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OM Group, Inc. (NYSE:OMG)

Q1 2012 Earnings Call

May 3, 2012 10:00 AM ET

Executives

Joe Scaminace – Chairman and CEO

Chris Hix – CFO

Steve Dunmead – VP and GM, Specialty Businesses

Analysts

Andrew Don – KeyBanc Capital Markets

Steven Schwartz – First Analysis

Saul Ludwig – Northcoast Research

Operator

Good morning and welcome to OM Group’s First Quarter 2012 Financial Results Conference Call. Information presented on the call may include forward-looking statements that are subject to uncertainties, risks and factors that 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 OM Group’s press release or in Form 10-K and applied to this call.

I will now turn the call over to Mr. Joe Scaminace, Chairman and Chief Executive Officer of OM Group.

Joe Scaminace

Good morning, everyone, and welcome to our first quarter earnings call. Today, I’m joined by Chris Hix, our CFO; and Steve Dunmead, VP and GM of our Specialty Businesses, also with me our Troy Dewar, Director of Investor Relations and Rob Pierce, VP of Finance.

Before we discuss our first quarter’s results, I want to announce a few changes to our Investor Relations Program. Troy will be leaving OM Group at the end of this week for a different opportunity, and we wish him well in his career, while Pierce will be assuming responsibility for our Investor Relations here at OM’s as part of this new role as Vice President of Finance reporting to Chris.

Rob has been with the company for ten year, most recently as Vice President and Corporate Controller, and has been involved as strategic activities, such as the acquisitions of VAC and EaglePicher. He knows the company very well, and will help us get the story out to the investment community.

So let’s get started on slide 3, I’m pleased to report that we started the New Year with solid results in the first quarter of 2012. Despite low cobalt prices sales and profitability are higher than the prior year. This performance is based largely on the strength of VAC, which we acquired last August and EaglePicher which we acquired in 2010. These two businesses form the foundations of our newest strategic platforms; Magnetic Technologies and Battery Technologies. They both accounted for a substantial portion of our first quarter performance, underscoring the progress we’ve made in our strategic transformation over the past few years.

As anticipated in our last call with you, our businesses faced challenges, including lower metal prices, customer disruptions from the Thailand flooding, and the economic pressures on some of our European customers. In spite of these challenges as a result of our portfolio diversification, we were able to deliver solid and improved financial results. Compared with last year, sales grew 41%, while adjusted EBITDA grew 42%.

Cash flow was very good in the month of March, reversing the trends of January and February. We anticipate generating strong cash flows during the second quarter and for the full year driven by lower working capital levels. Our first quarter results included positive rare-earth pricing effects, similar to our second half results from last year.

Slide four provides an overview of our business portfolio. Advanced Materials or Cobalt franchise contributed $15 million of adjusted EBITDA during the first quarter, this is a great business with market leading positions and is a consistent generator of cash. However, it does have significant exposure to metal prices.

On the right-hand side of the chart, and this is important are the three platforms that we built by executing our transformation strategy. These businesses contributed nearly $67 million of EBITDA or 81% of the consolidated total excluding corporate expenses. Most of our economic performance is now driven by businesses with exposure to attract it, long-term end market dynamics and by businesses that are better rewarded for the value they bring to customers not for selling materials by the pound.

Our strategic platforms provide multiple task for organic growth as well opportunities for synergistic acquisitions to create shareholder value.

Turning to slide 5, the execution of our strategy enhances our ability to grow profitably and sustainably. As these charts demonstrate trailing 12-month sales have nearly doubled compared to 2009 while adjusted EBITDA has more than doubled, and this does not yet reflect a full year of VAC results. OM Group is definitely on the move.

Turning to slide 6, through strategic realignment of our portfolio and solid execution of our strategy, we’ve created a diversified materials company with growing exposure to attractive end markets. With our platforms established, we are clearly focused on enhancing the value of this company by continuously developing our capabilities, identifying and acting on synergistic acquisitions, investing in organic growth and improving our operating execution. What does this take us, our vision as a company where sales grow faster than GDP and earnings grow faster than sales due to our operating leverage. We remain committed to prudent financial and operational management to maintain earnings growth and cash flow generation, and we’ll continue the strategy to create long-term shareholder value.

