10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-12515

 

 

OM GROUP, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   52-1736882
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
127 Public Square  
1500 Key Tower  
Cleveland, Ohio   44114-1221
(Address of principal executive offices)   (Zip Code)

216-781-0083

Registrant’s telephone number, including area code

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller Reporting Company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of Act).    Yes  ¨    No  x

As of October 31, 2011, there were 32,322,657 shares of Common Stock, par value $.01 per share, outstanding.

 

 

 


Table of Contents

OM Group, Inc.

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

     2   

Item 1.

  Unaudited Financial Statements      2   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      30   

Item 3.

  Quantitative and Qualitative Disclosures about Market Risk      51   

Item 4.

  Controls and Procedures      52   

PART II - OTHER INFORMATION

     52   

Item 1A.

  Risk Factors      52   

Item 6.

  Exhibits      53   
 

Exhibit 10.1

  
 

Exhibit 31.1

  
 

Exhibit 31.2

  
 

Exhibit 32

  
 

Exhibit 101.1 INSTANCE DOCUMENT

  
 

Exhibit 101.2 SCHEMA DOCUMENT

  
 

Exhibit 101.3 CALCULATION LINKBASE DOCUMENT

  
 

Exhibit 101.4 LABELS LINKBASE DOCUMENT

  
 

Exhibit 101.5 PRESENTATION LINKBASE DOCUMENT

  
 

Exhibit 101.6 DEFINITION LINKBASE DOCUMENT

  
  Signatures      54   

 

1


Table of Contents

Part I - FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements

OM Group, Inc. and Subsidiaries

Unaudited Condensed Consolidated Balance Sheets

 

(In thousands, except share data)    September 30,
2011
    December 31,
2010
 

ASSETS

    

Current assets

    

Cash and cash equivalents

   $ 346,369      $ 400,597   

Restricted cash on deposit

     88,885        68,096   

Accounts receivable, less allowance of $3,842 in 2011 and $5,187 in 2010

     251,225        155,465   

Inventories

     578,741        293,625   

Refundable and prepaid income taxes

     45,449        40,740   

Other current assets

     53,946        44,602   
  

 

 

   

 

 

 

Total current assets

     1,364,615        1,003,125   

Property, plant and equipment, net

     478,852        256,098   

Goodwill

     524,582        306,888   

Intangible assets, net

     426,938        153,390   

Notes receivable from joint venture partner, less allowance of $3,100 in 2011 and $5,200 in 2010

     16,015        13,915   

Other non-current assets

     81,807        39,292   
  

 

 

   

 

 

 

Total assets

   $ 2,892,809      $ 1,772,708   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current liabilities

    

Current portion of long-term debt

   $ 10,314      $ 30,000   

Accounts payable

     138,311        105,900   

Liability related to joint venture partner injunction

     88,885        68,096   

Accrued employee costs

     48,480        37,932   

Other current liabilities

     184,122        42,396   
  

 

 

   

 

 

 

Total current liabilities

     470,112        284,324   

Long-term debt

     676,117        90,000   

Deferred income taxes

     137,346        23,499   

Uncertain tax positions

     19,604        14,796   

Pension liabilities

     196,643        58,107   

Purchase price of VAC Holding payable to Seller

     86,304        —     

Other non-current liabilities

     28,626        25,364   

Stockholders’ equity:

    

Preferred stock, $.01 par value:

    

Authorized 2,000,000 shares, no shares issued or outstanding

       —     

Common stock, $.01 par value:

    

Authorized 90,000,000 shares; 32,069,370 shares issued in 2011 and 30,725,792 shares issued in 2010

     320        307   

Capital in excess of par value

     624,123        578,948   

Retained earnings

     654,900        667,882   

Treasury stock (208,157 shares in 2011 and 202,556 shares in 2010, at cost)

     (7,427     (7,234

Accumulated other comprehensive loss

     (38,509     (3,119
  

 

 

   

 

 

 

Total OM Group, Inc. stockholders’ equity

     1,233,407        1,236,784   

Noncontrolling interests

     44,650        39,834   
  

 

 

   

 

 

 

Total equity

     1,278,057        1,276,618   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 2,892,809      $ 1,772,708   
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

OM Group, Inc. and Subsidiaries

Unaudited Condensed Statements of Consolidated Income

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(In thousands, except per share data)    2011     2010     2011     2010  

Net sales

   $ 415,057      $ 297,222      $ 1,075,924      $ 903,518   

Cost of products sold (excluding lower of cost or market charge)

     335,871        222,941        841,194        689,425   

Lower of cost or market charge

     62,444        —          62,444        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     16,742        74,281        172,286        214,093   

Selling, general and administrative expenses

     71,828        39,436        161,595        117,042   

Gain on sale of land

     (9,693     —          (9,693     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit (loss)

     (45,393     34,845        20,384        97,051   

Other income (expense):

        

Interest expense

     (8,512     (1,481     (11,327     (3,794

Interest income

     294        255        981        641   

Foreign exchange gain (loss)

     7,425        (688     7,264        (8,088

Other, net

     (547     183        (876     (210
  

 

 

   

 

 

   

 

 

   

 

 

 
     (1,340     (1,731     (3,958     (11,451
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income tax expense

     (46,733     33,114        16,426        85,600   

Income tax expense

     (18,421     (9,159     (24,497     (31,791
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax

     (65,154     23,955        (8,071     53,809   

Income (loss) from discontinued operations, net of tax

     234        1,003        (95     622   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated net income (loss)

     (64,920     24,958        (8,166     54,431   

Net (income) loss attributable to the noncontrolling interest

     (3,334     (757     (4,816     5,159   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to OM Group, Inc.

   $ (68,254   $ 24,201      $ (12,982   $ 59,590   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share - basic:

        

Income (loss) from continuing operations attributable to OM Group, Inc. common shareholders

   $ (2.18   $ 0.76      $ (0.42   $ 1.94   

Income from discontinued operations attributable to OM Group, Inc. common shareholders

     0.01        0.03        —          0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to OM Group, Inc. common shareholders

   $ (2.17   $ 0.79      $ (0.42   $ 1.96   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per common share - assuming dilution:

        

Income (loss) from continuing operations attributable to OM Group, Inc. common shareholders

   $ (2.18   $ 0.76      $ (0.42   $ 1.93   

Income from discontinued operations attributable to OM Group, Inc. common shareholders

     0.01        0.03        —          0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) attributable to OM Group, Inc. common shareholders

   $ (2.17   $ 0.79      $ (0.42   $ 1.95   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding - basic

     31,382        30,474        30,817        30,417   

Weighted average shares outstanding - assuming dilution

     31,382        30,560        30,817        30,535   

Amounts attributable to OM Group, Inc. common shareholders:

        

Income (loss) from continuing operations, net of tax

   $ (68,488   $ 23,198      $ (12,887   $ 58,968   

Income (loss) from discontinued operations, net of tax

     234        1,003        (95     622   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (68,254   $ 24,201      $ (12,982   $ 59,590   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

OM Group, Inc. and Subsidiaries

Unaudited Statements of Consolidated Comprehensive Income

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(In thousands)    2011     2010     2011     2010  

Consolidated net income (loss)

   $ (64,920   $ 24,958      $ (8,166   $ 54,431   

Foreign currency translation adjustment

     (47,303     15,884        (36,008     7,955   

Reclassification of hedging activities into earnings, net of tax

     293        817        (80     2,032   

Unrealized gain (loss) on cash flow hedges, net of tax

     (98     1,482        398        (2,784

Pension liability adjustment

     100        —          300        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in accumulated other comprehensive income (loss)

     (47,008     18,183        (35,390     7,203   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

     (111,928     43,141        (43,556     61,634   

Comprehensive (income) loss attributable to noncontrolling interest

     (3,330     (762     (4,816     5,162   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss) attributable to OM Group, Inc.

   $ (115,258   $ 42,379      $ (48,372   $ 66,796   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

OM Group, Inc. and Subsidiaries

Unaudited Condensed Statements of Consolidated Cash Flows

 

     Nine Months Ended
September 30,
 
(In thousands)    2011     2010  

Operating activities

    

Consolidated net income (loss)

   $ (8,166   $ 54,431   

Adjustments to reconcile consolidated net income to net cash provided by operating activities:

    

(Income) loss from discontinued operations

     95        (622

Depreciation and amortization

     47,264        40,186   

Share-based compensation expense

     5,118        4,151   

Foreign exchange (gain) loss

     (7,264     8,088   

Lower of cost or market charge

     62,444        —     

Gain on sale of land

     (9,693     —     

Restructuring charges

     507        2,054   

Deferred income tax provision (benefit)

     (27,322     (46

Allowance on GTL prepaid tax asset

     (6,225     11,465   

Other non-cash items

     (2,379     529   

Changes in operating assets and liabilities, excluding the effect of business acquisitions

    

Accounts receivable

     (12,178     (22,654

Inventories

     (1,573     30,393   

Accounts payable

     (13,485     30,127   

Accrued income taxes

     44,569        13,818   

Other, net

     14,791        (10,246
  

 

 

   

 

 

 

Net cash provided by operating activities

     86,503        161,674   

Investing activities

    

Expenditures for property, plant and equipment

     (26,405     (16,003

Proceeds from sale of land

     9,693        —     

Cash paid for acquisitions

     (669,818     (171,979

Other, net

     (4,090     (777
  

 

 

   

 

 

 

Net cash used for investing activities

     (690,620     (188,759

Financing activities

    

Payments of revolving line of credit

     (120,000     (125,000

Proceeds from the revolving line of credit

     —          245,000   

Proceeds from long-term debt

     697,975        —     

Debt issuance costs

     (29,283     (2,596

Proceeds from exercise of stock options

     361        3,802   

Payment related to surrendered shares

     (193     (1,209

Other, net

     —          93   
  

 

 

   

 

 

 

Net cash provided by financing activities

     548,860        120,090   

Effect of exchange rate changes on cash

     1,029        (1,599
  

 

 

   

 

 

 

Cash and cash equivalents

    

Increase (decrease) in cash and cash equivalents from continuing operations

     (54,228     91,406   

Discontinued operations - net cash provided by operating activities

     —          (33

Balance at the beginning of the period

     400,597        355,383   
  

 

 

   

 

 

 

Balance at the end of the period

   $ 346,369      $ 446,756   
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

OM Group, Inc. and Subsidiaries

Unaudited Condensed Statements of Consolidated Total Equity

 

     Nine Months Ended
September 30,
 
(In thousands)    2011     2010  

Common Stock - Shares Outstanding, net of Treasury Shares

    

Beginning balance

     30,523        30,269   

Shares issued in connection with acquisition of VAC Holding

     1,308        —     

Shares issued under share-based compensation plans

     30        241   
  

 

 

   

 

 

 

Common Stock - Dollars

     31,861        30,510   
  

 

 

   

 

 

 

Beginning balance

   $ 307      $ 304   

Shares issued in connection with acquisition of VAC Holding

     13        —     

Shares issued under share-based compensation plans

     —          3   
  

 

 

   

 

 

 
     320        307   
  

 

 

   

 

 

 

Capital in Excess of Par Value

    

Beginning balance

     578,948        569,487   

Share-based compensation

     5,118        4,151   

Shares issued in connection with acquisition of VAC Holding

     39,696        —     

Excess tax benefit from exercise/vesting of share awards

     —          93   

Shares issued under share-based compensation plans

     361        3,799   
  

 

 

   

 

 

 
     624,123        577,530   
  

 

 

   

 

 

 

Retained Earnings

    

Beginning balance

     667,882        584,508   

Net income (loss) attributable to OM Group, Inc.

     (12,982     59,590   
  

 

 

   

 

 

 
     654,900        644,098   
  

 

 

   

 

 

 

Treasury Stock

    

Beginning balance

     (7,234     (6,025

Reacquired shares

     (193     (1,209
  

 

 

   

 

 

 
     (7,427     (7,234
  

 

 

   

 

 

 

Accumulated Other Comprehensive Loss

    

Beginning balance

     (3,119     (16,969

Foreign currency translation adjustment

     (36,008     7,955   

Pension liability adjustment

     300        —     

Reclassification of hedging activities into earnings, net of tax benefit of $131 and $785 in 2011 and 2010, respectively

     (80     2,032   

Unrealized gain (loss) on cash flow hedges, net of tax expense (benefit) of $97 and ($1,398) in 2011 and 2010, respectively

     398        (2,784
  

 

 

   

 

 

 
     (38,509     (9,766
  

 

 

   

 

 

 

Total OM Group Inc. stockholders’ equity

     1,233,407        1,204,935   
  

 

 

   

 

 

 

Noncontrolling interest

    

Beginning balance

     39,834        44,827   

Net income (loss) attributable to the noncontrolling interest

     4,816        (5,159

Foreign currency translation

     —          (3
  

 

 

   

 

 

 
     44,650        39,665   
  

 

 

   

 

 

 

Total equity

   $ 1,278,057      $ 1,244,600   
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

Notes to Unaudited Condensed Consolidated Financial Statements

OM Group, Inc. and Subsidiaries

Note 1 – Basis of Presentation

OM Group, Inc. (“OMG” or the “Company”) is a global solutions provider of engineered materials, specialty chemicals, electrochemical energy storage, and technologies crucial to enabling its customers to meet increasingly stringent market and application requirements. The Company believes it is the world’s largest refiner of cobalt and producer of cobalt-based specialty products.

The consolidated financial statements include the accounts of OMG and its consolidated subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation. The Company has a 55% interest in a joint venture (“GTL”) that has a smelter in the Democratic Republic of Congo (the “DRC”). The joint venture is consolidated because the Company has a controlling interest in the joint venture. Noncontrolling interest is recorded for the remaining 45% interest.

On August 2, 2011, the Company completed the acquisition of VAC Holding GmbH (“VAC Holding”). The financial position, results of operations and cash flows of VAC Holding are included in the Unaudited Condensed Consolidated Financial Statements from the date of acquisition. As a result of the acquisition of VAC Holding, the Company’s segment formerly known as Advanced Materials was re-named Engineered Materials. The Engineered Materials segment includes the Company’s existing Advanced Materials business and Magnetic Technologies as they will be managed as one segment. Magnetic Technologies consists of VAC Holding.

On January 29, 2010, the Company completed the acquisition of EaglePicher Technologies, LLC. The financial position, results of operations and cash flows of EaglePicher Technologies are included in the Unaudited Condensed Consolidated Financial Statements from the date of acquisition.

These financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and do not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position of the Company at September 30, 2011 and the results of its income, comprehensive income (loss), cash flows and changes in total equity for the three and nine months ended September 30, 2011 and 2010 have been included. The balance sheet at December 31, 2010 has been derived from the audited consolidated financial statements at that date but does not include all of the information or notes required by U.S. generally accepted accounting principles for complete financial statements. Past operating results are not necessarily indicative of the results which may occur in future periods, and the interim period results are not necessarily indicative of the results to be expected for the full year. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Note 2 – Recently Issued Accounting Guidance

Accounting Guidance adopted in 2011:

In March 2010, the Financial Accounting Standards Board (“FASB”) issued guidance that recognizes the milestone method as an acceptable revenue recognition method for substantive milestones in research or development arrangements. This guidance sets forth requirements for an entity to recognize consideration that is contingent upon achievement of a substantive milestone as revenue in the period in which the milestone is achieved. In addition, this guidance requires disclosure of certain information with respect to arrangements that contain milestones. The Company adopted this guidance on January 1, 2011 and such adoption did not have a material effect on the Company’s results of operations or financial position.

In October 2009, the FASB issued guidance on multiple-deliverable revenue arrangements that addresses the unit of accounting for arrangements involving multiple deliverables. The guidance also addresses how arrangement consideration should be allocated to separate units of accounting, when applicable, and expands the disclosure requirements for multiple-deliverable arrangements. The Company adopted this guidance on January 1, 2011 and such adoption did not have any effect on the Company’s results of operations or financial position.

Accounting Guidance not yet adopted:

 

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Table of Contents

In May 2011, the FASB issued additional authoritative guidance relating to fair value measurement and disclosure requirements and provides a uniform framework for fair value measurements and related disclosures between U.S. generally accepted accounting principles and International Financial Reporting Standards. For fair value measurements categorized in Level 3 of the fair value hierarchy, the new guidance requires (1) disclosure of quantitative information about unobservable inputs; (2) a description of the valuation processes used by the entity; and (3) a qualitative discussion about the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, if any. Entities must report the level in the fair value hierarchy of assets and liabilities that are not recorded at fair value in the statement of financial position but for which fair value is disclosed. The new requirements clarify that the concepts of highest and best use and valuation premise only apply to measuring the fair value of nonfinancial assets. The new requirements also specify that in the absence of a Level 1 input, a reporting entity should incorporate a premium or a discount in a fair value measurement if a market participant would take into account such an input in pricing an asset or liability. The guidance requires the disclosure of all transfers between Level 1 and Level 2 of the fair value hierarchy. Additionally, the new guidance introduces an option to measure certain financial assets and financial liabilities with offsetting positions on a net basis if certain criteria are met. This guidance is effective for interim and annual periods beginning after December 15, 2011. The Company has not determined the effect, if any, the adoption of this guidance will have on its results of operations or financial position.

