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Executives

Timothy McKenna - Vice President of Investor Relations & Communications

Seifi Ghasemi - Executive Chairman, Chief Executive Officer, President, Chairman of Rockwood Specialties Group and Chief Executive Officer of Rockwood Specialties Group

Robert J. Zatta - Chief Financial Officer, Senior Vice President, Chief Financial Officer of Rockwood Specialties Group and Senior Vice President of Rockwood Specialties Group

Analysts

David L. Begleiter - Deutsche Bank AG, Research Division

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

Aleksey V. Yefremov - BofA Merrill Lynch, Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Cooley May - Macquarie Research

Sachin Shah

Alina Khaykin

Larry Oxley

H Dale Houser

Brian Lalli - Barclays Capital, Research Division

Neal Sangani - Goldman Sachs Group Inc., Research Division

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Rockwood Holdings (ROC) Q3 2012 Earnings Call October 25, 2012 11:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Rockwood Holdings 2012 Third Quarter Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I'll now turn the conference over to Vice President, Investor Relations, Tim McKenna. Please go ahead, sir.

Timothy McKenna

Kathy, thank you. Good morning, and welcome to Rockwood's third quarter earnings conference call.

Seifi Ghasemi, our Chairman and Chief Executive; and Bob Zatta, our Chief Financial Officer, will give a formal presentation. And after that, we will have a Q&A session. You can follow the presentation for the call on our website at rocksp.com.

Before I begin the call, I'll read a short statement that the call contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, concerning the business operations and financial condition of Rockwood Holdings and its subsidiaries.

Although Rockwood believes the expectations reflected in such forward-looking statements are based upon reasonable assumptions, there can be no assurance that its expectations will be realized. Forward-looking statements consist of all non-historical information, including statements referring to the prospects and future performance of Rockwood.

Actual results could differ materially from those projected in Rockwood's forward-looking statements due to numerous known and unknown risks and uncertainties including, among other things, the risk factors described in our form 10-K and other filings with the -- on file with the Securities and Exchange Commission. We do not undertake any obligation to publicly update any forward-looking statement to reflect events or circumstances after the date of which any statement is made, or to reflect the occurrence of unanticipated events.

One other thing before we begin, I just want to remind people, we have scheduled an Investor Day. We have now moved that Investor Day to Thursday, January 17. This is a change from earlier announcements to accommodate the closing of the acquisition of Talison Lithium, which should be completed by mid-December. You can register for the Investor Day by going to a website, rockwoodmeetings.com, that's just rockwoodmeetings, all one word, dot com. If you've already responded, you don't need to sign up again. There will be another announcement that goes out to everyone on this shortly. So with that, I will turn the call over to Seifi.

Seifi Ghasemi

Thank you, Tim, and good morning, everyone. Thank you for joining us for Rockwood's 28th quarterly conference call. During our discussion, I will be referring to the presentation material, which has been posted on our website. When you analyze our results and compare them to last year, please note that in the third quarter of 2011, the euro-to-dollar exchange rate averaged EUR 1.41 per dollar. During the third quarter of this year, the exchange rate averaged EUR 1.25 per dollar. This significant movement in the exchange rate does not have any material effect on our real performance, since we do not have any significant transaction gains or losses. Our portfolio has a built-in natural hedge against currency movements due to the geographic balance of our operations around the world. But as a U.S. company, we report our results in U.S. dollars. Therefore, the exchange rate fluctuation does have a purely translational effect on our reported results. So please note that our reported sales are lower by $73 million or 7.8%, and our EBITDA is down by $15 million or 6.6% pure reviewed to the effect of the translation of our results from mainly euro to U.S. dollars.

During the rest of this presentation, I will compare our results to last year, mainly in constant currency terms, although you have the full details in actual dollars.

Now, please turn to Page 6. Sales for the quarter were down by 0.5% in constant currency. Our volumes were down, but that was partially compensated by higher selling prices. Our adjusted EBITDA was down 13.3% in constant currency. This was mainly due to very big performance in our TiO2 business. I will give you details of the performance of each one of our 5 business sectors as we move forward.

Adjusted earning per share was $0.94 for the quarter, and overall EBITDA margin was 21.1%.

During the quarter, as already announced, we entered into a definitive agreement to buy Talison Lithium for approximately $736 million. This strategically important and accretive acquisition is a major step forward to further strengthen our Lithium business. We currently expect this acquisition to close in late December 2012. To finance the above acquisition and other corporate activities, Rockwood issued $1.25 billion of unsecured senior notes due in 2020 at an attractive interest rate of 4.625%. As of September 30, 2012, we do have close to $1.5 billion of cash on hand.

Now please turn to Page 7. I have already mentioned the key numbers here, but please note on the bottom right-hand side of the page that our adjusted earnings per share for the first 9 months of 2012 is $3.42, which is 10% higher than the same period last year.

