OM Group's CEO Discusses Q2 2012 Results - Earnings Call Transcript

Aug. 9.12 | About: OM Group, (OMG)

OM Group, Inc. (NYSE:OMG)

Q2 2012 Earnings Call

August 9, 2012 10:00 AM ET

Executives

Joe Scaminace – Chairman and CEO

Chris Hix – CFO

Steve Dunmead – VP and GM, Specialty Businesses

Analysts

Rosemarie Morbelli – Gabelli & Company

Mike Harrison – First Analysis

Ivan Marcuse – KeyBanc Capital Markets

Saul Ludwig – Northcoast Research

Operator

Good morning, and welcome to OM Group’s Second Quarter 2012 Financial Results Conference Call. Information presented on the call may include forward-looking statements that are subject to uncertainties, risks 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 OM Group’s press release or in their Form 10-K, and applies 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 second quarter earnings call. Today I’m joined by Chris Hix, our CFO; Steve Dunmead, VP, GM of our Specialties business; and Rob Pierce, Vice President of Finance, whose responsibilities include Investor Relations.

You can see our standard Safe Harbor disclosure on slide two, so let’s get right into the details on slide three. I’m pleased to report that in the second quarter of 2012, we delivered solid profitability and very strong cash flows. We accomplished this in the face of several difficult factors that were beyond our control.

Sales and adjusted EBITDA were both higher than last year, driven by excellent results from our newer transformative platforms, Magnetic Technologies and Battery Technologies.

We were able to deliver these overall results despite low cobalt prices. This further validates our strategy to move away from commodity businesses which subject us to earnings volatility. We now generate a significant portion of our sales and earnings from more stable, non-commodity businesses. Magnetic Technologies perfectly illustrates the progress that we’ve made.

VAC is a market leader, operating close to end users. They meet customers’ complex applications and demanding requirements. Magnetic Technologies is a leading innovator, and gets rewarded for its technology. And it’s well-positioned in diverse and growing end markets.

More importantly, they are a high-tech and efficient converter of raw materials into finished products; and most importantly, they prefer low material costs. This platform is the foundation on which we will grow both organically and through synergistic acquisitions.

Our other newer platform, Battery Technologies, also delivered another strong quarter for us. Defense and aerospace sales remain strong, and batteries for medical applications continue to grow, driven by new device wins and product enhancements.

We’re very proud of the fact that EaglePicher batteries, manufactured by our Battery Technologies business, provided electrical power which helped to safely land NASA’s new rover, Curiosity, on the surface of Mars earlier this week.

As anticipated in our last call with you, our other businesses face challenges in the second quarter, including lower metal prices in Advanced Materials; economic pressures in Europe; and continued disruptions in our customers from last year’s Thailand flooding, which impacted our Specialty Chemicals business.

In spite of these challenges, as a result of our strategy portfolio changes, we were able to deliver solid financial results. Compared with last year, sales grew 32%, while adjusted EBITDA grew 18%. Cash flow from operations was particularly strong in the quarter, as we generated $75 million. This was the highest cash flow in nearly four years, and is the result of heightened financial discipline to optimize working capital levels. Our second quarter results included positive rare-earth pricing effects, as we’ve discussed in the last few quarters.

Slide four provides an overview of our business portfolio. On the right-hand side of the chart are the three platforms that we’ve built by executing our strategy. These businesses contributed $58 million of adjusted EBITDA in the second quarter of 2012. This represents over 90% of the consolidated total, excluding corporate expenses.

Advanced Materials, our cobalt franchise, contributed $5 million of adjusted EBITDA during the quarter as a result of low cobalt prices and the maintenance shutdown of our Kokkola facility. This is still a great business, with growing demand and market-leading positions. It’s a consistent generator of cash, but it has significant exposure to metal prices. Most of our economic performance is now driven by businesses with attractive long-term and market dynamics. They are businesses that are better rewarded for the value they bring to customers, not for selling materials by the pound. We are in fact, a growth company, and our strategic platforms provide multiple paths for both organic and acquisitive growth to create shareholder value.

Slide five shows the value-added profile of our four businesses, based on cost of sales. And this is a really important slide for you to see. You can see that our newer transformative platforms of Magnetic Technologies and Battery Technologies enjoy a higher value-added profile, as they are better rewarded for their technology and innovation. These businesses are much less reliant on a single raw material or input cost and as such, have less long-term volatility in their results than our cobalt franchise.

In Advanced Materials, cobalt price changes have created many years of earnings volatility. This was seen in our second quarter results, and again, highlights the rationale for our transformation strategy.

Slide six demonstrates the execution of our strategy and how it enhances our ability to grow profitably and sustainably. As these charts demonstrate, trailing 12-month sales and adjusted EBITDA have more than doubled compared to 2009. Our strategy is clear, and its execution is well underway and already paying off.

Slides seven and eight include our key enterprise priorities for 2012. We have many examples of successfully growing our market share in our various end markets.

In Magnetic Technologies, we’ve recently launched specialized chokes for electrical power-assisted steering. This is a new addition to our product lines, serving the growing global market for German automobiles. This end market is showing great strength in 2012, and is anticipated to perform well in the foreseeable future, driven by the electrification of automobiles, which utilizes many VAC products.

In aerospace, we also enjoyed recent successes, providing critical products for airplanes of the American and European aircraft industry and, for example, products on the new Boeing Dreamliner.

In the solar market, in which we are now starting to see stabilization and the first signs of a recovery, we’ve doubled our market share over the past three years. And in specialty chemicals, we continue the growth of our Borchi OXY-Coat product line.