In June 2011, the FASB issued new accounting guidance regarding the presentation of comprehensive income in financial statements prepared in accordance with U.S. GAAP. This new guidance requires entities to present reclassification adjustments included in other comprehensive income on the face of the financial statements and allows entities to present total comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. It also eliminates the option for entities to present the components of other comprehensive income as part of the statement of equity. This guidance is effective for interim and annual periods beginning after December 15, 2011. Retrospective application to prior periods is required. As this new guidance is related to presentation only, the adoption of this new guidance will not have a material impact on the Company’s results of operations or financial position.

In September 2011, the FASB issued amendments to the goodwill impairment guidance which provides an option for companies to use a qualitative approach to test goodwill for impairment if certain conditions are met. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 (early adoption is permitted). The adoption of this new guidance will not have a material impact on the Company’s results of operations or financial position.

Note 3 – Acquisition of VAC Holding

On August 2, 2011 (the “Acquisition Date”), the Company completed the acquisition of the outstanding equity interests in VAC Holding from VAC Luxembourg S.à r.l. for $812.0 million. The financial position, results of operations and cash flows of VAC Holding are included in the Unaudited Condensed Consolidated Financial Statements from the date of acquisition. VAC Holding employs approximately 4,500 people in its three businesses: Materials and Parts, Cores and Components, and Permanent Magnets. VAC Holding has production facilities in Germany, Slovakia, Finland, China and Malaysia and is engaged in the development, manufacturing and distribution of industrial-use magnetic products for electronic equipment markets, including the alternative energy, automotive, electrical installation, and energy conversion and distribution sectors. The acquisition further diversifies the Company’s existing lines of business and provides exposure to additional high-growth end markets.

As a result of the acquisition of VAC Holding, the Company’s segment formerly known as Advanced Materials was re-named Engineered Materials. The Engineered Materials segment includes the Company’s existing Advanced Materials business and Magnetic Technologies, which consists of VAC Holding.

For the period from August 2, 2011 to September 30, 2011, VAC Holding contributed revenues of $106.6 million and an operating loss of $77.9 million, which includes $93.5 million of charges as a result of purchase accounting and the volatility of rare earth material prices. Acquired inventory with a net book value of $191.2 million was determined to have a fair value of $359.3 million as of the acquisition date, resulting in a step-up to fair value for inventory of $168.1 million. The inventory step-up is required as part of the allocation of the purchase price, discussed below. During the third quarter of 2011, $31.1 million of the estimated fair value step-up was recognized in cost of products sold as inventory on-hand as of the acquisition date was sold in the ordinary course of business. In addition, at September 30, 2011, the Company recognized a charge of $62.4 million to reduce the carrying value of inventory to market. The impact of the step-up being recognized in cost of products sold and the charge to reduce the carrying value of inventory to

 

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market, totaling $93.5 million, are included in the Company’s results of operations for the third quarter of 2011. The remaining net $74.6 million inventory step-up will be recognized in cost of products sold as inventory on-hand on the acquisition date is sold in the ordinary course of business in the remainder of 2011 and in 2012.

Acquisition-related expenses of $15.1 million were incurred in conjunction with the acquisition, of which $11.1 was incurred in the third quarter of 2011 and $4.0 million was incurred in the second quarter of 2011, and are included in Selling, general and administrative expense in the Unaudited Condensed Statements of Consolidated Income. Of the total acquisition-related expenses, $12.8 million was recognized as a corporate expense and $2.3 million was recognized in Engineered Materials.

The consideration transferred on the closing date of the acquisition consisted of cash paid and the issuance of 1,307,819 shares of OM Group common stock. The fair value of the OM Group common stock issued as consideration and included in the purchase price reflects a discount from the market price at the date of the acquisition because the common stock issued is subject to a 15-month holding period. In accordance with the Stock Purchase Agreement, the Company withheld $86.3 million of the purchase price, which will be transferred to the seller on the second anniversary of the closing date of the acquisition, subject to adjustment for indemnification claims made by OM Group and accepted by the seller, if any. The Company financed the purchase with borrowings under a new senior secured credit facility (the “Senior Secured Credit Facility”) and cash on hand.

The preliminary purchase price for VAC Holding based on the exchange rate on August 2, 2011 is summarized below (in millions):

 

Cash paid to VAC shareholders (net of cash acquired)

   $ 439.6   

Cash paid to retire VAC Senior Credit Facility and VAC High Yield Notes

     230.2   

Fair value of OM Group, Inc. common stock (1,307,819 shares) issued

     39.7   

Working capital and purchase price adjustments

     16.2   

Purchase price of VAC Holding payable to Seller

     86.3   
  

 

 

 

Total purchase price, net of cash acquired

   $ 812.0   
  

 

 

 

The working capital and purchase price adjustments are included in the Unaudited Condensed Consolidated Balance Sheets in Other current liabilities and are expected to be paid in the fourth quarter of 2011.

The following table summarizes the preliminary purchase price allocation based on estimated fair values as of the acquisition date (in millions):

 

Accounts receivable

   $ 82.3   

Inventories

     359.3   

Property, plant and equipment

     243.9   

Identifiable intangible assets

     307.5   

Other assets

     32.6   
  

 

 

 

Total assets acquired

     1,025.6   
  

 

 

 

Accounts payable

     45.8   

Other current liabilities, including deferred income taxes

     103.5   

Other liabilities, primarily pension and deferred income taxes

     296.4   
  

 

 

 

Total liabilities assumed

     445.7   
  

 

 

 

Net assets acquired

     579.9   

Purchase price, net of cash acquired

     812.0   
  

 

 

 

Goodwill

   $ 232.1   
  

 

 

 

The allocation of the purchase price is subject to finalization of the Company’s determination of the fair value of assets acquired and liabilities assumed as of the acquisition date. Therefore, it is possible that the fair values of assets acquired and liabilities assumed could materially differ from those presented when such determination is finalized. The Company has not finalized its analysis of the fair value of inventories, property, plant and equipment, intangible assets, pension and deferred taxes. The adjustments arising out of the finalization of the purchase price allocation will not impact cash flows. However, such adjustments could result in material increases or decreases to net income. The final allocation is expected to be completed as soon as practicable but no later than 12 months after the acquisition date.

 

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The goodwill of $232.1 million arising from the acquisition consists largely of intangible assets that do not qualify for separate recognition. The factors that contribute to the recognition of goodwill include VAC Holdings (i) reputation in its markets, (ii) strength of its management team, (iii) efficiency of its operations, and (iv) future cash flows and income projections. All of the $232.1 million of goodwill was assigned to the new Magnetics Technologies reporting unit of the Engineered Materials reportable segment. Goodwill arising from the acquisition of VAC Holding is not expected to be deductible for tax purposes.

The following table provides the changes in the carrying amount of goodwill by segment (in millions):

 

     Engineered
Materials
    Specialty
Chemicals
    Battery
Technologies
    Consolidated  

Balance at December 31, 2010

   $ 103.3      $ 138.2      $ 65.4      $ 306.9   

VAC Holding acquisition

     232.1        —          —          232.1   

Foreign currency translation adjustments

     (10.9     (3.3     (0.2     (14.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 324.5      $ 134.9      $ 65.2      $ 524.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Identifiable intangible assets arising from the VAC Holding acquisition include the following (at preliminary estimated fair value, in millions):

 

     Estimated
fair value
     Weighted
average
useful lives
 

VAC tradename

   $ 87.9         indefinite   

Developed technology

     93.5         17.0   

Customer relationship

     126.1         14.3   
  

 

 

    
   $ 307.5      
  

 

 

    

The customer relationship and developed technology intangible assets are being amortized on a straight-line basis. The VAC tradename is an indefinite-lived intangible asset and therefore is not being amortized but will instead be tested at least annually for impairment.

The following table provides pro forma financial information for the three months and nine months ended September 30, 2011 and 2010 as if the acquisition had occurred as of January 1, 2010 instead of on August 2, 2011 (amounts in thousands).

 

     Supplemental Unaudited Pro Forma  
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Net sales

   $ 466,599       $ 418,599       $ 1,458,417       $ 1,235,925   

Operating profit

   $ 65,963       $ 48,049       $ 180,583       $ 103,066   

The pro forma results were calculated by applying the Company’s accounting policies and reflect the impact on depreciation expense resulting from the preliminary estimated fair value and estimated remaining useful lives of certain fixed assets amortization expense related to recording intangible assets at their preliminarily estimated fair value, including customer relationships and developed technology.

Acquisition related expenses of $11.1 million and $15.1 million that were incurred in the three and nine months ended September 30, 2011, respectively, were eliminated from these periods as a pro forma adjustment. Total acquisition related expenses of $15.1 million were added as an additional expense for the nine months ended September 30, 2010 as if these costs were incurred on January 1, 2010.

An adjustment was made to the three and nine months ended September 30, 2011 to remove the non-recurring charges as a result of

 

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the step-up of inventory to fair value: (i) a $62.4 million lower of cost or market charge and (ii) a $31.1 million charge as inventory on-hand as of the acquisition date was sold in the ordinary course of business. Due to the non-recurring nature of these charges, they were not added as an expense to the three and nine months ended September 30, 2010.

The pro forma amounts are not indicative of the results that actually would have occurred if the acquisition had been completed on January 1, 2010, nor are they indicative of the future operating results of the combined company.

Note 4 – Inventories

Inventories consist of the following (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Raw materials and supplies

   $ 145,864       $ 134,655   

Work-in-process

     290,337         41,909   

Finished goods

     142,540         117,061   
  

 

 

    

 

 

 
   $ 578,741       $ 293,625   
  

 

 

    

 

 

 

As part of the allocation of the purchase price of VAC Holding to the acquired assets and liabilities, the Company recorded a step-up of inventory to its estimated fair value on the date of acquisition, as required under purchase accounting. Acquired inventory with a book value of $191.2 million on the date of acquisition was estimated to have a fair value of $359.3 million. The $168.1 million step-up of inventory was primarily due to (i) the fair value as determined by August 2, 2011 market prices of certain rare earth materials, primarily dysprosium and neodymium, compared to book value as of the acquisition date and; (ii) acquired work-in-process and finished goods which are required to be valued at their net realizable value less costs to complete and sell the inventory. During the third quarter of 2011, $31.1 million of the estimated fair value step-up was recognized in cost of products sold as inventory on-hand as of the acquisition date was sold in the ordinary course of business. In addition, at September 30, 2011, the Company recognized a charge of $62.4 million to reduce the carrying value of inventory to market. The remaining net $74.6 million inventory step-up will be recognized in cost of products sold as inventory on-hand on the acquisition date is sold in the ordinary course of business in the remainder of 2011 and in 2012. The lower of cost or market charge resulted from raw materials, primarily metals and rare earth materials, being written up to market prices on August 2, 2011. Since these raw materials will be used in production rather than sold at market prices as of the acquisition date, and since the selling prices of manufactured products is generally based on an average price of raw materials over a period of time rather than at a specific point in time, the Company recorded a lower of cost or market charge to write-down the value of its raw materials to the lower of cost or market.

Note 5 – Debt

On August 2, 2011, in connection with the acquisition of VAC Holding, the Company terminated its revolving credit facility and the Kokkola Credit Facility and entered into the Senior Secured Credit Facility. The borrowers under the Senior Secured Credit Facility are the Company and Harko C.V., a limited partnership organized under the laws of the Netherlands and a wholly-owned subsidiary of the Company (“Harko”). The Senior Secured Credit Facility was used to (i) finance a portion of the purchase price of VAC Holding, (ii) repay existing indebtedness of the Company under its former revolving credit facility, (iii) repay VAC Holding’s indebtedness outstanding on the date of the acquisition on behalf of the seller, (iv) pay certain fees and expenses in connection with the VAC Holding acquisition and will be used to fund working capital and for general corporate purposes as needed.

The Senior Secured Credit Facility provides for (i) a $100 million term loan A facility (the “Term A Facility”), which was fully drawn on August 2, 2011, (ii) a $350 million term loan B facility (the “Dollar Term B Facility”), which was fully drawn on August 2, 2011, (iii) a €175 million term loan facility (the “Euro Term B Facility” and, together with the Dollar Term B Facility, the “Term B Facility” and, together with the Term A Facility, the “Term Loan Facility”), which was fully drawn on August 2, 2011, and (iv) a $200 million undrawn revolving credit facility (the “Revolving Credit Facility”), of which up to $100 million may be denominated in Euros.

The obligations of the Company under the Senior Secured Credit Facility are guaranteed by the Company and all of the Company’s U.S. subsidiaries. In addition, the obligations of the Company under the Senior Secured Credit Facility are secured by a first priority security interest in substantially all of the existing and future property and assets of the Company and its U.S. subsidiaries and 65% of the voting capital stock of the Company’s direct foreign subsidiaries. The obligations of Harko under the Senior Secured Credit Facility are guaranteed by certain of the Company’s subsidiaries. The obligations of Harko under the Senior Secured Credit Facility

 

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are secured by a first priority security interest in substantially all of the existing and future property and assets of Harko and the Company’s subsidiaries and a 100% pledge of the voting capital stock of the Company’s subsidiaries, subject to certain exceptions, including limitations relating to German capital maintenance rules and other financial assistance limitations in certain foreign jurisdictions.

The Company has the option to specify that interest be calculated based on either a London interbank offered rate (“LIBOR”) or on a variable base rate, plus, in each case, a calculated applicable margin. The interest rate for base rate loans will be the greater of (i) the federal funds rate plus 0.50%, (ii) Bank of America’s prime rate or (iii) LIBOR plus 1.00%. The applicable margins for the Term A Facility, the Dollar Term B Facility and the Revolving Credit Facility range from 2.75% to 3.25% for base rate loans and 3.75% to 4.25% for LIBOR loans. The margin for the Euro Term B Facility is 4.75%. The LIBOR rates under the Term B Loan Facility are subject to a floor of 1.5%. At September 30, 2011, the weighted average interest rate for the outstanding borrowings under the Senior Secured Credit Facility was 5.7%.

The Term A Facility and the Revolving Credit Facility mature on August 2, 2016. The Term B Facility matures on August 2, 2017. In addition, the Term Loan Facility requires mandatory prepayments of principal based on certain percentages of Excess Cash Flow (as defined in the Senior Secured Credit Facility), beginning in 2013, subject to certain exceptions. In addition, subject to certain thresholds and exceptions, the Company will be required to prepay the loans outstanding under the Term Loan Facility with all of the net cash proceeds of certain asset sales and from the issuance or incurrence of additional debt of the Company.

The Senior Secured Credit Facility contains customary representations and warranties and certain covenants that limit the ability of the Company to, among other things: (i) incur or guarantee additional indebtedness; (ii) pay distributions on, redeem or repurchase capital stock or redeem or repurchase subordinated debt; (iii) make investments; (iv) sell assets; (v) enter into agreements that restrict distributions or other payments from restricted subsidiaries to the Company; (vi) incur or suffer to exist liens securing indebtedness; (vii) consolidate, merge or transfer all or substantially all of their assets; and (viii) engage in transactions with affiliates. In addition, the Senior Secured Credit Facility contains financial covenants that limit capital expenditures in any fiscal year and that measure (i) the ratio of the Company’s total indebtedness to the amount of the Company’s consolidated EBITDA, and (ii) the ratio of the amount of the Company’s consolidated EBITDA to the Company’s cash interest expense.

The Company incurred fees and expenses of $29.3 million related to the Senior Secured Credit Facility. These fees and expenses were deferred and are being amortized to interest expense over the term of the Senior Secured Credit Facility.

Note 6 – Pension Plans

At September 30, 2011 and December 31, 2010, the Company had pension liabilities of $197.3 million and $58.8 million, respectively, the majority of which were assumed in the VAC Holding and EaglePicher Technologies acquisitions.

