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OM Group, Inc. (NYSE:OMG)

Q3 2011 Earnings Call

November 9, 2011 10:00 AM ET

Executives

Troy Dewar – IR

Joe Scaminace – Chairman and CEO

Kenneth Haber – CFO

Stephen Dunmead – VP, General Manager, Specialties Group

Analysts

Ivan Marcuse – KeyBanc Capital Markets

Michael Harrison – First Analysis

Saul Ludwig – Northcoast Research

Rosemarie Morbelli – Gabelli

Operator

Good morning. My name is Adrian, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter 2011 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

Troy Dewar, you may begin your conference.

Troy Dewar

Thank you, Adrian. Good morning and welcome everyone to our review of OM Group’s 2011 third 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 of Strategic Planning, Development and Investor Relations.

The 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 accompanying 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 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. I’m going to forego some of the formalities of our past prepared remarks and jumpstart our discussion today by highlighting some of our accomplishments from the past quarter.

Revenue in the third quarter of 2011 grew 40% compared with last year. Our performance generated a 66% improvement in our income. Likewise, operating profit increased 38%, also benefiting from volume growth and positive pricing. And once again, we generated positive cash flow from operations. Cash flow was positive even after funding one of the largest acquisitions in the history of our company. We’re certainly well positioned to continue the execution of our growth strategy with a very strong balance sheet. It’s also very encouraging that our acquisition of VAC is contributing right from the start.

What makes our performance particularly satisfying to me is the manner in which we achieve these results. Clearly, we are continuing to deliver on our commitment to diversify this company’s portfolio through an unrelenting focus on executing our long-term business strategy. In fact, we are a different company today, with a portfolio of technologies that serve diverse and growing markets all over the world.

For example, nearly one-third of our sales in our Engineered Materials segment meet specific requirements for the energy sector. This includes high quality materials for next-generation rechargeable batteries, critical components for solar and wind power generation, energy storage solutions for managing the variability in alternative energy sources and a range of products that help combustion engines improve their efficiency through advance fuel systems, high efficiency motors and state-of-the-art sensors.

Now to be sure, commodity prices still a factor in our Advanced Materials business. However, that portion of our portfolio is a much smaller piece of the overall company today. And it will continue to shrink in relative size as we build upon our other core growth platforms. I look forward to updating you on our progress as we continue to diversify our portfolio.

Before I turn the call over Ken, I want to give you a quick update on VAC, which we acquired in August of this year. I am pleased to report that the integration of VAC is essentially complete and the business is performing very well against plan. Even though we’ve only reported two months of this stub year, we’re strongly encouraged by what we are seeing in this business. VAC’s high quality products, blue chip customers and strong R&D efforts have provided major portfolio diversification for our company. We believe that VAC will meet or exceed our expectations in 2011 and also enter 2012 with significant momentum.

Adding to the strong VAC performance, we also benefited from strong contributions from our Engineered Materials, Battery Technologies, and Specialty Chemicals. For 2011, we are on trend to generate pro forma revenues approaching $2 billion, and operating profit could approach $250 million.

Now, we can’t ignore the fact that there is significant stress in the world economy, even from what we’re hearing this morning, and it’s difficult to forecast the future given all the volatility and uncertainty out there. However, I have to admit I really like how this company is positioned and I share the opinion of many industry experts who anticipate that our core markets will grow above GDP over the next three to five years. It’s clear to me we that have in place the basis for sustainable and profitable growth over the long-term.

At this time I’ll turn the call over to Ken.

Kenneth Haber

Thank you, Joe, and good morning, everyone. Before I discuss the details of our third quarter results, I would like to highlight the change to our reporting structure. As a result of the acquisition of VAC on August 2nd, the operating segment formally known as Advanced Materials has been renamed engineering materials. This segment contains our Advanced Materials business, and our new business, Magnetic Technologies, which consists of the acquired VAC business. Our third quarter results contain two months of VAC’s results from the date of acquisition.

Revenue in the third quarter improved 40% to $415 million including $107 million from the acquisition. As higher volumes in many markets, such as battery materials, semiconductors, ceramics, chemical and defense, more than offset unfavorable pricing in the Advanced Materials business due to lower cobalt reference price.

Our third quarter reported operating results include several special items, mostly related to the VAC acquisition. I invite you to turn to slide five of our presentation for a summary of these items. On the date of acquisition, U.S. GAAP requires that we recognize the fair value of all assets and liabilities, including inventory. As a result, we recognized $168 million step up to fair value for the inventory we acquired. This step up reflects, among other things, the market costs of raw materials on the date of acquisition.