On Pages 8 and 9, we have the details of the performance of each sector in the quarter and year-to-date. I plan to comment on the results of each sector in more detail, so please turn to Page 10.

Our Lithium business continues to do well. Sales in constant currency were up 6.6% for the quarter and 5% year-to-date. EBITDA was up 10.8%, and our EBITDA-to-sales margin improved from 37.4% to 39.1%.

I have, at the beginning of the call, mentioned our strategic initiative to buy Talison Lithium. In addition, during the third quarter, we brought our new lithium hydroxide plant in North Carolina on a stream. I am very pleased to report that the plant is functioning well and producing lithium hydroxide quality which is significantly better than anything else on the market. We continue to believe that our Lithium business will do well for the balance of the year and in the future.

Now please turn to Page 11 to discuss our Surface Treatment business, which trades under the name Chemetall. In constant currency, sales were up 1.7% and EBITDA was up 6.9%, and EBITDA margins improved to 21.6%, a record high. Our very competent management team in this sector has done an excellent job to raise prices and gain market share to compensate for weaker volumes in Europe. Our business in the U.S. in this sector is doing very well, and sales are up 12% year-to-date. I'm also pleased to report that our brand-new surface treatment facility constructed in Michigan, and the largest facility of its kind in the world, successfully came on stream in October and is already producing products for our valued customers in the United States. We expect our Surface Treatment business to continue to do well for the balance of the year.

Now please turn to Page 12, our Performance Additives sector. As you know, this business has significant exposure to construction markets in the United States and Europe. In addition, we sell products that are used in oil and gas drilling in North America. We continue to see, as we have mentioned to you in the previous quarters, weak demand in construction, especially in Europe. In addition, we are experiencing a material drop in demand for our drilling products in -- used in oil and gas production. Therefore, performance of this sector will be weak for the balance of the year, although our management team here has done -- has been successful in increasing prices and controlling costs. We continue believe -- to believe that, in the long-term, when the housing market turns around in the United States in 2014 and 2015, that this sector will produce excellent results.

Now please turn to Page 13, an appropriate page number for our TiO2 business. The very bleak and unsatisfactory performance of this business in the third quarter of this year is mainly due to significant slowdown in demand from China and southern Europe. It is appropriate to give you more details. On a comparative basis, our volumes in the third quarter of 2012 were about 25% lower than those of the third quarter of 2011, prices were actually higher by 11% during this quarter versus last year. On a sequential basis, volumes in the third quarter similar to those of the second quarter of 2012, and prices were down about 4%. Raw material costs were significantly higher during this quarter from those of the second quarter and third quarter of last year. Since we do not expect a material change in demand in the fourth quarter, we are operating our facilities at around 60% to 65% of capacity to reduce our current inventories. We believe this significant slowdown in demand is due to material weakness in construction in China, weak demand in Europe and customers' attempt to operate at minimum inventories. We expect these trends to continue in the fourth quarter. But as we move forward, with improved demand in China, expected pickup in housing sector in the U.S. and our customers' need to replenish their inventories, we continue to be optimistic about the future of this business in the long-term.

The fundamentals of the industry have not changed significantly since 2011, when we were totally sold-out, and no material new capacity is expected to come on stream in the Western world.

Now please turn to Page 14, our Advanced Ceramic business. Our medical ceramic sector, mainly the ceramic hip joint business, continues to do well and grow at a 6% to 8% annual rate. But we have seen slower volumes in Cutting Tools business due to lower demand in the industrials and automotive sector. In addition, volumes in our products that go into the consumer electronics sector have been weaker, too. Our management team in this sector continues to do a great job in controlling their costs and maintaining their EBITDA margins above 32%. We expect those kind of margins to continue for the next quarter.

Now please turn to Page 15. Here, we break down our sales so that you have more visibility into our performance. You will note on the left-hand side of the page that, for the quarter, we had an increase of 4.1% in sales due to the positive effect of prices, prices were higher in every single one of our 5 sectors. As explained before, currency translation reduced our sales by 7.8%. Volumes were down by 4.6%, mainly due to our TiO2 and Performance Additive sectors.

At this point, I will turn this over to Mr. Bob Zatta, our Senior Vice President and Chief Financial Officer, to give you more details. After he is finished, we will open the call to answer your questions. Bob?

Robert J. Zatta

Thank you, Seifi, and good morning, everyone.

I'm on Page 17 of the presentation. This is our reported income statement for the third quarter and the first 9 months of the year.

Rockwood reported net sales of $862.8 million for the quarter as compared with $940.9 million in the same period last year, a decrease of 8.3%. On a constant currency basis, sales were down 0.5%. Sales were down primarily from lower volumes, partially offset by higher selling prices across most businesses.