As a result of the VAC Holding acquisition, the Company assumed approximately $154 million of pension obligations (based on the exchange rate on August 2, 2011), the majority of which are unfunded. VAC Holding sponsors various defined benefits plans for its employees, including pension, early retirement benefits and anniversary benefits, mainly in Germany. Future expected pension benefit payments for the VAC Holding defined benefits plans are as follows based on the September 30, 2011 exchange rate (in thousands):

 

Remainder of 2011

   $ 3,878   

2012

   $ 11,004   

2013

   $ 12,262   

2014

   $ 11,585   

2015

   $ 11,539   

2016 - 2020

   $ 51,790   

The EaglePicher Technologies pension plans consist of four non-contributory defined benefit pension plans. The Technologies Salaried Plan is a defined benefit, cash balance plan that covers EaglePicher Technologies salaried employees hired prior to January 1, 2007. The Technologies Hourly Plan is a defined benefit plan that covers EaglePicher Technologies non-union hourly employees hired prior to January 1, 2007 and union hourly employees hired prior to May 3, 2008. The Company also assumed two frozen defined benefit pension plans. Pension benefits are paid to plan participants directly from pension plan assets.

 

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The Company also has a funded, non-contributory, defined benefit pension plan for certain retired employees in the United States related to the Company’s divested SCM business. Pension benefits are paid to plan participants directly from pension plan assets. In addition, the Company has an unfunded obligation to its former chief executive officer in settlement of an unfunded supplemental executive retirement plan (“SERP”). Payments under the SERP are made directly from the Company. Certain non-U.S. employees are covered under other defined benefit plans. These non-U.S. plans are not material.

Set forth below is a detail of the net periodic expense for the U.S. pension defined benefit plans (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Interest cost

   $ 2,619      $ 2,829      $ 8,015      $ 7,630   

Service cost

     209        263        744        699   

Amortization of unrecognized net loss

     98        104        293        272   

Expected return on plan assets

     (2,740     (2,587     (7,888     (6,948
  

 

 

   

 

 

   

 

 

   

 

 

 

Total expense

   $ 186      $ 609      $ 1,164      $ 1,653   
  

 

 

   

 

 

   

 

 

   

 

 

 

Set forth below is a detail of the net periodic expense for the VAC Holding defined benefit plans (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Interest cost

   $ 1,323       $ —         $ 1,323       $ —     

Service cost

     725         —           725         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total expense

   $ 2,048       $ —         $ 2,048       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 7 – Restructuring

During 2009, the Company commenced a restructuring plan for its Advanced Organics business within the Specialty Chemicals segment to better align the cost structure and asset base of its European carboxylate business to industry conditions resulting from weak customer demand, commoditization of products and overcapacity in that market. The restructuring plan included exiting the Manchester, England manufacturing facility and workforce reductions at the Company’s Belleville, Ontario, Canada; Kokkola, Finland; Franklin, Pennsylvania and Westlake, Ohio locations. The majority of position eliminations were completed by mid-2010. The restructuring plan does not involve the discontinuation of any material product lines or other functions.

Set forth below is a detail of restructuring charges recognized:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
(in thousands)    2011     2010     2011      2010  

Restructuring charges included in cost of products sold

   $ 24      $ 1,106      $ 422       $ 1,913   

Restructuring charges (reversals) included in SG&A expenses

     (50     (37     85         141   
  

 

 

   

 

 

   

 

 

    

 

 

 

Total restructuring charges

   $ (26   $ 1,069      $ 507       $ 2,054   
  

 

 

   

 

 

   

 

 

    

 

 

 

The Company has incurred and expects to incur the following restructuring charges (in thousands):

 

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     Total charges
expected to
be incurred
     Total charges
incurred through
December 31, 2010
     Charges incurred
in the nine

months ended
September 30, 2011
     Additional
charges
expected to
be incurred
 

Cash charges

           

Workforce reductions

   $ 6,394       $ 6,225       $ 169       $ —     

Decommissioning, demolition, lease termination and other charges

     1,677         1,238         338         101   
  

 

 

    

 

 

    

 

 

    

 

 

 
     8,071         7,463         507         101   

Non-cash charges

           

Fixed asset impairment

     5,536         5,536         —           —     

Inventory impairment/other charges

     1,809         1,809         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     7,345         7,345         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total charges

   $ 15,416       $ 14,808       $ 507       $ 101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Decommissioning and demolition of the Manchester, England facility began in 2010 and was completed during the first half of 2011. Cash charges were for severance, decommissioning and demolition costs, lease termination costs and other exit costs. The Company expects to continue to incur costs related to the restructuring through December 31, 2011. Such costs will be expensed as incurred. During the third quarter of 2011, the Company completed the sale of land at the Manchester, England manufacturing facility for $9.7 million and recognized a pre-tax gain on the sale of the property of $9.7 million.

The following table presents the activity and accrued liability balance related to the restructuring program (in thousands):

 

     Workforce
reductions
    Other charges     Total  

Balance at December 31, 2010

   $ 401      $ 6      $ 407   

Charges

     169        338        507   

Foreign currency translation adjustment

     10        —          10   

Cash payments

     (580     (323     (903
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ —        $ 21      $ 21   
  

 

 

   

 

 

   

 

 

 

The restructuring accrual represents future cash payments and is recorded on the Unaudited Condensed Consolidated Balance Sheets in Other current liabilities.

Note 8 – Derivative Instruments

The Company enters into derivative instruments and hedging activities to manage, where possible and economically efficient, commodity price risk, foreign currency exchange rate risk and interest rate risk related to borrowings. It is the Company’s policy to execute such instruments with creditworthy counterparties and not enter into derivative instruments for speculative purposes. All derivatives are reflected on the balance sheet at fair value and recorded in other current assets and other current liabilities in the Unaudited Condensed Consolidated Balance Sheets. The accounting for the fair value of a derivative depends upon whether it has been designated as a hedge and on the type of hedging relationship. Changes in the fair value of derivative instruments are recognized immediately in earnings, unless the derivative is designated as a hedge and qualifies for hedge accounting. Under hedge accounting, recognition of derivative gains and losses can be matched in the same period with that of the hedged exposure and thereby minimize earnings volatility. To qualify for designation in a hedging relationship, specific criteria must be met and appropriate documentation prepared.

For a fair value hedge, the change in fair value of the hedging instrument and the change in fair value of the hedged item attributable to the risk being hedged are both recognized currently in earnings. For a cash flow hedge, the effective portion of the change in fair value of a hedging instrument is initially recognized in Accumulated other comprehensive income (loss) (“AOCI(L)”) in stockholders’ equity and subsequently reclassified to earnings when the hedged item affects income. The ineffective portion of the change in fair value of a cash flow hedge is recognized immediately in earnings.

 

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Commodity Price Risk

The Company enters into derivative instruments and hedging activities to manage commodity price risk. The Company, from time to time, employs derivative instruments in connection with certain purchases and sales of inventory in order to establish a fixed margin and mitigate the risk of price volatility. Some customers request fixed pricing and the Company may use a derivative to mitigate price risk. The Company makes or receives payments based on the difference between a fixed price (as specified in each individual contract) and the market price of the commodity being hedged. These payments will offset the change in prices of the underlying sales or purchases and effectively fix the price of the hedged commodity at the contracted rate for the contracted volume. While this hedging may limit the Company’s ability to participate in gains from favorable commodity price fluctuations, it eliminates the risk of loss from adverse commodity price fluctuations.

Derivative instruments employed by the Company to manage commodity price risk include cash flow and fair value hedges as well as some contracts that are not designated as accounting hedges.

Cash Flow Hedges

From time to time, the Company enters into copper and nickel forward sales contracts that are designated as cash flow hedges. At September 30, 2011, the notional quantity of open contracts designated as cash flow hedges in accordance with the “Derivatives and Hedging” topic of the Accounting Standards Codification (‘ASC”) was 0.2 million pounds of nickel. The outstanding contracts as of September 30, 2011 had maturities ranging up to three months. As of September 30, 2011, AOCI(L) includes a cumulative loss of $0.1 million, net of tax, related to these contracts, all of which is expected to be reclassified to earnings within the next three months. The Company had no forward sales contracts designated as cash flow hedges at December 31, 2010. No hedge ineffectiveness was recorded in income in the first nine months of 2011 or 2010 for these hedges.

Fair Value Hedges

From time to time, the Company enters into certain cobalt forward purchase contracts designated as fair value hedges. The Company had no fair value hedges during the first nine months of 2011 or the year ended December 31, 2010.

Foreign Currency Exchange Rate Risk

The functional currency for the Company’s Finnish operating subsidiary is the U.S. dollar since a majority of its purchases and sales are denominated in U.S. dollars. Accordingly, foreign currency exchange gains and losses related to transactions of this subsidiary denominated in other currencies (principally the Euro) are included in earnings. While a majority of the subsidiary’s raw material purchases are in U.S. dollars, it also has some Euro-denominated expenses. From time to time, the Company enters into foreign currency forward contracts to mitigate a portion of the earnings volatility in those Euro-denominated cash flows due to changes in the Euro/U.S. dollar exchange rate. The Company had no Euro forward contracts at September 30, 2011 or December 31, 2010.

Interest Rate Risk

The Company is exposed to interest rate risk primarily through its borrowing activities. If needed, the Company predominantly utilizes U.S. dollar-denominated borrowings to fund its working capital, acquisition and investment needs. There is an inherent rollover risk for borrowings as they mature and are renewed at current market rates. From time to time, the Company enters into derivative instruments and hedging activities to manage, where possible and economically efficient, interest rate risk related to borrowings. The Company uses interest rate swap agreements to partially reduce risks related to floating rate financing agreements that are subject to changes in the market rate of interest. The Company had interest rate swaps with notional values that totaled $60.0 million at December 31, 2010. There were no interest rate swap contracts outstanding at September 30, 2011. No hedge ineffectiveness was recorded in income in the nine months ended September 30, 2011 or September 30, 2010 for these hedges.

The following table summarizes the fair value of derivative instruments recorded in the Unaudited Condensed Consolidated Balance Sheets (in thousands):

 

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     Derivatives Designated as Hedging Instruments  
     Derivative Liabilities  
     September 30, 2011     December 31, 2010  
     Balance sheet location    Fair value     Balance sheet location    Fair value  

Commodity contracts

   Other current liabilities    $ (111   Other current liabilities    $ —     

Interest rate swap agreements

   Other current liabilities      —        Other current liabilities      (393
     

 

 

      

 

 

 

Total

      $ (111      $ (393
     

 

 

      

 

 

 

 

     Derivatives Not Designated as Hedging Instruments  
     Derivative Liabilities  
     September 30, 2011      December 31, 2010  
     Balance sheet location    Fair value      Balance sheet location    Fair value  

Commodity contracts

   Other current liabilities    $ —         Other current liabilities    $ (378
     

 

 

       

 

 

 

Total

      $ —            $ (378
     

 

 

       

 

 

 

The following table summarizes the effect of derivative instruments:

 

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Table of Contents

Derivatives in Cash Flow Hedging Relationships

 
     Amount of Gain (Loss) on Derivative
Recognized in AOCI(L) (Effective
Portion)
for the Three Months Ended
 
   September 30,
2011
    September 30,
2010
 

Euro forward contracts

   $ —        $ 1,689   

Commodity contracts

     (76     —     

Interest rate swap agreements

     (22     (207
  

 

 

   

 

 

 

Total

   $ (98   $ 1,482   
  

 

 

   

 

 

 

 

     Amount of Gain (Loss) on Derivative
Recognized in AOCI(L) (Effective
Portion)
for the Nine Months Ended
 
     September 30,
2011
     September 30,
2010
 

Euro forward contracts

   $ —         $ (2,237

Commodity contracts

     297         (54

Interest rate swap agreements

     101         (493
  

 

 

    

 

 

 

Total

   $ 398       $ (2,784
  

 

 

    

 

 

 

 

    

Location of Gain (Loss)
Reclassified from
AOCI(L) into Income
(Effective Portion)

   Amount of Gain (Loss)
Reclassified from AOCI(L)
into Income  (Effective Portion)
for the Three Months Ended
 
        September 30,
2011
     September 30,
2010
 

Euro forward contracts

   Cost of products sold    $ —         $ (817

Commodity contracts

   Net sales      —           —     

Interest rate swap agreements

   Interest expense      293         —     
     

 

 

    

 

 

 

Total

      $ 293       $ (817
     

 

 

    

 

 

 

 

     Location of Gain (Loss)
Reclassified from
AOCI(L) into Income
(Effective Portion)
   Amount of Gain (Loss)
Reclassified from AOCI(L)
into Income (Effective Portion)
for the Nine Months Ended
 
        September 30,
2011
    September 30,
2010
 

Euro forward contracts

   Cost of products sold    $ —        $ (1,811

Commodity contracts

   Net sales      (373     (221

Interest rate swap agreements

   Interest expense      293        —     
     

 

 

   

 

 

 

Total

      $ (80   $ (2,032
     

 

 

   

 

 

 

 

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Derivatives Not Designated as Hedging Instruments

 
     Location of Gain
(Loss) Recognized in
Income on Derivative
   Amount of Gain (Loss) Recognized in
Income on Derivative for the Three
Months Ended September 30,
     Amount of Gain (Loss) Recognized in
Income on Derivative for the Nine
Months Ended September 30,
 
      2011      2010      2011     2010  

Commodity contracts

   Net sales    $ —         $ —         $ (407   $ —     
     

 

 

    

 

 

    

 

 

   

 

 

 

Total

      $ —         $ —         $ (407   $ —     
     

 

 

    

 

 

    

 

 

   

 

 

 

Note 9 – Fair Value Disclosures

The following table shows the Company’s assets and liabilities accounted for at fair value on a recurring basis (in thousands):

 

            Fair Value Measurements at Reporting Date Using  

Description

   September 30, 2011      Quoted Prices in
Active Markets
for Identical
Assets (Level 1)
     Significant
Other
Observable
Inputs (Level 2)
     Significant
Unobservable
Inputs (Level 3)
 

Liabilities:

           

Commodity contracts

   $ —         $ —         $ 111       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ —         $ —         $ 111       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company uses significant other observable inputs to value commodity contracts; therefore, they are classified within Level 2 of the valuation hierarchy. The fair value for these contracts is determined based on metal prices. There were no transfers into or out of Levels 1, 2 or 3 in the third quarter of 2011.

The Company also holds financial instruments consisting of cash, accounts receivable, and accounts payable. The carrying amounts of cash, accounts receivable and accounts payable approximate fair value due to the short-term maturities of these instruments. The carrying value of the Company’s Senior Secured Credit Facility approximates fair value due to the variable interest rate terms. Derivative instruments are recorded at fair value as indicated in the preceding disclosures.

Note 10 – Income Taxes

The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2003. The Company’s major tax jurisdictions include the U.S., Finland and Germany. The Internal Revenue Service is currently examining the Company’s 2007 U.S. federal income tax return. This examination is expected to be completed in 2011. Finnish tax authorities are currently examining the Company’s Finnish tax returns for the years 2007 -2010. This examination is expected to be completed in 2012. VAC Holding’s German tax returns have been audited through 2005. The Company is indemnified, subject to certain limitations, for any pre-acquisition income tax liabilities of VAC Holding. Examination of VAC Holding’s post 2005 German income tax returns is expected to commence within the next 12 months.

During 2008 and 2009, the Company recorded tax benefits related to its election to take foreign tax credits on prior year U.S. tax returns. The Company has a receivable of $37.5 million and $37.9 million at September 30, 2011 and December 31, 2010, respectively, (included in Refundable and prepaid income taxes on the Unaudited Condensed Consolidated Balance Sheets) related to amending its U.S. tax returns. The Company expects to receive this refund in the first half of 2012.

As required under ASC 740, the Company’s interim income tax provisions are based on the application of an estimated annual effective income tax rate applied to year-to-date income from continuing operations before income tax expense. In determining the estimated annual effective income tax rate, the Company analyzes various factors, including forecasts of the Company’s projected annual earnings (including specific subsidiaries projected to have pretax income and pretax losses), taxing jurisdictions in which the earnings will be generated, the Company’s ability to use tax credits and net operating loss carryforwards, and available tax planning

 

18


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alternatives. The Company evaluates the estimated annual effective income tax rate on a quarterly basis based on current and forecasted earnings by tax jurisdiction, including the impact of foreign currency exchange rate movements and changes in the Company’s structure. The estimated annual effective income tax rate may be significantly impacted by foreign currency exchange rate movements and changes to the mix of forecasted earnings by tax jurisdiction. Adjustments to the estimated annual effective income tax rate are recorded in the period such estimates are revised. The tax effects of discrete items, including the effect of changes in tax laws, tax rates, certain circumstances with respect to valuation allowances or other unusual or non-recurring items, are reflected in the period in which they occur as an addition to, or reduction from, the income tax provision, rather than included in the estimated annual effective income tax rate.