During the months of August and September, we sold a portion of the inventory on hand at the date of be acquisition of which $31 million of this step up flow through our cost of goods sold as a non-cash expense. At the end of the quarter we recognized a $62 million non-cash charge for lower of cost to market, all of which was driven by the $168 million step up mentioned earlier.

The third quarter includes $11 million in transaction expenses related to the acquisition. Of these expenses, 2 million was recorded in engineered materials and 9 million in corporate expenses. And finally, the third quarter – in the third quarter we recorded a gain of $10 million in especially chemicals for the sale of land located in Manchester, England. This is the site of the former Advanced Organics manufacturing facility which was closed during the summer of 2010.

Excluding special items operating profit improved 38% with growth in each segment. Engineered Materials achieved the lightest increase as the VAC acquisition offset lower margins in Advanced Materials. Specialty Chemicals saw higher operating profit due to increased volumes, while battery technologies benefited from favorable pricing and mix.

Income tax expense in the third quarter was $18 million and includes discreet items and the significant effect of VAC holding on our estimated annual effective income tax rate for 2011. As a result of the VAC acquisition, we realized certain one-time purchase accounting adjustments such as the step up to inventory I discussed previously. These adjustments affected not only our operating profit but also our income tax expense.

As a result, this quarter we recognized a $45 million expense for the effect of applying our estimated annual effective tax rate to the year-to-date pre-tax income. If we hit our forecast for the full year, the $45 million expense will be reversed in the fourth quarter therefore it is included as a special item in this quarter.

In the second quarter of 2010, we recognized a discreet tax expense of $11.5 million as an allowance against prepaid tax assets in the DRC. At that time the DRC government was no longer granting request to utilized prepaid tax asset to offset more than 20% of the current tax payable.

This quarter we recognize a $7.3 million benefit due to a partial reversal of that policy of which the impact on our consolidated net income was $3.4 million. Excluding the discreet items and the effect of VAC, our effective tax rate would have been 13%, which is within the range that I have stated during our second quarter call. And this is approximately the same rate excluding VAC and discrete items that we anticipate for the full year.

Moving on to our segments, Engineered Materials revenue grew 75%, it was due primarily to the acquisition of VAC. Excluding the acquisition revenue grew 3% on higher volume and on an increase in byproduct sales. Partially offset by lower pricing due to the decline in the cobalt reference price. Metal resale was down $3 million on lower volume and decreased pricing while byproduct revenue was up $4 million due to higher copper price and volume.

Product sales volumes for Advanced Materials increased 7% on strong demand for battery materials and ceramics. Powder metallurgy was off slightly from a very strong third quarter 2010 and chemical experienced some softness in catalyst demand. Despite lower cobalt reference price revenue improved for all end market except powder metallurgy. Other volume improved 35% primarily due to copper byproduct volume. We expect advanced material’s demand will remain strong for the balance of the year, and volumes remain near record levels.

Our Magnetic Technologies business should see consequentially higher revenue in the fourth quarter as the period won’t grew three months activity rather than just two months in the third quarter and there end markets are expected to grow with the exception of continued softness of solar.

Excluding special items, operating profit improved to $39 million as the positive contribution from the acquisition and higher cobalt volumes offset the impact of declining cobalt reference price, higher manufacturing expenses and a weaker dollar versus the euro. For the fourth quarter, margins should benefit from continued strong demand for advanced materials and a full quarter result for Magnetic Technologies.

In addition to the potential impact from the movement in cobalt reference price and the dollar to euro exchange rate. We will have additional non-cash charges related to the inventory. Especially chemical’s revenue grew 6% compared with last year driven by favorable foreign currency. Improved pricing and mix max and advanced organics and electronic chemicals and higher volumes in advanced organics and semiconductor.

Advanced organics signs were up 3% primarily due to strong demand for chemical applications especially rigid form installation. Tire volumes were lower as last year shipments including some product sale from the manufacturing facility, we closed during the summer of 2010.

Revenue grew on the higher volume as well as favorable pricing and mix particularly in coatings and favorable foreign currency. We do expect demand to slow in the fourth quarter following normal seasonal trends coupled with a softening economy.

Revenue for the semiconductor end market grew as higher volumes offset unfavorable price and mix. PCB and memory disk revenue was essentially flat as favorable pricing and mix were offset by lower volumes. Fourth quarter volumes are likely to decline from third quarter levels as we enter the normal year end slow down and as customers work to minimize inventory ahead of an uncertain economic outlook.

