Minerals Technologies Inc. (MTX) Q2 2012 Earnings Call Transcript

Good morning. My name is Cristy, and I will be your conference operator today. At this time, I would like to welcome everyone to the second quarter 2012 Minerals Technology's Inc. Conference Call. [Operator Instructions] It is now my pleasure to hand the program over to Mr. Rick Honey. Please go ahead.

Good morning. I'm Rick Honey, Vice President of Investor Relations. Welcome to our Second Quarter 2012 Earnings Conference Call. Joe Muscari, Chairman and Chief Executive Officer, will begin today's call by providing some perspective on our second quarter performance. He will be followed by D.J. Monagle, Head of our Paper PCC business, who will discuss the advancement of our portfolio technologies. Then Doug Dietrich, our Chief Financial Officer, will review our second quarter financial results. Before we begin, I need to remind you that on Page 8 of our 2011 10-K, we list the various factors and conditions that may affect future results. Statements related to future performance by members of our management are subject to these cautionary remarks and conditions. Now I will turn the call over to Joe Muscari. Joe?

Thanks, Rick. Good morning, everyone. We continued our strong overall operating performance into the second quarter and that's a 3 consecutive $1-plus quarters as we earned $1.11 per share. This was also another record quarter in the company's history as well as a record first half with an EPS of $2.12. Earnings in the second quarter increased 23% from the $0.90 we achieved in the second quarter of 2011. This solid performance included an 18% increase in operating income to $29.5 million, and a 25% increase in operating income as a percentage of sales to 11.6%. Our return on capital continued to show improvement, increasing 19% to 9.4% for the second quarter on an annualized basis. In addition, our cash flow remain strong as we generated $40 million. Both the Specialty Minerals and Refractories segments recorded improved operating income as a result of higher productivity, lower material and energy cost, good expense control as well as pricing improvements. Specialty Minerals benefited from very strong operating performance from Performance Minerals, as well as higher profits in North American Paper PCC. It's important to note that we were able to achieve this high level of performance despite a lower revenue base than previous highs, which attest to our strategic and operational initiatives to improve performance on all fronts: operational excellence, new products, growth and market positioning. In fact, if you isolate the European recessionary effects on our sales as well as the currency impact of the weakening Euro, the underlying growth in the company is 1% to 2%. Our FulFill new products achieved a significant milestone as we recently announced 3 new contracts, 2 of which are in Europe. We now have a total of 9 commercial agreements with paper mills around the world and this program continues to gain momentum as we are actively engaged with 26 other paper mills that have a serious interest in the technology. It should be noted that we added 10 new paper sites through our global marketing plan for this product. D.J. Monagle, our President of Paper PCC, will be providing a comprehensive overview and update of where the program stands later in the call. The economic conditions in Europe obviously remain a major concern. We've closed 1 satellite PCC plant and Finland experienced reduced volumes at another satellite there, and a satellite in France remains idle at a paper mill that is being held for sale. We are also seeing reduced steel production in Europe that affected us during the quarter, along with a reduction in our Specialty PCC sales on the continent. In the U.S., the recent drop in the steel industry utilization rate is also of concern to us as we look forward. The key strategic and operational initiatives that I just referenced, what we refer to as our pillars of the foundation for change, have been critical to transforming Minerals Technologies into a stronger operating company. Our efforts to revitalize our new product development process is now bearing fruit with the momentum of our FulFill technologies, as well as the new products in Performance Minerals and Refractories. Innovation is an integral part of our DNA and a key aspect of our growth strategy going forward. Our operational excellence lean initiative, which is embedded throughout the company, is also paying off. Employees are engaged all over the globe in ways to improve efficiency, productivity and quality through their relentless efforts to remove waste from our processes in all parts of the company and to deliver higher value to our customers. Continued tight control of our expenses also helps to provide additional leverage as revenues increase. Over the last 3.5 years, the company has reduced its break even point through these efforts by 25%. We've also made dramatic improvements in safety over the last 5 years, with safety performance levels that are now at the best in the company's history. And as with our other initiatives, we strive for continuous improvement in this area. Our current running loss workday rate of 0.55, by the way, is the lowest it has ever been, a testament to all our employees' desire to continue to create a safer place to work. These pillars that I referenced relate directly to creating business and shareholder value, as they tie to the key longer-term objectives that we set for the company at the beginning of 2011, when we laid out revenue, margin, profit and return targets. Let's take a minute and see how we are progressing. We're tracking well to achieve our target to increase operating margin from 10% to 12% as, during the second quarter this year, operating income as a percentage of sales was 11.6%. The effort to move EBITDA from 16% to 18% is also on the right track with our EBITDA now at 16.5%. We also outlined the goal of moving our return on capital from 8.3% in 2010 to 12-plus percent in 2015 and today, we're at 9.4%. Keep in mind that the current cash we have on our balance sheet is in the denominator of this calculations. The target for revenue growth from $1 billion a year to $1.4-plus billion, however, is not quite on track due largely to the economic weakness in Europe and slower economic growth than anticipated in the U.S. However, the underlying drivers to that growth are things we're going to talk about further today. New product commercialization, new satellite facilities in Asia are basically on track. As you can see from this chart, our earnings for the last 3 quarters are back on a high-performance track of more than $1 per share. And our earnings of the last 2 halves are tracking above the best pre-recession 6-month period. Our return on capital also continues to improve, and at 9.4%, we are above our cost of capital, 19% above the second quarter of 2011 when our ROC was 7.9%. Let's now take a quick look at how we've been executing our strategies of geographic expansion and new product development. As I mentioned, we recently obtained 3 commercial agreements with paper