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OM Group, Inc. (NYSE:OMG)

Q2 2011 Earnings Call

August 4, 2011, 10:00 am ET

Executives

Troy Dewar - Director, Investor Relations

Joe Scaminace - Chairman & CEO

Ken Haber - CFO

Steve Dunmead - VP and General Manager, Specialties Group

Analysts

Mike Harrison - First Analysis Securities

Saul Ludwig - Northcoast Research

Rosemarie Morbelli - Ingalls & Snyder

Operator

Good morning. My name is Ryan and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2011 results conference call. All lines have been placed on mute in order to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Troy Dewar, Director of Investor Relations, you may begin the conference.

Troy Dewar

Thank you, Ryan, and welcome everyone to our review of OM Group’s 2011second 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 of Specialties and Greg Griffith, Vice President, Strategic Planning, Development and Investor Relations.

A copy of the press release we 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.

During the course of this call, we will be discussing certain non-GAAP financial measures. I’ll refer you to the company presentation materials for the reconciliation of those measures to GAAP financial measures.

Comments made this morning by any of the participants on the call may include forward-looking statements based upon specific assumptions and subject to uncertainties and factors, which are difficult to predict. Actual results could differ materially from those 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 apply to this call.

At this time, I’ll turn the call over to Joe Scaminace.

Joe Scaminace

Thank you Troy, and good morning everyone. We continue to generate strong financial and operational result in the second quarter of 2011. This was a quarter notable for its continued sales growth and the generation of significant cash from operations. And of course, the addition of the previously announced VAC acquisition, makes our future look even brighter. Here is what is fueling our continued topline growth.

During the quarter, we continued to experience healthy demand for our products across the various markets we serve. For, within Advanced Materials, demand growth was fueled by strength in rechargeable batteries used in portable or electronic devices such as smartphones and tablets, hard metal tooling, used in global industrial production and strong growth for chemical and ceramic applications.

Similarly Specialty Chemicals performed well despite lower production resulting from our factory closing in Advanced Organics last year. We also experienced some softness in electronic technologies due to supply disruptions from the natural disaster in Japan.

The battery technology segment performed very well in the quarter. EaglePicher drove its quarterly sales to its highest level yet with increased shipments to all of its core end markets. Given our strong sales growth, two issues prevented us from fully maximizing our bottom line results; rising operating expenses and unfavorable movements in foreign exchange rates.

However, we continue to generate strong cash flow from operations. Ken will provide more details of this shortly. As we head into the second half of the year we are quite enthusiastic about our near-term outlook and our longer-range potential. We believe demand from our various end markets will remain strong in the second half of 2011. We also believe the newly acquired VAC business which closed earlier this week will accelerate our growth in several ways.

For example VAC has a significant presence in the alternative energy sector providing components that are used to make converters for solar and wind power supply and magnetic materials used in high efficiency wind generators. Within automotive that provides parts and components used by leading automotive suppliers to improve fuel efficiency and reduce emissions in vehicles.

And VAC is a provider of value added components used in electrical installation applications such as residential circuit breakers and smart meters in addition to sustainable earnings and attractive end markets. This is important, VAC has high-quality employees and they’re led by an experienced and excellent management team.

Based on our experience with the electronic technologies acquisition in 2007 and the battery technology acquisition in 2010, we understand that strong leadership with a proven history of success is critical for ongoing strong performance. We expect no less from VAC. I truly believe OMG is better positioned for long-term value creation that at anytime since I became CEO of this company.

Our balance sheet is strong even after completing a $1 billion acquisition. We remain willing and able to fund future growth opportunities. We have exposure to an even greater number of acquisition targets and growth opportunities than ever before. Many of our businesses served fragmented markets that could benefit from strategic consolidation.

Along with our growing exposure to alternative energy and our competencies in advanced materials we believe the possibilities for building on the foundation we’ve established are numerous and attractive. With the acquisitions we’ve made over the last several years including VAC, we’ve clearly marked the path that brings us closer to end-users in markets that are strong upside growth potential. These markets are not subject to earnings volatility from fluctuating raw material costs. We also have the size now that provides more options for us to consider in delivering long-term shareholder value. At this time, I’ll turn the call over to Ken Haber to walk us through the details of our financial performance.

Ken Haber

Thank you Joe and good morning everyone. Second quarter revenue improved 9% compared with the same period last year. Global economic growth and share gains spurred the demand for our products across each of our segments in most of our end markets.