For the first 9 months, sales were $2.7 billion, a decrease of 6.2% from last year. On a constant currency basis, sales were flat.

We reported gross profit for the quarter of $267.6 million or 31% of sales, as compared with $331.5 million or 35.2% of sales last year. For the first 9 months of the year, gross profit as a percent of sales was 34.8% compared to 35%. The decline in gross margin year-on-year in the quarter and first 9 months of the year was primarily due to lower volumes and raw material cost increases, partially offset by higher selling prices.

For the quarter, SG&A as a percent of sales was 18.1%, down from 18.7% last year. The year-on-year percent decrease was 11.2% in the quarter, driven primarily by foreign exchange. We also had some restructuring and severance accruals in the third quarter related to the continued streamlining of our operations, especially in Surface Treatment, as we have just started up the new plant. This brings us to operating income of $105.3 million for the quarter, which is 12.2% versus 16% last year.

The next major item is net interest expense. The composition of interest expense is shown at the bottom of the page. Net interest expense decreased the third quarter and first 9 months of the year, compared to the same periods in the prior year, primarily due to the prepayment of debt. And this brings us to income from continuing operations before taxes, which is $84.3 million for the third quarter and $329.5 million for the first 9 months.

Against this, the income tax provision is $23.3 million for the quarter. On an adjusted basis, the effective tax rate for the quarter is 23.5%.

We then show net income attributable to the noncontrolling interest in the TiO2 in Timber joint ventures. The change in the quarter was primarily related to lower earnings in the TiO2 joint venture. And this results in net income of $61.6 million for the third quarter.

Page 18 presents the reconciliation of net income to adjusted EBITDA. For the third quarter, beginning with net income of $61.6 million, we have deducted a net loss attributable to noncontrolling interest and have added back income taxes, which gets us to pre-tax income from continuing operations of $84.3 million. Then, adding back interest expense and D&A brings us to a subtotal of $170.9 million. We then have several onetime adjusting items, which brings us to the adjusted EBITDA in the quarter of $181.9 million.

Page 19 provides a detailed reconciliation of net income and EPS from continuing operations on a reported basis to net income and EPS from continuing operations as adjusted. As you can see, the adjustments are shown on an after-tax basis and include the same items already identified on the previous charts. This gives us an adjusted EPS of $0.94 per share for the third quarter.

Page 20 provides a detailed reconciliation between the income from continuing operations before tax of $84.3 million to the normalized-as-adjusted profit after tax, which is $99.0 million. We reported a normalized tax charge about [ph] $23.3 million, and this gives us an effective tax rate of 23.5% for the third quarter. The adjusted tax rate is lower than the reported rate, since most of the adjustments were costs incurred in the U.S. related to our new surface treatment plant, the Performance Additives division and the Talison acquisition and some other projects that are not tax-affected in the U.S.

Page 21 provides a summary of our cash and debt position at September 30, 2012. In September, we issued $1.25 billion of unsecured senior notes due in 2020, with a coupon rate of 4.625% and used a portion of the proceeds to prepay $250 million of term loan B under our senior secured credit facility in October. We expect to use the remainder to finance the Talison acquisition and other corporate activities.

Page 22 shows the long-term trend in Rockwood's leverage ratio. We have continued to deleverage the company in accordance with our plan.

And then, Page 23 represents our free cash flow. As you can see, we generated free cash flow of $81.2 million in the third quarter and $101.5 million in the first 9 months of the year.

And with that, Seifi, I'll turn it back to you.

Seifi Ghasemi

Thank you very much, Bob. And with that, we are ready to take your questions. We'll be delighted to answer your questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to our first question from David Beigleiter from Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Seifi, just on TiO2, can you talk about perhaps the earnings power of this segment, both in Q4 as well as 2013?

Seifi Ghasemi

Well, we think that the business has bottomed out. And I expect the fourth quarter to be something like the second quarter, and then start improving as we go forward in 2013.

David L. Begleiter - Deutsche Bank AG, Research Division

So you expect TiO2 EBITDA in Q4 to be similar to Q2?

Seifi Ghasemi

Q3.

David L. Begleiter - Deutsche Bank AG, Research Division

Q3, I'm sorry. Very good. And just can you talk about perhaps the potential to remove this business from the portfolio in 2013?

Seifi Ghasemi

David, we have said before that this -- we do not consider this business to be a core business for Rockwood in the long-term, so we constantly review our options. And obviously, the intent to remove it is -- to remove it from our portfolio. But, obviously, we have to do it at the right time and in the right conditions to create the proper value for our shareholders. And we constantly evaluate that. And if there is anything worthwhile, we will let you know.

David L. Begleiter - Deutsche Bank AG, Research Division

And if -- on Talison I know it hasn't closed and you can't say too much, but can you give a little more color on the strategic rationale for acquiring this business?

