15% may be conservative.

For the electronic chemicals related markets, first quarter held onto the momentum that we saw in the second half of 2009. Overall volumes of electronic plating chemicals were up 61% versus the prior year and essentially flat sequentially.

Hard disk drive shipments were reported to be 2% versus the fourth quarter. Our sales into this market were up approximately 100% year-over-year and up 6% sequentially. For the balance of the year, the market is expected to remain essentially flat versus the first quarter. Our current outlook calls for full year volume to increase by approximately 25% due to a combination of market recovery and share gains.

The printed circuit board market held onto the improvements that we have seen in the second half of 2009. Overall volumes were up 43% year-over-year and up 1% versus Q4. As we discussed during the fourth quarter conference call, this modest improvement is very significant in that this industry typically sees a 15% downturn in Q1 versus Q4. Our recent strength is coming from Chinese LCD and notebook PC manufacturers. Our overall outlook for 2010 now calls for growth of approximately 10% to 15% versus 2009.

At this point, I would like to turn the call back over to Joe Scaminace.

Joe Scaminace

Thank you, Steve, for your comments. And at this time, I would like to turn the call over to the operator to take any questions that you may have.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Your first question come from the line of Mike Harrison with First Analysis.

Mike Harrison - First Analysis

Couple of questions about EaglePicher, you called out the $2.2 million in fees that were included in corporate expense. Should we think of those fees as one time in nature, or are we going to see those fees persist for a couple more quarters?

Ken Haber

Mike, this is Ken. That was a one time payment that will not continue in the future quarters. That was specifically to the acquisition tied to the closing of the deal.

Mike Harrison - First Analysis

And then, roughly how much integration cost was included in EaglePicher's operating profit in the quarter? And I guess, how should we expect that to change over the next few quarters? Will it grow? Will it decline?

Ken Haber

It was very minimal in the first quarter. We spent most of our time just getting them into our accounting systems, reporting, stuff like that. We'll start to experience some increase in transition and compliance cost in the second and third quarter. I can't give you an exact figure, but you will see some increase over that. You'll see an increasing amount, I think we sent $200,000 in the first quarter. It'll be probably two, three times higher than that in the second quarter.

Mike Harrison - First Analysis

Got it. And the EaglePicher backlog that you guys highlighted, did that grow in the quarter? And can you also assess for how long typically you see between the time a contract hits your backlog and when you recognize it as revenue?

Ken Haber

Well, again, the backlog again covers long-term contracts, primarily for the defense and aerospace. They can cover anywhere from a year to possibly two years. The revenue will be recognized as we fulfill those contracts tied to shipments in that regard.

A lot of these contracts were signed back in the late 2009 time period. Usually, we bid on these once a year, but, there is also ongoing contracts that we're currently actively looking at it and in the process of bidding on. So, it'll fluctuate. I can't give you anything more specifically at this point. I would say that at this point, roughly about 70% of what you see there on the balance sheet at the end of the first quarter will be recognized, we're forecasting 70% of that figure to be recognized in the remainder part of this year.

Mike Harrison - First Analysis

Question for Joe just related to the liquidity that you highlighted, obviously, a big cash balance, you've got a new revolver now, and I guess I was a little bit surprised to see how much of debt you took on and wanting to continue to keep powder dry. Can you give us a sense of what you're seeing in the M&A marketplace, what your pipeline looks like and sort of how this strategy might unfold over the next year or so?

Joe Scaminace

On the debt side, Ken can probably add more on why we did what we did. But, we still have a significant amount of our cash outside the country. So, that certainly gives us the ability to continue to grow our company. But, I think, Mike, the best way to answer that would be that we've been very clear about our desire to transform our model, not totally away from the cobalt side. We like that business still. We like moving up the channel closer to our customers. We like the whole idea of our mixed metal offerings toward becoming better suppliers of more value added products up to the cathode level but, what we're seeing in terms of other areas to integrate and find synergistic growth opportunities now that we've got these growth platforms. I mean, we've identified the whole idea of battery materials, we've identified electronic chemicals. And what we're seeing, Mike, is a lot of activity out there. There's all kind of terms we're hearing, in inflexion point, this is the time of the strategic buyer. And clearly, we fit right into that mold of a company that has done, in our opinion, a reasonable job of managing our balance sheet. We've got the ability now to affect this transition with our balance sheet.