Income (loss) from continuing operations before income tax expense consists of the following (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

United States

   $ 2,595      $ (563   $ (2,819   $ (10,722

Outside the United States

     (49,328     33,677        19,245        96,322   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ (46,733   $ 33,114      $ 16,426      $ 85,600   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company’s income tax expense is as follows:

 

     2011      2010      2011      2010  

Income tax expense

   $ 18,421       $ 9,159       $ 24,497       $ 31,791   

The Company’s effective income tax rates are as follows:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Effective income tax rate

     -39.4     27.7     149.1     37.1

The effective income tax rates for the three and nine months ended September 30, 2011 are affected by the acquisition of VAC Holding, the impact of the adjustments to inventory related to the VAC Holding acquisition discussed in Note 3, acquisition-related expenses and discrete items. In the three and nine months ended September 30, 2011, the Company recorded total discrete tax benefits of $7.3 million and $9.5 million, respectively. The benefit recorded in the third quarter of 2011 relates primarily to a partial reversal of an allowance against the GTL prepaid tax asset previously impaired (see discussion of GTL prepaid below) and to the tax benefits of a post-acquisition tax restructuring of VAC Holding.

Without the discrete items, the effective income tax rates for the three and nine months ended September 30, 2011 would have been -54.9% and 206.9%, respectively. Excluding the impact of the VAC Holding acquisition, the adjustments to inventory related to the VAC Holding acquisition discussed in Note 3, acquisition-related expenses and discrete items, the effective income tax rates for the three and nine months ended September 30, 2011 would have been 12.6% and 12.9%, respectively.

The effective income tax rate excluding discrete items and the impact of VAC Holding for the three and nine months ended September 30, 2011 is lower than the U.S. statutory tax rate primarily due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure and the effect of foreign currency translation, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit. In addition, in the three and nine months ended September 30, 2011, there is no U.S. tax expense related to the planned repatriation of foreign earnings during 2011 due to utilization of foreign tax credits and U.S. losses.

In the nine months ended September 30, 2010, the Company recorded discrete tax items netting to expense of $6.1 million (comprised of expense through the second quarter of $6.4 million and a benefit of $0.3 million in the third quarter). Excluding discrete items, the effective income tax rate would have been 30.0% for the nine months ended September 30, 2010. During the nine-month period, the Company recorded $8.9 million of discrete tax expense related to the GTL joint venture. The GTL items are primarily comprised of a benefit of $2.6 million in the first quarter and an $11.5 million charge in the second quarter. The $2.6 million benefit in the first quarter of 2010 related primarily to a return to provision adjustment. The $11.5 million charge in the second quarter of 2010 was to reserve a portion of GTL’s prepaid income tax balance. In July 2010, certain companies doing business in the DRC, including GTL,

 

19


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received notification from the DRC tax authorities that requests to utilize tax overpayments to offset more than 20% of 2010 taxes payable would not be granted. Based on past precedent set by the DRC tax authorities, GTL had previously estimated it would be able to utilize its prepaid tax asset to offset more than 20% of its future tax obligations. In addition, during the second quarter of 2010, it was determined that GTL was no longer subject to certain import taxes that had been assessed through the first quarter of 2010. Given these changes, the Company updated its estimation of the realizability of GTL’s prepaid tax asset in the DRC and recorded an allowance of $11.5 million against the prepaid tax asset in the second quarter of 2010. During the three months ended September 30, 2011, GTL received notification that it would be able to offset more of its prepaid tax asset against future taxes payable than previously estimated. As a result, GTL recognized a $6.2 million discrete tax benefit in the third quarter of 2011 to reduce the allowance established in the second quarter of 2010.

The effective income tax rate excluding discrete items for the three and nine months ended September 30, 2010 is lower than the U.S. statutory rate due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure, the effect of foreign currency translation and a tax holiday in Malaysia, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit.

The decrease in the effective income tax rates excluding discrete items and the impact of VAC Holding in the 2011 periods compared with the 2010 periods is primarily due to the impact of foreign currency exchange rate movements, and the benefits of tax efficient financing. In the third quarter and first nine months of 2011, the weakening U.S. dollar against the Euro resulted in foreign exchange losses on the statutory tax books on U.S. dollar denominated cash balances, resulting in lower accrued income tax liabilities and a lower effective income tax rate; the opposite occurred in the 2010 periods, when the U.S. dollar strengthened against the Euro.

Note 11 – Earnings Per Share

The following table sets forth the computation of basic and diluted income per common share from continuing operations attributable to OM Group, Inc. common stockholders (in thousands, except per share amounts):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011     2010      2011     2010  

Income (loss) from continuing operations attributable to OM Group, Inc. common stockholders

   $ (68,488   $ 23,198       $ (12,887   $ 58,968   

Weighted average shares outstanding — basic

     31,382        30,474         30,817        30,417   

Dilutive effect of stock options and restricted stock

     —          86         —          118   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding — assuming dilution

     31,382        30,560         30,817        30,535   
  

 

 

   

 

 

    

 

 

   

 

 

 

Earnings per common share:

         

Income (loss) from continuing operations attributable to OM Group, Inc. common stockholders — basic

   $ (2.18   $ 0.76       $ (0.42   $ 1.94   
  

 

 

   

 

 

    

 

 

   

 

 

 

Income (loss) from continuing operations attributable to OM Group, Inc. common stockholders — assuming dilution

   $ (2.18   $ 0.76       $ (0.42   $ 1.93   
  

 

 

   

 

 

    

 

 

   

 

 

 

The following table sets forth the computation of basic and diluted net income per common share attributable to OM Group, Inc. common stockholders (in thousands, except per share amounts):

 

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Table of Contents
     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011     2010      2011     2010  

Net income (loss) attributable to OM Group, Inc. common stockholders

   $ (68,254   $ 24,201       $ (12,982   $ 59,590   

Weighted average shares outstanding — basic

     31,382        30,474         30,817        30,417   

Dilutive effect of stock options and restricted stock

     —          86         —          118   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted average shares outstanding — assuming dilution

     31,382        30,560         30,817        30,535   
  

 

 

   

 

 

    

 

 

   

 

 

 

Earnings per common share:

         

Net income (loss) attributable to OM Group, Inc. common stockholders — basic

   $ (2.17   $ 0.79       $ (0.42   $ 1.96   
  

 

 

   

 

 

    

 

 

   

 

 

 

Net income (loss) attributable to OM Group, Inc. common stockholders — assuming dilution

   $ (2.17   $ 0.79       $ (0.42   $ 1.95   
  

 

 

   

 

 

    

 

 

   

 

 

 

The Company uses the treasury stock method to calculate the effect of outstanding share-based compensation awards, which requires the Company to compute total employee proceeds as the sum of (a) the amount the employee must pay upon exercise of the award, (b) the amount of unearned share-based compensation costs attributed to future services and (c) the amount of tax benefits, if any, that would be credited to additional paid-in capital assuming exercise of the award. The treasury stock method assumes that the Company uses the proceeds from the exercise of awards to repurchase common stock at the average market price during the period.

The following table sets forth the non-vested share-based compensation awards that could potentially dilute earnings per share in the future which were not included in the fully diluted computation (in thousands):

 

2011

 

2010

 

2011

 

2010

—     301   —     220

As the Company had a loss from continuing operations and a net loss for the three months and nine months ended September 30, 2011, the effect of including dilutive securities in the earnings per share calculation would have been antidilutive. Accordingly, all stock options and restricted stock were excluded from the calculation of loss from continuing operations attributable to OM Group, Inc. common shareholders assuming dilution and net loss per common share assuming dilution for the three months and nine months ended September 30, 2011.

Note 12 – Commitments and Contingencies

In October 2010, GTL was served in Jersey, Channel Islands, with an injunction obtained by Marange Investments (Proprietary) Limited (“Marange”), which restrains La Générale des Carrières et des Mines (“Gécamines”) (a partner in GTL) from removing any of its assets from the island of Jersey up to the amount of 14.5 million British Pounds, pending the resolution of proceedings brought by Marange against Gécamines in the Supreme Court of South Africa. In January 2011, Marange obtained a new order amending the injunction to include an additional claim for 5.0 million British Pounds. As a result, GTL has been enjoined from making payments to Gécamines under the Long Term Slag Sales Agreement between GTL and Gécamines up to the value of 19.5 million British Pounds.

In March 2009, GTL was served in Jersey, Channel Islands, with an injunction obtained by FG Hemisphere Associates LLC (“FG Hemisphere”), which was seeking to enforce two arbitration awards made in 2003 by an arbitral tribunal operating under the auspices of the International Court of Arbitration against the DRC and Société Nationale D’Electricité for $108.3 million (the “Arbitration Awards”). One of the terms of the injunction prohibits GTL from making payments to Gécamines, including amounts payable for raw material purchases under the Long Term Slag Sales Agreement. In November 2010, the Royal Court of Jersey (the “Court”) released its Final Judgment in favor of FG Hemisphere for the full amount of the Arbitration Awards. The Court rejected Gécamines’ argument that it was not an organ of the DRC and rejected GTL’s various arguments, including that the Court did not have jurisdiction to seize monies to be paid to Gécamines under the Long Term Slag Sales Agreement between GTL and Gécamines on the basis that such monies are not held in Jersey. In December 2010, GTL appealed the decision of the Court; as a condition of not paying FG Hemisphere such monies prior to appeal, the Court requires that all amounts owed by GTL to Gécamines (up to the amount of the Arbitration Awards), including monies payable under the Long Term Slag Sales Agreement, be deposited into the Court. As a result,

 

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Table of Contents

as of September 30, 2011 and December 31, 2010, $88.9 million and $68.1 million, respectively, have been deposited with the Court. In July 2011, the Jersey Court of Appeal (“Court of Appeal”) released its Judgment in favor of FG Hemisphere. In September 2011, Gécamines lodged its appeal of the decision of the Court of Appeal to the Judicial Committee of the Privy Council. In separate proceedings, Gécamines has raised two additional challenges to the claims of FG Hemisphere: the calculation of interest on the Arbitration Awards and whether or not Gécamines is an organ of the DRC following a restructuring of that company in December 2010. Until the appeal is resolved, and all other matters related to the Arbitration Awards are resolved, additional amounts due from GTL to Gécamines, up to the amount of the Arbitration Awards, will be deposited with the Court as they become due. While there can be no assurances with respect to the final outcome of either matter, the Company believes that, based on the information currently available to it, these matters will not have a material adverse effect upon its financial condition or results of operations.

The Company has potential contingent liabilities with respect to environmental matters related to its former Precious Metals Group (“PMG”) operations in Brazil. The Company has been informed by the purchaser of the PMG operations of environmental issues at three locations in Brazil. Environmental-cost sharing arrangements are in place between the original owner and operator of those PMG operations, the Company and the subsequent purchaser of the PMG operations. The Company has reviewed the information made available to it on these environmental conditions and is awaiting additional information. The Company cannot currently evaluate whether or not, or to what extent, it will be responsible for any remediation costs until more detailed information is received.

The Company is subject to a variety of environmental and pollution control laws and regulations in the jurisdictions in which it operates. As is the case with other companies in similar industries, the Company faces exposure from actual or potential claims and legal proceedings involving environmental matters. A number of factors affect the cost of environmental remediation, including the determination of the extent of contamination, the length of time the remediation may require, the complexity of environmental regulations, and the continuing improvements in remediation techniques. Taking these factors into consideration, the Company estimates the undiscounted costs of remediation, which will be incurred over several years, and accrues an amount consistent with the estimates of these costs when it is probable that a liability has been incurred. The Company has recorded environmental liabilities related to remediation and decommissioning at the Company’s closed manufacturing sites in Newark, New Jersey and Vasset, France. In addition, the Company has an environmental liability associated with the Joplin, Missouri site acquired in the EaglePicher Technologies acquisition.

Environmental liabilities consist of the following (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Newark, New Jersey and Vasset, France

   $ 1,361       $ 1,492   

Joplin, Missouri

     1,293         1,319   
  

 

 

    

 

 

 
   $ 2,654       $ 2,811   
  

 

 

    

 

 

 

Although it is difficult to quantify the potential impact of compliance with, or liability under, environmental protection laws, the Company believes that any amount it may be required to pay in connection with environmental matters is not reasonably likely to exceed amounts accrued by an amount that would have a material adverse effect upon its financial condition, results of operations or cash flows. During the first nine months of 2011, the Company recorded income of $1.2 million in selling, general and administrative expenses for an insurance recovery related to environmental remediation at the Newark, New Jersey site.

From time to time, the Company is subject to various legal and regulatory proceedings, claims and assessments that arise in the normal course of business. The ultimate resolution of such proceedings, claims and assessments is inherently unpredictable and, as a result, the Company’s estimates of liability, if any, are subject to change and actual results may materially differ from the Company’s estimates. The Company’s estimate of any costs to be incurred as a result of these proceedings, claims and assessments are accrued when the liability is considered probable and the amount can be reasonably estimated. The Company believes the amount of any potential liability with respect to legal and regulatory proceedings, claims and assessments will not have a material adverse effect upon its financial condition, results of operations, or cash flows.

Note 13 – Share-Based Compensation

Under the 2007 Incentive Compensation Plan (the “2007 Plan”), the Company may grant stock options, stock appreciation rights, restricted stock awards and phantom stock and restricted stock unit awards to selected employees and non-employee directors. The 2007 Plan also provides for the issuance of common stock to non-employee directors as all or part of their annual compensation for serving as directors, as may be determined by the board of directors.

 

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Table of Contents

Non-employee directors of the Company are paid a portion of their annual retainer in unrestricted shares of common stock. For purposes of determining the number of shares of common stock to be issued, shares are valued at the average of the high and low price of the Company’s common stock on the NYSE on the last trading day of the quarter. The Unaudited Condensed Statements of Consolidated Income include share-based compensation expense for common stock granted to non-employee directors as a component of Selling, general and administrative expenses.

Set forth below is the detail of share-based compensation expense for option grants, restricted stock awards and restricted stock unit awards included as a component of Selling, general and administrative expenses (in thousands, except share information):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011     2010      2011      2010  

Stock options and restricted stock awards

   $ 1,505      $ 1,319       $ 4,873       $ 3,966   

Restricted stock unit awards

     (201     133         129         246   
  

 

 

   

 

 

    

 

 

    

 

 

 

Share-based compensation expense - employees

   $ 1,304      $ 1,452       $ 5,002       $ 4,212   
  

 

 

   

 

 

    

 

 

    

 

 

 

Share-based compensation expense - non-employee directors

     90      $ 53         245       $ 185   

Number of shares issued to non-employee directors

     1,982        2,518         5,967         6,598   

Compensation expense for nonvested share-based awards is expected to be recognized as follows (in thousands):

 

Remaining three months of 2011

   $ 1,514   

2012

     4,567   

2013

     2,399   

2014

     130   
  

 

 

 
   $ 8,610   
  

 

 

 

Unearned compensation expense is recognized over the vesting period for the particular grant. Total unrecognized compensation cost will be adjusted for future changes in actual and estimated forfeitures and fluctuations in the fair value of restricted stock unit awards.

Stock Options

Options granted generally vest in equal increments over a three-year period from the grant date. Upon any change in control of the Company, as defined in the applicable plan, or upon death, disability or retirement, the stock options become 100% vested and exercisable. The Company accounts for options that vest over more than one year as one award and recognizes expense related to those awards on a straight-line basis over the vesting period. During the nine months ended September 30, 2011, the Company awarded stock options with a vesting period of one year to its chief executive officer in connection with achievement of financial performance criteria in 2010 under the Company’s high-performance incentive plan.

A summary of the stock options granted is as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Three year vesting

     12,000         —           212,200         238,050   

One year vesting

     —           —           5,289         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     12,000         —           217,489         238,050   
  

 

 

    

 

 

    

 

 

    

 

 

 

The fair value of options granted during the nine months ended September 30, 2011 and 2010 was estimated at the date of grant using a Black-Scholes options pricing model with the following weighted-average assumptions:

 

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Table of Contents
     2011     2010  

Risk-free interest rate

     2.7     2.7

Dividend yield

     —          —     

Volatility factor of Company common stock

     0.56        0.58   

Weighted-average expected option life (years)

     6.0        6.0   

Weighted-average grant-date fair value

   $ 19.93      $ 17.23   

The risk-free interest rate assumption is based upon the U.S. Treasury yield curve appropriate for the term of the options being valued. The dividend yield assumption is zero, as the Company intends to continue to retain earnings for use in the operations of the business and does not anticipate paying dividends in the foreseeable future. Expected volatilities are based on historical volatility of the Company’s common stock. The expected term of options granted is determined using the simplified method allowed by Staff Accounting Bulletin (“SAB”) No. 110 as historical data was not sufficient to provide a reasonable estimate. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term.