With respect to our leading technologies, we’re focused on innovation that meets customer requirements and improves their applications. Examples include reducing the rare earth content in certain magnetic formulations to reduce our customers’ cost and their dependency on rare earth prices and availability. We’ve entered into a license agreement with BASF for mixed-metal precursor technology for lithium-ion batteries and our Peak Shaver Power Pyramid system at Battery Technologies, which is in the demonstration phase.

We’re highly focused on reducing working capital and improving our fixed asset utilization, particularly in light of current business conditions and we’re working very hard to optimize inventory levels and reduce capital expenditures where possible. We remain committed to pursuing synergistic acquisitions to grow our company. We’ve implemented a rigorous acquisition process with an emphasis on synergies and integration. Finally, it’s a priority in 2012 to capitalize on the benefits from our recent acquisitions.

Turning to slide nine, our vision is a growth company where sales grow faster than GDP, and earnings grow faster than sales, due to our sales and operating leverage. We’re committed to strong financial discipline and operational excellence to maximize earning growth and cash flows and to improve our returns. And we’ll continue this strategy to create long-term shareholder value.

In summary on slide 10, the first half of 2012 was highlighted by solid earnings and strong cash flows in spite of factors that were beyond our control. We’re achieving significant contributions from the acquisitions of VAC and EaglePicher technologies, and the execution of our strategy has reduced our dependency on cobalt prices.

Longer term, we’re well positioned to pursue our strategy with a strong balance sheet, attractive transformative platforms and multiple internal and external growth paths. OM Group’s investment proposition is compelling. We’re a diversified product portfolio aligned with favorable attractive growth trends, financial strength and flexibility to create shareholder value, a global organization to support a global customer base and a growth strategy designed to take advantage of our strengths.

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

Chris Hix

Well, thank you, Joe. Slide 11 provides an overview of our second quarter P&L compared with last year. The GAAP reconciliations are in the appendix of this presentation. Our Magnetic Technologies, or VAC business once again contributed to strong top line growth with sales growing 32% over the prior-year second quarter.

This business contributed nearly $24 million of adjusted operating profit in the quarter, offsetting declines in the Advanced Materials and Specialty Chemicals businesses. A sharp year-over-year decline in the price of cobalt and lower Specialty Chemicals volumes were the principal headwinds faced during the quarter.

The euro weakened relative to the US dollar during the quarter, resulting in approximately $7 million less sales and $2 million less adjusted operating profit. But our hedging strategy of holding euro-based debt drove a $6 million FX gain, as we revalue this debt into US dollars. So we came out ahead in the quarter. For the full year, we expect the net FX impact on EPS to be small.

Adjusted EBITDA increased 18% compared to a year ago, again, driven by the VAC acquisition, and excludes $54 million of VAC-related inventory step-up and LCM charges. Let me point out that we have only $8 million of unamortized step-up charges left on the balance sheet, and expect these to be gone by year end. Below the operating line, interest expense and the tax rate are tracking where we expected. So for the total picture, adjusted EPS came in at $0.59, below the prior-year comparable period.

Slide 12 shows an overview of our cash flow. As outlined in our last call, we expected strong performance in the second quarter, and, boy, we got it. All of our teams ratcheted up the attention on working capital, with DSO coming down a day, and days in inventory coming down nine days. As a result, we generated $75 million of operating cash flow in the second quarter, our highest level since Q4 of 2008.

Capital expenditures in the quarter were $18 million, and primarily related to previously discussed expansions of our primary Advanced Materials and Magnetic Technologies facilities. Early in the quarter, we worked with all of our business teams to reprioritize capital spending, and we have reduced expected full-year spending to under $85 million.

Slide 13 looks at our overall working capital performance, where we reduced net working capital as a percent of sales by 60 basis points to 35.4%. We expect to make further progress throughout the second half of this year. Also on this page is a summary of our cash and debt positions. Debt decreased in the quarter, due to the weakened euro and another small scheduled debt payment. Strong cash flow in the quarter drove the cash balance up to $318 million. We expect to increase our liquidity throughout the rest of the year, which supports our strategy of synergistic acquisitions for our transformative platforms.

As we dig into the business results, you can see another strong quarter for the Magnetic Technologies business displayed on slide 14. The business continues to benefit from the export success of the German automotive industry, but we see mixed results in other applications, particularly those destined for shipment within the Eurozone.

However, this business is also driven by innovation, such as recent introductions of components into the aerospace industry, which creates yet another long-term growth path for VAC. The business, again, benefited from rare-earth pass-through pricing, but as previously signaled, this is a timing item that has peaked, and is expected to decline in the second half of the year.

The unprecedented run-up in rare earth prices last year and the subsequent drop off this year created this timing benefit, and is not expected to recur. We believe adjusted EBITDA margins will return to more normalized low to mid-teen levels in the second half of 2012, on lower sales levels.

Turning to slide 15, you can see that our Advanced Materials business turned in difficult results. Even though cobalt volumes are higher year-over-year, prices, as shown on the chart on the right side of the page, weakened further and pressured segment profitability. Profits in this business are significantly impacted by cobalt price levels; the pace and direction of price changes from month-to-month, and the cost of raw material feed and inventory that turns through cost of sales in a given period.

Byproduct sales and profit also decreased on lower copper volumes and prices. On the positive side of the ledger, cost controls and other reductions helped to offset the effects of lower cobalt pricing. And we are working on other initiatives that will lower costs and improve productivity, creating long-term financial and operating benefits.

Looking ahead, we believe we have hit a trough in cobalt pricing and have begun to see some firming, which should benefit us in Q3, and especially Q4. We continue to expect full-year cobalt volumes to continue to increase in 2012.