mills for our FulFill E-325 high-filling technology. Two of these mills mark our first penetration into Europe where we signed an agreement with the Mondi Group for FulFill at Mondi's paper mill in Ruzomberok, Slovakia. We also announced another new agreement in Europe where the paper maker wish to remain unnamed for competitive reasons, and we also signed one with another Asian paper company since the last call. On the progress we've made with FulFill, I'd like to provide you with a little perspectives on potential operating income. In the last call, I said that the operating income from the 6 sites we had last quarter would deliver around $750,000 to $1 million of operating income for 2012. Today, the 9 sites are estimated to provide between $1.4 million to $1.7 million operating income. And on an annualized basis, the 9 agreements should generate about $2.5 million to $3 million in operating income. Our Performance Minerals group continues to make inroads with new talc anti-block products, and we are now in trials with 4 paint, coating and ink manufacturers in the U.S. for use of our new titanium dioxide extender products. Refractory business has also seen success with new products and geographic expansion. Minteq, the operating division for Refractories, recently sold its first LaCam Torpedo Laser Measurement equipment to a steel mill in Europe. Minteq also signed a contract to provide all refractory maintenance for a new steel mill owned by United Steel Company in Bahrain that will start up in the third quarter and will provide $30 million in sales over the next 3 years. This is a new business venture for our refractories team, as we will be providing a general contractor lead role to this customer for all of their Refractories maintenance, including monolithics and brick. This could serve as a future business model for Minteq to enhance growth in the coming years as part of their adjacency strategy. I'd now like to spend just a few moments to highlight our Performance Minerals business unit. This group, which is well advanced in our operational excellence lean initiative, improved efficiency and productivity by 8% over the second quarter of 2011. In the second quarter and first half of 2012, Performance Minerals increased operating income by 27%, which were company records for both time periods. Sales increased 3% and return on capital was more than 16%, a 20% increase over the second quarter of 2011. The entire Performance Minerals team, led by Doug Mayger, has done an outstanding job on all key business fronts: improving safety, removing waste, penetrating new markets with innovative products as well as improving prices. In past calls, we've discussed our ongoing M&A strategy and our use of cash, topics that have come up from recent visits to shareholders as well. We continue to maintain a very active approach in searching for appropriate acquisitions As I've stated before, we're seeking minerals-based companies with technological capabilities that we can leverage with our expertise in crystal engineering and fine particle technology. We're also looking at businesses outside of our highly cyclical end markets of paper, steel, construction and automotive, such as energy, environmental and consumer products. As yet, as you all well know, we have not finalized any deals. At the same time, we are also using our cash to buy back shares through our most recent share repurchase program. So far this year, we've repurchased over $8 million of shares and we plan to continue with this balanced use of cash in our shareholders' best interest going forward. Now I'd like to turn it over to D.J. Monagle, who'll provide you with a special update on FulFill. D.J.? D. J. Monagle: Thanks, Joe. Let's look at the progress made with the FulFill E and V technologies. To provide some perspective, here's the slide we showed you from our fourth quarter conference call when we had 5 signed commercial agreements and we're actively engaged with 24 paper mills. Now let's take a look at where we are today at our marketing activity for the FulFill portfolio of technologies. We now have 9 commercial agreements but more importantly, we're actively engaged with 26 other paper mills around the world that are interested in this cost saving technology. The arrows show the progress we've made since the fourth quarter. We now have agreements with 6 paper Mills in Asia, where it is customary practice to adopt new technologies quickly. In the first quarter, we executed our first agreement in the United States when we began our application at a plant in Wisconsin with Flambeau River Paper. More recently, we added the 2 customers Joe referred to in Europe, one with Mondi, a premier paper maker at their world-class paper mill in Slovakia and another in Asia. We're also quite close to commercialization with several more paper mills in North America and a fourth from our European region. The FulFill E and V technologies used primarily in uncoated freesheet or office-type paper typically allow the papermakers to consume 15% to 25% more filler, saving $5 to $20 per paper type. We see this portfolio as advancing our position as the global leader in paper filling technology. In addition to these commercial accomplishments, we continue to make technical progress across the FulFill portfolio. FulFill E-325 remains the workforce technology and we're running numerous trials across the globe. As this program gains further momentum, our objective is to work with papermakers to expand the technology across all their uncoated freesheet paper grades, which will increase our revenue stream. As I've explained in the past, our approach begins, we've demonstrated with the customer that trialing this technology is worth the effort and should merit urgency in terms of developing the application techniques that will save them money. To do this, we undertake a very specific technical cost-benefit analysis, taking into account the customer cost structure and paper machine configuration. With agreement to trial, we've entailed our engineers specifically designed equipment to enable integration of the FulFill technology. In essence, we collaborated with the customer to determine the optimal FulFill recipe, a combination of our PCC, the chemical additive and the specific machine operating conditions in every grade before agreeing that the technology is indeed worth it for them to convert to this new system. As I've stated on previous occasions, the Asian papermakers are quick to adopt the new technologies into their system, then they slowly proliferate across the grade structure. We see North America and European papermakers as slower to accept and validate the technology, but we expect them to integrate it into their manufacturing plants across all of their product mix quicker. In summary, regardless of the region, the nature of this technology is a grade-by-grade, machine-by-machine proliferation once the concept has been validated. In either case, however, it's important to note, the paper industry is extremely risk adverse. Now let's turn it over to Doug Dietrich for an in-depth look at our second quarter financial performance.