And what we've done, quite interestingly, because of our acquisition of EaglePicher, we've sort of raised our profile on certain radar screens where not only our initiative to go out there and find these properties, we're finding a lot more ideas coming our way. So, clearly, the field right now is fairly populated for candidates for us to go out there, find companies that are synergistic with us right now and really solidify the critical mass in a lot of these businesses we're in.

Mike Harrison - First Analysis

Last question, and then I'll getting back in queue. Was just curious if you guys have been using the LME contracts to hedge any cobalt and whether you've taken any steps to register OM Group cobalt materials for trading in those LME contracts.

Steve Dunmead

I'll answer your last question first. Since we do not manufacture cathode or ingot on our own, we have nothing that we can register with the LME. The (inaudible) material that we have under contract that we distribute. My understanding is that is in the process of being registered. I'm not sure whether it's done yet or not, but it's in the process, some of those grades.

The LME contracts, as I said, has attracted moderate activity on the order of 20 or 30 tons a day if you take what's traded in the ring plus what goes on in our office. We have been talking to some of our customers about selective hedging activities. But at this point, 20 or 30 tons doesn't do us much when we're processing 10,000 tons a year. And so, we are hopeful that the activity in the market continues to increase and then if we wanted to go out and hedge 1,000 tons a quarter or whatever it was, then we would have the opportunity to do that. But, today, it's still gathering acceptance and we'll see what happens over the balance of the year.

Operator

Your next question comes from the line of Rosemarie Morbelli with Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

You had, if I am correct, you must have had a low cobalt cost inventory helping your gross margin in the quarter. Where do you see now and what do you see if cobalt is around the $21 to $23 average that you mentioned in your comments, what do you see the impact on the gross margin?

Steve Dunmead

Really, if you look at the overall flow through during the quarter including the finished goods that were sold, there really wasn't a great deal of lift from low cost inventory. And so, as we look forward, compared to past years, as you've followed the company for a long period of time, cobalt prices have been relatively stable over the course of the past nine months or so and so we obviously aren't out there predicting cobalt prices. But, really, from an inventory swing standpoint, there hasn't been that much change in the cobalt pricing.

Rosemarie Morbelli - Ingalls & Snyder

Okay, thanks. On the advanced materials, it looks as though your volume grew faster or more than the revenues for battery materials and for powder metallurgy. Did you have to give some price concession? Could you give us a better picture as to what is happening in those two markets?

Steve Dunmead

I'll attack the battery materials first. What you're seeing there is a, as Joe talked about, our continued focus on a broader product offering than just simply cobalt and cobalt based precursors. And so, we're focused on mixed metal precursors that may have lower cobalt content. And so, the average selling price of those would be lower than if you were selling something straight cobalt. And that's one of the reasons people are using it. It's the price impact, and in some applications, a performance issue.

In powder metallurgy, I'd have to look at those exact numbers. I don't have them in my head. But, we did not give significant price concessions on anything associated with powder metallurgy.

Joe Scaminace

Yes, like I said, Rosemarie, on the powder metallurgy side, last year, if you recall, in the first quarter or two, that market basically just dried up to the point where we were even stunned at the lack of orders that were occurring. And if you recall, powder metallurgy is used in cutting tools. And the customers are fairly substantial there in the form of a Sandvik and Kennametal and (inaudible) And what we've seen in the first quarter of this year is just a tremendous volume increase in that business, probably led by replenishing inventory, but we are seeing a resurgent in industrial production at the end market side, which is pulling some of those cutting tools through.

Rosemarie Morbelli - Ingalls & Snyder

Lastly, you have about 80% of your cash in Europe and a lot of your business there, as well. Could you talk about the potential negative impact from the crisis going on throughout Western Europe at the moment? I am assuming it did not affect the first quarter terribly, but it could definitely do that in the second and third.