Seifi Ghasemi

Most important rationale for acquiring the business, David, is that we believe that in the long-term, China will have significant growth in lithium demand because they have made the decision to go electric. And as a result of that, we've wanted to participate in that market. Talison is supplying about 60% of that market, and we believe by owning Talison, we will be able to participate in that growth without having to go and do that in a roundabout way. I mean we already have a company that is supplying that. The second rationale is that by owning Talison, we will diversify our lithium sources. We will be -- have lithium sources in the United States, in Chile and in Australia, which will give a lot of comfort to our customers that we have a diversified base to supply them in the long term.

Operator

Your next question is from Silke Kueck with JPMorgan.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

I'd also like to start with TiO2. So what you said is that your volumes from the second to the third quarter were flat, though your EBITDA fell by half. And so, presumably, there is a -- there is like higher oil cost that your -- that you have to assume, and probably there are -- there's like fixed cost distribution isn't as good as plants taking shut downs. Though with prices falling, and oil costs rising, how do you expect the level of profitability to improve next year? Even if prices stay stable from this level?

Seifi Ghasemi

Silke, there's several reasons. Number one, as you mentioned, when we run the facilities at 60%, our fixed cost absorption is high, therefore, that affects our EBITDA. But we are doing that because we want to generate cash from the business. We have more inventory than we need. The second item that has affected the results is obviously higher raw material costs. But the raw material costs that we report is as a result of what we bought in the previous quarters. Obviously, the demand for TiO2 is low, the raw material prices we expect to go down. But they are not reflected because we are using them from inventory from what we had bought before. So we do negotiate the raw material prices every quarter. So -- and the other thing is that we obviously expect that the demand to come back for the reasons that I mentioned before.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

Were the shutdowns taken in the third quarter similar to the shutdowns taken in the second quarter?

Seifi Ghasemi

I can tell you actually our utilization rate, I don't have any problem with that. I -- when you look at this business, to be very specific, in the 2011, in the first quarter, we had a utilization rate of 93%. In the second quarter of 2011, we were at 90.7%. In third quarter of 2011, we were at 93%. In fourth quarter of 2011, we were at 90%. In the first quarter of 2012, when we ran our facilities flat out in the expectation that Chinese demand will go up, our utilization rate was 98%. Then, we cut it back in the second quarter of 2012 to 65%. And in the third quarter, the actual utilization was 56.9%. And we expect in the fourth quarter that our utilization will be, as I said, something between 55% to 60%.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

Okay. Okay. Can you talk about the source of the lower volumes in the Lithium business? And whether that's just like a temporarily related to the electronics set markets? Or what's behind that?

Seifi Ghasemi

When you look at our Lithium business, there is 3 sectors that you have to keep in mind. One is lithium demand for batteries. We have always said that the volumes in that sector have been up significantly from last year. The second way -- that -- item that you have to consider is sales of potash. Potash sales are lower because, as you know, we are -- we don't -- we store this stuff and we don't want to sell it cheap. Then the third item is lithium carbonate demand for what we call technical grade, which is lithium that goes into the production of grease, production of glass, production of ceramics and other industrial application. So the technical grade applications are slower because of the general slowdown in the industrial sector.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

Okay. And if I can ask a last question, what is behind the delay of the closure of the Talison acquisition?

Seifi Ghasemi

There is no delay. We expected that we would be able to close that deal at the beginning of December. And right now, considering the specific court dates, you have to get a date with the judge and to -- the judge has to give you the time. And right now, the judge has given us the time that we expect that the closing will be more in the second half of December rather than the first half. It has nothing to do with the process, it's just a court scheduled date and the specific judges. Because the judge has to approve all of the documents that goes into the shareholders. And then once the shareholders have voted, the judge again has to certify that and approve that. So that is the reason, there is nothing else.

Operator

We'll go next to Bob Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc., Research Division

Maybe first a question for Mr. Zatta, if I might. It looked like year-on-year to last September, inventories were up about 40%. Can you give us a sense, across the businesses, was there 1 or 2, obviously TiO2 is in there, but that had a larger increase in inventory or something that had a lesser increase?

Robert J. Zatta

First of all, our inventories at the end of December 2011 were $674 million. And at the end of June, they were $763 million, so they were up about $89 million. And then since June, until now, they were up another $90 million. Year-to-date, about $180 million. On a net-net basis, all of the increase in inventory is TiO2. All of it. There's some pluses and minuses by other businesses. The Lithium business has some higher inventory, which is primarily related to potash that Seifi has talked about. The Performance Additives, particularly color pigments and clay additives, inventories are coming down as they are reducing inventories and will continue to reduce them. So it's pluses and minuses, but it's primarily related to the TiO2 business. Now you need to keep in mind that included in that number is crenox, which is probably about 1/3 of the increase. So a big chunk of it is the fact that we bought the business, brought it on board and the inventories are now consolidated in our numbers, but obviously, the business is just getting started. So you don't really see any benefit of it as -- at the end of the third quarter. So we would expect that we will continue to reduce inventories in the fourth quarter, and we would see working capital, in total, as being kind of a net positive contributor to the cash in the fourth quarter.