Consumer electronic demand drove growth for our Battery Materials and Electronic Technologies products, with some headwinds from the Japan supply chain disruptions. Sector such as industrial production, construction, automotive and defense also contributed to the revenue growth. While volume improved we did experience lower pricing and mix including a decline in cobalt price, which offset some of the volume driven revenue growth.

Operating profit slipped $2 million pushing margins down to 8.5% of sales. Only Battery Technologies achieved year-over-year growth in operating profit while Advanced Materials fell slightly and Specialty Chemicals was down 12%. Corporate expenses increased due primarily to fees related to the VAC acquisition.

Gross margin was essentially flat at 22% of sales as benefit from volume leverage was offset by the impact of unfavorable pricing and mix, high manufacturing expense and unfavorable foreign currency moment.

SG&A increased to 13.8% of sales due to the acquisition related fees, higher employee compensation and increased sales activity. Net income nearly doubled compared to 2002, improving to $24.6 million.

A significant factor in the increase was income tax expense of only $300,000 this quarter compared with $18.3 million last year. There are several factors contributing to the lower tax expense. First, this year’s number includes a $2 million discrete tax benefit while last year’s number included $10.4 million in discrete tax expense items but when you back out the discrete items from each period this years effective tax rate would have been 9% compared to 32% last year.

The year-to-date tax rates where 13% in 2011 compared with 31% in 2010. There are primarily two items causing our tax rate to be lower this year. Movement in foreign exchange rates primarily the Euro versus the US dollar and the benefits of tax efficient financing. Each of these tended to lower our effective tax rates for 2011. For the full year we anticipate our tax rate including the VAC acquisition for five months to be approximately 14% plus or minus 3%.

Income from continuing operations as adjusted for special items such as the discrete tax items just discussed was $23 million or $0.74 per diluted share in the second quarter of this year compared to $21 million or $0.67 per diluted share last year.

Revenue grew 10% in our Advanced Material segment driven by higher volumes and an increase in byproduct sales. Sales grew in all end markets despite lower pricing due to a decline in the cobalt reference price. Metal resale was down $3 million on lower volumes while byproduct revenue was up $9 million due to higher copper price and volume.

Revenue for Battery Materials was up 9% due to demand for rechargeable batteries used in electronic devices such as tablets and smart phones. Industrial production activity kept our Powder Metallurgy volumes near record levels. And chemical and ceramics volumes and revenue were strong again with solid global demands especially from the emerging markets. We expect demand will remain strong in all these end markets during the second half of this year, which should push volumes to record levels for this year.

Operating profit was down slightly pushing margins lower to 10% of sales, while higher cobalt volumes were a benefit to the segments bottom line, operating expenses increased due to higher volumes as well as increase in some input cost. The biggest non-volume factor was a weaker dollar relative to the Euro, which push operating profit lower by about $3 million year-over-year. While we expect volumes to remain a net positive for the balance of the year movement in cobalt reference price and the dollar to Euro exchange rate may potentially impact results.

Specialty Chemicals revenue grew 3% compared with last year as higher semiconductor volumes, better pricing in Advantage Organics and positive foreign currency effect were are partially offset by unfavorable pricing and mix. Although Advanced Organics volumes were 8% of lower due to the restructuring activity last year, revenue was slightly higher due to growth in higher value additives, favorable pricing and FX movement. While we expect demands to remain healthy, we do anticipate a slight decline in volumes in the second half of the year compared with the second quarter, due to normal seasonal demand trends.

Revenue from a semiconductor end market was higher as growth in demand offset unfavorable price in mix. PCB and memory disc volumes were lower due primarily to supply chain destructions related to the recent disasters in Japan. Our second half forecast for electronic technologies end markets is mixed as we expect sequential growth in PCB, stable revenue in semiconductor and softness in memory disc, resulting in flat to slightly improved revenue for the group.

Segment operating margins fell as higher volumes and lower manufacturing expense were not enough to offset the impact from lower pricing and mix. We expect margins in the second half of 2011 for this segment to be in line with our first half margins.

Battery Technologies achieved revenue of nearly $36 million, a 26% improvement from last year and the highest level since the business was acquired in the first quarter of 2010. Growth was broad-based as each end market expanded by over 20% on strong demand, good mix and increased program deliveries as some sales were delivered ahead of schedule in the second quarter.