Thanks, D.J. Good morning, everyone. I'll now take you through our consolidated and business segments results for the second quarter. I'll highlight key market and operational elements of our financial results in each major product line and comment on comparisons to the second quarter of 2011 and sequentially to the first quarter of this year. As Joe mentioned, we reported record quarter earnings per share of $1.11, which represents a 23% increase from the $0.90 per share recorded in the second quarter of 2011. Another quarter of record earnings from our Performance Minerals business, a solid performance from our refractory segment, higher profitability in our Paper PCC business and continued productivity improvements were the primary drivers of the earnings growth. We're able to achieve this level of income despite the continued weakening of our European end markets, where sales and operating income were down 17% and 27% respectively. Our consolidated sales decreased 5% or about $14.4 million from the prior year. However, excluding foreign exchange, the permanent and temporary paper mill shutdowns in Finland and France and the deconsolidation of our Korea Refractory business last year, our underlying sales were up slightly at 1%. Our cost of sales decreased 8%, which had a favorable leveraging impact on sales, resulting in a 5% increase in gross margin. A favorable leveraging occurred in all business units, but most significantly in Performance Minerals. Expenses declined 6% from last year and represented 10.6% of sales in the second quarter versus 10.7% last year. This resulted in operating income of $29.5 million, an increase of 18% over last year and represented 11.6% of sales versus 9.3% in the second quarter of last year, a 25% improvement. Our return on capital for the quarter was 9.4% on an annualized basis, which is above our weighted average cost of capital of 8.3% and higher than the 7.9% achieved last year. In the quarter, we generated $40 million in cash from operations of which $15 million was used for capital expenditures. Sequentially, our consolidated sales decreased 1% and our sequential operating income performance was above expectations, increasing 9%. This was primarily due to stronger results in the performance minerals product line due to lower utility costs, good cost control and higher volumes in our talc business. As we indicated on the last call, we expected Paper PCC profits to decline in the range of 7% to 10% from the first quarter levels due to annual paper mill maintenance shutdowns. Paper actually came in slightly better at 6% lower. The Refractories segment performance was lower than expected as its operating income declined 4%. However, this was more than offset by strong results in our Performance Minerals business. In total, our performance resulted in the highest quarterly earnings per share in the company's history. Each of the 3 product lines contributed to the increase in operating margin. The improvement in Paper PCC was primarily due to higher volumes in all regions with the exception in Europe and price recovery of higher raw material costs. In addition, productivity improvements, lower operating cost and overhead expenses helped to offset the effects of lower European volumes. The improvement of Performance Minerals was due to lower utility costs, higher pricing, improved volumes in most product lines and continued productivity gains being driven by our operational excellence program. In Refractories, lower raw material costs, higher metallurgical wire volumes and continued cost and expense control programs drove this improvement. Today's volume growth in our business is primarily driven by the economic conditions in uncoated wood-free paper, construction, automotive and steel markets. This chart shows the changes in these markets over the prior year in our 2 main regions, North America and Europe. Uncoated wood-free paper production was down about 3% in North America and about 5% in Europe. For the full-year, North America uncoated wood-free paper production is forecasted to decline 2% and then Europe is forecasted to decline over 5%. I'd like to note that as of today, there's still no new information regarding the status of the Mesta Board Corporation's Alizay paper mill in France. The paper mill is presently not operating. We believe discussions for the sale of the mill continue. The construction market in the U.S., which includes both residential and commercial markets, was up nearly 7% in the second quarter versus the prior year. Automotive unit production in North America also continues to be strong, with production rates up 26% and steel production in North America has improved by more than 6%. Average steel capacity utilization rates in the U.S. increased to 78% in the second quarter from 75% last year. However, rates dropped approximately 6% in June to 76% from up high of around 81% in April. This raises some concern for us as operating rates have declined further in July. In Europe, you can see that the construction, automotive and steel markets reflect the current soft economic conditions as each are down more than 6%. I'd like to highlight our regional sales and operating income changes over last year. I think this will give you a perspective of the impact that Europe and weaker foreign exchange rates were having on us. Figures in the lower right corners of this chart are shown excluding the effect of currency and for Asia, also reflect the deconsolidation of the Korea refractories business. Excluding foreign exchange, sales in all regions are higher than 2011 levels, except for Europe, which has been affected by the weak economic conditions and the closure or idling of several paper and steel