On slide 16, we lay out the performance of our Advanced Organics and Electronic Chemicals product lines. The chart on the right side of the page shows a small sequential improvement in volume in our Electronic Chemicals product lines – that’s the black line – where we are seeing the hard drive market slowly recovering towards last year’s pre-flood levels. The chart also includes our Advanced Organics product lines – the blue line – which sequentially strengthened, but not as quickly as expected.

The slower European economy is reducing demand for products, as is the shorter painting season due to an abnormally rainy year in Europe. Our fourth quarter 2011 investment in Rahu, which secured the Borchi OXY technology, contributed to the current quarter sales and we remain bullish on the future of these products. As a result of lower year-over-year sales, operating profit declined to $10.7 million.

Slide 17 summarizes the performance of our Battery Technologies business. Reported sales were close to prior year levels, and operating profit was a bit lower. Keep in mind that the prior year included a couple million dollars of operating profit from selling an unusually high quantity of recycled material at the highest prices in over a decade. Margin performance in the quarter was quite strong at over 17%.

As a reminder, the business has historically seen quarter-to-quarter lumpiness due to the timing of contract releases, customer changes to shipping dates, and progress in contracts accounted for under the percentage-of-completion method. Demand for U.S. defense applications has waned a bit, but we’ve seen foreign demand increase. We continue to improve our penetration of the medical market, and have other new applications that are a bit too proprietary to discuss for now.

One item we can discuss is the Peak Shaver Power Pyramid system, as depicted on the right side of the page. This system has a number of applications, including complementing alternative and remote energy applications, and effectively arbitraging time-of-day pricing differences on the power grid. The system was debuted at our facilities at the end of June and received a terrific response, which will help our commercialization efforts.

I will wrap up with our 2012 third quarter outlook on slide 18. Overall, we expect another good cash flow quarter. We also expect sequentially lower adjusted EBITDA. Our Advanced Materials business is expected to improve on firming cobalt prices, and no repeat of the second quarter annual shut down. In Magnetic Technologies, the core business is expected to remain at current levels, but profitability will trend lower due to minimal rare earth price effects going forward.

Our Specialty Chemicals business should strengthen, primarily within Electronic Chemicals. Battery Technologies is projected to be flat to lower due to a return to more normalized sales and profit levels.

That concludes our prepared remarks. Operator, let’s open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rosemarie Morbelli with Gabelli & Company. Your line is now open.

Rosemarie Morbelli – Gabelli & Company

Thank you, good morning, all.

Joe Scaminace

Hello, good morning.

Rosemarie Morbelli – Gabelli & Company

I have a question regarding the strength of your business in Germany. Auto has been quite strong, but the German economy is slowing down. So could you touch on the potential impact on both the automotive area, and then other parts of your business in the region?

Joe Scaminace

Yes, Rose, let me start off by saying that we are a very strong player in the German automotive – within the German automotive industry. We occupy growing automotive applications that have been growing over time, as I indicated, through the electrification of the vehicle. These are products such as the keyless entry antenna; we make parts for fuel injectors. We have – the power steering assist is now a magnetic sensor. We make magnet assemblies. We make chokes, brazing foils, common mode chokes.

And this market has been very, very strong, primarily due to export. We’ve indicated all along, over some of the concerns that VAC is a German European-centric company, and we’ve countered that by saying that a lot of the German products are being exported outside of Germany, and in fact outside of the Eurozone. And this is exacerbated by the low euro, which is certainly making these products competitive on global markets. And so, the answer to the question is that we are pretty optimistic that this will continue, and the product line will continue to grow within that sector.

Rosemarie Morbelli – Gabelli & Company

So, Joe, just clarifying something for me, if the automotive productions slowdown in Germany because fewer exports and so on in addition to the European issues, do you have enough new application to offset fewer numbers of cars? Or is that not enough to offset a decline in constructions – I mean, automotive build.

Joe Scaminace

Sure, sure. I would answer that by saying, we absolutely are confident in not just the new applications, Rosemary, but new geographies and new applications going into the global automotive industry. For example, if you think about German engineering and European technology that finds its way into other forms, we have opportunities in other parts of the world to take the technology and sell it into these other automotive applications.

The other thing that is occurring is that the German tier suppliers are actually going offshore and producing in areas like the United States and South America. And we plan on playing a position and a role in those movements.

Rosemarie Morbelli – Gabelli & Company

Okay. And if I may ask one last question, on the Advanced Materials, could you give us a better feel as to which initiatives you are taking in order to offset some of the volatility in cobalt? Can you lower your break-even point? I mean at whatever it was, $6.00 a pound or – if you could give us a little more color on that.

Steve Dunmead

This is Steve, Rosemarie. Yes, we’ve got a bunch of initiatives underway that are optimizing the refinery; decreasing chemical consumption, modifying things based upon the current feed mix that is coming in. And as Chris mentioned in his remarks, we believe that looking forward, we’ve already identified about $5 million of savings that we are in various phases of implementing now.

Joe Scaminace

Rosemarie, let me also point out – and for the entire audience here too that when you look at cobalt pricing and the effect it’s had on us, there is always a downturn in cobalt price in the summer months. There is – we seen it year after year. And add this year to the backdrop of Europe and Asia, and we’re not surprised by what’s happening with cobalt price.

Commodity economics is what we’re playing in a macroeconomic world here. End market demand for our products in Advanced Materials remains very, very strong. The electrification of electronic devices continue and we have no concerns there and we’re very satisfied with our product line, our technology and our quality. And as Steve mentioned, we’re doing all the things we can to reduce our cost and make sure that we’re very, very competitive in these markets.

Rosemarie Morbelli – Gabelli & Company

Thank you.

Joe Scaminace

You’re welcome.

Operator

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

Mike Harrison – First Analysis

Hi, good morning.

Joe Scaminace

Hey, good morning Mike.