We anticipate segment revenues will trend lower in the second half of the year compared with the first half, as many of the sales delivered in the second quarter will not be replaced.

We also expect headwinds from reduced levels of government spending, impacting both defense and aerospace. Our medical outlook is positive as devices powered by our batteries are moving closer to FDA approval.

Operating profit grew significantly in the second quarter due to higher volumes, benefit from sales of recycled material and 2010 purchase adjustments that did not repeat this year. Some of these items that were positively influencing operating results in this quarter are not expected to be reoccurring, such as the profit from sales of recycled material.

If you back out these items and adjust for lower expected volumes in the second half of the year, we still expect full-year margins to be in line with 2010 results excluding purchasing accounting adjustments.

Now, I would like to make a few comments regarding our recently acquired business VAC. For the last five months of 2011, VAC is expected to generate revenue of $250 million to $300 million with EBITDA margins in the range of 17% to 20% excluding one time items. This will be partially offset by higher interest expense, one-time purchase accounting adjustments and amortization of intangible assets. We will also see some dilution from the issuance of an additional 1.3 million shares related to the acquisition.

Our cash balance at the end of the second quarter was $452 million with $120 million in total debt. Following the funding of our acquisition, cash balance is approximately $315 million and total debt is $700 million. Due to the balance sheet strength and flexibility that we have build over the last several years, we were able to fund a significant acquisition and still maintain a conservative balance sheet with solid credit metrics. We are pleased with the results from the debt syndication that we just completed.

The capital structure we have established provides the company with the right balance and flexibility to support both future growth as well as the current business needs. Networking capital increase compared with last year due to the increased sales activity and a reduction of accounts payable related to the Jersey Court injunction that temporary enjoined GTL from paying us accounts payable to our joint venture partner for raw materials slide purchases. Networking capital fell slightly sequentially due to lower inventory as a result of the maintenance shutdown in Finland.

This completes my review of our financial results. I will now turn the call over to Steve. Thank you.

Steve Dunmead

Thanks Ken. During the second quarter the cobalt market showed its resiliency given some minor impact from the disaster in Japan and seasonally lower battery demand. Powders and chemicals demand was down approximately 4% sequentially and up 10% versus the prior year.

Cobalt prices weakened sequentially on slightly softer demand and market uncertainty. The average price during the second quarter was $17.05 a pound down approximately $1.40 versus the first quarter. Prices rose in the middle of the quarter only to fall again in June to lower levels as spot demand was negatively impacted by the normal summer slowdowns in Europe. This softness should ease as Europe comes back its summer holiday season.

Before I discuss the key end-use markets, I’d like to make a few comments regarding the impact on OMG’s business following the crisis in Japan. While the disaster severely rattled some of the industries in which OMG participates, such as battery, electronics and automotive, we’re pleased to see how rapid the recovery has been. The impact on our overall business during the second quarter was minimal as most business that was lost was offset by increased sales elsewhere.

Now for the some of the key end-use markets impact in our advanced materials segment. As forecasted, our Q2 cobalt volumes were impacted by the annual maintenance shutdown in Kokkola and some seasonality on the battery side. Nevertheless, cobalt volumes were down only 5% versus a very strong first quarter and were up 19% versus the prior year. Looking forward, we expect volumes in the second half to be at record levels up to 8% to 10% versus Q2.

The battery materials market held up well in Q2, a strong demand for batteries used in next generation, affordable consumer electronics offset normal seasonal softness and the impact of the crisis in Japan. Cobalt sales volumes were down 5% sequentially and up 21% year-over-year.

There continues to be a resurgence of high cobalt-lithium iron batteries in the more advances slim designed electronics such tablet devices and smartphones. At the same time, mixed-metal chemistries that contained lesser amounts of cobalt are powering lower end laptop PCs and other new applications such EVs, HEVs, power tools and e-bikes. As a result, our mixed-metal sales were up 11% sequentially and up 600% year-over-year.

Overall, OMG remains well positioned in a wide range of rechargeable battery chemistry. Looking forward, we expect battery cobalt volume to increase 8% to 10% for the balance of the year based upon a combination of solid market growth and normal seasonality.

Our Powder Metallurgy team recorded another excellent quarter in Q2 due a combination of share gains and strong global tooling demand. Cobalt sales volumes were down approximately 3% versus a record Q1 and up 14% year-over-year. Looking forward, we expect volumes to remain at or slightly above these levels for the balance of the year as we are currently capacity constrained.