mills. You can see the impact that Europe and the weaker euro is having on our overall sales and operating income. We've been able to overcome this with strong performances in all other regions, which has helped improve our operating income by almost 20%. This improvement is a direct result of our operational excellence program, diligent cost control, price increases and solid supply-chain sourcing decisions related to raw materials and utility costs. This gives you a view of our profitability improvement by region. As I mentioned earlier, our operating income ratio increased to 11.6% this quarter, approaching to 12% operating income target we set for ourselves in 2010. The company was able to overcome the weak conditions in Europe, improved operating margins over last year. North America drove 2 percentage points of improvement due to record earnings in Performance Minerals and increased profitability in both Paper PCC and Refractories. Europe was affected by lower paper PCC volumes, including the temporary and permanent paper mill shutdowns and by lower volumes across the refractory segment product lines. Asia increased primarily due to improved profits in our Japanese -- in our Japan Refractories business. Our raw material costs are lower in the region and if you recall, our Japan refractory business was affected by the tsunami that occurred in March of last year. These increases were offset by startup costs associated with our new PCC satellite operations in India. Latin America also demonstrated an improvement. This slide illustrates the financial results within the Specialty Minerals segment. The $22.1 million of operating income is an all-time best for the segment. In total, segment sales decreased 2% from the prior year to $168 million. However, excluding foreign exchange and the permanent and temporary paper mill shutdowns in Europe, the segment's underlying sales grew 5%. Paper PCC sales, excluding the shutdowns in foreign exchange, grew 6%. The volume declines in Europe were partially offset by new volumes from the 3 satellite facilities that came online over the past year, 1 in Superior, Wisconsin and 2 in India. In the other segment product lines, Specialty PCC sales were up 2%. Talc sales increased 3% and GCC sales were down slightly 1%. Segment operating income in the second quarter increased 19% over the prior year driven by a 27% increase in Performance Minerals operating income and an 11% increase in Paper PCC. As I mentioned earlier, the improvement of Performance Minerals was due to lower utility costs, higher prices, improved Specialty PCC and talc volumes and continued productivity gains. The increase in Paper PCC is primarily due to higher pricing in North America and Latin America, lower operating costs and an 8% improvement in productivity. In addition, we're starting to see profit contributions from our growth initiatives related to our new satellite facilities and the FulFill E-325 program. Overall, segment operating income represented 13.1% of sales in the second quarter, compared to 10.8% in the prior year. This operating income level is the highest for the segment since the third quarter of 2002 or nearly 10 years. Sequentially, segment sales were the same as the first quarter levels. Despite the flat sales, operating income increased 11%, is higher than we had anticipated on our last call. Performance Minerals benefited from lower utility and operating costs, slightly higher volumes in the talc product line and a favorable mix in the GCC East product line. Paper PCC profits decreased 6%, just slightly better than the 7% to 10% decline we had indicated on our last call. Looking forward, third quarter North America paper production is projected to be up slightly at 1.5% compared to the second quarter. However, European paper demand is expected to be down about 5%. Current indications are the third quarter profits and our Paper PCC product line will be similar to the second quarter levels as the expected volume increases in North America will be offset by lower volumes in Europe. In Performance Minerals, we expect profits to decrease between 5% and 10% from the second quarter as the construction sector will seemingly drop off late in the third quarter. Overall, we expect the third quarter operating income for the segment to be down 5%. As I mentioned on the last chart, Specialty Minerals' operating margin increased to 13.1% from 10.8% last year as the segment overcame some significant factors to improve profitability. Volume declines in Europe associated with the closure of Myllykoski, paper machine curtailments at Aanekoski and the temporary closure of the Alizay paper mill impacted segment margins by slightly more than 1 percentage points. Currency had a negative impact of 0.5 percentage point and PCC price increases, including contractual pass-through of higher lime and raw material costs, increased our rate by 1.5 percentage points. Price increases and favorable mix in the Performance Minerals improved margins by over 1%. Finally, productivity improvements in both Paper PCC and Performance Minerals and good expense control have also added another percent to the margin improvement. This slide shows the financial results within the refractory segment. In total, sales in the second quarter were 11% lower than the prior year, excluding foreign exchange and the deconsolidation of our Korea Refractories business, which occurred in the third quarter of last year. Underlying sales declined 6%. Refractory product sales were down 13% to $65.4 million. In North America, refractory product sales decreased 9% due to the closure of RG Steels, Sparrows Point and Warren mills in early June and to lower volumes from our non-steel