Slide 7, includes our key enterprise priorities for 2012. We’ve already discussed the positive impact from our VAC acquisition, not only through its contribution to our sales and earnings, but to the effectives we had on our portfolio transformation and our ability to build off that platform in the future. We’ve introduced new products, our activity level remains high in both sales and development of new products, and we’re seeing opportunities to gain market share through increased customer penetration and expansion in our new accounts and regions. All of these actions help us to deliver against our strategic objectives and bring about transformation of our portfolio.

So turning to slide 8, and then summary, 2012 has started with strong financial performance even in the phase of some challenges. We’re achieving significant contributions from the acquisitions of that in EPT and longer-term we are well positioned to pursue our strategy building out our business platforms to grow the enterprise and reduce volatility.

OMG’s investment proposition is compelling. We are a diversified product portfolio aligned with favorable attractive growth trends. We have the financial strength and flexibility to create shareholder values. We are a global organization to support a global customer base and a growth strategy designed to take advantage of these strengths.

At this time I will turn the call over to Chris Hix, who will walk us through the financial results.

Chris Hix

Well, thank you Joe and good morning everyone. Slide 9, provides an overview of our first quarter P&L compared with last year. The GAAP reconciliations are in the appendix of the presentation. Sales grew 41% with the contribution from VAC more than offsetting decreases and Advanced Materials and Specialty Chemicals. Advanced Materials volumes were down from a very strong first quarter last year with cobalt prices well below last year’s levels.

Specialty Chemicals volumes were once again negatively affected by the slowing European economy and the lingering effects from last year’s flooding in Thailand. Battery Technologies achieved higher sales across their end markets. Adjusted operating profit increased 33% and adjusted EBITDA increased 42% compared to a year ago, again driven by the VAC acquisition.

Adjusted figures exclude the $15.7 million inventory step up charge resulting from the VAC acquisition.

Lower volumes in Specialty Chemicals and lower cobalt prices in Advanced Materials led the margin contraction in those businesses, while Battery Technologies top line growth led the margin expansion. Below the operating line interest expense came in as expected.

The effective income tax rate was a little higher than we expected, due to some DRC related discrete items and the mix of our profits around the globe. We expect our effective rate to be in the mid to high 20s for the balance of the year. The first quarter results include an FX loss of $5 million due primarily to the strengthening euro during the quarter, which increased our euro denominated debt as we’ve reported in U.S. dollars.

Combining all of these factors our adjusted EPS, which excludes VAC inventory step-up charge was below last year. First quarter EPS includes a $0.12 loss for the FX we discussed a moment ago, offset by a benefit of $0.10 from a property sale gain in Specialty Chemicals. Slide 10 shows an overview of our cash flow for the quarter. Operating cash flow was negative driven by a higher networking capital. We had a slow start to cash flow in January and February as we paid for inventory that was received in the fourth quarter, but paid for in January and February. But March cash flow was terrific setting the stage for positive cash flow in the second quarter and beyond.

On slide 11, we take a deeper dive into working capital and our capital structure. The chart on the upper left hand corner of the page shows working capital as a function of sales. We began trending up in the third quarter last year, following the VAC acquisition and increased again in the fourth quarter due to a misalignment between sales and inventory levels. This stabilized in the first quarter of this year and we expect to see progress throughout the remainder of the year, perhaps as much as a few 100 basis points.

The chart in the upper right hand corner of the page shows our cash and debt levels. Debt increased slightly in Q1 due to the strengthening euro partially offset by a small scheduled debt repayment. We expect cash to increase throughout the remainder of the year further improving our already strong balance sheet which provides us options and flexibility to fund our strategic transformation.

The next few slides provide an overview of our business results beginning with the Magnetic Technologies on slide 12. Demand was strong for aerospace, automotive, wind and certain industrial applications. Both aerospace and automotive were benefiting from electrification trends in passenger cars and commercial aircraft.

Wind continues to see demand driven by growth in direct drive wind generators. And industrials type closely to automation equipment used in manufacturing. On the other hand, the solar market remains weak and we’re seeing softness in retail and certain electronic applications.