Segment operating margins excluding the gain on the sale of land increased to 12.5% due to the additional volume. It’s likely the margins will remain at this level through the fourth quarter. Battery technologies revenue was slightly lower than the third quarter of 2010 as growth in defense volume was more than offset by declines in aerospace.

Medical was flat on steady demand for our batteries used in implantable medical devices. Consisting with our second quarter outlook, we anticipate volumes to trend lower sequentially in the fourth quarter due to the expected reduced levels of government spending impacting both defense and aerospace.

Operating margins expanded to 11% of sales an improvement on last year but down sequentially as some non-recurring items deposit to the interim in the second quarter. We still expect full year margins to be in line with 2010 results excluding purchase accounting adjustments with potential upside depending on the mix of products shift in the fourth quarter.

Since the acquisition date of VAC, the combined segments have added $20 million to the company’s cash balance, which at the end of the third quarter was $346 million. Total debt of $686 million is related to the funding used for the acquisition. The increase in net working capital dollars is primarily attributable to the VAC acquisition.

Excluding the acquisition, networking capital as a percent of sale was 28.6%, and networking capital days were 120. I believe there’s a true demonstration of our financial strength and flexibility to be able to fund a large acquisition and still maintain a strong balance sheet without excessive leverage. We’re in a great position to reduce our debt going forward to cash generated by our operation as well as consider additional growth opportunities as they emerge.

This completes my review of the financial results. I will now turn it over to Steve, thank you.

Stephen Dunmead

Thanks, ken. First I like make a few comments on the key end use markets impacting our Specialty Chemicals segment. Overall Specialty Chemical sales were up 6% year-over-year as most markets remain ahead of last year’s pace. Sequentially, however, revenues were down 7% as economic uncertainty weighed on consumer confidence and ultimate demand.

During the third quarter, our sales in the coatings and chemical’s markets fell 7% sequentially but were up 5% year-over-year. The sequential decline was due to combination of normal seasonality and the overall economy.

Looking forward, we expect volumes to decline approximately 10 to 12% during Q4 based upon a combination of the economy in normal seasonality. In the tire market, our Q3 volumes were down 13% sequentially as the short-term sales share gains due to the disaster in Japan began to decline.

Year-over-year volumes fell due to the shutdown of our Manchester, UK facility. We currently expect Q4 to be down approximately 15% due to softening in China and further declines in the short-term gains associated with Japan.

Turning to the electronics markets, after an extremely strong start to the year, global semiconductor sales growth weakened. Current projections are calling for 2011 to be flat with 2010 whereas projections at the start of the year were calling for 7% growth.

Our semiconductor related sales fell 4% sequentially but were up 12% year-over-year due to share gains. The market outlook is very unclear, but at this point we are expecting a decline of approximately 5% to 6% during Q4 in line with the market.

Hard disc drive shipments were reported to up 6% versus Q2, while the portion using aluminum media were reported to be flat. Our sales into this market were down 23% sequentially and down 16% year-over-year due to a move by one of our customers to 100% in-house produced product. At this point, the outlook for the balance of the year is very uncertain due to the flooding in Thailand, which is greatly affecting the hard drive supply chain.

The credit circuit board market performed well during the third quarter despite the weakness in the U.S. and European economies. Our volumes in this market were flat both sequentially and year-over-year as strengthen smart phone and tablet sectors was offset by weakness in the LCD market. We are currently anticipating that our Q4 volumes to be flat with Q3.

Now turning to the advanced materials portion of our new engineered materials segment. Overall global demand for cobalt picked up in Q3 after seasonal soften during Q2 in batteries. Cobalt chemicals and powders demand was up 4% sequentially and up approximately 9% year-over-year. Cobalt prices gradually strengthened throughout the quarter until the economic outlook turned the sentiment for most metals in a very negative direction mid September. On a positive note however, most cobalt market participants are not reporting significant excess inventory in the supply chain.

As expected, our Q3 inorganic cobalt sales volumes approached the record levels reached during Q1. Cobalt volumes were up 5% sequentially and up 10% versus the prior year. Looking forward, we expect Q4 volumes to remain at Q3 levels.

Battery material markets was strong as cobalt sales volumes were up 10% sequentially and up 16% year-over-year. These results were driven by strong demand for pure cobalt cathode material for the rapidly expanding tablet devices and smartphones partially offset by weaker demand for laptop PC batteries.