Robert Koort - Goldman Sachs Group Inc., Research Division

Great, that's helpful. Seifi, on TiO2, if I look over the last year, you've had 4 quarters now of pretty horrendous year-on-year volume comps, somewhere between 10% and 30% lower each quarter. It seems sort of surprising given that global paint demand hasn't fallen off a cliff that there can be that much inventory across the system. Has this ever happened before? And when will it finally stop? I mean obviously your comps get easier, but is there still inventory at the customer level, too, that needs to bleed down before you can get your own inventories in check?

Seifi Ghasemi

Look, Bob, first of all, when we look at our sectors that have exposure to coating, coating, in general, is weak, so -- and especially in China. We have seen this happen before. When you look at 2008 and 2009, our volumes were down for several consequential quarters. So this is not very surprising. The mistake that we made, Bob, and we have to be very open with -- where we make the wrong decision. The wrong decision was we operated our facilities at 98% capacity during the first quarter. And that is because we misjudged that the Chinese demand was low because of the Chinese New Year, and we expected that come April, the Chinese demand will go up as it usually does. That didn't happen, and actually China weakened. That's why we ended up with the inventories that Bob mentioned. Our inventories in all of our businesses are under control, this is only with TiO2. And that increase in inventory, which has happened to us, and I believe it has happened to the industry, has -- is going to cause -- to have an effect on the industry. But in terms of fundamental of the business, it's either running at the kind of capacity that we were running in 2010 or 2011. Once China's demand comes up, U.S. housing comes up, this business is going to do fine.

Robert Koort - Goldman Sachs Group Inc., Research Division

Okay. And if I could ask one last one on Surface Treatment. I guess you guys get something like 50% or 60% of sales from Europe. How were volumes year-on-year to that end market? And then we're reading about Europe auto production rate's not looking so exciting. I know you guys tend do go on the higher-end cars. How is that holding up? And what's the outlook going forward?

Seifi Ghasemi

In our Surface Treatment business, volumes are approximately flat versus last year. The reason that we -- you are right, that you are seeing some slowdown in the auto sector. But you have to be careful about making sure that you look at the luxury sector and overall sector. But the fact is that our business has 2 things going for it that I mentioned: one is that we continue to get price increases; and the other one that we do not advertise usually, but since you asked the question, is that we are picking up market share. And, therefore, that is compensating for any kind of a weakness in Europe, Bob. That's why I feel very confident about the performance of that business, not only for the next quarter but in the -- for the next quarters.

Operator

Your next question is from Aleksey Yefremov with Bank of America Merrill Lynch.

Aleksey V. Yefremov - BofA Merrill Lynch, Research Division

Seifi, what kind of cost relief do you expect in titanium feedstocks? And what is the potential timing, anything in 4Q or 2013?

Seifi Ghasemi

We negotiate the prices every single quarter. And therefore, we negotiated some last quarter, and we are negotiating that this quarter. There will be a kind of an out-of-phase sequence because if we negotiate the lower prices for the third quarter, then by the time we receive that material and put it in inventories, you are not going to see the result because we are going to be reporting our result based on what we drew out of the inventory that we had bought -- of the material that we had bought in the second and third quarter. So we do expect -- I mean there is no question that we are operating at 60% capacity, then it will have an effect on the price of raw materials, sure.

Aleksey V. Yefremov - BofA Merrill Lynch, Research Division

All right. And I just wanted to confirm something. On your TiO2 inventories, did you actually build TiO2 inventory in the third quarter compared to the beginning of the quarter?

Seifi Ghasemi

Yes we did. Yes we did. That's why when you look at the Page 23 of our presentation that Bob talked about, in terms of our cash flow, you'll see that our working capital change is actually positive. That means that we -- it hasn't -- we actually gained some from reducing inventories.

Aleksey V. Yefremov - BofA Merrill Lynch, Research Division

Oh, so you reduced the tonnage of your TiO2 inventory during the quarter?

Seifi Ghasemi

Yes.

Aleksey V. Yefremov - BofA Merrill Lynch, Research Division

Okay. And final question, if I may. On the Talison deal, are you expecting any pending regulatory approvals there? Or you're all set in that department?

Seifi Ghasemi

We are in that process. I don't want to comment on that because of the sensitivity, but we are in the process of getting that done before closing.

Operator

We'll go next to Mike Harrison with First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

I wanted to start with Performance Additives. How much of the revenue decline -- the organic revenue decline there was driven by clay-based additives?