Sales of our inorganic chemicals products softened as demand for petrochemical processing catalyst fell inline with customer and usage cycles and our sales were constrained by the Kokkola shutdown. Cobalt sales volumes were down 14% sequentially, but up 5% versus the prior year. Looking forward this market should improve over the balance of the year driven by higher refinery output and normal usage cycles. We expect second half sales to return to Q1 levels up 6% to 8% versus Q2.

During the second quarter, advanced materials benefited from continued strong demand for ceramic pigments. Cobalt sales volumes were up 6% versus a strong Q1 and up 34% versus the prior year. The strength seems to be coming from construction activities in developing countries. For the balance of the year, we expect sales to be down 5% to 8% versus the levels seen during the second quarter.

Now for a few comments on the key markets impacting our specialty chemical segment. Overall, specialty chemical sales were up 4% year-over-year as strength in semiconductors more than offset the decline in advanced organics due to the shutdown of our Manchester, UK facility. Sequentially, sales were up 7% as advanced organics and semiconductors more than offset sluggishness in electronic plating chemicals.

During the second quarter, our sales into the coatings and chemicals markets were flat year-over-year and up 12% sequentially. Our strategy in these businesses were discussed previously just to offset declines in the traditional carboxylic drier market with increased sales of higher margin additives which were up 5% year-over-year. Looking forward, we expect our sales volumes over the next couple of quarters to be down slightly 2% to 3% based upon normal seasonality.

The Asian tire market was negatively impacted by the disaster in Japan and seems to have stabilized. Due to the shutdown of our Manchester, UK facility our volumes were down 10% year-over-year and were up 13% sequentially as we experienced some short-term share gains due to the events in Japan. Even with limited visibility over the next two quarters, we currently expect volumes to be flat to down slightly.

Turning to the electronics markets. After an extremely strong start to the year, global semiconductor sales growth weakened a bit and year-to-date stands at 45%. Our sales were up 7% sequentially and 17% year-over-year, as we continue to see share gains.

Analysts have decreased our outlook for the balance of the year to approximately 3% growths versus 7% at the beginning of the year. The market outlook is less clear, but at this point our sales should be flat to up slightly, as flat to plus 3% in the second half. For the electronic chemicals related markets, Q2 saw mix demand as strength in tablets devices and smartphones was offset by softness in the Japanese automotive and server markets. The supply chain in the latter two markets were negatively impacted by shortages of key components due to the events in Japan.

Overall volumes of electronic plating chemicals were down 2% sequentially and down 5% versus prior year. At this point we expect the balance of the year to remain relatively flat with improvements in PCB offsetting reductions in memory disc. Hard disk drive shipments were reported to be up 4% versus Q1 as expected after a strong first quarter in which restocking occurred, our sales into this market were down 8% sequentially and down 5% year-over-year.

For the balance of the year, we expect our volumes to be down approximately 15% due to plating efficiency gains at our key customers, coupled with losses due to a customer moving a portion of their consumption to inhouse produced product. Performance in the printed circuit board market was also mixed. Our volumes in this market were flat sequentially and down 6% year-over-year due to supply chain disruptions in the overall automotive and server sectors.

Industry analysts are currently calling for the print and circuit board market to grow by approximately 5% during 2011. Our volumes are expected to be up 2 to 4% for the balance of the year as market and organic growth are being partially offset by our election to walk away from some low margin commodity business. At this point, I would like to turn the call back over to Joe Scaminace.

Joe Scaminace

Okay. Thank you gentlemen for your comments. At this time I would like to hand 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 Mike Harrison.

Mike Harrison - First Analysis Securities

The first couple of questions are for Steve. It sounds like in terms of your thoughts on the cobalt market right now, it's mainly just summer doldrums that we are seeing, but I was wondering if you had any kind of longer-term concerns about the market maybe showing some signs of supply demand balance. If you do have concerns, are they on the supply side more, or the demand side? And maybe if you could talk about what you are seeing out of China in terms of the cobalt inventory level there.

Steve Dunmead

I guess, there’s three issues there that I think I heard. The first relative to the cobalt pricing and what’s gone on over the course of the past, say 2 or 3 months. Yeah, I think it’s just summer doldrums. I think if we go back 6,7, 8 years that nine times out ten, you’ve seen that same kind of summer dip as Europe takes their holidays.