And even though a lot of the this businesses output is tied to export outside of Europe some of it inside of the European economy, which is resulting in lower volumes. Positive pricing listed both sales and profit in this segment, primarily due to the effect of rare pricing. Magnetic Technologies is typically able to pass-through increases in raw material costs, including rare-earth to customers.

Price fluctuations and raw materials for this business have historically not had much of an impact on financial results. However, due to the unprecedented spike in rare-earth prices last year, the pricing on – the pricing effects on VAC were amplified. The result was higher the normal margins in the later stages of 2011 and the first quarter of 2012 due to the positive benefit experienced as rare-earth prices retreated from their peak.

During the eight months since the acquisition, adjusted EBITDA margins for Magnetic Technologies have been about 20%. As rare-earth price have declined of their peak and appeared to have stabilized, we would anticipate these margins to return to historically lower levels over the next two to three quarters. Our Advanced Materials business shown on Slide 13 was negatively impacted by both price and volume. Growth and demand for rechargeable batteries was offset by declines in cutting tool demand from very strong prior year levels. Lower cobalt volumes and price comprised sales and margins. By-product sales and profit decreased on lower copper prices.

The chart in the upper right hand corner of the page gives you a longer-term perspectives of cobalt price and volume in this business. Volumes are down 9% from a year ago, or 5% down excluding resale and prices are 21% lower. On a positive note, cobalt prices firmed up a bit in the first quarter and industry projections suggest further upside this year. We expect mid single-digit percentage full year volume growth in 2012 in the Advanced Materials business principally due to growth in battery materials.

And especially chemicals business on slide 14, first quarter volumes were lower than in the prior year. The chart in the upper right hand side of the page shows the volume performance of our advanced organics and electronic chemicals product lines for the past nine quarters. It demonstrates the impact of the Thailand flooding on our electronic chemicals product lines starting in the third quarter of last year.

Even though electronic chemical volumes were down 15% year-over-year in the first quarter, the chart shows a sequential improvement this quarter. We expect further strengthening as our customers recover from the Thailand flooding and we are also seeing positive signals from the semiconductor industry.

The chart also includes the volume trend in our advanced organics product line, which were 7% lower than the prior year due to weaker European demand, but shows the expected seasonal strength. Looking ahead this profit line is expected to show additional seasonal strengthening in the second quarter.

Advanced organics is also benefiting from growth in Borchi OXY sales, which were associated with our acquisition of Rahu in the fourth quarter of last year, though currently small, these sales are expected to grow as customers change their formulations to produce more environmentally friendly formulations and meet regulatory requirements. Operating profit in the business was flat in the quarter from the prior year, excluding the $2.9 million property sale gains profits were down on lower volumes.

Slide 15 summarizes the performance of our Battery Technologies business, sales and operating profit both achieved growth quarter-over-quarter, primarily due to higher volumes across all major product lines. As you have seen, this business can be lumpy quarter-to-quarter due to the timing of contract releases, customer changes to shipping dates and progress on contracts accounted for into the percentage of completion method.

Having said that, the business continues to enjoy good sales in the defense and aerospace sectors. We have a small, but growing exposure to medical applications, which is benefiting from product placement into new devices.

I will wrap up with our 2012 second quarter outlook on slide 16. Overall, we expect adjusted EBITDA to be sequentially lower in the second quarter and cash flow to be higher. Our Advanced Materials business will be sequentially flat to down as we anticipate slowly firming cobalt prices to be offset by the impact of our annual maintenance shutdown in Kokkola.

Magnetic Technologies is expected to trend lower due to weaknesses in Europe and in certain end markets such as solar and reduced rare-earth price effects. We see the Specialty Chemicals business as flat to improving, primarily on increased demand in electronics end-markets and seasonal strengthening in Advanced Organics, partially offset by no repeat of the first quarter property sale gain.

Battery Technologies is projected to be flat to lower due to a return to more normalized sales and profit levels in the second quarter. Cash flow should improve in the second quarter due to greater working capital efficiency primarily around inventory levels.

That concludes our prepared remarks. Operator, please open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Andrew Don from KeyBanc Capital Markets. Your line is open.

Andrew Don – KeyBanc Capital Markets

Guys, good morning. Thanks first of all for providing some extra detail on the slide deck, that’s really helpful. So if I could start out looking at rare-earth, is there any chance you quantify for us the impact on the first quarter and perhaps even the impact that it had in terms of the benefit in the back half of 2011?