Seifi Ghasemi

You're talking about how much of the volume decline was in clay-based additives?

Michael J. Harrison - First Analysis Securities Corporation, Research Division

That's right, or revenue dollars.

Seifi Ghasemi

Well, I can tell you the volume decline in our clay-based additive was -- you know we usually don't give these details, but it was about $7 million.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Okay. And was that mostly volumes there? Or is pricing also weaker in clay-based additives?

Seifi Ghasemi

Pricing is actually -- the pricing in our clay-based additives for the quarter was actually higher. And so was it in color pigment. And so was it in timber. We had price increases in every sector.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And the weakness in clay-based additives, is that completely related to slower oil and gas drilling activity? Or do you think that there were some customers maybe working down inventory levels? Obviously, we've seen a lot of growth in that industry with shale activity, et cetera.

Seifi Ghasemi

Our volumes were down mainly because of oil and gas drilling, but we are also seeing weakness in the coating sector that we serve in that sector.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Okay. In terms of the volume weakness in lithium, I guess I was surprised to see that it was technical grade carbonate you've highlighted this quarter. Last quarter, you noted the butyllithium weakness related to catalyst polymerization, catalyst demand in China. How did butyllithium look this quarter compared to last quarter?

Seifi Ghasemi

Not significantly different.

Cooley May - Macquarie Research

Okay. And then the new lithium hydroxide plant, congratulations on opening it. Can you maybe give us some more details on how it's operating thus far? How the ramp-up is progressing? And maybe what that contributed in the quarter, in terms of revenue or EBITDA contribution?

Seifi Ghasemi

The new plant did not contribute anything in the third quarter because we just brought it up, and we are -- and we are producing material and sending samples to customers. So that was not -- that did not contribute in the third quarter. That plant has a capacity of 5,000 metric tons per year. And as I've told you, the most important thing that we were focused on is our goal to produce a material that in terms of purity is significantly ahead of anything that anybody else can produce. We have demonstrated that. And now, obviously, we will go to our customers and try to improve our positioning there and load the plant.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And can you give us any sense, order of magnitude, how much higher the margin would be on a high purity lithium hydroxide as opposed to conventional or normal purity?

Seifi Ghasemi

Mark, I can't answer that because it's a new product and we have to start marketing it. So, obviously, it will be as high as we can get it.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

That's fair enough. The last question I had, just around the TiO2 business. How much did the crenox plant contribute to revenue in the third quarter?

Seifi Ghasemi

In revenue, about $60 million. In revenue.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Just in the third quarter?

Seifi Ghasemi

Yes.

Operator

And then our next question is from Sachin Shah with Tullet Prebon.

Sachin Shah

I just wanted to follow up on the deal. I think I heard you say that you're expecting the deal to close second half of December. But just wanted to get an update on the regulatory approvals?

Seifi Ghasemi

I cannot comment on the regulatory approval because we are in the middle of the process. And I think whatever I say would be -- would not be appropriate. Because while you are in the process, we should let the process go forward.

Sachin Shah

Okay. Could you maybe just talk about which are remaining, and which are not?

Seifi Ghasemi

No, I don't want to comment on that either.

Sachin Shah

Okay. All right. So the guidance, just to be clear, the guidance that you're using for the second half of December close, that's not only for the court dates that you need or the shareholder vote, November 29, the final court proceedings for all the approvals, but it's also because of the regulatory? I just wanted to understand.

Seifi Ghasemi

No. We fully expect to have the regulatory approvals done well before that. The determining factor for the second quarter is the court dates. It is not the regulatory approval.

Sachin Shah

Okay, fair enough. All right. So it's still pending, but you expect it before the court date?

Seifi Ghasemi

Yes.

Operator

Your next question is from John McNulty with Credit Suisse.

Alina Khaykin

This is actually Alina Khaykin sitting in for John. Seifi, in Surface Treatment, how should we think about the growth from the new facility in the U.S. next year and the profits from that?

Seifi Ghasemi

Our new facility in the United States was primarily designed as a cost reduction measure although the plant has significant capacity for growth. But our focus and the capital investment are justified on cost reduction. We expect the plant to help us reduce our cost, by consolidating 3 plants into 1 plant, by about $5 million to $6 million a year on EBITDA level.

Alina Khaykin

Okay. And then just another one on lithium. I think you mentioned that you're going to -- that you're adding 5,000 tons in Nevada. But how should we think about that coming online? Is that all going to be next year or over the next 5 years? Just a sense of how quickly that could ramp up?

Seifi Ghasemi

Well. I think you should take 2 things into consideration. We already do have a lithium hydroxide facility in Nevada that we operate, that provides the lithium hydroxide that we sell. So depending on the market conditions, one option that we have -- I'm not saying we are going to do this, but one option we have is to reduce the production in Nevada and increase the production in Kings Mountain, because the Kings Mountain plant, the new plant is more efficient. So we can load up the new plant pretty quickly, but that doesn't mean that our lithium hydroxide plants are going -- hydroxide sales are going to jump. We expect lithium hydroxide sales for us to grow at around 10% to 12% a year. So that would be the dynamics there.