Our mixed metal precursors continue to penetrate the market with volume seen more than a 3X increase year-over-year. These materials are being used in lower cost laptop PC batteries, as well as emerging lithium ion powered XCVs. Looking forward, we expect battery cobalt volumes to increase a modest 3% to 4% during Q4.

Product metallurgy volumes were off approximately 3% versus record levels of Q2 and the prior period. We expect volumes to decline approximately 10% during Q4 due to combination of normal seasonal softness and the uncertain economic outlook.

With respect to Magnetic Technologies, VAC’s Q3 exceeded our pre-acquisition expectations as strength in permanent magnets was partially offset by softer results in cores and components and materials and parts. In permanent magnets, results were driven by strong demand and wind energy, industrial motors and automotive applications coupled with increased pricing due to rare earth.

Cores and components saw somewhat softer results as sales of solar inverters have weakened due to excess inventory in the overall solar supply chain. In materials and parts, results were driven by some customer inventory optimization in the electronic article surveillance market partially offset by steady demand in automotive and transportation, industrial and electrical installation applications.

Looking forward, we expect Q4 sales to increase in the range of 6% to 8% based upon price increases and permanent magnets due to rare earth pricing, normalization in the electronic article surveillance market and steady demand across the remaining markets.

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

Joe Scaminace

Thank you, Steve and Ken. At this time, we would like to open the call up to your questions.

Question-and-Answer Session

Operator

(Operator instructions) The first question from Ivan Marcuse from KeyBanc Capital Markets. Your line is open.

Ivan Marcuse – KeyBanc Capital Markets

Hi, guys, thanks for taking my question. In VAC, now that you’ve had for the next two months, in the permanent magnets, how much of those revenues are into wind energy?

Joe Scaminace

Well, I think that there’s a portion in wind, but it’s also the whole turbine field. So it’s not just wind turbines that permanent magnets are involved in, but it’s also water turbines and permanent magnets going to other type of products. So at this point, I can’t give you an exact percentage for wind, but I can tell you that the magnets are basically used in power steering units, etcetera. So what I would like to suggest is that you get back to Troy after the call and he can give you an exact number, Ivan.

Ivan Marcuse – KeyBanc Capital Markets

Great. And then you mentioned when you initially made the acquisition, you were looking for invest in several growth opportunities within in the business. Now that you’ve – now with I guess things have changed a little bit in Europe, solar is sort of weakening, do you still plan to invest in those businesses or how do you expect to grow the businesses going forward.

Joe Scaminace

Absolutely, we plan on investing in those businesses in synergetic opportunities. We’re focused on long-term growth and we’re going to deploy capital where it could get the greatest returns and as we get more familiar with VAC and see the diversified markets that they’re involved in all areas. They’ve got a great profile of higher than GDP growth in lot of their end markets, so absolutely we plan on growing in these fields.

Ivan Marcuse – KeyBanc Capital Markets

And then you looked at – I think you mentioned that you expect to make 250 million in operating profit in 2012, if I heard you correctly, what are your assumptions to get there to that level?

Kenneth Haber

I think that was – this is Ken first. That was just a directional number. That’s not – we’re not telegraphing our 2012 operating profit – for 2012. So, that’s just a directional number that we’re looking at here.

Ivan Marcuse – KeyBanc Capital Markets

So, you wouldn’t, or you do expect to make that?

Kenneth Haber

The number that Joe stated was a 2011 pro forma.

Ivan Marcuse – KeyBanc Capital Markets

I got you.

Kenneth Haber

Right. All we’re saying, Ivan is that given what we seeing so far, we’re into November that the operating profit could approach $250 million.

Ivan Marcuse – KeyBanc Capital Markets

Got you. And then my last question, I’ll jump back into the queue. Electronic Chemicals, do you expect to grow this business, now that you’ve had for four to five years and is there any opportunities down the road, where we’re going to be able to add some bolt-on acquisitions or are you looking to grow in different platforms still?

Kenneth Haber

Let me take that, and I will tell you that the world has certainly changed from what we originally saw in Electronic Chemicals a few years ago when we got down a platform in this field.

Clearly, we’re attempting to grow organically in printed circuit board chemicals; we have R&D activities going on in alternative solar pace technologies for example. We have opportunities to grow in ultra pure chemicals. We’re seeing a little bit of stress for example, in the electroless nickel going on to the hard drives just due to the stress in the notebook and the computer market.

But on the other hand, we plan on growing this organically. We do see greater opportunities in areas that we we’ve recently acquired and – so we’re going to look at both, and deploy capital where it – it provides the biggest return.