Mike Harrison – First Analysis

Just to build on the questions on German automotive. Was just curious, have you gotten any indications from your – any of the automotive customers that you serve that they expect to take extended downtime during Q4?

Joe Scaminace

We haven’t heard of any, Mike, of any downtime to speak of at this point.

Mike Harrison – First Analysis

Okay. On the Advanced Materials side, were the maintenance costs higher than you expected in this quarter? And can you also give us an update on the increased battery precursors’ capacity that you’ve been installing?

Chris Hix

Yes. Mike, it’s Chris. Let me tackle the first one. The maintenance costs or costs related to the annual shutdown were pretty much in the range of $2 million to $3 million, as we had expected. And that’s really pretty consistent with last year as well. So, not a big factor year-over-year, but more of a consideration as we transition from Q2 to Q3. Maybe I could turn it over to Steve for your question on battery–

Steve Dunmead

On the battery precursor expansion that’s underway, things are going along well. We have modified the schedule slightly, about – as we went through looking at the weakness in the European economy. So, we’ve modified a little bit of the timing, but this is six months one way, six months the other. And so – but things are going along well. We’re getting good acceptance from a product standpoint from the customer base, and we’re moving along on that front.

Mike Harrison – First Analysis

And just in terms of the volume strength in Advanced Materials, it sounds like battery – you said battery and chemical applications were seeing better demand. Can you talk a little bit about what you are seeing in the powder metallurgy market?

Steve Dunmead

Certainly in Q2, we saw a little bit of weakness, specifically from more of the – we’ve got global customers, but the materials being sold into the European market, especially when you start looking at things like woodcutting, stone cutting, those kinds of things that are all going into construction, because construction just went to hell in Europe.

So, I think that, certainly, we saw some weakness there. It’s come back a little bit and we’re doing fine on that front, but it’s certainly nothing like what we saw in the ‘08/’09 timeframe.

Mike Harrison – First Analysis

And what do – your powder metallurgy customers – what do their inventories look like? I know in the past they’ve kind of overshot in either direction and its hurt you. Are they sort of acting on more...

Steve Dunmead

I think they are all so cognizant of what happened in ‘08, ‘09, that people are not sitting on excess amounts of inventory. They’re reacting much faster, which can be good and bad for us. It makes things a little bit more lumpy and we’re seeing some modifications of orders, but I don’t see a significant probability that we’re going to have an extended – having a guy not take anything for four months. That – we haven’t seen any of that.

Mike Harrison – First Analysis

And then, last question, then I’ll jump back in queue. But kind of around plans for cash – obviously, you had a nice quarter of cash flow, and expect continued improvement in working capital. So, being a year removed from the VAC purchase and having built this nice cash pile, can you maybe update us on your appetite and activity on the bolt-on M&A front?

And also, whether any of your plans for cash would include discussion of a share repurchase at the board level, or any debt pay down? Just walk us through how you are thinking about things strategically right now.

Joe Scaminace

Absolutely. And let me just point out at the very outset, that that is a very dynamic discussion that’s occurring within our company right now at the management level, at the board level; it is a significant conversation that is really accelerated by the fact of our confidence right now.

We have great confidence in our balance sheet, great confidence in our ability to generate cash. We’ve been good at that. We continue to get better at it by the things I mentioned; better management of working capital, much more rigorous treatment of our capital expenditures, looking at higher returns there. So against that backdrop, Mike, I would say to you that we discuss often and dynamically the opportunities for share repurchase and the opportunity for dividend payment.

Our preference right now, given the fact that there is an M&A pipeline out there that is allowing us to move our strategy even further down the road – and let me underscore the priorities we have. We have a – our business leaders that are empowered to take steps to grow their businesses, both organically and adding accretive and synergistic acquisitions, covering their cost of capital. We look at this in a new, dynamic way now.

So our preference, when I talk about us being a growth company, having high technology, we continue to move in that direction. So there is a number of legitimate business opportunities right now that we have kicked the tires on our strategy, and we’re looking at these fits and see if we could even enhance the company even greater.

Mike Harrison – First Analysis

All right, thanks very much.

Operator

Your next question comes from the line of Ivan Marcuse from KeyBanc Capital Markets. Your line is now open.

Ivan Marcuse – KeyBanc Capital Markets

Hi, guys. Thanks for taking my question.

Joe Scaminace

Good morning, Ivan.

Ivan Marcuse – KeyBanc Capital Markets

When you look at – I guess going to your guidance real quick, when you look at a sequential increase in Advanced Materials, could you – I mean that’s a pretty big truck you could drive through. I mean, does that mean up a couple million dollars from where you are? Because I guess material costs are sort of flat right now, or sort of bounce around this $13, $12 level. Or would you expect to get back more to the 10%, 11% type of margin that historically you’ve been at?

Chris Hix

Well, Ivan, I think that’s always been the challenge for us with – having the cobalt in the portfolio, is the difficulty for us to put a stake in the ground without being able to control the commodity cost.

Ivan Marcuse – KeyBanc Capital Markets

Well, if you keep commodity costs where they are right now.

Chris Hix

What we do know going forward is that the – without a repeat of the shutdown of the facility that should benefit us sequentially by a few million dollars. We certainly have that to look forward to sequentially. In addition to that, as we mentioned in our prepared remarks, we do see the price firming up a little bit. It feels like we were bouncing along the bottom. We’re starting to see some indicators that it’s moving up a little bit there. I think that could be positive to us as we roll into Q3, but as I mentioned, especially as we get into Q4.

And then there’s always a little bit of a wildcard on the byproduct, just given the feed that comes in. And that can bounce around a little bit for us as well. So we do think, sequentially it will improve; just a question of how much.

Ivan Marcuse – KeyBanc Capital Markets

How much of the rare earth was a benefit to you in this quarter? How much did it impact the operating profit?