Operator

And next we have Larry Oxley with MetLife.

Larry Oxley

Yes. Just to get a little bit more clarity on the sequential change from the second quarter into the third quarter on the cost of the ore? If you could quantify that, what was that, 10% sequential increase in the raw material input?

Seifi Ghasemi

Sequential increase from the second quarter to the third quarter was probably more like 35% to 40%.

Larry Oxley

And then moving sequentially into the fourth quarter, on the pricing side of the TiO2, are you seeing any changes there? A continued decline? And if so, ballpark it maybe the decline of another 5% or so?

Seifi Ghasemi

I obviously don't know that yet, but I wouldn't be surprised if it is in that order of magnitude.

Operator

Our next question comes from Dale Houser with Raymond James.

H Dale Houser

I wondered if you could give me a little color on the geographical breakdown of your lithium sales?

Seifi Ghasemi

No. I apologize, I will not want to do that because we believe that's very sensitive competitive information.

H Dale Houser

Okay. And could you give us some indication of the split between battery grade and tech grade sales?

Seifi Ghasemi

Well, currently our battery grade is about -- currently our battery grade is approximately 30%, and 70% is technical grade.

H Dale Houser

Okay. And how do you see that changing with the Talison? I guess what I was asking about geography was I was trying to get an idea how it would change with Talison as well.

Seifi Ghasemi

Well it will change because Talison -- most of Talison production goes to battery grade. Actually about 60% of their production, 65% of the production goes to battery grade, and the balance of it is technical grade. So with the acquisition of Talison, then we would have a significantly more exposure to battery grade versus technical grade.

H Dale Houser

Okay. You did mention that 60% of Talison's exports go to China. Or they -- sorry, they supply 60% of China demand.

Seifi Ghasemi

Yes. The raw material for making lithium carbonate in China. That's correct.

H Dale Houser

Okay. And so I guess I was trying to get that, where you were headed? Where you are now, I guess?

Seifi Ghasemi

We current -- now I see where you're going. We currently do not sell very much product into China. That is not the market that we are serving today.

H Dale Houser

Okay. Okay. So yours will be North America and Europe and something like that?

Seifi Ghasemi

Ours is mainly America, Europe, Japan, Korea. We are not -- we are almost nonexistent in China, currently.

Operator

We'll go next to Brian Lalli with Barclays.

Brian Lalli - Barclays Capital, Research Division

Real quick question on the balance sheet front, if I could. The number of 1.8x net leverage obviously is inclusive of a significant cash balance, about $740 million of which we know is going to go towards the acquisition. Would you be willing to disclose, just maybe pro forma, credit metrics? Or maybe just an EBITDA contribution of the Talison business? So that we can think about those metrics after that money leaves the system?

Robert J. Zatta

Ye. I mean, I think as -- if you leave Talison out of the equation, for the moment, we're at about 1.8x leverage. And that's where we would be at the end of the year, more or less. We anticipate our leverage ratio to increase as we -- once we make the Talison acquisition. But we expect to get back to where we are, and below where we are, very quickly. And quite honestly, all of that was factored into our discussions when we did the bond offering with the rating agencies and everybody else. So everything is predicated upon those assumptions. So we are not anticipating any changes versus what we had thought we were going to see a couple of month or so ago.

Brian Lalli - Barclays Capital, Research Division

And on that, I think in a recent investor meeting, you've mentioned that 1.5x is kind of a target. Is that still the right way to think about it? And then would that mean that excess cash flow, outside of, maybe, kind of regular dividends, would be used specifically for deleveraging? For paying down maybe of the secure term loan?

Seifi Ghasemi

Well, we had said that our ideal case is to be at leverage ratio at around 1.5x to 2x, actually. That's what we have said. So any kind of an excess cash flow will -- we do generate a lot of cash. You saw in the third quarter, even with the TiO2 being as weak as it was.

[Audio Gap]

normal year, if we are not having a significant change in our working capital, Rockwood has the potential of generating just more than $350 million of free cash. That combined with the cash that we have on hand, as Bob said, should put us in a position that we will get back to around 1.5x, 1.8x pretty quickly. And that's the target that we have.

Brian Lalli - Barclays Capital, Research Division

And then one last, if I may. You've been pretty public around investment grade ratings. I guess would you have any comment on maybe focusing on that specifically, driving towards that? Or are you more just hopeful that your metrics may be in that 1.5x to 1.8x range would be warranting of an upgrade as you think about the agency process?