Chris Hix

Yeah, this is Chris, Andrew and, hello.

Andrew Don – KeyBanc Capital Markets

Yeah, I’m sorry, that music kicked in, I’m not sure why.

Chris Hix

Okay, all right. Andrew, hi, it’s Chris – in telecom issues here. Andrew, can you hear us, okay?

Andrew Don – KeyBanc Capital Markets

Yeah, it’s coming in fine hear.

Chris Hix

Okay, good.

Joe Scaminace

Yeah, it’s difficult to put all the specific numbers on each of the effects because you’ve got the combination of volume changes and price and mix, rare earth passers that are happening as well. We do understand the business had some benefit in principally the fourth quarter of last year as it relates to these issues of mix and price and so forth and we’ve continue to enjoy those benefits even probably a little bit more so in the first quarter.

As you look at the second quarter, we expect both price, mix and volume all three of those to be a bit of a headwind sequentially as we go from the first quarter to second quarter in the Magnetic Technologies or VAC business, but tough to identify each of those individual components.

Andrew Don – KeyBanc Capital Markets

Okay. I understand. And then secondly, if we could just move on, you’ve mentioned Thailand flooding now that was kind of 2Q to 3Q 2011 event. And it seems like kind of looking at some commentary coming out of people with manufacturing they are seeing thing start to pick up. So I guess my question is, have you seen any acceleration demand looking month over month in the recent months or how is your outlook there?

Steve Dunmead

Andrew, this is Steve Dunmead, we have started to see some of the key customers going through their qualifications as they restart the plant and we expect that as we get to the second part of this quarter and end of the third quarter the things are going to clear out, but it was a real mess.

Andrew Don – KeyBanc Capital Markets

Okay, great. Thanks very much guys, I will hop back in queue.

Joe Scaminace

Thank you Andrew.

Operator

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

Steven Schwartz – First Analysis

Hi good morning guys, it’s actually Steve Schwartz sitting in for Mike today. You know you noticed – or you noted a favorable project timing in battery Technologies and you know there is something around 30 million in sales at 10% operating margin, a good estimate for Q2, or the Q1 had so much pull forward that maybe Q2 comes in lower than that?

Joe Scaminace

Yeah, it’s we are not necessary in to position to offer specific guidance on each of the businesses, but I think, your idea around the lumpiness of the timing of revenues and profitability is spot on. If you look at the fourth quarter, the business actually reported a small loss, first quarter of this year reported very good margins and we would expect that it contract a little bit as you get more normalized revenue levels. And so, I don’t know, if I characterize it is as pull forward or push back or but the revenue levels in this business are lumpy for the reasons that we enumerated.

Steven Schwartz – First Analysis

I see, okay. And I guess looking at supply and demand in the cobalt market, you know we’ve seen little improvement in pricing recently, but given some of the concerns on the demand side, can you share some thoughts around your near term outlook?

Steve Dunmead

Yeah Andrew or Steve, this is Steve. Certainly from a demand standpoint as Chris talked about when he is going through the slides that we’ve seen a little bit of issues especially in Europe with cutting tool applications and some of the industrial applications. But overall, I think, the demand side is okay.

From a supply side, we are starting to see more press about the continuing powers used in the Congo and so I am not sure that we can quantify that, but I think roughly the metal, the cobalt supply and demand is roughly in balance at this point in time. And hopefully, we get out of these power issues in the Congo but we will see.

Steven Schwartz – First Analysis

Okay, that’s great. Thank you, guys.

Joe Scaminace

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Saul Ludwig from Northcoast Research. Your line is open.

Saul Ludwig – Northcoast Research

Very good morning, guys.

Joe Scaminace

Good morning, Saul.

Saul Ludwig – Northcoast Research

Although in the specialty chemical sector, what you know the other impact on profits $5.3 million you’ve said $2.9 million was from the sale of the property, what was the other positive impact from?

Chris Hix

Yeah there is a host of other items in there, probably the biggest one is just control over the some of the SG&A spending, as well as control over some of the input costs from our cost of goods sold standpoint.

Saul Ludwig – Northcoast Research

Do you have some lower input costs?