Chris Hix

Yes, we’ve talked about in the past, the margins of this business on a more normalized basis being in the low to mid-teens. And this quarter was another quarter where it was 20%-plus. So I think that’s a way to really get a good idea or a good range around where we think it will trend to in Q3 and Q4.

Ivan Marcuse – KeyBanc Capital Markets

Low to mid-teens, that’s EBITDA, right? So EBIT would be high single-digits?

Chris Hix

Yes. Yes, different number for EBIT than EBITDA, yes.

Ivan Marcuse – KeyBanc Capital Markets

Got you. And then would there – how – rare earths have fallen off as sharply as they have, do you have like a – is there a chance or an expectation that there is a reversal? So, as much as you’ve benefited from it being high, will there be, on the other side of the coin, if, with it dropping as hard as it did, does that actually negatively impact you the other way, and then, before you get to a more normalized type of profitability level.

Joe Scaminace

No. And the reason is, is that this is an entirely different model from the cobalt business, Ivan. I think we referred to – it was in slide five, when you look at the cost of sales as it relates to what our Advanced Materials business looks like and what our VAC business looks like.

Lower rare-earth prices benefit us in a variety of ways, increasing the applications for magnet-based applications, basically helping our customers, and helping us with technology. There’s just no doubt about it.

Ivan Marcuse – KeyBanc Capital Markets

Got you. And then, when you look at – I guess going to slide five that you pointed out, there is two – there is a couple of things that I guess I – on the Specialty Chemicals, the value-add portion of the COGS is hardly – or just is barely above the Advanced Materials. So do you sort of consider that more of a commodity type of business as well or – and does that have like a long-term view as a bolt-on opportunity to grow that business? Or do you sort of consider that more now, I guess in the Advanced Materials sort of category, of being more of a commodity type of business? Or how should we look at that in more of a long-term basis?

Chris Hix

Yes, Ivan, it’s Chris. The chart is really looking at the profile of cost of goods sold. As I think you appreciate, that Specialty Chemicals business has actually generated pretty good margins. So if you were to look at it from a sales and gross margin standpoint as well, you’d see the differentiation that we get rewarded for there.

And the company has done a terrific job over the last few years of improving the returns in this business by getting the cost structure right; moving toward technology; reducing the fixed asset base. So this is a business that we consider to be one of the cornerstones of company rolling forward.

We talk about investing in synergistic acquisitions. And we view Specialty Chemicals, Battery Technologies and our Magnetic Technologies businesses as being prime candidates for investment.

Ivan Marcuse – KeyBanc Capital Markets

Great. And then how much of the Borchi, how much of sales is that? Or how much is – how large of a piece of business is that?

Chris Hix

It’s still a pretty small business for us there, one that is not going to move the needle tremendously today. But it’s really about the potential for that business, as customers look to more environmentally friendly ways in replacing cobalt dryers and so forth. So it’s really a nice long-term play for us. And quite honestly, for the small investment we made, it’s not a bad return even today.

Joe Scaminace

It’s – Ivan, it’s going into new applications. When you look at – when you think about the coatings industry itself, it’s very difficult to go in and take existing formulations and tweak it with a new product line. Where we’re seeing the great applications and a great future for Borchi OXY, it is being formulated into new environmentally friendly products globally right now.

Ivan Marcuse – KeyBanc Capital Markets

Got you. And then if you – so what do you think is the expectation of Borchi is? Like, if you look out over the next five, 10 years, is this a $100 million business? Or is it – how do you view it on a long-term basis?

Chris Hix

It’s such a new technology that if you look at the existing applications for it today, I think it’ll – it could have a nice growth rate for the company and for that small investment we made. But depending on other applications and rates of adoption, it could turn out to be something even more.

Joe Scaminace

Yes, more than that.

Chris Hix

Yes.

Steve Dunmead

We’re at this point looking at other applications that we already participate in outside of coatings, such as the composites market that has the same drivers as the coatings market. And so, if some of those things hit, this could be a real big one for the company.

Ivan Marcuse – KeyBanc Capital Markets

Got you. Thank you for taking my questions.

Steve Dunmead

Thank you.

Chris Hix

Thank you, Ivan.

Operator

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

Saul Ludwig – Northcoast Research

Hey, good morning, guys.

Joe Scaminace

Good morning, Saul.

Saul Ludwig – Northcoast Research

I have a question on VAC. Their revenues in the first quarter were $190 million and then they fell off sharply here to $168 million from first quarter to second quarter. What was sort of going on there? And how should we think about their revenues in the back end of the year?

Chris Hix

Saul, it’s Chris. As you transition from Q1 to Q2, there’s a couple of factors there; one is, the weakening euro took a little bit of the wind out of our sales in the reported results. That cost us in that business probably $5 million, $6 million or so of revenue.

In addition to that you had some of the decline in rare earth prices. We signaled in our last call that that would decline in Q2 and then much more sharply in Q3 and Q4. So we’re – I think we’re consistent in that message out to investors there. I’d say those are really the primary effects. You’re going to have other things going on in the business in various applications. Some of that’s timing and so forth, but I think those are the big pieces.

Saul Ludwig – Northcoast Research

Do you think your volume of product that you sold was any different in the second quarter than the first quarter?

Chris Hix

It may have been slightly different, Saul, but really in the noise.

Saul Ludwig – Northcoast Research

Okay. Next question is on Advanced Materials – a couple parts. Way I understand, if you look from the first quarter to the second quarter, where your earnings fell off $10 million; and $2 million to $3 million coming from the maintenance, that’s pretty clear. But there was another substantial falloff in their profits. And I wonder if you could address what drove that? And then I’ll have a follow-up on Advanced Materials.