Refractories product line. Europe refractory sales declined 14% as a result of 3 steel mill shutdowns, 2 at ArcellorMittal and 1 at Ten [ph] Steel, weak refractory demand from other steel customers and the impact of foreign exchange. Metallurgical wire sales decreased 4% to $20.5 million as sales in Europe were down 13%. Operating income for this segment increased 12% in the second quarter to $8.7 million from $7.8 million in the prior year. The improvement was due to a number of factors, including lower raw material costs, slightly higher pricing, higher margins in our metallurgical wire business, productivity gains, and reduced overhead expenses. The segment operating income ratio improved significantly to 10.1% of sales compared with 8.1% in the prior year. Sequentially, both refractory segment sales and operating income decreased 4% from the first quarter, both larger decreases than we had indicated on our last call. Steel capacity utilization in U.S. reached 81% in April, but then dropped to around 76% in June, a 6% decline. Two steel furnace reliance that were postponed from the first to the second quarter, combined with 4 other vessel relines and the closure of the 2 steel mills in June, drove lower demand for our refractory products. Overall, our volumes in North America were down 6%. The region was able to offset most of the impact from the lower volumes with good cost and expense control. Looking forward, we anticipate lower refractory volumes in North America as the decline in U.S. steel utilization rates through June has continued further through the first few weeks of July. We will also see a full quarter of sales and income impacts from the closure of the Sparrows point and Warren mills. In Europe, steel production levels continue to soften. We expect that a number of European steel customers will delay equipment orders as they curtail their capital spending. Equipment products are some of our higher-margin sales. Therefore, we expect that our third quarter operating income for the full segment to be 10% to 15% lower than the second. The refractory segment operating margin ratio increased significantly to 10.1% of sales this quarter. Refractory volume declines, lower equipment sales and the weaker euro impacted margins by about 2.5 percentage points. It was offset by lower raw material costs, primarily magnesium oxide, and higher margins in our North America metallurgical wire business. In addition, the business has improved productivity levels and has continued with its cost and expense control programs. These items contributed over 2 percentage points to the margin growth. These charts illustrates our working capital and cash flow trends. Total days of working capital decreased slightly to 56 days, which is 1 day lower than both the first quarter of 2012 and the second quarter of last year. Our cash flow from operations was approximately $40 million in the second quarter as compared to $38 million in the second quarter of 2011, and our capital investment for the quarter was $15 million. As Joe mentioned, we recorded record first-half earnings per share of $2.12, which represents the 20% increase from the $1.76 per share recorded in the first half of 2011. Our consolidated sales decreased 4% or about $20 million from the prior year. However, excluding foreign exchange, the paper mill shutdowns in Europe and the deconsolidation of Korea, our underlying sales grew 2%. Our cost of sales decreased 6%, which had a favorable leveraging impact on sales, resulting in a 4% increase in gross margin. Expenses declined 3% and represented 10.7% of sales in the first half, about the same ratio as last year. This resulted in an operating income of $56.5 million, an increase of 13% and represented 11.1% of sales versus 9.4% last year. Our return on capital for the half was 9.1% on an annualized basis, higher than the 7.8% achieved last year. We generated $65 million in cash from operations this half versus $57 million last year. In total, our performance resulted in the strongest first half performance in the company's history. As I mentioned earlier, our earnings of $1.11 per share was a record second quarter performance for the company and was above our expectations, primarily due to stronger-than-expected results in the Performance Minerals business. Looking forward, weaker foreign exchange rates both sequentially and year-over-year will have a negative impact on both segments' results. In Specialty Minerals, we expect segment operating income to decline by 5% from the second quarter. Profits in our Paper PCC product line will be similar to second quarter levels and in Performance Minerals, we expect profits to decrease, as sales for the construction sector will begin the normal seasonal decline late in the third quarter. In our Refractories segment, we expect that the third quarter operating income will be 10% to 15% lower than the second quarter. The drop in U.S. steel capacity utilization rate is a concern and we anticipate a decline in refractory volumes as a result. In addition, we'll see the impact of the closure of the Sparrows Point and Warren Mills for the full third quarter. In Europe, the steel market continues to soften, which will impact our refractory volumes and equipment sales. And overall, we expect total company profits for the third quarter to be around 10% lower than the second. However, further deterioration in the market conditions in Europe remains a concern and could have an additional negative impact on us. Even though we face these market challenges in Europe, we'll build upon our strong first-half performance and continue to focus on driving the growth initiatives in each of our businesses. Now let's open up to questions.