Joe Scaminace

Slightly lower input costs in certain areas Saul, but I’d say and I’d say it’s also cost control on the SG&A side.

Saul Ludwig – Northcoast Research

Also I was kind of surprised, FX you have that every quarter, some quarters it is a plus some it is a minus and we understand why that happens, that’s always been considered an appropriate part of adjusted earnings per share. I was somewhat surprised that the $0.10 a share from the property sale was included in the adjusted number versus treating that as a special. Why was that done that way?

Joe Scaminace

We actually left the FX and the property sale both in earnings per share, but we call them out specifically, so investors could see it, and then determine on their own how they want to model that so and how they want to consider it.

Saul Ludwig – Northcoast Research

Okay. And the backup here, they have a particular good quarter. Could you have any commentary on the either knowing the business last year, but should know what the numbers we’re. They historically had reported their results and sort of three segments, the core is the battery, how does those sub-segments do in the quarter?

Joe Scaminace

Well, we had a very good quarter in VAC in particular driven by a very, very strong automotive sales. Globally, right now, the automotive business is just really smoken, both here in the United States, I think to some extent, but to a greater extent in the German automotive industry.

So our sales to that segment have been pretty strong, just to give you a flavor for that. And on the other side of the business, I think it’s just a continuation of what we’ve talked about where solar seems to be lagging just a little bit of what we thought. There was a thought in the last call where we mentioned, we thought there would be a firming in April. We’re seeing a very, very slight roaming of that. And that business I think are hopefully as the year goes on, will improve. But those are the two major items that are affecting the VAC business.

Saul Ludwig – Northcoast Research

And I was wondering, is it the permanent magnets that are strong or is that more of the cores or the other category of VAC that seems to be really strengthens?

Joe Scaminace

e seeing strength in magnets.

Saul Ludwig – Northcoast Research

In the permanent magnets?

Joe Scaminace

Yes.

Saul Ludwig – Northcoast Research

Great and the – the other things that’s sort of confusing, you know rare-earth prices were really, I mean super high last year and I think second quarter or third quarter and then they dropped in the fourth quarter. They dropped further in the first quarter and they appear to be even lower in the second quarter, so with this declining trend in rare-earth prices, why was that a positive effect in the first quarter and will be a negative effect in the second quarter?

Chris Hix

Yeah, so Saul, this is Chris. The business loaded up on a lot of inventory last year to secure its sources supply in rare-earth and was loading up when prices were high and it’s prices have come down, we’ve been able to hang on to some of that price for a while and that produces a little bit of profit or super normal profits. But that’s going to be a – that’s turning now is – as our pricing is reflecting more current levels there and so we expect to see that reverse in the second quarter. I think we’ll see some of that in Q2 and then the rest of it probably in Q3.

Joe Scaminace

And you saw from an end market standpoint, I think it really bodes well for continued growth in direct-drive wind energy for increase the applications in automotive and power steering assist in new technology are relative to some of the hydraulics in the electric motors. So I think that the idea of lower rear earth prices just like any other raw material input, which it is, this is a raw material input into a very highly engineered model, I think it really bodes well for the future of this business.

Saul Ludwig – Northcoast Research

It’s interesting one of the rationales for your diversification was to move away from our fluctuating our cobalt prices and the effect that it was going to have on you know your earnings. Are you back in same vote again with fluctuating rare-earth prices?

Joe Scaminace

Absolutely not Saul. And the reason is, this is an entirely different business model than VAC then we had in the AM business. The rare-earth is a raw material input into a very strong business with intellectual property, this has got great process technology, great product technology selling into a premium customer base, which clearly has great growth potential. So while there are some anomalies I guess is what you could look at, right now given the fact of the big spike at the time of the closing of this transaction, we are seeing some of that right now, but absolutely unequivocally and categorically this is not similar to the fluctuations that go into a business that is sold more as a commodity in terms of its customer base.

Saul Ludwig – Northcoast Research

Gotcha, thank you very much guys.

Joe Scaminace

Thank you. Okay are there any other questions?

Joe Scaminace

Okay, well thank you very much for your participation today. We feel very strongly about our start to the year here. We know we’ve got some challenges going forward, but thank you very much for your interest. And we will look forward to updating as the year goes on.

Operator

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

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