Ken Haber

Well, first off, we don't have any operations in Greece, so we have no direct exposure. Our exposure would be what we're seeing in the euro weakening against the dollar from that perspective. And so, we do have some exposure on our balance sheet with regards to US dollar cash balances over there in Europe. And so, we've taken some currency losses in the first quarter and likely will take some again this second quarter, given the current strengthening of the dollar.

Operator

Your next question comes from the line of Saul Ludwig with Northcoast Research.

Saul Ludwig - Northcoast Research

In the specialty materials sector, looking from the fourth quarter to the first quarter, you had a $6 million increase in revenue and a $4 million increase in profit, which is a tremendous sales to profit recovery. Can you just talk about what drove that dramatic improvement in margins from the fourth quarter to the first quarter? And then, conversely, in the advanced materials sector, you had a decrease in your margins from the fourth to the first quarter. Yet, volume improved and cobalt prices were higher. So, I'm trying to understand those two divergent trends.

Ken Haber

I can talk to the key indicators, and then Steve needs to maybe fill in a little. But, in the specialty chemicals segment, the biggest driver there was in our advanced organics business, I think we mentioned before. So, we saw significant increases both in volume, but also we saw benefit of positive form with regards to product mix, customer mix, particularly in tire, and also we did get some pricing increases implemented early in the first quarter of this year. And then, we also saw some improved pricing with in our electronic chemicals businesses.

With regards to the second question relative to advanced materials segment, probably about a third of that revenue increase was due to metal resell, which has very little margin contribution. And I think that was probably the key driver there.

Saul Ludwig - Northcoast Research

Okay. With the weaker euro, could you kind of explain, A, how that currency number was what it was in the first quarter, what sort of drove it, what's going to drive it in the second quarter? And then, conversely, won't the lower euro result in lower expenses in your second quarter versus your first quarter relative to your operating cost in Europe in (inaudible)

Ken Haber

Yes, and I'll answer specific to the second part of your question, Certainly, if the dollar continues to strengthen the way that it has already, as we've seen in the second quarter, it would have a positive impact on our advanced materials operations, as you said specifically relative to (inaudible) because most of our exposure in that area, in that business is their expenses, which are in euros. So, if that dollar continues to strengthen in the current trend, that's the outcome of that.

With regards to our specialty chemicals segment, it would be slightly negative, primarily because their revenues are basically equal or exceed slightly their expenses. So, they're almost naturally hedged from that perspective.

Saul Ludwig - Northcoast Research

Okay. And what gave rise to the $3 million currency loss in the first quarter? In other words, how do we think about calculating that number based on where the euro goes?

Ken Haber

Well, directionally, again, if you look at, again, with the assumption the dollar continues to strengthen in this quarter, it's a negative impact on us. So, we'll be booking potentially losses in that second quarter as, again, as the dollar strengthens against the euro.

Saul Ludwig - Northcoast Research

Yes, I understand that, but makes that number $3 million or $2 million or $16 million?

Ken Haber

Two things. One is the amount of dollars, the balances that we have, and second is the change in the rate.

Saul Ludwig - Northcoast Research

So, if we look at your cash balance, is that kind of what drives that number?

Ken Haber

Yes, it's not all of it, but a portion of that cash balance is exposed to that.

Saul Ludwig - Northcoast Research

Okay. How much did copper profits improve first quarter versus first quarter?

Ken Haber

It was I think about $3 million, $4 million, about $4 million year-over-year. About two-thirds of that was driven by price.

As I indicated in my comments, pricing was almost double from the prior quarter year. And then, buying was about a third.

Saul Ludwig - Northcoast Research

Okay. And then, finally, what was the Big Hill's pretax profits and work through the normal taxes and special taxes to get to the Big Hill bottom line?

Ken Haber

Okay. If you look at the GTL as a standalone operation, their profit in the first quarter included or their operating profit was about $900,000. Now, that also included refining expenses. As we said, we started to do our planned maintenance shutdown in the first quarter of this year. That was about a $1.2 million expense in the quarter.