Actually, the past two quotations, we have seen it hit the bottom and come back up a bit. We are up about a $1, I think from the low on the high grade and so, I think it’s not a gross over supply. I think it’s summer doldrums. With respect to anything changing from a supply demand imbalance, demand is very, very strong right now.

And I think, I haven’t seen anything that’s changed the overall supply demand balance over the course of the past 12 months. Certainly, more materials come to the market, but for the most part, it’s been taken up by growth in the end applications specially battery. With respect to China there is this constant debate about what the actual inventory level is in China.

But it’s very interesting because in some of our key markets and I am not going to point them out individually, we aren't seeing significant competition from China outside of China and either there's an awful lot of applications that westerners are not seeing domestically in China or people are wrong on the inventory levels and I am not sure for the industry’s conclusion on that yet.

Mike Harrison - First Analysis Securities

And then in terms of the battery market, I appreciate the additional color you are giving on cobalt materials versus mixed metal materials. But can you give us any sense on kind of what portion of your battery sales right now are mixed metal, in terms of the either volumes or sales dollars?

Steve Dunmead

Mike, we struggle with this because in some cases we are selling cobalt materials, pure cobalt materials that are going into mixed metal applications and so if I had to guess and I had to look at every unit that leaves Kokkola and which kind of chemistry it goes into, I guess it’s probably a 50-50 split, maybe 60-40 lithium pure cobalt.

But that's the reason it’s hard for us to answer. It’s not just our mixed metal materials that are going into mixed metal chemistries. There's also some of our key customers that are taking the various cobalt chemicals that we are selling and they are making a mixed metal out of it.

Mike Harrison - First Analysis Securities

But when you talk about your mixed metal sales being up 600% year-over-year?

Steve Dunmead

That is our mixed metal precursors, Mike.

Mike Harrison - First Analysis Securities

And what portion of your total battery sales or volumes does that mixed metal precursors account for?

Steve Dunmead

I don’t think we’re going to disclose that.

Mike Harrison - First Analysis Securities

I guess the last question for now, just in terms of the Vacuumschmelze acquisition, you guys talk pretty frequently about how much of your cash is stranded overseas, and I guess I'm just a little bit surprised that you didn't spend more of that overseas cash on the acquisition. Can you help me understand what the rationale was there?

Ken Haber

First off our cash, well 80% of our cash is overseas, not always in Europe, it’s in other areas of the world. Asia has a significant amount of cash too, so from that perspective. Second is, we’re not done with our transformation strategy and we want to maintain sufficient flexibility to be able to support opportunities and also to be a little conservative relative to some uncertainty in the world economy as we’re going forward.

If there is any excess cash, we’ll certainly use that to pay down the debt, so we can de-leverage as quickly as we can to be in a good position when the next significant acquisition comes along.

Joe Scaminace

You know Mike, let me take that to a more strategic level. Ken just mentioned the fact that we’ve been saying right along that our desire is to reduce cobalt variability and volatility on our earning stream and in fact we’ve made a significant move to further reduce that down to what was 75% down to 15 to 35% of our earnings coming from cobalt.

And in light of a $1 billion acquisition that we just made, we still have a significant amount of cash or dry powder, let’ say to basically continue to affect value for our shareholders by continuing to reduce the volatility.

Operator

Your next question comes from the line of Saul Ludwig.

Saul Ludwig - Northcoast Research

Ken, what were the DLPs in the corporate expense?

Ken Haber

They are about $4 million in the second quarters.

Saul Ludwig - Northcoast Research

What would you think about DLPs going forward?

Ken Haber

Probably minimal, may be half a million dollar or so in the third quarter.

Saul Ludwig - Northcoast Research

And then if you say the sales in the backend of the year going to be $250 million to $300 million, let's just call it $275 million for the sake of this discussion. And you said EBITDA margins might be 17%, so that would say EBITDA would be up $47 million. In that $47 million, how much is one-time expenses, whether it be inventory mark up or whatever you would call one-time in nature? And how much is DA and how much would be true EBIT? How would you slice apart the $47 million?