Ivan Marcuse – KeyBanc Capital Markets

Great. Thanks for answering my question.

Kenneth Haber

Sure.

Operator

The next question comes from the line Mike Harrison from First Analysis. Your line is open.

Michael Harrison – First Analysis

Hi, good morning.

Joe Scaminace

Good morning.

Michael Harrison – First Analysis

First of all, I was hoping you could give a little bit more detail on the Electronic Article Surveillance market, VAC, and sort of what was driving the weakness this quarter and what gives you, I guess, confidence that it’s going to normalize next quarter.

Joe Scaminace

Yeah, this was – Mike, this was yearend of one of our key customer’s inventory optimization process. The year end was at the end of Q3.

Michael Harrison – First Analysis

Is this something that VAC has seen in previous years?

Joe Scaminace

Not necessarily.

Michael Harrison – First Analysis

And is that key customer – are we talking about a 10% or 20% customer or like a 50% plus customer.

Joe Scaminace

I don’t have that in front of me, Mike.

Michael Harrison – First Analysis

Okay.

Kenneth Haber

It’s certainly not a 50% customer.

Michael Harrison – First Analysis

Okay. The lower cost or market charge; was any of that related to OM Group inventories or was it all related to VAC inventories?

Kenneth Haber

It was all – Mike, this is Ken. It was all related to the step-up that we took with regards to the acquisition of VAC, so all VAC-related.

Michael Harrison – First Analysis

With cobalt prices down around 16% over the past couple of months, would you expect a lower cost or market charge on your cobalt inventories.

Kenneth Haber

Well, if you look at the current market trend, it’s been a very gradual. So, usually when we have exposures and LCM, it would be one there’s a significant drop in price over a very short period of time. If you look at the pricing and we’d see, it’s a very gradual thing. So, at this point, we don’t expect to see one. But, again, it depends on, as we said before, how that metal price moves.

Michael Harrison – First Analysis

And then, Joe, I was hoping maybe you could talk a little bit just strategically about the memory disk business. It continues to be one where I’m just not sure given the transition to solid state and now you’re seeing a major customer moving the plating process in-house, just give me a sense of how you’re thinking of that business strategically going forward.

Joe Scaminace

Yeah, Mike, this is a business that actually is a legacy, Electronic Chemical business, that OMG had in its portfolio for many, many, years. We’ve been a market leader in that with a 70% plus share. There’s been a lot of consolidation at the customer base, no question about it.

Our margins are very good in that business, and clearly every time we re-examine the issue of solid state versus aluminum hard disk drives, we continue to see hard disk drive out there being invested in by some of these customers and so we’re going to continue to generate good cash flow and good margin from this business to the best of our ability.

Michael Harrison – First Analysis

All right. Thanks very much. I’ll get back in queue.

Operator

And the next question comes from the line of Saul Ludwig from Northcoast Research. Your line is open.

Saul Ludwig – Northcoast Research

Hi. Good morning, everybody.

Troy Dewar

Good morning, Saul.

Saul Ludwig – Northcoast Research

Steve, all the numbers that you are giving us for the fourth quarter outlook were volume versus the third quarter, is that correct.

Stephen Dunmead

Yes.

Saul Ludwig – Northcoast Research

Okay. Good. In fact, when you look at their results over a long period of time, is there much seasonality in their business?

Stephen Dunmead

You are referring to VAC?

Saul Ludwig – Northcoast Research

Yes.

Troy Dewar

It’s not nearly as seasonal as some of the, say, if you looked at Advanced Organics when you’ve got a heavy construction season in North America and Europe, it’s nothing like that.

Saul Ludwig – Northcoast Research

I just wondering, you know, your results there were terrific, or outstanding, and that was in the month of August and September, and August is usually, in general, a kind of weaker month for European industrial activity. So is this a business that doesn’t really experience that summer weakness in Europe?

Troy Dewar

Well, Saul, let me qualify something that you just said. You know, VAC, being a European-centered company in terms of their headquarters is a global company in terms of its markets. So when you look at seasonality, you can’t look at European markets only. You have to look at, just to give an example, Chinese acquisition of German Automobiles. You have to look at solar inverters going into the Chinese solar market.

You have got to look at blue chip customers that are buying ground fault interrupters all over North America, all over the world that need current sensors. So the issue of seasonality is much less on VAC side, but it would be a mistake to look at the European industrial output as a marker for them.

Saul Ludwig – Northcoast Research

The bottom line is there shouldn’t be a lot of seasonality on their business because of seasonal factors there could be macro forces that would affect them to be better or worse, but not because of the season, so to speak.