Chris Hix

Okay. Saul it’s – I think in the materials that we – during our presentation or our prepared remarks, we show you that there were three impacts on the profitability that we highlighted. Number one was the cobalt price itself, which I guess is somewhat self-evident, and folks can see the numbers and draw their conclusion.

Saul Ludwig – Northcoast Research

I’m talking first to second – first to second, not second versus second.

Chris Hix

Yes, no, I understand. Sequentially, going from – okay, let me back up. Going sequentially from Q1 to Q2, what we saw was a change in the price that was not in our favor. That was certainly an impact. We saw the maintenance or shutdown that we do every year that – that’s – we’ve talked about that. And then the third piece is, we did see some of the lower prices for copper, and lower recovery on some of the copper based on the feed that we’re getting. So the – really, those are the three principal discussion items on a – for the sequential analysis.

Saul Ludwig – Northcoast Research

Yes, and then as we think about going to the third quarter it’s – the average price for cobalt in the second quarter was $14.20 or $14.25. I don’t know if you gave us that, but I think that’s what it was. And then, the cobalt price fell to under $13 and now it’s in the neighborhood of $13.

And pretty soon, by the end of August, the die gets cast. And it would seem to be that in effect you’d be selling – in the third quarter, you’d be selling your product sort of based on $13 cobalt, but your cost of goods, because of FIFO accounting, might be based on cobalt products that cost you $14.50 a share. It would seem like there would be a negative FIFO effect, if you will, having a meaningful impact as we go from second to third quarter. Does that make any sense?

Steve Dunmead

It depends on how quickly we see – we’ve seen some firming; we’ve seen it on the LME; seen it reflected a little bit in the Metal Bulletin numbers. But as Chris said in his prepared remarks that the biggest impact as we see the firming, because as soon as you come off the bottom, the flow-through goes in the opposite direction, is – would be toward the end of the third and into the fourth quarter.

Saul Ludwig – Northcoast Research

Okay. Joe, I have a more sort of a broader type question. You see the problems – the billions of dollars that have been spent on new battery technologies and you’ve seen the problems at A123 and Ener1 and Johnson Controls and all the people that are trying to play in this rechargeable battery market. Is this just a tough battle to fight? I mean, how do you look at what’s going on in this industry, and then look at OM and how you see your future in rechargeable batteries?

Joe Scaminace

Absolutely. Well, first of all, Saul, we were very skittish about getting into the mass market for lithium-ion batteries. I think we’ve stated that years ago. We had opportunities to even access some of the Obama dollars, and we chose not to. And the reason is, is that we’ve always been players in the portable electronic market and the power technology market.

If you think about our products – power; netbooks, iPads, cell phones, Husky power tools, you just go on and on and on. And so, we look at what’s happening in the automotive battery excess capacity – I don’t want to boast here, but we predicted it. We felt that as we looked at all this capacity being built, we were just stunned, absolutely stunned at the fixed asset base that went into the infrastructure to build batteries for automobiles. We presented at an alternative energy conference a few years ago in Washington, DC.

And OMG was probably the only company that was incredibly cautious about all the capacity being built out there. So, quite frankly, we are unaffected by what’s happening with A123, Johnson Controls, all this capacity. When we acquired EaglePicher, we did it with the absolute awareness that we are playing in a niche market for defense batteries, for aerospace batteries, for Peak Shaver technology, for medical application; and our capacity utilization is acceptable to us right now.

So our view is that we are glad that we didn’t invest fixed assets. We stayed in a fragmented marketplace that needs technology that we have to offer, and we’ve always looked at the automotive battery as a call, that if it took off, we would be the recipients of great volume going into the, the Nissan Leaf and other applications out there. But, quite frankly we look at it with great interest.

Steve Dunmead

And, Joe – this is Steve, Saul – Joe has always said to us that it’s not if, it’s when. And you’re seeing the fallout of those people that didn’t bet on the win. They just said, we’ll build it, it will come. And you’re seeing the fallout of that. But I think that we are pretty cautious on it; and as Joe said, it’s really a call.

Saul Ludwig – Northcoast Research

Just finally, so we are all on the same page with regard to the proper expectations, let’s say looking to the third quarter, it sounds like, directionally, Magnetic Technologies will have lower earnings, because you won’t have the benefit of the rare earth pricing. You’ll have higher earnings in Advanced Materials; lower earnings in batteries. It seems like the earnings would be less than the $0.59 that you reported in this quarter, at least – you won’t have the FX gain. So at least directionally, without quantifying it, we should be thinking less than $0.59. Is that thinking about it the right way?

Chris Hix

I think, directionally, that’s the way to think about it.

Saul Ludwig – Northcoast Research

Great, thank you very much.

Operator

Your next question comes from the line of Rosemarie Morbelli with Gabelli & Company. Your line is now open.

Rosemarie Morbelli – Gabelli & Company

Well it just so happened that I had a question on the automotive batteries. Do you actually see that there is absolutely no progress? And if you look at all of the lithium capacity expansion, is that also an issue? Or is there enough growth on the rechargeable batteries for all of our gadgets that it really doesn’t make that much of a difference over the short term whether or not batteries for cars are picking up?

Steve Dunmead

Rosemarie, this is Steve. We have never, in the – whether it’s a three-year or five-year outlook, we have not baked a whole – huge amount going into the automotive applications anyhow. We know that the consumer electronics market, especially the pad devices that are using bigger batteries, thinner batteries is going to continue to grow. And so we haven’t – we’re participating in a bunch of the vehicles that you just mentioned. But I don’t think that it changes the trajection – the trajectory that we have been looking at from that standpoint.

Joe Scaminace

And I would say, Rosemarie, that the day will come when the technology will be there; where the rechargeability, where the cost will be lower, but it’s just not today.