[Operator Instructions] Our first question comes from the line of Rosemarie Morbelli with Gabelli & Company.

So you have already answered a few of my questions regarding where your surprise was and the sustainability of the gross margin in the next 2 quarters, I am also guessing is going to be lower. I mean, you won't be able to sustain this particular level based on your comments. Any potential positive on what you actually can control versus what is going on in the marketplace, which could improve those margins or at least keep them at the same level?

This is Douglas, let me start. I think you're right. I think it will be difficult to sustain these type of margins going forward. Let's take Specialty Minerals segment. Paper PCC, we see some stability but in Performance Minerals, you'll see the normal seasonal decline and you'll see that operating income could drop 5% to 10%. I think, last year, it was 8% as a result. So there could be some pressure on those level of margins coming in the third quarter. Refractories, it's twofold. We have the market conditions in steel, both in North America and Europe, the loss of RG Steel will pressure our margin, but also magnesium oxide around the world, though we've purchase most of it, is purchased in dollars. So the currency impact of our sales, our foreign sales, could pressure those margins as well.

Given the lower level of utilization in the steel industry, do you expect the magnesium oxide price to decline?

Well, we do. It actually has recently had come off slightly. Hard to predict where it will go further, but I don't suspect it will go up. Well, this is my personal -- it will go up significantly over the next couple of quarters, so we purchase -- because of our long supply chain, we purchased most of our magnesium oxide for the year.

So did you -- if you look at your inventories, are they -- are the costs higher than where the price is currently and how long will it take before you can actually offset, kind of close the gap?

Slightly higher, but again, we continue to buy magnesium oxide on a regular basis. But it takes us a little over a quarter before -- especially in North America -- to both purchase, deliver and consume that magnesium oxide. So the lower prices would manifest themselves further in the first quarter.

If I may, on the SG&A side, the $23 million expense in the second quarter, is that something that you can reduce some more going forward or is this a good level in dollar signs, in dollars that you can expect?