The following table sets forth the number of shares and weighted-average grant-date fair value:

 

     Shares     Weighted
Average Fair
Value at Grant
Date
 

Non-vested at January 1, 2011

     397,914      $ 17.07   

Granted during the first nine months of 2011

     217,489      $ 19.93   

Vested during the first nine months of 2011

     (183,642   $ 18.63   

Forfeited during the first nine months of 2011

     (8,016   $ 18.17   
  

 

 

   

Non-vested at September 30, 2011

     423,745     
  

 

 

   

Non-vested at January 1, 2010

     337,812      $ 18.96   

Granted during the first nine months of 2010

     238,050      $ 17.23   

Vested during the first nine months of 2010

     (171,544   $ 21.10   

Forfeited during the first nine months of 2010

     (11,404   $ 16.04   
  

 

 

   

Non-vested at September 30, 2010

     392,914      $ 17.06   
  

 

 

   

A summary of the Company’s stock option activity for the nine months ended September 30, 2011 is as follows (aggregate intrinsic value in thousands):

 

     Shares     Weighted
Average
Exercise
Price
     Weighted
Average
Remaining
Contractual
Term
(Years)
     Aggregate
Intrinsic
Value
 

Outstanding at January 1, 2011

     1,071,454      $ 36.27         

Granted

     217,489      $ 36.46         

Exercised

     (12,444   $ 29.04         

Expired unexercised

     (13,500   $ 46.48         

Forfeited

     (8,016   $ 32.88         
  

 

 

         

Outstanding at September 30, 2011

     1,254,983      $ 36.28         6.45       $ 1,197   

Vested or expected to vest at September 30, 2011

     1,227,961      $ 36.27         6.42       $ 1,173   

Exercisable at September 30, 2011

     831,238      $ 38.32         5.28       $ 881   

 

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The Company may use authorized and unissued or treasury shares to satisfy stock option exercises and restricted stock awards. The Company does not settle stock options for cash. The intrinsic value of an option represents the amount by which the market value of the stock exceeds the exercise price of the option.

Cash payments received in connection with the exercise of stock options and the intrinsic value of options exercised was as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2010      2011      2010  

Cash proceeds from exercise of stock options

   $ 204       $ —         $ 361       $ 3,802   
  

 

 

    

 

 

    

 

 

    

 

 

 

Intrinsic value of options exercised

   $ 70       $ —         $ 117       $ 2,063   
  

 

 

    

 

 

    

 

 

    

 

 

 

Restricted Stock – Performance-Based Awards

The Company grants performance-based restricted stock awards that vest subject to the Company’s financial performance. The number of shares of restricted stock that ultimately vest is based upon the Company’s achievement of specific measurable performance criteria. A recipient of performance-based restricted stock may earn a total award ranging from 0% to 100% of the initial grant, with target being 50% of the initial grant. The shares awarded during 2011 will vest upon the satisfaction of established performance criteria based on consolidated EBITDA margin (defined as operating profit plus depreciation and amortization expense divided by revenue) percentage and average return on net assets, in each case over a three-year performance period ending December 31, 2013. Shares awarded during 2010 and 2009 will vest upon the satisfaction of established performance criteria based on consolidated EBITDA margin measured against a predetermined peer group, and average return on net assets, in each case over three-year performance periods ending December 31, 2012 and 2011, respectively.

A summary of the Company’s performance-based restricted stock awards for the nine months ended September 30, 2011 is as follows:

 

     Shares     Weighted
Average
Grant Date
Fair Value
 

Non-vested at January 1, 2011

     253,975      $ 32.90   

Granted

     117,770      $ 36.51   

Vested

     (1,773   $ 58.57   

Forfeited

     (57,922   $ 56.28   
  

 

 

   

Non-vested at September 30, 2011

     312,050      $ 29.78   
  

 

 

   

Expected to vest at September 30, 2011

     91,820     

The value of the performance-based restricted stock awards was based upon the market price of an unrestricted share of the Company’s common stock at the date of grant. The Company recognizes expense related to performance-based restricted stock ratably over the requisite performance period based upon the number of shares that are anticipated to vest. The number of shares anticipated to vest is evaluated quarterly and compensation expense is adjusted accordingly. Upon any change in control of the Company, as defined in the applicable plan, or upon retirement, the shares become 100% vested at the target level. In the event of death or disability, a pro rata number of shares remain eligible for vesting at the end of the performance period.

The performance period for shares awarded during 2008 ended on December 31, 2010. Such shares were subject to vesting based upon the level of satisfaction of established performance criteria based on the Company’s consolidated operating profit and average return on net assets, in each case over the three-year performance period ended December 31, 2010. Upon vesting, employees surrendered shares of common stock to the Company to pay required minimum statutory withholding taxes applicable to the vesting of restricted stock. The surrendered shares are held by the Company as treasury stock.

The performance period for shares awarded during 2007 ended on December 31, 2009. Certain shares awarded during 2007 were subject to vesting based upon the level of satisfaction of established performance criteria, based on the Company’s consolidated

 

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operating profit and average return on net assets, in each case over the three-year performance period ended December 31, 2009. Upon vesting, employees surrendered shares of common stock to the Company to pay required minimum statutory withholding taxes applicable to the vesting of restricted stock. The surrendered shares are held by the Company as treasury stock. Additional shares issued in 2007 did not vest as the Company did not meet an established earnings target during any one of the years in the three-year performance period ended December 31, 2009.

Based upon the level of satisfaction of the performance objectives, as determined by the Compensation Committee, the following performance-based shares vested and were issued:

 

     Nine Months Ended
September 30,
 
     2011     2010  

Vested based on meeting performance criteria

     1,773        74,676   

Shares surrendered to pay withholding taxes

     (578     (26,651
  

 

 

   

 

 

 

Net shares issued

     1,195        48,025   
  

 

 

   

 

 

 

Restricted Stock Units – Performance-Based Awards

The Company awards performance-based restricted stock units to employees outside the U.S. that vest subject to the Company’s financial performance for three and four-year performance periods. These awards will be settled in cash based on the value of the Company’s common stock at the vesting date. Since the awards will be settled in cash, they are recorded as a liability award in accordance with the “Stock Compensation” topic of the ASC. Accordingly, the Company records these awards as a component of other non-current liabilities on the Unaudited Condensed Consolidated Balance Sheets. The fair value of the award, which determines the measurement of the liability on the balance sheet, is remeasured at each reporting period until the award is settled. Fluctuations in the fair value of the liability awards are recorded as increases or decreases to compensation expense. Over the life of these awards, the cumulative amount of compensation expense recognized will match the actual cash paid. The number of restricted stock units that ultimately vest is based upon the Company’s achievement of the same performance criteria as the performance-based restricted stock awards described above.

A summary of the Company’s performance-based restricted stock unit awards for the nine months ended September 30, 2011 is as follows:

 

     Units  

Non-vested at January 1, 2011

     38,530   

Granted

     31,125   

Forfeited

     (2,220
  

 

 

 

Non-vested at September 30, 2011

     67,435   
  

 

 

 

Expected to vest at September 30, 2011

     14,661   

The Company recognizes expense related to performance-based restricted stock units ratably over the requisite performance period based upon the number of units that are anticipated to vest. The number of units anticipated to vest is evaluated quarterly and compensation expense is adjusted accordingly. Upon any change in control of the Company, as defined in the applicable plan, or upon retirement, the units become 100% vested at the target level. In the event of death or disability, a pro rata number of units remain eligible for vesting at the end of the performance period.

Restricted Stock – Time-Based Awards

The Company awards time-based restricted stock that vest three years from the date of grant, subject to the respective recipient remaining employed by the Company on that date. During the nine months ended September 30, 2011, the Company awarded time-based restricted stock with a vesting period of one year to its chief executive officer in connection with achievement of financial performance criteria in 2010 under the Company’s high-performance annual incentive program.

A summary of the Company’s time-based restricted stock awards for the nine months ended September 30, 2011 is as follows:

 

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     Shares     Weighted
Average
Grant
Date Fair
Value
 

Nonvested at January 1, 2011

     99,025      $ 32.67   

Granted - one year vesting

     2,767      $ 36.51   

Granted - three year vesting

     60,825      $ 36.51   

Vested

     (15,575   $ 58.51   

Forfeited

     (1,920   $ 32.85   
  

 

 

   

Nonvested at September 30, 2011

     145,122      $ 31.59   
  

 

 

   

Expected to vest at September 30, 2011

     124,242     

The value of the time-based restricted stock awards was based upon the market price of an unrestricted share of the Company’s common stock at the date of grant. The Company recognizes expense related to time-based restricted stock ratably over the requisite vesting period based upon the number of shares that are anticipated to vest. The number of shares anticipated to vest is evaluated quarterly and compensation expense is adjusted accordingly. Upon any change in control of the Company, as defined in the applicable plan, or upon retirement, the shares become 100% vested. A pro rata number of shares will vest in the event of death or disability prior to the stated vesting date.

Upon vesting, employees may surrender shares of common stock to the Company to pay required minimum statutory withholding taxes applicable to the vesting of time-based restricted stock. The surrendered shares are held by the Company as treasury stock.

The following time-based shares vested and were issued:

 

     Nine Months Ended
September 30,
 
     2011     2010  

Vested - 3 year vesting period

     15,575        22,760   

Vested - 1 year vesting period

     —          4,127   

Shares surrendered to pay withholding taxes

     (5,023     (9,233
  

 

 

   

 

 

 

Net shares issued

     10,552        17,654   
  

 

 

   

 

 

 

Restricted Stock Units – Time-Based Awards

The Company awards time-based restricted stock units to employees outside the U.S. These awards will be settled in cash based on the value of the Company’s common stock at the vesting date. Since the awards will be settled in cash, they are recorded as a liability award in accordance with the “Stock Compensation” topic of the ASC. Accordingly, the Company records these awards as a component of other non-current liabilities on the Unaudited Condensed Consolidated Balance Sheets. The fair value of the award, which determines the measurement of the liability on the balance sheet, is remeasured at each reporting period until the award is settled. Fluctuations in the fair value of the liability awards are recorded as increases or decreases to compensation expense. Over the life of these awards, the cumulative amount of compensation expense recognized will match the actual cash paid. The restricted share units vest three years from the date of grant, subject to the respective recipient remaining employed by the Company on that date. Upon any change in control of the Company, as defined in the applicable plan, or upon retirement, the units become 100% vested. A pro rata number of units will vest in the event of death or disability prior to the stated vesting date.

A summary of the Company’s time-based restricted stock unit awards for the first nine months of 2011 is as follows:

 

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     Units  

Nonvested at January 1, 2011

     13,850   

Granted

     9,095   

Forfeited

     (800
  

 

 

 

Nonvested at September 30, 2011

     22,145   
  

 

 

 

Expected to vest at September 30, 2011

     20,240   

The Company recognizes expense related to time-based restricted stock units ratably over the requisite vesting period based upon the number of units that are anticipated to vest. The number of units anticipated to vest is evaluated quarterly and compensation expense is adjusted accordingly. Upon any change in control of the Company, as defined in the applicable plan, or upon retirement, the units become 100% vested. A pro rata number of shares will vest in the event of death or disability prior to the stated vesting date.

Note 14 – Reportable Segments

The Company is organized into three segments: Engineered Materials, Specialty Chemicals and Battery Technologies. Intersegment transactions are generally recognized based on current market prices and are eliminated in consolidation. General and administrative expenses not allocated to the segments are included in Corporate in the segment table set forth below.

As a result of the acquisition of VAC Holding, the Company’s segment formerly known as Advanced Materials was re-named Engineered Materials. The Engineered Materials segment consists of the Company’s existing Advanced Materials business and Magnetic Technologies as they will be managed as one segment. Advanced Materials includes Inorganics, the DRC smelter joint venture and metal resale. Advanced Materials manufactures inorganic products using unrefined cobalt and other metals and serves the battery materials, powder metallurgy, ceramic and chemical end markets. Magnetic Technologies consists of the VAC Holding business. Magnetic Technologies manufactures advanced cores and components, materials and parts, permanent magnets and magnet systems for electronic equipment markets, including the alternative energy, automotive, electrical installation, and energy conversion and distribution markets.

The Specialty Chemicals segment is comprised of Electronic Chemicals, Advanced Organics, Ultra Pure Chemicals (“UPC”) and Photomasks. Electronic Chemicals develops and manufactures products for the printed circuit board, memory disk, general metal finishing and photovoltaic markets. Advanced Organics offers products for the coating and inks, chemical and tire markets. UPC develops, manufactures and distributes a wide range of ultra-pure chemicals used in the manufacture of electronic and computer components such as semiconductors, silicon chips, wafers and liquid crystal displays. Photomasks manufactures photo-imaging masks (high-purity quartz or glass plates containing precision, microscopic images of integrated circuits) and reticles for the semiconductor, optoelectronics, microelectronics and micro electro mechanical systems industries under the Compugraphics brand name.

The Battery Technologies segment, which consists of the EaglePicher Technologies business acquired on January 29, 2010, provides advanced batteries, battery management systems, battery-related research and energetic devices for the defense, aerospace and medical markets. In the defense market, Battery Technologies develops battery products for missile launch vehicles, missiles, guided bombs and other weapons systems. It also provides primary (non-rechargeable) and secondary (rechargeable) batteries, battery management systems, battery chargers, and energetic devices for diverse defense applications such as unmanned vehicles, sub-munitions, mines, sonabuoys, and fuzes. In the aerospace market, Battery Technologies designs, manufactures and qualifies primary and secondary batteries for satellites, aircraft, packaging of cells and other special applications. In the medical market, Battery Technologies designs, builds and qualifies miniature batteries to power implantable medical devices.

The Company has manufacturing and other facilities in North America, Europe, Africa and Asia-Pacific, and the Company markets its products worldwide. Further, approximately 8% of the Company’s investment in property, plant and equipment is located in the DRC, where the Company operates a smelter through a 55%-owned joint venture.

Total assets have increased to $2,892.8 million at September 30, 2011 from $1,772.7 million at December 31, 2010. The increase is primarily the result of the acquired assets of VAC Holdings, which were $1,257.7 million at the August 2, 2011 acquisition date.

 

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The following table reflects the results of the Company’s reportable segments (in thousands):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  

Business Segment Information

        

Net Sales

        

Engineered Materials (b)

   $ 260,164      $ 148,455      $ 605,450      $ 468,685   

Specialty Chemicals

     120,622        113,337        369,954        352,786   

Battery Technologies (a)

     34,678        35,720        101,497        82,723   

Intersegment items

     (407     (290     (977     (676
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 415,057      $ 297,222      $ 1,075,924      $ 903,518   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating profit (loss)

        

Engineered Materials (b)(c)

   $ (57,134   $ 28,332      $ (8,153   $ 74,925   

Specialty Chemicals (e)

     24,719        12,409        56,311        47,961   

Battery Technologies (a)

     3,742        3,068        12,567        1,974   

Corporate (d)

     (16,720     (8,964     (40,341     (27,809
  

 

 

   

 

 

   

 

 

   

 

 

 
     (45,393     34,845        20,384        97,051   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense

     (8,512     (1,481     (11,327     (3,794

Interest income

     294        255        981        641   

Foreign exchange gain (loss)

     7,425        (688     7,264        (8,088

Other, net

     (547     183        (876     (210
  

 

 

   

 

 

   

 

 

   

 

 

 
     (1,340     (1,731     (3,958     (11,451
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations before income tax expense

   $ (46,733   $ 33,114      $ 16,426      $ 85,600   
  

 

 

   

 

 

   

 

 

   

 

 

 

Expenditures for property, plant & equipment

        

Engineered Materials (b)

   $ 8,167      $ 2,198      $ 13,332      $ 8,847   

Specialty Chemicals

     4,100        1,427        9,102        2,919   

Battery Technologies (a)

     1,693        1,576        3,971        4,237   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 13,960      $ 5,201      $ 26,405      $ 16,003   
  

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation and amortization

        

Engineered Materials (b)

   $ 12,563      $ 5,117      $ 22,786      $ 15,278   

Specialty Chemicals

     5,624        5,456        17,044        17,303   

Battery Technologies (a)

     2,071        2,588        7,059        6,749   

Corporate

     105        179        375        856   
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 20,363      $ 13,340      $ 47,264      $ 40,186   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) Includes activity since the acquisition of EaglePicher Technologies on January 29, 2010.
(b) Includes activity of Magnetic Technologies since the acquisition of VAC Holding on August 2, 2011 and the Company’s exisiting Advanced Materials business.
(c) Includes a $62.4 million lower of cost or market charge and a $31.1 million charge related to purchase accounting as inventory on-hand as of the VAC Holding acquisition date was sold in the ordinary course of business.
(d) Includes $8.8 million and $12.8 million of VAC Holding acquisition-related fees and expenses in the three and nine months ended September 30, 2011.
(e) Includes a $9.7 million gain for the sale of land at the Manchester, England manufacturing facility in the three and nine months ended September 30, 2011.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

OM Group, Inc. is a global solutions provider of engineered materials, specialty chemicals, electrochemical energy storage, and technologies crucial to enabling its customers to meet increasingly stringent market and application requirements. The Company is executing a strategy to grow through continued product innovation, as well as tactical and strategic acquisitions. The strategy is part of a process to leverage the Company’s core strengths in developing and producing value-added specialty products for dynamic markets while reducing the impact of metal price volatility on financial results. The strategy is designed to allow the Company to deliver sustainable and profitable volume growth in order to drive consistent financial performance and enhance the Company’s ability to continue to build long-term shareholder value.