Ken Haber

The $47 million does not include any acquisition or purchase price accounting items in that. That is their reported results on an IFRS basis also, I kind of remind people and then they are going to be some conversions from IFRS reporting to US GAAP which will lower those numbers from that perspective. I think we are only two days into this acquisition and it is a little hard yet for the evaluation to come up with those numbers, it is going to take couple of months. It is fairly complex. So it will be month or two before we can answer those questions more definitively. I will tell you little though that we based on the preliminary numbers we believe that this will be accretive.

Saul Ludwig - Northcoast Research

In other words, so what we're going to subtract from the EBITDA is that we are going to have a conversion to US accounting, might be a few million dollars, right? Then we're going to have the DA, that VAC would have had, and then we're going to have additional amortization of intangibles, before we get to EBIT? Is that correct?

Ken Haber

Yes

Saul Ludwig - Northcoast Research

And what you are saying is you don’t have any ideas as to what that EBIT contribution is going to be even approximately at this time?

Ken Haber

Right at this moment? No.

Saul Ludwig - Northcoast Research

Okay. How much was the profit from the recycled materials that helped the battery division?

Ken Haber

In the range of $2 million, $2 to $2.4 million, in that range.

Saul Ludwig - Northcoast Research

And that goes away?

Ken Haber

Yes it does.

Saul Ludwig - Northcoast Research

And then finally, Ken, what was the pre-tax earnings of Big Hill?

Ken Haber

It was about $4 million.

Saul Ludwig - Northcoast Research

And is there any one off-thing or just 42% of that tax rate and things were pretty clear or you don’t know…?

Ken Haber

I think the tax rates 46% all in. I think it was $100,000 or something like that but it is minor.

Saul Ludwig - Northcoast Research

Okay. With that said, there is none of the discrete tax items apply to Big Hill?

Ken Haber

No, I didn’t have.

Saul Ludwig - Northcoast Research

Okay. Great, thank you very much.

Ken Haber

You’re welcome.

Operator

(Operator Instructions) Your next question comes from the line of Mike Harrison. You line is now open.

Michael Harrison - First Analysis Securities

I guess it's kind of a quiet call today. I had a couple more questions on the cobalt front. I feel like it's been a little while since we have discussed your plans in terms of cobalt supply in your contract with Norilsk. Have you extended that contract or is it still slated to end in 2012? And if you have not extended it, what are some of the other potentials sources of supply going forward?

Joe Scaminace

We have not at this point extended the contract we are still talking to them and three other people. I am very confident that we are going to be able to replace the materials if that we need, based upon growth and based upon any changes in other feed sources. At this point I would never sit here and give a list of the people that we’re talking to. I think that would diminish my negotiating ability.

Michael Harrison - First Analysis Securities

That’s fair. And remind me, is that contract with Norilsk, is that mutual options to extend or there is it all your option?

Joe Scaminace

It’s a mutual option.

Michael Harrison - First Analysis Securities

Okay. And then I wanted to ask also about whether you’re guys are seeing any impact of some of the new U.S. legislation on conflict minerals. Whether that has changed at all the way that you guys need to do business and you have any concern that future legislation on conflict minerals could impact your business in a bigger way?

Steve Dunmead

Let’s break that into maybe three parts, Mike. First of all, from a cobalt perspective, cobalt is not a conflict mineral. There is a lot of misconception out there, especially when people start talking about coltan because it starts with CO. People think it has cobalt in it. It doesn’t. And so there is a lot of misconception out there. We’ve actually seen more impact on our overall business with respect to [tin] supply lines. People wanting to make sure, it’s basically tantalum gold and I think that’s it. And so, we’ve seen people wanting verification of supply chains and the like.

With respect to what future legislation might do and how that might impact the cobalt supply chain, both internally we are talking about that and also I am the Chairman of the Cobalt Development Institute and that’s a topic that we are talking about. Clearly OMG is in a very good situation because we are not buying from a wide variety of sources. We have the significant supply coming from the Big Hill, which is clearly verifiable and all of our other sources. We’ve been very careful about making sure that we are purchasing from reliable sources that we could audit their productions, whether it was looking for child labor or whatever else that you might be looking for in the Congo.

So, certainly I think that any future legislation, whether it’s around cobalt or not, is putting publicly traded U.S. companies at had disadvantage relative to privately held competitors say, in China. But we don’t have any real concerns about it impacting us.