Rosemarie Morbelli – Gabelli & Company

And since you seem to have a pretty good crystal ball, do you see that coming in three years, five years, longer than that?

Joe Scaminace

It’s really hard to say. I do think it’s years, because if you think about the volumes of cars that are being sold today – take a look at the Wall Street Journal article, the front page this morning; there are some volumes of cars sold globally right now and they’re very, very low. So, those numbers are quoted. You could take a look at it. And I would say that there needs to be a lot of work done yet on how the grid would recharge these batteries and how the cost could be more effective for consumers to buy it.

Steve Dunmead

And from the other perspective, you sit there and you look at the adoption of the hybrids, and that has gone along very well. But this is a different beast. You can’t use the same kind of battery. You’ve got to have a longer lifetime, because it’s not just a simple hybrid. So, it will get there. But there is a lot of development that needs to happen along the way.

Joe Scaminace

We like the tangible participation by making keyless entry antennas and magnetic sensors for power steering assist. That’s where we like to play in automotive right now.

Rosemarie Morbelli – Gabelli & Company

Don’t they use lithium-ion batteries on the – with a hybrid?

Steve Dunmead

Most – the bulk of them are not. They are nickel-metal hydride that we are participating in from cobalt additive standpoint. There are some, but it is – the bulk of them, especially the Japanese ones are nickel-metal hydride today.

Rosemarie Morbelli – Gabelli & Company

Okay. That is very helpful. And I was wondering if you could give us an update on the Congo, the smelters, the big hail, the political situation – the impact on all of those things on your business.

Steve Dunmead

Yes, Rosemarie, the operation is running well. It’s been well-publicized in the market that there is been electrical problems in the Congo. I think if you look at it overall, and we’re probably no different than any of the other operators in the Congo that our output out of the Congolese operation is probably down about 15% due to power cuts.

We have imported some additional electricity, as the rest of the operators have, from Zambia. But that’s part of the reason why we’re sitting here saying that we’ve seen demand. If we’re an example of it, we’ve seen demand year-over-year up 5%. And yet the output of cobalt units coming out of the Congo is probably down about 15% year-over-year. So, there’s some disconnect coming in the market at some point.

And so – but the operation is running fine. I think after the elections, the political situation calmed down. The biggest issue facing right now – facing the Congo as a whole, I think, is electrical issues that we think are going to be worked out by fourth quarter.

Rosemarie Morbelli – Gabelli & Company

And there were all sorts of announcements regarding additional capacity, whether it was a nickel mine, the copper mine, and the consequent byproducts in cobalt. Anything new? Are those projects coming on-stream, are they being delayed?

Steve Dunmead

In the Congo, everything is going along, with the exception of being – having to pull back because of the electrical issues.

There was an announcement that the operation in Madagascar is having some problems in getting its permitting in line. So I think that’s been pushed off somewhat. But, again, I think, whether it’s the mid-term or the longer-term, until the infrastructure issues, especially electricity and rail and the like are dealt with in the Congo, there’s only a limited amount of production of anything that you’re going to be able to do there. So – but things are okay right now.

Rosemarie Morbelli – Gabelli & Company

Okay. Thank you.

Joe Scaminace

Thank you.

Operator

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

Mike Harrison – First Analysis

Hi, just a few additional ones. You mentioned that you are optimizing the cobalt refinery for your feedstock. And then mentioning, obviously, in response to Rosemarie’s question that output out of the Congo is down 15%. And I also know that your Norilsk supply agreement has expired.

So can you give us a sense of why – where your feedstock is coming from right now? Is it primarily still coming from the big hill and your smelting operation in the DRC or have you secured some other sources that you haven’t disclosed? And maybe give us a sense of what portion of feedstock is coming from the DRC now, versus maybe a year ago?

Steve Dunmead

The Congolese operation prior to these electrical cuts was operating at capacity. And so, on a normalized basis, if you strip all that out – we’ve talked about 5000 tons of material coming out of there. And so it’s going to be down a little bit this year. Just to be clear, the old Norilsk contract expired. We renewed an agreement with them, or got a new agreement with them for a year, so we are getting that material.

And yes, we do have some – a couple of other – three other sources, but we’re not going to disclose who they are. So we’ve been cultivating those along the way to make sure that we’ve got security of supply, as we’ve always talked about.

Mike Harrison – First Analysis

And then, in terms of the VAC, or Magnetic Technologies margin stability going forward, and not expecting to see a negative impact from rare-earth. I mean, doesn’t the lower cost or market charge also help prevent that negative impact in forward quarters? In effect, you’ve pulled those losses forward and taken a lump-sum charge, because that’s what the accounting rules require?

Steve Dunmead

Yes, that certainly is a factor as we look at the margins for the back half of this year and rolling forward, Mike.

Mike Harrison – First Analysis

Okay. And then, also, on the Magnetic business, can you give us some more details on the stabilization and signs of recovery that you’re seeing in the solar market? Obviously, you’re speaking more to the inverter side. How are your customer – excuse me, inventory levels looking at this point?

Steve Dunmead

Mike, this is Steve. Certainly, we’ve been seeing, for the past six months, very short-term orders coming in. And so that gave us a sense that the inventory levels were getting down to a fairly minimal level. Since then, we have started to see some more steady pickup in order levels.

So we think, at least from the inverter standpoint – we’re not talking about cells now, but from the inverter standpoint, that the inventory is not excessive. And so, it all depends on what you believe the installations are going to be, which – some reports are calling it flat year-over-year. So it really was an inventory correction from, at least, the installation standpoint.

Mike Harrison – First Analysis

And are you guys focused primarily on Europe in – for that inverter business, or is it a global business for you?