On August 2, 2011, the Company completed the acquisition of the outstanding equity interests in VAC Holding for $812.0 million. VAC Holding employs approximately 4,500 people in its three businesses: Cores and Components, Materials and Parts and Permanent Magnets. VAC Holding has production facilities in Germany, Slovakia, Finland, China and Malaysia and is engaged in the development, manufacturing and distribution of industrial-use magnetic products for electronic equipment markets, including the alternative energy, automotive, electrical installation, and energy conversion and distribution sectors. As a result of the acquisition of VAC Holding, the Company’s segment formerly known as Advanced Materials was re-named Engineered Materials. The Engineered Materials segment will include the Company’s existing Advanced Materials business and Magnetic Technologies, as they will be managed as one segment. Magnetic Technologies consists of VAC Holding.

On January 29, 2010, the Company completed the acquisition of EaglePicher Technologies, LLC which is operated and reported within the Battery Technologies segment. The results of operations of EaglePicher Technologies have been included in the results of the Company from the date of acquisition.

Segments

The Company is organized into three segments: Engineered Materials, Specialty Chemicals and Battery Technologies. Engineered Materials is comprised of Advanced Materials and Magnetic Technologies. The Specialty Chemicals segment is comprised of Electronic Chemicals, Advanced Organics, Ultra Pure Chemicals (“UPC”) and Photomasks. The Battery Technologies segment is comprised of EaglePicher Technologies.

The Engineered Materials segment consists of the following:

Advanced Materials: Advanced Materials consists of Inorganics, a joint venture that operates a smelter in the Democratic Republic of Congo (“DRC”) and metal resale. Advanced Materials manufactures inorganic products using unrefined cobalt and other metals and serves the battery materials, powder metallurgy, ceramics and chemical end markets by providing products with functional characteristics critical to the success of the Company’s customers. These products improve the capacity of rechargeable batteries used in portable electronic devices such as cellular phones, video cameras, portable computers and power tools as well as various types of electric vehicles. The smelter joint venture (Groupement pour le Traitement du Terril de Lubumbashi Limited (“GTL”)) is consolidated in the Company’s financial statements because the Company has a controlling interest in the joint venture. The GTL smelter is a primary source of the Company’s cobalt raw material feed.

Magnetic Technologies: Magnetic Technologies is engaged in the development, manufacturing and distribution of industrial-use magnetic products for electronic equipment markets, including the alternative energy, automotive, electrical installation, and energy conversion and distribution sectors. Through its three businesses, Cores and Components, Materials and Parts and Permanent Magnets, Magnetic Technologies manufactures advanced cores and components, materials and parts, permanent magnets and magnet systems.

The Specialty Chemicals segment consists of the following:

Electronic Chemicals: Electronic Chemicals develops and manufactures products for the printed circuit board, memory disk, general metal finishing, and photovoltaic markets. Chemicals developed and manufactured for the printed circuit board market include oxide treatments, electroplating additives, etching technology and electroless copper processes used in the manufacturing of printed circuit boards widely used in computers, communications, military/aerospace, automotive, industrial and consumer electronics applications. Chemicals developed and manufactured for the memory disk market

 

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include electroless nickel solutions and preplate chemistries for the manufacture of hard drive memory disks used in memory and data storage applications. Memory disk applications include computer hard drives, digital video recorders, MP3 players, digital cameras and business and enterprise servers. Chemicals developed and manufactured for the photovoltaic industry focus on proprietary chemistries and processes used to manufacture solar cells.

Advanced Organics: Advanced Organics offers products for the coating and inks, chemical and tire markets. Products for the coatings and inks market promote drying and other performance characteristics. Within the chemical markets, the products accelerate the curing of polyester resins found in reinforced fiberglass. In the tire market, the products promote the adhesion of metal to rubber. During 2009, the Company commenced a restructuring plan to better align the cost structure and asset base of its European carboxylate business to industry conditions resulting from weak customer demand, commoditization of products and overcapacity in that market. The restructuring plan included exiting the Manchester, England manufacturing facility and workforce reductions at the Belleville, Ontario, Canada; Kokkola, Finland; Franklin, Pennsylvania and Westlake, Ohio locations. The majority of position eliminations were completed by mid-2010. The restructuring plan does not involve the discontinuation of any material product lines or other functions.

Ultra Pure Chemicals: UPC develops, manufactures and distributes a wide range of ultra-pure chemicals used in the manufacture of electronic and computer components such as semiconductors, silicon chips, wafers and liquid crystal displays. These products include chemicals used to remove controlled portions of silicon and metal; cleaning solutions; photoresist strippers, which control the application of certain light-sensitive chemicals; edge bead removers, which aid in the uniform application of other chemicals; and solvents. UPC also develops and manufactures a broad range of chemicals used in the manufacturing of photomasks and provides a range of analytical, logistical and development support services to the semiconductor industry. These include Total Chemicals Management, under which the Company manages clients’ entire electronic process chemicals operations, including coordination of logistics services, development of application-specific chemicals, analysis and control of customers’ chemical distribution systems and quality audit and control of all inbound chemicals.

Photomasks: Photomasks manufactures photo-imaging masks (high-purity quartz or glass plates containing precision, microscopic images of integrated circuits) and reticles for the semiconductor, optoelectronics, microelectronics and micro electro mechanical systems industries under the Compugraphics brand name. Photomasks are a key enabling technology to the semiconductor and integrated circuit industries and perform a function similar to that of a negative in conventional photography.

The Battery Technologies segment, which consists of the EaglePicher Technologies business acquired on January 29, 2010, provides advanced batteries, battery management systems, battery-related research and energetic devices for the defense, aerospace and medical markets. In the defense market, Battery Technologies develops battery products for missile launch vehicles, missiles, guided bombs and other weapons systems. It also provides primary (non-rechargeable) and secondary (rechargeable) batteries, battery management systems, battery chargers, and energetic devices for diverse defense applications such as unmanned vehicles, sub-munitions, mines, sonabuoys, and fuzes. In the aerospace market, Battery Technologies designs, manufactures and qualifies primary and secondary batteries for satellites, aircraft, packaging of cells and other special applications. In the medical market, Battery Technologies designs, manufactures and qualifies miniature batteries to power implantable medical devices. Battery Technologies has a 45% interest in Diehl & EaglePicher GmbH (“D&EP”), which manufactures thermal batteries for military applications and customized battery packs for the defense, electronics and communication industries. The investment in D&EP is accounted for under the equity method.

Key Market Factors Affecting Engineered Materials Operations

The Engineered Material’s business is critically connected to both the availability and price of raw materials. The primary raw material used by Advanced Materials is unrefined cobalt. The Company’s unrefined cobalt is obtained as a by-product of another metal (typically copper or nickel) and from recycled material. Cobalt raw materials include ore, concentrate, slag, scrap and metallic feed. The cost of the Company’s raw materials fluctuates due to changes in the cobalt reference price, actual or perceived changes in supply and demand of raw materials, and changes in availability from suppliers. The availability of unrefined cobalt is dependent on global market conditions, cobalt prices and the prices of copper and nickel. Also, political and civil instability in supplier countries, variability in supply and worldwide demand, including demand in developing countries such as China, have affected and will likely continue to affect the supply and market price of raw materials. The Company attempts to mitigate changes in availability of raw materials by maintaining adequate inventory levels and long-term supply relationships with a variety of suppliers. The GTL smelter in the DRC is a primary source for the Company’s cobalt raw material feed. After smelting in the DRC, cobalt/copper white alloy is sent to the Company’s refinery in Kokkola, Finland.

 

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The primary raw materials used by Magnetic Technologies are nickel, cobalt and certain rare earth materials, primarily dysprosium and neodymium. During 2011, there has been constraint in the supply of rare earth materials, resulting in significant increases in the costs of rare earth materials which are used by Magnetic Technologies. Rare earth materials are found in only a few parts of the world and are available from a limited number of suppliers, primarily in China. Supply of rare earth materials is expected to increase when additional sources outside of China become available.

The Company attempts to mitigate increases in raw material prices by passing through such increases to its customers in the prices of its products and by entering into sales contracts that contain variable pricing that adjusts based on changes in the price of the raw material. During periods of rapidly changing metal prices, however, there may be price lags that can impact the short-term profitability and cash flow from operations of the Company both positively and negatively. Fluctuations in the price of cobalt, nickel and rare earth materials have historically been significant and the Company believes that price fluctuations are likely to continue in the future. Fluctuations in the price of raw materials can also impact the short-term profitability and cash flow from operations of the Company both positively and negatively. Declines in the selling prices of the Company’s finished goods, which can result from decreases in the market price of raw materials or other factors, can result in the Company’s inventory carrying value being written down to a lower market value.

Executive Overview

The Company is providing operating profit - adjusted for special items, a non-GAAP financial measure that the Company’s management believes is an important metric in evaluating the performance of the Company’s business. The table below presents a reconciliation of the Company’s U.S. GAAP operating profit (loss) as reported to non-GAAP operating profit - adjusted for special items. The Company believes that the non-GAAP financial measures presented in the table facilitate a comparative assessment of the Company’s operating performance and will enhance investors’ understanding of the performance of the Company’s operations during 2011 and of the comparability of the 2011 results to the results of the relevant prior period. Such non-GAAP financial measures are unique to the Company and may not be employed by other companies. The non-GAAP financial information set forth in the table below should not be construed as an alternative to reported results determined in accordance with U.S. GAAP.

 

     Third Quarter of 2011  
(in thousands)    Engineered
Materials
    Specialty
Chemicals
    Battery
Technologies
     Corporate     Consolidated  

Operating profit (loss) - as reported

   $ (57,134   $ 24,719      $ 3,742       $ (16,720   $ (45,393

Special items - (income) expense:

           

Lower of cost or market charge

     62,444        —          —           —          62,444   

Inventory step-up recognized

     31,073        —          —           —          31,073   

Acquisition-related fees

     2,355        —          —           8,800        11,155   

Gain on sale of land

     —          (9,693     —           —          (9,693
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Operating profit - excluding special items

   $ 38,738      $ 15,026      $ 3,742       $ (7,920   $ 49,586   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

 

     Third Quarter of 2010  
(in thousands)    Engineered
Materials
     Specialty
Chemicals
     Battery
Technologies
     Corporate     Consolidated  

Operating profit - as reported

   $ 28,332       $ 12,409       $ 3,068       $ (8,964   $ 34,845   

Special items - (income) expense:

             

Restructuring

     —           1,069         —           —          1,069   

Purchase accounting - EaglePicher acquisition

     —           —           138         —          138   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Operating profit - excluding special items

   $ 28,332       $ 13,478       $ 3,206       $ (8,964   $ 36,052   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

As discussed above, the Company completed the acquisition of VAC Holding on August 2, 2011. From the date of acquisition, VAC Holding contributed revenues of $106.6 million and an operating loss of $77.9 million, which includes a $93.5 million of charges as a result of purchase accounting and the volatility of rare earth material prices. During the third quarter of 2011, $31.1 million of the

 

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estimated fair value step-up was recognized in cost of products sold as inventory on-hand as of the acquisition date was sold in the ordinary course of business. In addition, at September 30, 2011, the Company recognized a charge of $62.4 million to reduce the carrying value of inventory to market. Excluding the $93.5 million of charges related to the step-up of inventory to fair value and the $2.4 million of acquisition-related fees, VAC Holding contributed operating profit of $18.0 million. Excluding the VAC Holding acquisition, Engineered Materials experienced lower product selling prices as a result of the decrease in the average cobalt reference price in 2011 compared with 2010, increased process-based material costs, unfavorable foreign currency exchange rates and higher manufacturing and distribution costs. These items were partially offset by increased sales volume in the third quarter of 2011 compared with the comparable 2010 period. The $9.7 million gain recognized on the sale of land at the Manchester, England manufacturing facility and favorable sales volume resulted in increased operating profit in Specialty Chemicals in the third quarter of 2011 compared to the third quarter of 2010. Improved operating profit in Battery Technologies for the third quarter 2011 compared to the third quarter of 2010 was primarily due to favorable price/mix.

Consolidated Results of Operations

Consolidated results of operations are set forth below and are followed by a more detailed discussion of each segment.

Third Quarter of 2011 Compared With Third Quarter of 2010

 

     Three Months Ended
September 30,
       
(in thousands & percent of net sales)    2011           2010        

Net sales

   $ 415,057        $ 297,222     

Cost of products sold (excluding lower of cost or market charge)

     335,871          222,941     

Lower of cost or market charge

     62,444          —       
  

 

 

     

 

 

   

Gross profit

     16,742        4.0     74,281        25.0

Selling, general and administrative expenses

     71,828        17.3     39,436        13.3

Gain on sale of land

     (9,693       —       
  

 

 

     

 

 

   

Operating profit (loss)

     (45,393     -10.9     34,845        11.7

Other expense, net

     (1,340       (1,731  
  

 

 

     

 

 

   

Income (loss) from continuing operations before income tax expense

     (46,733       33,114     

Income tax expense

     (18,421       (9,159  
  

 

 

     

 

 

   

Income (loss) from continuing operations, net of tax

     (65,154       23,955     

Income from discontinued operations, net of tax

     234          1,003     
  

 

 

     

 

 

   

Consolidated net income (loss)

     (64,920       24,958     

Net (income) loss attributable to the noncontrolling interest

     (3,334       (757  
  

 

 

     

 

 

   

Net income (loss) attributable to OM Group, Inc.

   $ (68,254     $ 24,201     
  

 

 

     

 

 

   

Earnings per common share - assuming dilution:

        
  

 

 

     

 

 

   

Net income (loss) attributable to OM Group, Inc. common shareholders

   $ (2.17     $ 0.79     
  

 

 

     

 

 

   

Weighted average shares outstanding - assuming dilution

     31,382          30,560     

The Company is including certain non-GAAP financial measures, including income (loss) from continuing operations attributable to OM Group, Inc. and earnings per common share - assuming dilution, both as adjusted for special items. “Income from continuing operations attributable to OM Group, Inc. - as adjusted for special items” is a non-GAAP financial measure that the Company’s management uses as an important metric in evaluating the performance of the Company’s business. The table below presents a reconciliation of the Company’s GAAP results, as reported (both net income (loss) attributable to OM Group, Inc. and income (loss) from continuing operations attributable to OM Group, Inc.), to its non-GAAP results after adjusting for the special items shown. The Company believes that the non-GAAP financial measure presented in the table facilitates a comparative assessment of the Company’s operating performance and will enhance investors’ understanding of the performance of the Company’s operations during 2011 and of the comparability of the 2011 results to the results of the relevant prior period. Such non-GAAP financial measures are unique to the Company and may not be employed by other companies. The non-GAAP financial information set forth in the table below should not be construed as an alternative to reported results determined in accordance with U.S. GAAP.