Michael Harrison - First Analysis Securities

All right, and then I wanted to switch topics to the Specialty Chemical side of the business. You kind of discussed some of the impacts you are seeing in the semiconductor markets and maybe the forecasts are a little bit lower for the second half than they were maybe when we started out the year. But I guess maybe if I could just get your thoughts on kind of overall consumer electronics demand and trends and whether you have any concerns, just about the macro environment in sort of key markets and the impact on, obviously, the semiconductor market for you guys but also the battery end market.

Steve Dunmead

Yeah. Mike, the number of times you heard us mention smartphones and tablets, it’s probably more than 10, alright. And so whether its semiconductor, PCB or battery that's driving a lot of results right now. And am I a bit concerned about overall consumer electronics moving forward, concerned?

No, a little bit leery maybe because I think that, you are watching what's happened to the stock market in the past few days, I think that makes people nervous and then people may not go out and buy that next big 52-inch flat screen. But I do believe that we are very well positioned with the next generation devices that people are still buying and if you look at whether its tablet devices or smartphones the infiltration into the corporate environment is really driving that growth, it’s not as much just individual consumers.

Yeah I get what you are saying if we look at semiconductors, our share gains have actually been in Europe and I think part of that's related to the supply chain disruptions associated with the Japanese earthquake and so I think we’re in pretty good shape there.

Michael Harrison - First Analysis Securities

When you think about those share gains, though, being associated with Japan, I mean, that also suggests that they might not be sustainable. What are your thoughts on that?

Steve Dunmead

I think there’s a lot of big companies that are out there rethinking putting all their eggs in one regional basket.

Michael Harrison - First Analysis Securities

So it’s people looking for second sources or additional suppliers?

Steve Dunmead

That’s natural.

Michael Harrison - First Analysis Securities

And then kind of keeping on the Japan scene, just was hoping to get some more details on where you saw the negative impact and kind of how it hit you. Was it decline in volumes, was it additional cost for materials or cost related to sourcing and delivering material supply chain type impacts and –?

Steve Dunmead

It was components. Mike. With the server market, the automotive market and the server automotive and – one other it’s slipping me right now. But there were components and it wasn’t that the guys weren’t able to build the circuit board; it was that whoever was building the server at the end of the line weren’t able to get all the components. That has sort of work its way out. We did see a little bit of uptick as I mentioned in tire because one of our competitors had some problems and so the battery actually, we didn’t a whole lot of anything. So it was hard drive server and automotive was really where we saw the – and it was all components. We didn’t see any margins hit’s because of any changes in our cost structure.

Michael Harrison - First Analysis Securities

Got it and then the last question I have is for Ken, you mentioned the tax rate going forward and I think you said 14%, is that a second half rate or a full year rate?

Ken Haber

That’s a full year. That’s our estimate, because our effective tax rate is always updated quarterly on a full year basis.

Michael Harrison - First Analysis Securities

So it was 13% in the first half, so that means in the second half only 15%?

Ken Haber

14%, 15% in that range, yes.

Michael Harrison - First Analysis Securities

And with the addition of Vacuumschmelze, does that give you a little bit better visibility going forward on the tax rate or are we still going to see quite a bit of volatility depending on the mix, the geographic mix of earnings?

Ken Haber

I think, again the volatility on our effective tax rate is really as we have talked about many times before is really with regards to the Euro and U.S. dollar relationship relative to our tax structure that we have in place. And that’s what’s driving that. And that’s the biggest volatility on our tax rate.

Michael Harrison - First Analysis Securities

Alright.

Ken Haber

So it has nothing to do with VAC.

Operator

Your next question comes from the line of Saul Ludwig. Your line is now open.

Saul Ludwig - Northcoast Research

Ken, what is the tax rate on VAC?

Ken Haber

The statutory rate I think in Germany is 30%.

Saul Ludwig - Northcoast Research

So we should use that for, that portion of the company. That wasn’t included in your blended tax rate you were just discussing?

Ken Haber

Yeah, we did. Again, we’re only having for five months this year, number one. And number two; there are a number of one-time expenses that are going to reduce their net taxable income. So that’s why it’s not going to have that big of an impact this year or certainly next year. It will increase it slightly at this point.

Saul Ludwig - Northcoast Research

Got you. You mentioned that in the quarter with regard to advanced materials that was like stronger volume growth, your margins were pressured for I think there are three things you talked about, the lower cobalt prices, you talked about the stronger Euro and then you also mentioned that something about other input costs that were higher than you were expected.