Pretax and then, there was some other expense, so pretax income was about $700,000. There was discreet tax was a benefit of $2.3 million in the quarter, primarily due to discreet tax items. So, the GTL net income for the quarter standalone was about $3 million. So, the minority share of that 45% of that number was about $1.4 million and that's what you see in our P&L.

Saul Ludwig - Northcoast Research

And that was all the discreet items, right?

Ken Haber

I'm sorry again. Say it again.

Saul Ludwig - Northcoast Research

The $2.3 million tax was all discreet items?

Ken Haber

For the most part, yes. It was a benefit. So, actually, the benefit was a little higher than that. It was a net number, but it was a little higher than the 2.3.

Operator

(Operator Instructions). Your next question comes from the line of Mike Harrison with First Analysis.

Mike Harrison - First Analysis

A couple more questions for Steve - on the battery front, I know that the impact of lithium iron batteries in hybrid and electric vehicle applications, we're still a few years off on that. But, I just was hoping to revisit this issue of whether these vehicles are going to definitely be using next generation lithium ion batteries that use little or no cobalt or if you're seeing your customers moving more toward an improved version or a safer version of the lithium cobalt oxide cathode technology. What are you hearing right now from the customers that you're working with, and has your view on the amount of cobalt that might be used in hybrid and electric vehicle batteries changed at all over the past several months?

Steve Dunmead

Yes, Mike, first of all, you started out saying something about definitely. There's nothing definite with respect to electric or hybrid electric vehicles and the chemistry that's going to be used. However, I do not believe currently that straight lithium cobalt dioxide is going to be a prime material that's going to be used in those applications. Right now, there's a lot of people looking at nickel cobalt manganese, which we are manufacturing, nickel cobalt aluminum, which we are dealing with, high manganese materials, which we're also starting to deal with, and then you've got A123 looking at lithium iron phosphate. Has there been any significant changes in the thought processes on chemistry in EV applications? No, I don't think so. But, certainly, with the Nissan Leaf coming out that will be a lithium ion battery, we are getting to that inflexion point where we're

going to start getting some critical mass in lithium ion batteries going into those applications as opposed to the nickel metal hydride batteries that we are supplying cobalt into that, too.

Joe Scaminace

And Mike, indirectly, your question really, I really believe, validates why we went out and bought EaglePicher. I mean, if you think about it, we did not take our shareholder money here and lay a chip down on what we know has not been decided technology. So, what we really did was we bought a call on which way this technology is going to go. And in the meantime, we are tremendously learning an incredible amount to help our material suppliers portion of our business really understand what's going on here. The technical interchange between EaglePicher, given their knowledge of the end market in a very specialty battery orientation with aerospace and medical lithium ion batteries, the discussion and the dialog is incredibly intriguing for us where we're looking at all of the characteristics of performance regarding power needs, flammability issues, safety issues all the way down the line, and we have not put a chip down on what could go the wrong way. So, we're remaining pretty flexible, yet learning a lot about which way this is going.

Mike Harrison - First Analysis

Just out of curiosity, are you guys supplying any battery materials to the manufacturer of the batteries for the Nissan Leaf, and what technology are those batteries using?

Steve Dunmead

I'm not going to comment on what technology, but yes, we're in that supply chain.

Mike Harrison - First Analysis

Okay. Switching over to catalysts, you had noted strength in the catalyst business a couple of quarters ago. A lot of the refineries are still struggling, yet you guys seemed to highlight again this quarter that petrochemical catalyst is sort of the main driver in that business. Can you give us a little bit more detail on what you're seeing there and what your expectations are going forward?

Steve Dunmead

Yes, we expect that this market is going to continue to be strong for us. Combination of the hydro desulfurization and the gas to liquid catalyst looked very good to us, and the relative ratio of cobalt to other metals in those hydro desulfurization catalysts have been swinging in our favor. So, that market as you pointed out, we've been talking about it for about nine months being very good for us.

Mike Harrison - First Analysis

So, this is a situation part of what's driving this is that the catalyst makers can actually tinker with the combination of metals in the catalyst material and you've been a net beneficiary of that?