 

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     Three Months Ended
September 30, 2011
    Three Months Ended
September 30, 2010
 
(in thousands, except per share data)    $     Diluted EPS     $     Diluted EPS  

Net income (loss) attributable to OM Group, Inc. - as reported

   $ (68,254   $ (2.17   $ 24,201      $ 0.79   

Less: Income from discontinued operations, net of tax

     234        0.01        1,003        0.03   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax, attributable to OM Group, Inc. - as reported

   $ (68,488   $ (2.18   $ 23,198      $ 0.76   

Special items (net of tax) - income (expense):

        

Charges related to VAC inventory step-up, net of tax

     (66,181     (2.10     —          —     

Effect of applying annual effective rate to actual year-to-date pre-tax income

     (45,304     (1.44    

Fees and expenses related to the VAC acquisition

     (10,045     (0.32     —          —     

Gain on sale of land

     8,568        0.27        —          —     

Restructuring charges

     —          —          (1,069     (0.04

Purchase accounting - EaglePicher Technologies acquisition

     —          —          (138     —     

Adjustment of allowance on GTL’s prepaid tax asset (OMG’s 55% share)

     3,424        0.11        —          —     

Other discrete tax items, net

     1,031        0.03        329        0.01   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax, attributable to OM Group, Inc. - as adjusted for special items

   $ 40,019      $ 1.27      $ 24,076      $ 0.79   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding - diluted

       31,552          30,560   

The following table identifies, by segment, the components of change in net sales for the third quarter of 2011 compared with the third quarter of 2010 (in thousands):

 

2010 Net Sales

   $ 297,222   

Increase in 2011 from:

  

Engineered Materials

     111,709   

Specialty Chemicals

     7,285   

Battery Technologies

     (1,042

Intersegment items

     (117
  

 

 

 

2011 Net Sales

   $ 415,057   
  

 

 

 

Net sales increased $117.8 million, or 40%, primarily due to the VAC Holding acquisition ($106.6 million). Excluding the VAC Holding acquisition, Engineered Materials net sales benefited from increased cobalt volume ($12.2 million) and increased copper by-product sales ($4.2 million) due to the higher average copper price in the third quarter of 2011 compared with the third quarter of 2010, partially offset by lower product selling prices ($8.2 million). The average cobalt reference price decreased from $18.10 in the third quarter of 2010 to $16.13 in the third quarter of 2011. Engineered Materials also experienced a decrease in cobalt metal resale ($3.3 million) due to the decrease in the average cobalt reference price and decreased volume. Specialty Chemicals net sales were favorably impacted by foreign currency ($3.6 million), favorable selling price/mix ($1.5 million) and improved volume ($1.4 million). Battery Technologies decreased volume ($0.8 million) contributed to its decrease in sales.

Gross profit decreased to $16.7 million in the third quarter of 2011 compared with $74.3 million in the third quarter of 2010, primarily due to $93.5 million of charges related to VAC Holding inventory discussed below. In Engineered Materials, excluding the VAC Holding acquisition, gross profit decreased primarily due to unfavorable selling price ($4.7 million), higher process-based material costs ($3.6 million) and higher manufacturing and distribution expenses ($1.2 million), partially offset by increased cobalt volume ($3.3 million) in the third quarter of 2011 compared to the 2010 period. In the Specialty Chemicals segment, gross profit was impacted by increased volume, partially offset by unfavorable manufacturing and distribution expenses ($0.3 million). In Battery Technologies, gross profit was positively affected by favorable price/mix ($2.4 million) in the third quarter of 2011 compared to the third quarter of 2010.

 

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As part of the allocation of the purchase price of VAC Holding to the acquired assets and liabilities, the Company recorded a step-up of inventory to its estimated fair value on the date of acquisition. Acquired inventory with a book value of $191.2 million on the date of acquisition was estimated to have a fair value of $359.3 million. The $168.1 million step-up of inventory was primarily due to (i) the fair value as determined by August 2, 2011 market prices of certain rare earth materials, primarily dysprosium and neodymium, compared to book value as of the acquisition date and; (ii) acquired work-in-process and finished goods which are required to be valued at their net realizable value less costs to complete and sell the inventory. During the third quarter of 2011, $31.1 million of the estimated fair value step-up was recognized in cost of products sold as inventory on-hand as of the acquisition date was sold in the ordinary course of business. In addition, at September 30, 2011, the Company recognized a charge of $62.4 million to reduce the carrying value of inventory to market. The impact of the step-up being recognized in cost of products sold and the charge to reduce the carrying value of inventory to market, totaling $93.5 million, are included in the Company’s results of operations for the third quarter of 2011. The remaining net $74.6 million inventory step-up will be recognized in cost of products sold as inventory on-hand on the acquisition date is sold in the ordinary course of business in the remainder of 2011 and in 2012. The lower of cost or market charge resulted from raw materials, primarily metals and rare earth materials, being written up to market prices on August 2, 2011. Since these raw materials will be used in production rather than sold at market prices as of the acquisition date, and since the selling prices of manufactured products is generally based on an average price of raw materials over a period of time rather than at a specific point in time, the Company recorded a lower of cost or market charge to write-down the value of its raw materials to the lower of cost or market.

Selling, general and administrative expenses (“SG&A”) increased to $71.8 million in the third quarter of 2011, compared with $39.4 million in the third quarter of 2010. The increase in SG&A was primarily due to the SG&A of Magnetic Technologies of $25.6 million and $8.8 million in fees and expenses related to the VAC Holding acquisition recognized in Corporate.

During the third quarter of 2011, the Company completed the sale of land at the Manchester, England manufacturing facility for $9.7 million and recognized a pre-tax gain on the sale of the property of $9.7 million.

The following table identifies, by segment, the components of change in operating profit (loss) for the third quarter of 2011 compared with the third quarter of 2010 (in thousands):

 

2010 Operating Profit

   $ 34,845   

Increase (decrease) in 2011 from:

  

Engineered Materials

     (85,466

Specialty Chemicals

     12,310   

Battery Technologies

     674   

Corporate

     (7,756
  

 

 

 

2011 Operating Loss

   $ (45,393
  

 

 

 

The change in operating profit (loss) for the third quarter of 2011 as compared to the third quarter of 2010 was due to the factors discussed above.

The following table summarizes the components of Other expense, net (in thousands):

 

     Three Months Ended
September 30,
 
     2011     2010  

Interest expense

   $ (8,512   $ (1,481

Interest income

     294        255   

Foreign exchange gain (loss)

     7,425        (688

Other, net

     (547     183   
  

 

 

   

 

 

 
   $ (1,340   $ (1,731
  

 

 

   

 

 

 

The increase in interest expense is due to borrowings under the Senior Secured Credit Facility to (i) finance a portion of the purchase price of VAC Holding, (ii) repay existing indebtedness of the Company under its former revolving credit facility, (iii) repay VAC Holding’s indebtedness outstanding on the date of the acquisition on behalf of the seller, (iv) pay certain fees and expenses in connection with the VAC Holding acquisition and will be used to fund working capital and for general corporate purposes as needed.

 

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The foreign exchange gain is primarily related to movements in exchange rates (primarily the Euro) and the resulting impact on the revaluation of non-functional currency cash and debt balances held at foreign sites, primarily Euro-denominated debt.

The change in income (loss) from continuing operations before income tax expense for the third quarter of 2011 compared with the third quarter of 2010 was due to the factors discussed above.

The Company recorded income tax expense of $18.4 million on loss from continuing operations before income tax expense of $46.7 million for the three months ended September 30, 2011, resulting in an effective income tax rate of -39.4%. The effective income tax rate for the three months ended September 30, 2011 includes significant discrete items and the acquisition of VAC Holding. In the three months ended September 30, 2011, the Company recorded total discrete tax benefit of $7.3 million related primarily to a partial reversal of an allowance against the GTL prepaid tax asset previously impaired and to the tax benefits of a post-acquisition tax restructuring of VAC Holding. Without discrete items, the effective income tax rates for the three months ended September 30, 2011 would have been -54.9%. Excluding the discrete items and the impact of VAC Holding, the effective income tax rates for the three months ended September 30, 2011 would have been 12.6%. Without discrete items, the effective income tax rate for the three months ended September 30, 2010 would have been 27.7%. VAC Holding’s impact on the effective tax rate is primarily attributable to the impact on income tax expense of charges related to the step-up to fair value of inventory (see discussion in Note 3 and Note 4) and acquisition-related expenses.

The effective income tax rate excluding discrete items and the impact of VAC Holding for the three months ended September 30, 2011 is lower than the U.S. statutory tax rate primarily due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure and the effect of foreign currency translation, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit. In addition, in the three months ended September 30, 2011, there is no U.S. tax expense related to the planned repatriation of foreign earnings during 2011 due to utilization of foreign tax credits and U.S. losses. The effective income tax rate excluding discrete items for the three months ended September 30, 2010 is lower than the U.S. statutory rate due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure, the effect of foreign currency translation and a tax holiday in Malaysia, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit. The decrease in the effective income tax rates excluding discrete items and the impact of VAC Holding in the three months ended September 30, 2011 compared with the three months ended September 30, 2010 is primarily due to the impact of foreign currency exchange rate movements and the benefits of tax efficient financing. In the third quarter of 2011, the weakening U.S. dollar against the Euro resulted in foreign exchange losses on the statutory tax books on U.S. dollar denominated cash balances, resulting in lower accrued income tax liabilities and a lower effective income tax rate; the opposite occurred in the 2010 period, when the U.S. dollar strengthened against the Euro.

Income from discontinued operations in the third quarter of 2011 was primarily due to translation adjustments of retained liabilities of businesses sold denominated in a foreign currency. Income from discontinued operations in the third quarter of 2010 was primarily due to a $1.6 million tax benefit related to a prior period error, partially offset by translation adjustments of retained liabilities of businesses sold denominated in a foreign currency.

Net (income) loss attributable to the noncontrolling interest relates to GTL. Since the joint venture is consolidated, the noncontrolling interest is part of total income from continuing operations. Net (income) loss attributable to the noncontrolling interest removes the income (loss) not attributable to OM Group, Inc. Net income attributable to the noncontrolling interest was $3.3 million in the third quarter of 2011 compared with $0.8 million in the third quarter of 2010. The change was due to the reversal of $6.2 million of the reserve against prepaid tax credits.

Loss from continuing operations attributable to OM Group, Inc. was $-68.5 million, or $2.18 per diluted share, in the third quarter of 2011 compared with income from continuing operations attributable to OM Group, Inc. of $23.2 million, or $.76 per diluted share, in the third quarter of 2010.

Net loss attributable to OM Group, Inc. was $68.3 million, or $2.17 per diluted share, in the third quarter of 2011 compared with net income attributable to OM Group, Inc. of $24.2 million, or $0.79 per diluted share, in the third quarter of 2010. The increases were due primarily to the aforementioned factors.

First Nine Months of 2011 Compared With First Nine Months of 2010

 

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     Nine Months Ended
September 30,
       
(thousands of dollars & percent of net sales)    2011           2010        

Net sales

   $ 1,075,924        $ 903,518     

Cost of products sold (excluding lower of cost or market charge)

     841,194          689,425     

Lower of cost or market charge

     62,444          —       
  

 

 

     

 

 

   

Gross profit

     172,286        16.0     214,093        23.7

Selling, general and administrative expenses

     161,595        15.0     117,042        13.0

Gain on sale of land

     (9,693       —       
  

 

 

     

 

 

   

Operating profit

     20,384        1.9     97,051        10.7

Other expense, net

     (3,958       (11,451  
  

 

 

     

 

 

   

Income from continuing operations before income tax expense

     16,426          85,600     

Income tax expense

     (24,497       (31,791  
  

 

 

     

 

 

   

Income (loss) from continuing operations, net of tax

     (8,071       53,809     

Income (loss) from discontinued operations, net of tax

     (95       622     
  

 

 

     

 

 

   

Consolidated net income (loss)

     (8,166       54,431     

Net (income) loss attributable to the noncontrolling interest

     (4,816       5,159     
  

 

 

     

 

 

   

Net income (loss) attributable to OM Group, Inc.

   $ (12,982     $ 59,590     
  

 

 

     

 

 

   

Earnings per common share - assuming dilution:

        
  

 

 

     

 

 

   

Net income (loss) attributable to OM Group, Inc. common shareholders

   $ (0.42     $ 1.95     
  

 

 

     

 

 

   

Weighted average shares outstanding - assuming dilution

     30,817          30,535     

The Company is including certain non-GAAP financial measures, including income from continuing operations attributable to OM Group, Inc. and earnings per common share - assuming dilution, both as adjusted for special items. “Income from continuing operations attributable to OM Group, Inc. - as adjusted for special items” is a non-GAAP financial measure that the Company’s management uses as an important metric in evaluating the performance of the Company’s business. The table below presents a reconciliation of the Company’s GAAP results, as reported (both net income attributable to OM Group, Inc. and income from continuing operations attributable to OM Group, Inc.), to its non-GAAP results after adjusting for the special items shown. The Company believes that the non-GAAP financial measure presented in the table facilitates a comparative assessment of the Company’s operating performance and will enhance investors’ understanding of the performance of the Company’s operations during 2011 and of the comparability of the 2011 results to the results of the relevant prior period. Such non-GAAP financial measures are unique to the Company and may not be employed by other companies. The non-GAAP financial information set forth in the table below should not be construed as an alternative to reported results determined in accordance with U.S. GAAP.

 

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     Nine Months Ended
September 30, 2011
    Nine Months Ended
September 30, 2010
 
(in thousands, except per share data)    $     Diluted EPS     $     Diluted EPS  

Net income (loss) attributable to OM Group, Inc. - as reported

   $ (12,982   $ (0.42   $ 59,590      $ 1.95   

Less: Income (loss) from discontinued operations, net of tax

     (95     —          622        0.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from continuing operations, net of tax, attributable to OM Group, Inc. - as reported

   $ (12,887   $ (0.42   $ 58,968      $ 1.93   

Special items (net of tax) - income (expense):

        

Charges related to VAC inventory step-up, net of tax

     (66,181     (2.14     —          —     

Effect of applying annual effective rate to actual year-to-date pre-tax income

     (45,304     (1.46     —          —     

Fees and expenses related to the VAC acquisition

     (14,045     (0.45     —          —     

Gain on sale of land

     8,568        0.27        —          —     

Restructuring charges

     (507     (0.02     (1,956     (0.06

Purchase accounting - EaglePicher Technologies acquisition

     —          —          (2,748     (0.09

Adjustment of allowance on GTL’s prepaid tax asset (OMG’s 55% share)

     3,424        0.11        (6,306     (0.21

Other discrete tax items, net

     3,050        0.10        4,201        0.14   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations, net of tax, attributable to OM Group, Inc. - as adjusted for special items

   $ 98,108      $ 3.17      $ 65,777      $ 2.15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding - diluted

       30,993          30,535   

The following table identifies, by segment, the components of change in net sales for the first nine months of 2011 compared with the first nine months of 2010 (in thousands):

 

2010 Net Sales

   $ 903,518   

Increase in 2011 from:

  

Engineered Materials

     136,765   

Specialty Chemicals

     17,168   

Battery Technologies

     18,774   

Intersegment items

     (301
  

 

 

 

2011 Net Sales

   $ 1,075,924   
  

 

 

 

Net sales increased $172.4 million, or 19%, primarily due to the VAC Holding acquisition ($106.6 million). Engineered Materials, excluding the VAC Holding acquisition, experienced increased cobalt volume ($37.5 million) and higher copper by-product sales ($20.9 million) due to the higher average copper price in the first nine months of 2011 compared with the first nine months of 2010 and increased volume. The average cobalt reference price decreased from $20.11, $19.36 and $18.10 in the first, second and third quarters of 2010, respectively, to $18.38, $17.05 and $16.13 in the first, second and third quarters of 2011, respectively, which resulted in unfavorable product selling prices ($23.4 million) in Engineered Materials, excluding the VAC Holding acquisition. Engineered Materials, excluding the VAC Holding acquisition, was also impacted by a decrease in cobalt metal resale ($9.1 million). Favorable foreign currency ($8.9 million) and volume ($6.6 million) positively affected Specialty Chemicals in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010. A full nine months of sales for Battery Technologies in the 2011 period compared to eight months of sales in the 2010 period ($10.1 million) and improved volume ($6.0 million) contributed to the increase in sales.

Gross profit decreased to $172.3 million in the first nine months of 2011 compared with $214.1 million in the first nine months of 2010, primarily due to $93.5 million of charges related to VAC Holding inventory discussed below. In Engineered Materials, excluding the VAC Holding acquisition, gross profit increased due to increased cobalt volume ($17.0 million) in the first nine months of 2011 compared to the comparable 2010 period and a $6.6 million increase in profit associated with copper by-product sales due to both higher price and increased volume. These improvements to gross profit in Engineered Materials, excluding the VAC Holding acquisition, were partially offset by a decrease in the average cobalt reference price in the first nine months of 2011 compared with the

 

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first nine months of 2010, which resulted in lower product selling prices ($14.7 million), and higher process-based material costs ($11.9 million). In the Specialty Chemicals segment, gross profit was impacted by unfavorable price/mix ($8.5 million) partially offset by increased volume ($3.7 million) and favorable manufacturing and distribution expenses ($3.5 million). In Battery Technologies, gross profit was positively affected by 2010 purchase price adjustments that did not recur ($3.2 million), income from sales of recycled material ($3.1 million) and favorable price/mix ($2.8 million) in the first nine months of 2011 compared to the first nine months of 2010.