Troy Dewar

Absolutely. That’s an absolute true statement.

Saul Ludwig – Northcoast Research

And then, Ken, you mentioned that part of the step-up in inventory was charged off in this quarter as a special item. There is another portion, which I guess still resides in your inventory, in subsequent quarters to what extent is that going to affect the margins in VAC’s operations as that higher cost inventory flows through the cost of goods.

Kenneth Haber

You are correct, Saul. The margins will be impacted until that acquired inventory completely flows through our P&L. If you look at the third quarter and for two months of VAC we recorded about a $30 million charge related to that. So you look at that on a monthly basis and you get a good estimate on what the fourth quarter would look like. So quartering it would be maybe $45 million, but I again, that caution is going to depend on the actual movement of the inventories, the actual product sales of that as you’re going through that fourth quarter.

And also there will be a tail left remaining at the end of the year. Again, VAC has a good amount of inventory and raw materials and work-in-progress, some of that will not flow through until 2012. I think that that number right now on an estimated basis might be 20 to $25 million right now. But, again, that’s all dependent, as I said before, on actual sales of being recorded in the fourth quarter.

Saul Ludwig – Northcoast Research

Well, when these higher cost inventories flow through cost of goods, are they going to be sort of carved out as a special as you did here in the third quarter and be sort of stripped away from what you will call your true operating results?

Kenneth Haber

Absolutely. We will be consistent in that going forward, both in the fourth quarter, and as I said, whatever the amount of tail is as it gets recorded in 2012.

Saul Ludwig – Northcoast Research

I guess it’s obviously more special charges, you know, that we think about that were similar to what occurred this quarter.

Kenneth Haber

Absolutely. I like to remind everyone that these are all non-cash. And this is not what we pay for the inventory, just US GAAP requires us to fair value. So, again, these are all non-cash charges going through the P&L.

Saul Ludwig – Northcoast Research

So, I mean, it was all part of the cost of deal. You paid for the inventories as part of the cost of the deal.

Kenneth Haber

No. Our value of the deal was something less than that, accounting made us price it up on the current market value. On the date of sale, in other words, on that date of the sale, all this inventory was valued. It does not reflect what we paid for the business.

Saul Ludwig – Northcoast Research

Okay. And then from a amortization of the goodwill of the intangibles, I guess that’s going to be about $15 million a year?

Troy Dewar

Yeah. I think that – I’ve got a more of a summary number on a quarterly basis. I think their run rate probably on a quarter basis this would include both D&A, both depreciation and amortization on a combined basis, something around $11 million a quarter. So on a run for a full year that might be $40 million to $44 million.

Saul Ludwig – Northcoast Research

So that’s and the amortization. Okay.

Troy Dewar

Yeah. That’s a combined number.

Saul Ludwig – Northcoast Research

Gotcha. And that’s just related to VAC.

Troy Dewar

Yes.

Saul Ludwig – Northcoast Research

And then finally, the corporate expense this quarter, ex-special items was roughly $8 million. And normally you have sort of $12 million or so corporate expense. So it seems like maybe some of your normal corporate expense of 12 million, since a lot of those people worked on the deal that those were charged back to the deal. Going forward, are we going to be back to kind of a $12ish million corporate expense number per quarter.

Troy Dewar

No because I don’t know what the bases of 12, because our normal rate for corporate expense is somewhere in that 8 to 9. So it’s roughly around $35 million to $36 million a year. I think if you’re referencing 12, don’t forget in the previous first half of the year we had acquisition costs specifically $4 million. So, I think – and I think most of that got recorded in the second quarter. So again if you take our fourth quarter – or the second quarter I should say, back out 4, you back to the $8 million range. And that’s our normal run rate, excluding any special activity related M&A.

Saul Ludwig – Northcoast Research

Gotcha. Terrific. Thank you very much. .

Troy Dewar

You’re welcome.

Operator

Next question comes from Rosemarie Morbelli from Gabelli. Your line is open.

Rosemarie Morbelli – Gabelli

Thank you. Following up on Saul’s question. If you add the future impact on your corporate expense from VAC going forward, I am assuming that it’s going to be higher than the 8 to 9, so all in the group, isn’t it?

Troy Dewar

Yeah. I think there will be some incremental cost relative to more the, what I would call compliance cost, our audit fees will be up a little, some tax fee, stuff like that, but nothing of any significant.

Rosemarie Morbelli – Gabelli

So if we look at 10 million a quarter instead of 8 to 9 on a normalized basis with VAC?