So you said the SG&A expense?

Yes.

Part of that decline sequentially and year-over-year was due to currency. I'd say half of the decline was currency-related. So I think a portion of it, we'll be able to hold. Again, we could be spending some expense dollars to support our growth in Asia and again, depending on where the currency goes, that's half of the decline so far this year.

Your next question comes from the line of Jeff Zekauskas with JP Morgan.

This is Silke Kueck for Jeff. So a couple of questions. So I understand that your earnings guidance or like your profit guidance is all based on what theoretically should happen to your segments based on the underlying fundamentals, the utilization rates, the shipment levels of paper and then of course, the various rationalization programs that you must have in place. And so I think in like in the past 4 quarters, you've guided your operating performance one way and essentially, you beat it. So I understand in your guidance is that your profits maybe lower by 10% from the second to the third quarter, but if you take a step and factor in what kind of cost savings opportunities there are, do you think your profits in fact may just stay flat?

Well, we, as a matter, of course, we continuously, as I touched on in my remarks, have cost-reductions and so our current quarter reflected the efforts in our lean manufacturing approach and our suggestion system and our increasing utilization of Kaizen as a way to bring employees to solving problems. So those will continue and those have now become a normal part of a -- I touched on the term waste elimination, but it is about dealing with both opportunities to reduce costs and as new costs and pressures confront any companies as ours, we find ways to overcome those. And in terms of what we're trying to share with you is to give you the best possible insight into what we see as of today, and that's basically what it is based on where the markets are moving. What's a little different right now is the European situation is creating even more uncertainty and, for the first time, we're seeing some movement in steel that gives us some concern and both Doug and I share that with you. So what you're seeing is our best estimate based on current conditions and not having a perfect crystal ball because the planning horizon is somewhat limited right now of what we see happening, Silke.

Okay. And then if I can ask a question on PCC. I think you said that PCC sales, in fact, improved 6% in the second quarter year-over-year if you exclude currency and if you exclude the mill shutdowns and idling in Europe, is that correct?

Correct.

And can you give an indication whether all of that was priced or was there any incremental volume?

We had some incremental -- we had volume increases in each region except for Europe. So really, the major volume decline both year-over-year, on a year-over-year basis, was Europe. It was due to those shutdowns. There was some pricing impact due to currency. But for the most part, the only volume declines we saw year-over-year was in Europe. Sequentially though, the volume decline was in North America, which was due to the shutdowns.

Okay. And has the shipment of initial volumes for FulFill made any difference to volume and price, if you can quantify in any way?

They're very small in the second quarter, a very small amount. I don't think -- in the total volumes, it's not contributing a significant amount yet, Silke.

Okay. And I guess one more question on FulFill, if you expect operating income from the 9 contracts signed today of $1.4 million to $1.7 million for the year, does that translate into sales of like $14 million to $17 million, somewhere in that ballpark?

Well, we've -- as I think I touched on, on the last call, is that because we have a mix of technology fees and additional PCC volume sales, that we're very sensitive to competitive disclosure just how we're pricing right now, and so we're trying to give you is a direct line of sight into as we see it as to what the operating income impact is going to be, and that's why I gave you a range of 2.5 to 3. If you do a straight extrapolation of op income as a percentage of sales, that would take you into, on an annualized basis, you have a factor of 10%. Well, our op income percentage is going to be higher for these products than the 10%, 11% that you see. And so I really -- at this point in time, based on where we are, it wouldn't be appropriate for us to share anymore detail than that. It will obviously have an impact on sales, but there's actually a pretty significant impact as you can see or hear from the numbers we're sharing with you on the op income.

Okay. That's helpful. And last question, my recollection was that you said that if there aren't any opportunities to deploy the cash that you have in your balance sheet, you would begin to repurchase shares and so it looks like this quarter, you began to repurchase shares again. Does that mean that you're just a little bit further away from being able to do anything strategic?

Well, not necessarily and I'm not avoiding your question, but it is all about timing and in some cases as we've been deep into negotiations, that could require significant cash. We could put a hold or slow down the amount of repurchase. Other times, we see as we did this quarter a good opportunity to buy shares back and it can also be a reflection of the timing around doing something, having moved a little further out. So in any one period, that buying doesn't necessarily signal anything. It can, but it could be a number of different things. In this particular quarter, the share price did move down, and we felt it was a good value, a good opportunity to buy.