Steve Dunmead

Yes, in a lot of cases, Mike, they need to tinker with it. So, if the feedstock coming into the plant is different or where they are in their maintenance cycle for the plant that they're doing the petrochemical processing in, all those impact that usage.

Mike Harrison - First Analysis

All right. Last question is on electronic chemicals, specifically the photo mask business. Do you consider that to be a leading indicator? And I guess, if so, what is it telling you right now? And is there also any better metric that you can provide rather than

the number of masks that can maybe illustrate how that photo mask business is trending right now?

Steve Dunmead

I guess the first question was do we view the photo mask business as a leading indicator, and I think the answer to that is no. It is only a leading indicator of new devices. And so, what has happened here, and I think that we've talked about this in previous conference calls, is that when the market started to go down, no one was spending capital on new devices. And so, photo mask demand dropped over the course of the past 18 months. Then, all of a sudden, as we got to the second half of last year, semiconductor fabs started ramping up, and they didn't have time to deal with new devices. We are starting to see some recovery in the amount of devices. And as I also talked about that the market watchers are predicting that there will be an increase in capital spending of about 50% in the semicon industry that is a direct reflection then on both the equipment manufacturers, but also the mask makers.

With respect to a better metric, we'll give that some thought and have Troy or someone get back to you.

Operator

Your next question comes from the line of Chris Kapsch with BDR Research Group.

Chris Kapsch - BDR Research Group

Hi. A couple of follow ups - one, Steve, you mentioned something about dislocation of supply of cobalt grades into the super alloy market. I was wondering if you could just elaborate on that a little bit and maybe mention how you see that playing out going forward.

Steve Dunmead

During the first quarter and even into part of the second quarter, the spread between the low grade and the high grade went way off of its normal historical numbers. And what happened there was there is a distinct limited availability of materials that can be used in super alloy applications, and a couple of the higher grades of Russian material that we are distributing plus high grade materials like Falconbridge. And so, with limited availability of that, and that was coupled with some selective selling during the first quarter of some specific low grade materials at very, very low prices, the spread was up to about $6 at one point during the quarter. And so, that's what's driving that.

I don't see any significant changes coming on anything that's going to change the availability of high grade materials. No one's adding capacity for high grade materials. If you look at most of what's coming out of the Congo, it's really classified as low grade material.

Chris Kapsch - BDR Research Group

So, in other words, the investment down well, I'll let you pronounce it, but the upgrade capacity there is not enough to get it to super grade quality.

Steve Dunmead

No, Tenke Fungurume is only making a raw material. They're making a cobalt hydroxide raw material that has to go through someone else's refinery to make metal out of it. So, when I'm talking about and I don't think I'll mention names of the other projects, but there are some projects down there, some copper projects down there that are also making cobalt metal. They're not making feed, but they're making metal. Those are the ones that I'm talking about that it's the difference between 993 or 995 cobalt and 998 cobalt. And so, it's a modest difference. But, with respect to being able to use that in a super alloy that's going into a jet aircraft engine application, it's significant.

Chris Kapsch - BDR Research Group

Got you. So, just generally characterizing things, I mean, there might be this sort of overhang of potential sort of cobalt supply coming, but there's still sort of limited cobalt refining capacity globally and that could keep certain parts of the market tight.

Steve Dunmead

I think I agree with your last point that it could keep certain parts of the market tight. Is there limited refining capacity? It's grade specific. So, for certain chemicals, there's lack of refining capacity. For certain metals, or for certain grades of metals. But, I'm not sure I could make that broad comment that there's lack of overall refining capacity.

Chris Kapsch - BDR Research Group

Okay. And just follow up on the sort of your development efforts in the mixed metal cathode materials. Do you have what you suggested was you have a product for a development effort in nickel manganese cobalt cathode precursor materials. Do you have commercial sales of that product yet, or just have that being sampled to customers in the battery supply chain?

Steve Dunmead

No, we have commercial sales.

Chris Kapsch - BDR Research Group

Okay. So, it's something that is competitive with other materials that are currently being used in the marketplace?

Steve Dunmead

Absolutely.