Troy Dewar

I think that range, if we’re running at 8 to 9, 9 to 10 would be a probably reasonable for now to look at.

Rosemarie Morbelli – Gabelli

Okay. Thanks. And when you look at VAC’s inventory, and forget the fact that you had to step up and so on. Do you feel that the company can operate with a lower inventory level in the future or is what they have currently kind of a good number going forward?

Stephen Dunmead

Rosemarie, this is Steve. I think it’s too early to say that. We’ve only been at this for two and a half months. I think that if you start looking at permanent magnets, there’s a safety stock factor associated with some of the well publicized, rare shortages coming out of China. But I think that we’ve dealt with that well. So, I think, if you ask that question in three to six months, we may have a better answer for you, but I’m not sure that he we have a clear answer for you at this point of time.

Rosemarie Morbelli – Gabelli

Okay. Thanks. And moving to the solar industry, you are right at the – your products are sold right at the onset of manufacturers beginning to build new modules, am I correct, or are you further down the chain?

Troy Dewar

Could you repeat the question, Rosemarie?

Rosemarie Morbelli – Gabelli

Yeah. When solar module is being ordered, are your products right then at the onset of the manufacturing process or are you further down the hall. In other words, when the inventory is done, has been depleted to a normalized level, and manufacturers start ordering some of the basic material to make the next batch of modules, are you right at the beginning, are you going to see it first, do you see it towards the end of the process?

Troy Dewar

Rosemarie, let me try and clarify the participation we have in solar. The main product line for VAC that we concentrate on is in the area of what we call solar inverters that we make a component for the inverter itself. And this would be where solar energy, the current would be transferred from DC to AC current, and so we play in that arena in a bigger way than your typical view of how you’re looking at a solar panel.

Kenneth Haber

So we’re closer to – in other words, we’re just saying, we’re closer to...

Rosemarie Morbelli – Gabelli

...to the end.

Troy Dewar:...the installation...

Rosemarie Morbelli – Gabelli

Right.

Troy Dewar:...that we are, say, when someone’s making a wafer and then ultimately making the cell and assembling that. We’re closer – we’re not all the way at the installation line, but three-quarters of the way through that, probably.

Rosemarie Morbelli – Gabelli

And as a general rule, do you see – what kind of a window do you have when orders are being placed?

Troy Dewar

You mean what is our lead time.

Rosemarie Morbelli – Gabelli

Yeah. Thank you.

Troy Dewar

I think we’ve got a pretty good view six months out in most of the key markets for VAC today.

Rosemarie Morbelli – Gabelli

So then what do you see happening six months out? Do you think it is going to take six months to get rid of all those current modules sitting there waiting to be installed, or do you think that they will get rid of their inventory, it will take logger?

Troy Dewar

We believe that within – by the end of the second quarter that most of that excess inventory will be depleted. It doesn’t mean that we’re not selling solar inverter components today. It just means that there is an excess inventory in the overall system. And we certainly – and it, obviously, depends on the economy, but at this point, we would view that everything we’re hearing would suggest that some time in the second quarter that that should be working its way out of the system.

Rosemarie Morbelli – Gabelli

Okay. That is very helpful. And on the – lastly, if I may, on the decline in the demand for LCD, do you also have a feel for that inventory correction?

Troy Dewar

That one is a little bit, I’m not sure it’s simply inventory there. I think that may be demand driven at this point in time.

Rosemarie Morbelli – Gabelli

So, demand flows...

Troy Dewar

I don’t think that we have a very clear view today that there’s excess inventory and that within the next three to five months it’s going to turn. I think that it is simply demand driven, whether it’s for PCs or whether it’s for high-end TVs and I think that’s a consumer confidence issue.

Rosemarie Morbelli – Gabelli

Okay.

Troy Dewar

Does that answer...

Rosemarie Morbelli – Gabelli

All right. No, that is helpful. And I actually do have one last question. The Japanese, the benefits that you had given the Japanese issues. When do you see that fading away?

Troy Dewar

The last thing that we were seeing it in was in the tire market and we believe that that’s coming to an end in Q4.

Rosemarie Morbelli – Gabelli

Okay. Thank you.

Troy Dewar

You bet.

Operator

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

Michael Harrison – First Analysis

Hi, just to continue on the solar questions. Did I hear you guys say you were planning a foray into the solar-paced market?

Troy Dewar

No. What you heard was that in the electronic chemical business, Mike, that – and where we play in plating chemicals, we have projects that are looking at alternatives. That’s all I was referring to. We have not commercialized that product at this point.