Seifi Ghasemi

We run the company to generate the greatest amount of value for our shareholders. So -- but becoming an investment grade is an ambition that we do have. And if, during the course of running the company properly, we get there, which I think we will get there, that would be a very nice outcome.

Robert J. Zatta

Yes. We're pretty close, and that would be something that we would anticipate happening in the future.

Operator

We now have a follow-up from Bob Koort with Goldman Sachs.

Neal Sangani - Goldman Sachs Group Inc., Research Division

This is Neal Sangani with a follow-up. I just wanted to get a status update of the lithium carbonate expansion in Chile? Looking at the demand environment, how should we look at the ramp up of utilization there? And what kind of supply risk does the new concessions by the Chilean government pose?

Seifi Ghasemi

Number one, our plant in Chile is expected -- our new plant in Chile is expected to come on stream in 2014. And at that time, we expect -- we fully expect to load up the plant in less than 3 years considering the expected demand. The second thing is that the Chilean government process, as I'm sure you know, ended up in being nullified. There was no winner declared. There was a winner declared, and then they nullified that and the Chilean government has put all of that on ice for now. I have no idea what they're going to do next, but that process did not result in any new entrants into the market.

Operator

Then we'll go back to Mike Harrison with First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Just a few more, Seifi. First of all, what are your expectations around customers taking extended holiday downtime in some of your Surface Treatment end markets like automotive and general industrial?

Seifi Ghasemi

Right now, we do not have any indication of anything unusual. Usually, these people kind of shut down before Christmas and come back on the second week of January. And up to now, we haven't had any indication. We have been talking to our business people as of obviously yesterday, and we don't expect anything unusual, Mike, at this point. But usually, as you know, they don't really let you know anything until the last minute. So I cannot predict what they will do.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

I mean is that something you're concerned about?

Seifi Ghasemi

No, I'm not. I'm -- as far as our Surface Treatment business and our ceramic business which would be most affected by something like that, I'm not concerned because any kind of a slowdown on that will be picked up by the medical business growing and by their market share and pricing in Surface Treatment.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Okay. Speaking of the medical ceramics business, the hip joint components have obviously been a very important part of your success there. And you also have the knee joint components that have been in the works for several years now. Can you just update us on the time line for getting the knee joint components approved in Europe and the U.S.? And maybe talk a little bit about how that time line would compare to your experience with the hip joint approval process?

Seifi Ghasemi

Sure. Right now, our knee -- the knee joints, we have about close to 700 patients in Europe who do have the knee joint -- the ceramic knee joints, and we are collecting the data. We expect that we would be able to get approval and start marketing the knee joints in Europe in 2016, and we hope to be able to market them in the United States in 2017.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

And is that longer than the process took for hip joints?

Seifi Ghasemi

No, approximately the same.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

About the same. Okay. And then the last question for Bob, any guidance that you could give us for run rate interest expense for 2013? Again, kind of pro forma for the -- assuming Talison closes by December 31?

Robert J. Zatta

As far as 2013 is concerned, let's just see what I can tell you on that. The net increase in our expected interest cost for 2013 will -- and again, Talison is not really factored in, so it's just the net interest impact, is about $50 million, $55 million for the full year.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

So for the full year, maybe a number like $120 million?

Robert J. Zatta

Yes, about that.

Operator

And we now have a question from Chris Shaw with Monness, Crespi.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Just following up on the -- one of the other earlier questions about Chile. Do you guys have plans -- have you thought about what you would do with the Talison salars that they have? And I guess within -- with the same region but not that close to yours? I mean, does it change at all with the sort of news with the problems they are having with the bidding down there?

Seifi Ghasemi

Once we buy Talison, then we will have ownership of what they call Salares 7, which is a combination of 7 salars south of Salar de Atacama. Currently, we do not have any plans for exploration out of there because we have plenty of lithium at Salar de Atacama. If in the future the demand is such that we would need additional exploration there, obviously, it is ours and we would be able to do that.

Christopher L. Shaw - Monness, Crespi, Hardt & Co., Inc., Research Division

Is the concentration there equal to your salars or little less? Or...

Seifi Ghasemi

No, it is less.

Operator

And we have no further questions in queue. So please go ahead with any closing remarks.

Seifi Ghasemi

Well, I just want to thank everybody for participating in our call. Thank you very much for your good questions and interest in the company. And we look forward to talking to you about our fourth quarter results in 2013. And thanks again and all the best to everybody, and all the best for the holidays.

Operator

Thank you. And ladies and gentlemen, this conference will be available for replay after 1:00 p.m. today through midnight, November 8. You may access the AT&T executive playback service at anytime by dialing 1 (800) 475-6701 and entering the access code 266579. International callers, dial (320) 365-3844 using the same access code, 266579. That does conclude our conference for today. Thank you for your participation and choosing AT&T executive teleconference. You may now disconnect.

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