Chris Kapsch - BDR Research Group

Okay. And then, just I had a follow up on the catalyst side. You mentioned gas to liquids. I assume you've been selling materials for the Shell project for a number of years. Is that fair to put it that way? And then, just if you could characterize what the growth opportunity is in that market going forward, because my understanding was there wasn't going to be another sort of Shell project out there any time soon.

Steve Dunmead

I really can't comment specifically on specific customers. All I can say is we have some very specialty niche products that we are selling at fairly significant volumes into that gas to liquid space. With respect to future growth, yeah, those are big, big plants that people are contemplating building. And so, the time between them, it's good and bad from a supplier standpoint. Someone builds a plant, you get specked into that plant, and it may operate for 20 or 30 years, and that's a really good thing. The flipside of that is that it may be a long time before someone else builds a plant. From a growth from our standpoint, the other thing that we are looking at very, very hard, both from a sustainability standpoint, but also from a profitability standpoint, is recycling of those various materials. And so, if there are ways for us to close the loop with our customers, whoever they may be, that's a very good thing for us.

Operator

Your last question is a follow up from the line of Rosemarie Morbelli with Ingalls & Snyder.

Rosemarie Morbelli - Ingalls & Snyder

Just looking at EaglePicher performance, if you eliminate all of the acquisition cost and look at the first months, which you didn't

own, but I am sure you have looked at the numbers, what would have been the operating income on kind of a normalized type?

Ken Haber

Well, the results that were reported was $1.5 million and the restructure the purchase accounting adjustments was about equivalent amount. So, for the first two months in this quarter, their operating results was basically break even.

Rosemarie Morbelli - Ingalls & Snyder

I guess my question was if you had not acquired it, is that what you what would have been expected as a normalized type of operating income, meaning break even level?

Ken Haber

Well, I think that we're a publicly traded company and they were being operated as a privately held company. So, I think that might explain part of the difference.

Rosemarie Morbelli - Ingalls & Snyder

All right. So, there are some additional costs. While you are expecting a negligible impact on earnings or neutral to earnings by the end of the year, what is in your opinion, based on what you have seen, a normalized type of operating margin for that company?

Ken Haber

Well, I think if you look the only thing I can refer to is what we found in our due diligence. And one of the reasons we were very attracted to this business was because of its good EBITDA margins, sustainable earnings and the potential upside to those earnings. And I think their EBITDA margins historically have been in the mid teens. And so, we would expect to see that and continue excluding whatever cost we would have to incur, which we will incur to get them compliant as part of a publicly traded company.

Rosemarie Morbelli - Ingalls & Snyder

Did you find any did you have any surprises, positive or negative, since you had it?

Ken Haber

Nothing of any significance, no.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And then, just quickly, the corporate expense excluding fees, is that a good quarterly level for the balance of the year?

Ken Haber

I'd say that's reasonable outside of the fact that we are, as Greg [sic] talked about earlier and Joe that we're constantly in the hunt for buying businesses. And certainly, as we pursue some of these things, we do incur expenses specifically with that. And in the past, the accounting practices were you could have deferred those. Now, you have to expense them in the period you incur them. So, it's likely that that cost could go up slightly due to that factor. Outside of that, it should be fairly level.

Rosemarie Morbelli - Ingalls & Snyder

Okay. And the amortization and depreciation for the year?

Ken Haber

We have about I think we forecast about $58 million of combined depreciation and amortization. That includes that was our plan for the year, and that includes about $12 million for the EaglePicher Technology acquisition as part of the battery

technology segment.

Joe Scaminace

Okay. I would just like to conclude by, first of all, thanking you all and mentioning that we feel like we've made a strong start in 2010. We think that our strategy is working. We're capitalizing on organic and acquisition growth opportunities. We've made progress throughout the year. We remain focused on cash and cost. And we're confident that the way we've started 2010, this will be a very strong year for OMG. So, again, thank you really very much for your time this morning. We appreciate your interest in OM Group and look forward to updating you on our progress. Good day.

Operator

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

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Source: OM Group Inc. Q1 2010 Earnings Call Transcript
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