Michael Harrison – First Analysis

So this would be an alternative material to wire the solar cell rather than using a conductive paste?

Troy Dewar

Absolutely.

Michael Harrison – First Analysis

Okay. Steve, I was hoping maybe you could give us just a little better sense of what you’re kind of seeing broadly in the electronics market. And specifically in consumer electronics, it sounds like – at least on LCD you’re a little bit concerned that you may be seeing a demand decline in addition to maybe some inventory reduction. But I guess I’m particularly interested in sort of how this relates to your batteries volume or demand outlook and obviously on the semi-conside and electronic chemicals as well.

Troy Dewar

You really hit on a key thing that we’ve been talking about for the past sings months. And there’s a bit of confusion here because what’s driving most of our battery demand today are patent devices and smartphones. And those as you know are flying off the shelves.

Whereas when you’re looking at lowering things like laptop sales, those laptop sales are being cannibalized by pad sales and so that’s at the consumer level. If you look at semiconductor, certainly semiconductor due to a consumer confidence issues has over the course of the past couple of months, we started seeing it midway through Q3. Some rumblings of extended shutdowns over the holidays and things like that, not nearly the amount of excess inventory in the supply chain as we saw in the ‘08 and ‘09 downturn. But certainly there is some nervousness at the semiconductor level.

Michael Harrison – First Analysis

And just in terms – just to kind of drill down a little bit more on the cannibalization of laptop sales by tablet devices. It sounds like you guys probably net out a little bit ahead in terms of cobalt battery material volumes because they’re a higher purity cobalt materials that are demanded by the smartphones and pads?

Troy Dewar

That’s true. But, again, I want to re-emphasize since, Joe, walked in the door, prided ourselves on being agnostic about the chemistry going in the battery applications. I talked about our mixed metal sales up 3X year-over-year. And that’s all – some of it going into lower end laptop device, some of its going into emerging XEV markets, but certainly your on smartphones and pad devices today using more high purity lithium cobalt dioxide as oppose to a mixed metal was absolutely true because they want the thinner design, the thinner packing more into thinner design.

Michael Harrison – First Analysis

And if I could shift over to the battery technologies business, I just was hoping to get a little bit more detail on the outlook for the medical market there. Can you talk about some of the devices you’re involved with, potentially what the timing of FDA acceptance could be on some them and maybe what the magnitude of sales or additional backlog could be to the $6 million or $7 million backlog we see now.

Joe Scaminace

Yeah, Mike, I’ll answer by saying when we acquired EaglePicher, the medical piece, really we were bullish on the in terms of the neuromodulation market which is the deep-brain stimulation that our batteries were used and we have multiple customer there, not just the big three, but even some start-up customers that we supply batteries to.

If you were to talk to any of the big medical device manufacturers, be it Medtronic, Boston Scientific, J&J, St. Jude. You’re going to hear a lot about issues of FDA bogging down a lot of these developments and it’s just taking a lot longer and we’re certainly feeling some of the impact of that in the medical side of our battery business.

Now, the outlook there is we still feel is reasonable given the fact that we not only play in the neuromodulation market, but we’re looking at making batteries for a field called CRM, or Cardiac Rhythm Management, which requires charges of electricity, which lithium-ion batteries play a role.

So, right now the business has been softer than we would like. However, the outlook for us, we’re continuing to pound away at it trying to gain market share and grow with the market, but until we see these devices gaining more traction out there, I think it’s going to be a tough goal for us.

Michael Harrison – First Analysis

Okay. And last question, I guess more for Joe, but just for comment is – I thought Ken might be relaxing on a beach somewhere by now. Can you give us any update on the CFO search process?

Joe Scaminace

Yes, I think I could answer that and say that we’ve been happy to have Ken here for the year that we’ve been out doing a very exhaustive search to find an adequate replacement, and I think we’re getting close. And I’ll stop right there and say I think within the next few months – or I’ll say the next few weeks or months, I think we’ll be able to announce a replacement.

Michael Harrison – First Analysis

All right. Thank you very much.

Joe Scaminace

Okay. I think that’s it for the questions. Let me just conclude by, first of all, thanking all of you for the interest and attention to your company. We’re really encouraged by what we’re seeing right off the first tea with VAC. And I want to stress again that this is a continuation of our transformation. We’ve got the ability, the flexibility, the balance sheet to continue, and I think you’re going to see great results from us going forward. Thank you everyone.

Operator

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

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