Joe Scaminace

It is a global business. I think we’ve indicated in past calls, Mike that we are not in any way tied to any geography producing these panels. I mean, we are agnostic to that. And the fact that we are in the inverter component business really makes for great opportunities for us to capitalize on wherever these inverters are needed.

Mike Harrison – First Analysis

And then, just on the electronics market for the Specialty Chemicals segment – looking at slide 16 and that volume index still kind of being below the 100 level, when would you expect to get back above that 100 level? And can you maybe just talk about where the normal second half seasonality would look like relative to Q2? And what are your expectations for 2012? Should we follow that normal pattern, see a weaker or stronger build into the holiday season?

Steve Dunmead

So, if we’re talking specifically about electronics, Mike, certainly we’ve always seen Q3 being stronger than the beginning of the year, and then Q4 at or above that same level and most of that is building of gadgets for back-to-school and the Christmas holiday season. We don’t expect to see anything different this year than we had seen in previous years.

If you look at the Advanced Organics business, it’s a little bit different, because there is this coding seasonality to it, where the middle two quarters of the year are typically the strongest. And the issue is, this year – and I think Chris or Joe, one of them said it in their prepared remarks that with all the rain and the cold weather that people saw in Europe, there was a push-off of the coating season. And you really don’t catch that up, I don’t think; you end up just simply delaying it. And I don’t think you ever really catch it back up.

So certainly, Q4 is always the weakest from an Advanced Organics standpoint. But I think that we are seeing three to go up from two; the second half to be greater than the first, overall. And again, it – a lot of it depends ultimately on consumer sentiment. And so, we’re working our way through that. But the good thing is, whether it’s the VAC business or the Specialty Chemicals business, we really play globally and we aren’t tied to any one specific geography.

Mike Harrison – First Analysis

And is the memory disk – the weakness you’re seeing in Thailand, is that a meaningful contributor to the volume being so – still under that 100 level on the index that you show here?

Steve Dunmead

Yes, that’s definitely been an impact on us. If you look at the chart going from Q3 to Q4 of last year, and you can see the very slow recovery since then, that’s – a big part of that’s been driven by the flooding in Thailand. And we’re seeing our customers getting their facilities back up and running, but we’re not all the way back yet.

Mike Harrison – First Analysis

All right. Thanks very much.

Steve Dunmead

Thanks, Mike.

Joe Scaminace

Thank you, Mike.

Operator

Your next question comes from the line of Ivan Marcuse with KeyBanc Capital Markets. Your line is now open.

Ivan Marcuse – KeyBanc Capital Markets

Hey, guys. Most of my questions were answered, actually. But one quickie, if you look back at the Advanced Materials – I’m just trying to reconcile the profitability this quarter. If you look at – back to like – go to an extreme, the first quarter of ‘09, where volumes and – it was obviously a different environment but you still had cobalt touch around $10 or $11 a pound. Yet you still, and that quarter at least, you were fairly profitable, at least in the mid-single-digits. So even if you exclude the maintenance expense that you had this year, how do you – what’s the main difference between that period and now? So I guess it would be – the Norilsk contract is the only thing that I could fathom?

Chris Hix

Which period are you talking about, Ivan?

Ivan Marcuse – KeyBanc Capital Markets

First quarter of ‘09. And then, so if you look at that–

Chris Hix

The difference that you’ve got there is, you’ve got differences in inventory flow-through that are impacting that. You’ve got a different feed mix, so the amount of byproduct coming in is going to be totally different. So I’m not sure that going back to ‘09 you can compare apples-to-apples.

Ivan Marcuse – KeyBanc Capital Markets

Really, even with – well, the way I was looking at is that the raw materials, sort of I was trying to reconcile at sort of the same level. So was in a falling environment at that point and it touched $10 or $11 a pound. So is it – do you have an opportunity to get profitability up, assuming costs stay the same, to get back to this – historically, we’ve always been in this low-teens type of level. Or is that probably – or is that past, just the way the market is set up?

Chris Hix

Absolutely, we do.

Ivan Marcuse – KeyBanc Capital Markets

Okay. And when would you expect to get to there?

Chris Hix

Tell me what cobalt prices are going to be.

Ivan Marcuse – KeyBanc Capital Markets

Remain flat.

Chris Hix

As we signaled, we expect to see a sequential improvement here in Q3, Ivan; and then an even bigger sequential improvement in Q4.

Ivan Marcuse – KeyBanc Capital Markets

Assuming materials stay sort of on a flattish type of basis.

Chris Hix

Well, as we suggested in our comments, we see the prices firming and beginning to improve. So I think we’re baking some of that into our thoughts.

Ivan Marcuse – KeyBanc Capital Markets

Got you. Thank you for taking my question.

Operator

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

Saul Ludwig – Northcoast Research

Just had a quickie, Chris. How much of the $53 million charge was the lower-of-cost-or-market component?

Chris Hix

The lower-of-cost-or-market component was I believe approximately $46 million or $47 million of that, much of it related to the step-up charge.

Saul Ludwig – Northcoast Research

Okay. And how much, on a year-over-year basis was the profit from copper down?

Chris Hix

As we indicated in the presentation, the byproduct impact was about $4 million, year-over-year.

Saul Ludwig – Northcoast Research

Got you. Okay, terrific. Thank you. That’s all I had.

Chris Hix

Okay. Thanks, Saul.

Steve Dunmead

Thanks, Saul.

Joe Scaminace

Okay, that ends the Q&A period. And I just want to thank all of you for your interest. And I’ll just leave you with the last thought that going forward, please view us as a growth and technology company. And we really feel like our investment proposition right now is as solid as it’s ever been. Thanks for your interest, and have a great day.

Operator

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

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