As discussed under “Third Quarter of 2011 Compared With Third Quarter of 2010” above, the Company recorded a step-up to record the VAC Holding acquired inventory at its estimated fair value on the date of acquisition. During the first nine months of 2011, $31.1 million of the estimated fair value step-up was recognized in cost of products sold as inventory on-hand as of the acquisition date was sold in the ordinary course of business. In addition, at September 30, 2011, the Company recognized a charge of $62.4 million to reduce the carrying value of inventory to market. The impact of the step-up being recognized in cost of products sold and the charge to reduce the carrying value of inventory to market, totaling $93.5 million, are included in the Company’s results of operations for the first nine months of 2011. The remaining net $74.6 million inventory step-up will be recognized in cost of products sold as inventory on-hand on the acquisition date is sold in the ordinary course of business in the remainder of 2011 and in 2012.

SG&A increased to $161.6 million in the first nine months of 2011, compared with $117.0 million in the first nine months of 2010. The $44.6 million increase was primarily due to SG&A of VAC Holding of $25.6 million, and $12.8 million in fees related to the VAC Holding acquisition recognized in Corporate, partially offset by a $1.2 million insurance recovery related to environmental remediation at the Company’s closed manufacturing site in Newark, New Jersey. The first nine months of 2010 included $2.2 million in fees related to the acquisition of EaglePicher Technologies.

During the first nine months of 2011, the Company completed the sale of land at the Manchester, England manufacturing facility for $9.7 million and recognized a pre-tax gain on the sale of the property of $9.7 million.

The following table identifies, by segment, the components of change in operating profit for the first nine months of 2011 compared with the first nine months of 2010 (in thousands):

 

2010 Operating Profit

   $ 97,051   

Increase (decrease) in 2011 from:

  

Engineered Materials

     (83,078

Specialty Chemicals

     8,350   

Battery Technologies

     10,593   

Corporate

     (12,532
  

 

 

 

2011 Operating Profit

   $ 20,384   
  

 

 

 

The change in operating profit for the first nine months of 2011 as compared to the first nine months of 2010 was due to the factors discussed above.

The following table summarizes the components of Other expense, net (in thousands):

 

     Nine Months Ended
September 30,
 
(In thousands)    2011     2010  

Interest expense

   $ (11,327   $ (3,794

Interest income

     981        641   

Foreign exchange gain (loss)

     7,264        (8,088

Other expense, net

     (876     (210
  

 

 

   

 

 

 
   $ (3,958   $ (11,451
  

 

 

   

 

 

 

The increase in interest expense is due to borrowings under the Senior Secured Credit Facility to (i) finance a portion of the purchase price of VAC Holding, (ii) repay existing indebtedness of the Company under its former revolving credit facility, (iii) repay VAC Holding’s indebtedness outstanding on the date of the acquisition on behalf of the seller, (iv) pay certain fees and expenses in connection with the VAC Holding acquisition and (v) fund working capital and for general corporate purposes. The foreign exchange gain in the first nine months of 2011 is primarily related to movements in exchange rates (primarily the Euro) and the resulting impact

 

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on the revaluation of non-functional currency cash and debt balances held at foreign sites, primarily Euro-denominated debt. The foreign exchange loss in the first nine months of 2010 was primarily related to the revaluation of non-functional currencies cash balances due to changes in exchange rates (primarily the Euro and the Malaysian Ringgit).

The change in income from continuing operations before income tax expense for the first nine months of 2011 compared with the first nine months of 2010 was due to the factors discussed above.

The Company recorded income tax expense of $24.5 million on income from continuing operations before income tax expense of $16.4 million for the nine months ended September 30, 2011, resulting in an effective income tax rate of 149.1%. The effective income tax rates for the nine months ended September 30, 2011 is affected by significant discrete items and the acquisition of VAC Holding. In the nine months ended September 30, 2011, the Company recorded total discrete tax benefits of $9.5 million. Without the discrete items, the effective income tax rates for the nine months ended September 30, 2011 would have been 206.9%. Excluding the discrete items and the impact of VAC Holding, the effective income tax rates for the nine months ended September 30, 2011 would have been 12.9%. Without discrete items, the effective income tax rate for the nine months ended September 30, 2010 would have been 30.0%. VAC Holding’s impact on the effective tax rate is primarily attributable to the impact on income tax expense of charges related to the step-up to fair value of inventory (see discussion in Note 3 and Note 4) and acquisition-related expenses.

The effective income tax rate excluding discrete items and the impact of VAC Holding for the nine months ended September 30, 2011 is lower than the U.S. statutory tax rate primarily due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure and the effect of foreign currency translation, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit. In addition, in the nine months ended September 30, 2011, there is no U.S. tax expense related to the planned repatriation of foreign earnings during 2011 due to utilization of foreign tax credits and U.S. losses. See Note 10 for further discussion of the discrete tax items. The effective income tax rate excluding discrete items for the nine months ended September 30, 2010 is lower than the U.S. statutory rate due to income earned in tax jurisdictions with lower statutory rates than the U.S. (primarily Finland and Taiwan), a tax efficient financing structure, the effect of foreign currency translation and a tax holiday in Malaysia, partially offset by losses in certain jurisdictions (including the U.S.) with no corresponding tax benefit. The effective tax rate for the nine months ending September 30, 2010 is higher than the US statutory rates due to the GTL discrete items discussed above. The decrease in the effective income tax rates excluding discrete items and the impact of VAC Holding in the nine months ended September 30, 2011 compared with the 2010 period is primarily due to the impact of foreign currency exchange rate movements, and the benefits of tax efficient financing. In the first nine months of 2011, the weakening U.S. dollar against the Euro resulted in foreign exchange losses on the statutory tax books on U.S. dollar denominated cash balances, resulting in lower accrued income tax liabilities and a lower effective income tax rate; the opposite occurred in the 2010 period, when the U.S. dollar strengthened against the Euro.

Loss from discontinued operations in the first nine months of 2011 was due to translation adjustments of retained liabilities of businesses sold denominated in a foreign currency. Income from discontinued operations in the first nine months of 2010 was primarily due to a $1.6 million tax benefit related to a prior period error, partially offset by a $1.2 million increase in a tax contingency accrual.

Net (income) loss attributable to the noncontrolling interest relates to GTL. Since the joint venture is consolidated, the noncontrolling interest is part of total income from continuing operations. Net (income) loss attributable to the noncontrolling interest removes the income (loss) not attributable to OM Group, Inc. Net income attributable to the noncontrolling interest was $4.8 million in first nine months of 2011 compared with net loss attributable to the noncontrolling interest of $5.2 million in the first nine months of 2010. The first nine months of 2011 includes the reversal of a portion of the allowance against GTL’s prepaid tax asset and the benefit of increased deliveries due to timing of arrivals of cobalt raw material to the Kokkola refinery from the DRC smelter in the first nine months of 2010 compared to the first nine months of 2011. The first nine months of 2010 included costs associated with the maintenance shutdown of the GTL smelter ($5.7 million) and discrete tax items at GTL.

Loss from continuing operations attributable to OM Group, Inc. was $12.9 million, or $0.42 per diluted share, in the first nine months of 2011 compared with income from continuing operations attributable to OM Group, Inc. of $59.0 million, or $1.93 per diluted share, in the first nine months of 2010. The increase was due primarily to the aforementioned factors.

Net loss attributable to OM Group, Inc. was of $13.0 million, or $0.42 per diluted share, in the first nine months of 2011 compared with net income attributable to OM Group, Inc. of $59.6 million, or $1.95 per diluted share, in the first nine months of 2010. The increase was due primarily to the aforementioned factors.

 

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Segment Results and Corporate Expenses

Engineered Materials

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(millions of dollars)    2011     2010      2011     2010  

Net sales

   $ 260.2      $ 148.5       $ 605.5      $ 468.7   
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating profit (loss)

   $ (57.1   $ 28.3       $ (8.2   $ 74.9   
  

 

 

   

 

 

    

 

 

   

 

 

 

The following table reflects the Engineered Materials volumes:

 

     Three Months Ended
September 30,
    

Nine Months Ended

September 30,

 
     2011      2010      2011      2010  

Volumes (metric tons)

           

Product sales volume - Advanced Materials *

     3,926         3,672         11,745         10,778   

Other sales volume (cobalt metal resale and by-product sales) - Advanced Materials

     3,266         2,422         10,943         8,307   

Cobalt refining volume - Advanced Materials

     2,740         2,578         7,678         6,851   

 

* Excludes cobalt metal resale and by-product sales.

The following table summarizes the Engineered Materials percentage of sales dollars by end market for the periods indicated:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011 (b)     2010     2011 (b)     2010  

Battery Materials

     26     42     33     41

Chemical

     8     13     11     13

Powder Metallurgy

     8     16     11     13

Ceramics

     3     6     5     5

Automotive and Transportation

     9     n/a        4     n/a   

Energy

     11     n/a        4     n/a   

Industry

     14     n/a        6     n/a   

Other - Advanced Materials (a)

     14     23     23     28

Other - Magnetic Technologies

     7     n/a        3     n/a   

 

(a) Other includes cobalt metal resale and copper by-product sales.
(b) Includes VAC Holding since the acquisition date.

The following table summarizes the percentage of sales dollars by region for Engineered Materials for the periods indicated:

 

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Table of Contents
     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011 (a)     2010     2011 (a)     2010  

Americas

     14     11     13     13

Asia

     39     48     34     47

Europe

     47     41     53     40

 

(a) Includes VAC Holding since the acquisition date.

The following table summarizes the average quarterly reference price per pound of low grade cobalt (as published in Metal Bulletin magazine):

 

     2011      2010  

First Quarter

   $ 18.38       $ 20.11   

Second Quarter

   $ 17.05       $ 19.36   

Third Quarter

   $ 16.13       $ 18.10   

Fourth Quarter

     n/a       $ 17.41   

Full Year

     n/a       $ 18.74   

The following table summarizes the average quarterly London Metal Exchange (“LME”) price per pound of copper:

 

     2011      2010  

First Quarter

   $ 4.37       $ 3.29   

Second Quarter

   $ 4.14       $ 3.18   

Third Quarter

   $ 4.08       $ 3.28   

Fourth Quarter

     n/a       $ 3.91   

Full Year

     n/a       $ 3.42   

Net Sales

The following table identifies the components of change in net sales:

 

(in millions)    Three Months Ended
September 30
    Nine Months Ended
September 30
 

2010 Net Sales

   $ 148.5      $ 468.7   

Increase (decrease) in 2011 from:

    

VAC Holding acquisition (a)

     106.6        106.6   

Selling price/mix

     (8.2     (23.4

Cobalt volume

     12.2        37.5   

Cobalt metal resale

     (3.3     (9.1

Copper by-product (price and volume)

     4.2        20.9   

Foreign currency

     (3.1     (4.2

Other

     3.3        8.5   
  

 

 

   

 

 

 

2011 Net Sales

   $ 260.2      $ 605.5   
  

 

 

   

 

 

 

 

(a) Includes activity since the acquisition of VAC Holding on August 2, 2011.

The net sales increases in the third quarter and the first nine months of 2011 were primarily due to the VAC Holding acquisition and increased cobalt volume and copper by-product sales in Engineered Materials excluding VAC Holding. The increase in cobalt volume was the result of increased demand. Demand increased across all Advanced Materials end markets in the first nine months of 2011 compared to the first nine months of 2010; demand in the third quarter of 2011 increased in battery materials and ceramics, partially offset by decreased demand in chemical and powder metallurgy. The increase in copper by-product sales in Advanced Materials was primarily due to the higher average copper price in 2011 compared with 2010 and increased volume. These increases were partially

 

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offset by the lower product selling prices in Engineered Materials, excluding the VAC Holding acquisition, resulting from the decrease in the average cobalt reference price in 2011 compared with 2010. The decrease cobalt metal resale was due to the decrease in the average cobalt reference price and decreased volume.

Operating Profit (Loss)

The following table identifies the components of change in operating profit:

 

(in millions)    Three Months Ended
September 30
    Nine Months Ended
September 30
 

2010 Operating Profit

   $ 28.3      $ 74.9   

Increase (decrease) in 2011 from:

    

VAC Holding acquisition (a)

     (77.9     (56.4

Price (including cobalt metal resale)

     (4.7     (14.7

Volume (including cobalt metal resale)

     3.3        17.0   

Copper by-product (price and volume)

     0.7        6.6   

Process-based material costs

     (3.6     (11.9

Foreign currency

     (2.8     (2.2

Manufacturing and distribution expenses

     (1.2     0.6   

SG&A expenses

     1.9        (1.9

Other

     (1.1     1.3   
  

 

 

   

 

 

 

2011 Operating Profit (Loss)

   $ (57.1   $ 13.3   
  

 

 

   

 

 

 

 

(a) Includes activity since the acquisition of VAC Holding on August 2, 2011.

The Company is including operating profit - adjusted for special items, a non-GAAP financial measure that the Company’s management believes is an important metric in evaluating the performance of the Company’s business. The table below presents a reconciliation of the Company’s GAAP operating profit (loss) as reported to non-GAAP operating profit - adjusted for special items. The Company believes that the non-GAAP financial measure presented in the table below facilitates a comparative assessment of the Company’s operating performance and will enhance investors’ understanding of the performance of the Company’s operations during 2011 and of the comparability of the 2011 results to the results of the relevant prior period. Such non-GAAP financial measures are unique to the Company and may not be employed by other companies. The non-GAAP financial information set forth in the table above should not be construed as an alternative to reported results determined in accordance with U.S. GAAP.

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(in thousands, except per share data)    2011     2010      2011     2010  

Operating profit (loss) - as reported

   $ (57.1   $ 28.3       $ (8.2   $ 74.9   

Special items - (income) expense:

         

Lower of cost or market charge

     62.4        —           62.4        —     

Inventory step-up recognized in cost of goods sold

     31.1        —           31.1        —     

Acquisition related fees

     2.4        —           2.4        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Operating profit - excluding special items

   $ 38.8      $ 28.3       $ 87.7      $ 74.9   
  

 

 

   

 

 

    

 

 

   

 

 

 

The decrease in operating profit (loss) in the third quarter and first nine months of 2011 was primarily due to the Magnetic Technologies $77.9 million operating loss, which includes a $62.4 million lower of cost or market charge and a $31.1 million charge as inventory on-hand as of the acquisition date was sold in the ordinary course of business. Excluding the $93.5 million of charges related to the step-up of inventory to fair value and $2.4 million of acquisition-related fees, VAC Holding contributed operating profit of $18.0 million.

 

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Table of Contents

In Engineered Materials, excluding the VAC Holding acquisition, operating profit (loss) in the third quarter and first nine months of 2011 compared to the comparable 2010 periods was impacted by unfavorable cobalt pricing, increased process-based material costs and an unfavorable currency impact. These items were partially offset by higher cobalt volume due to the increase in demand that drove the increase in net sales discussed above. The first nine months of 2011 compared with the 2010 comparable period include increased copper by-product sales due to the higher average copper price and increased copper volume. Favorable manufacturing and distribution expenses in the first nine months of 2011 are due primarily to expenses related to the maintenance shut-down of the GTL smelter in the first nine months of 2010, partially offset by increased distribution expenses due to increased shipments at GTL in the first nine months of 2011 compared to the comparable 2010 period. SG&A expenses in the three and nine months ended September 30, 2011 includes the reversal of $2.1 million of the allowance against the note receivable from one of our joint venture partners.

Specialty Chemicals

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
(millions of dollars)    2011      2010      2011      2010  

Net sales

   $ 120.6       $ 113.3       $ 370.0       $ 352.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating profit

   $ 24.7       $ 12.4       $ 56.3       $ 48.0   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table summarizes the percentage of sales dollars by end market for the periods indicated:

 

     2011     2010     2011     2010  

Semiconductor

     29     29     28     26

Coatings

     16     16     18     16

Tire

     8     9     8     11

Printed Circuit Boards

     23     20     22     19

Memory Disk

     9     10     10     12

Chemical

     11     9     8     9

General Metal Finishing

     2     3     3     2

Other

     2     4     3     5

The following table summarizes the percentage of sales dollars by region for the periods indicated:

 

<
     2011     2010     2011     2010