What were the nature of the other input costs that were higher than expected and then when we look to the second half of the year, if we assume cobalt to say not selling at $17 if we assume that, we assume the Euro is where it is, are the same pressures going to hold down the margin in the second half of the year as they did in the second quarter?

Ken Haber

As far as your first question, the input cost primary were process chemicals that we use in the refineries, so the caustic soda and other items like that they go into their use in the process are higher on a year-over-year basis. Also some of our manufacturing expenses relative to the shutdown and the startup relative to that.

As far as looking forward, I will remind people that when you look at the FX impact last year in the third quarter of 2010, the exchange rate 129 and right now we are looking at 144, so I would say that the FX Euro to U.S. will have some of the impact if it stays at 144 through the third quarter as it did in the second quarter from that perspective.

Saul Ludwig - Northcoast Research

And there was third reason, and higher input costs are going to be there; and the lower cobalt prices are going to be there.

Ken Haber

And our production will be higher and we will have some better absorptions as well as through from that perspective.

Saul Ludwig - Northcoast Research

So you would think that the…

Ken Haber

Offset some of that.

Saul Ludwig - Northcoast Research

So the margin should be better than the 10.2 of the second quarter, but below the 19% margin that you had last year in the third quarter?

Ken Haber

I will say that yeah that would fall in that range.

Operator

Your next question comes from the line of Rosemarie Morbelli. Your line is now open.

Rosemarie Morbelli - Ingalls & Snyder

I was wondering if when the price of cobalt to slow, shouldn’t that automatically mathematically translate to a higher margin?

Joe Scaminace

Ken you can take that.

Ken Haber

No, it doesn’t. Again our model is based on a percentage based model and therefore as the prices are lower, the percentage of those dollars or the percentage creates lower dollars of operating profit.

Rosemarie Morbelli - Ingalls & Snyder

Well, with the prices lower you have lower sales in dollar terms and therefore a similar amount of profitability will result in a higher percent margin?

Steve Dunmead

Rosemarie that’s only true if you are paying a fixed discount versus the metal price for your raw materials, because as Ken just said, because we pay a percentage in dollar terms as the cobalt price goes down the discount that we get versus the base is lower.

Rosemarie Morbelli - Ingalls & Snyder

Okay. I had missed the discount. I was wondering also, if you could touch on the progress you see out there in terms of electrical vehicle and the demand for batteries of that category. Is that including do you also benefit from what I understand is going to be higher batteries for electrical trucks in China, especially all the high trucks. You know the bigger batteries for trucks factory in China include your products and then do you see really a pickup in demand for electrical vehicles as far as your products are concerned?

Steve Dunmead

The main real ongoing supply at this point in time is going in to the existing ATVs, mostly the Japanese ATVs. We did see a bit of a disruption in that demand in Q2, because little bit at the end of Q1, but definitely Q2, because of the earthquake in Japan. Certainly, the EV-ATV market continues to grow as we see $100 barrel oil prices. Our exposure to the big truck batteries and the like in Japan at this point is limited.

When you start looking at EV applications, especially in Europe and the U.S., those are really still emerging, people are still playing with chemistries that we have great exposure and we are working with 80% of the people that are looking at various chemistries for those applications, but it’s not a big driver for results yet.

Rosemarie Morbelli - Ingalls & Snyder

Do you have a feel for when it will become a big driver, could it be 2015, 2016 or could it happen before or actually be delayed?

Steve Dunmead

I think 2015-2016 is a good enough bet. But if these volumes kick off there's significant changes to manufacturing processes that are needed in every step in the value because now you are talking about huge volumes versus consumer electronic little batteries. So the 2015-2016 is that's what you read in the industry, could it go sooner, I doubt it, could it go later, yes.

Rosemarie Morbelli - Ingalls & Snyder

And you would be prepared for that, how quickly would the demand you know get to lot of the chain, the supply chain?

Steve Dunmead

I think that we will see it well in advance and if you look at our typical construction cycle if we had to add capital those are typically 12 to 18 months plus design, so we would know well in advance of that.

Joe Scaminace

Okay. Thank you very much for your time this morning and attention this morning. I am very excited about the opportunities before us. Our businesses are growing. We are expanding into adjacent markets and gaining market share. We have a pipeline of new products that should benefit from macro growth trends around the world and we are well positioned to continue to invest in future high growth opportunities. Thank you all and have a great day.

Operator

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

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