Your next question comes from the line of Andrew Gadlin with CJS Securities.

I wanted to follow-up on Slide 17, I think it is, that discuss the market conditions in North America as well as Europe. Could you comment on how the North American markets there through the quarter, meaning, did momentum accelerate or decelerate through the quarter?

I think it's down for this sector. I think the steel market decelerated through the quarter. We saw utilization rates, as I mentioned, go from 81% high. So in April, down to about 76% through June and we've seen utilization rates continue to decline further and that's in steel. Automotive, I think, continues to be strong, though, automotive really impacts -- are you -- you're talking about the industry market condition?

Yes.

Sorry. Automotive continuous, I believe, pretty strong. Paper, we indicated, an increase of about 1.5% and that's largely due to the -- we're past the shutdowns. I think if you saw International Paper, their earnings came out yesterday and indicated the impacts that the shutdowns had, and so if it's largely through those shutdowns, then we should see paper production pick-up slightly in North America.

And in Asia, you have a number of PCC satellites beginning productions this quarter and next. Could you comment on conditions in there?

We actually have 2 satellites that are coming online, 3 satellites coming online, but that's in the fourth quarter of this year. We have 3 -- 2 that are online now, 1 that continues to ramp up. Conditions are stabilizing. I think we have -- they're online. They're producing the PCC tonnages that we expected. We are having some startup costs associated with them and some stability around getting some local lime sources adjusted in our production process.

Is that typical?

That's typical. That's typical for a startup. It usually takes at least 6 to 9 months before, hey, they ramp up and we get stability in the process with the lime source.

So you indicated on SG&A that about half of the, call it, $2 million improvement was related to currency? Could you give a little more granularity on the other half?

Well, I think the other half has just been both in all of our research units and the business units just good cost control. Taking a look at as we go through areas of waste, we've also removed some costs in Europe, but we may probably look to redeploy some of that into Asia. So I think it's just been a diligent cost control in the areas that we find waste. It's an ongoing thing that we look at in the company quarter-over-quarter.

Doug, I would add, the implementation of Oracle in Europe last year had a very positive impact on us that we're seeing the benefits of that. We also, just as a matter of info, we've recently upgraded to Oracle R12, which is the new version, and it also will give us -- allow for doing some additional things to the enhancement that are built into that current version.

And so that -- you're expecting that to be a benefit for the coming quarters as well...

Well, yes. It's something that we will continue to get benefits from as we go forward and I would reinforce the ongoing deployment and utilization of lean principles and processes by all resource units and our business units. It's having an ongoing positive impact on improvement to where that -- that is a way of how we work in a company and it's a very positive thing.

Your next question comes from the line of Steve Schwartz for First Analysis.

If we could touch back on a comment you guys made and then Silke brought it up, regarding the European paper volume. If you take out the mill closures, what was your underlying operating mill volume in the region for the quarter on a year-over-year basis?

It's about additional 2%, Steve. So down...

So it was up?

No, it's down 2%. So if you take out the mill closures, there's still an additional 2% decline due to the conditions there.

Okay. And on a consolidated basis, what -- to what extent did pricing contribute? It sounds like it was a positive for revenue growth.

It is a positive. I've broken it out largely on by business unit, I have to get you the total consolidated number. We have it by segment. It's about -- I'd say it's about $1 million in PCC, but is -- a portion of that is pass-through of lime prices. So when you look at the revenue increases, it comes with the pass-through of that higher lime cost.

Okay. When you guys came into this year, I think there was a gap, right? Your cost had run-up through last year, pricing hadn't yet caught up. At this point, mid-2012, have your -- has your pricing caught up to where your cost inflation was?

Well, let's take that in 2 pieces. So if you look at paper PCC, we generally take cost increases due to lime at the beginning of the third quarter of each year and we get to pass those through at the beginning of the year. So for North America, we're caught up, but we'll see that increase again beginning in the fourth quarter. In Europe, we take -- in general, we take lime cost increases twice a year at the beginning and at the middle of the year and pass them through. Some of our contracts, we're able to pass -- are set-up to pass through immediately. So it depends upon which region you're looking at. Steve. In Europe, we're largely caught up now. In North America, yes, but we're going to see another increase coming in the third quarter.

[Operator Instructions] Your final question comes from the line of Rosemarie Morbelli with Gabelli & Company.

I was wondering if you could quantify the savings from raw material and energy costs and whether you see them continuing at that particular level and I'm talking dollars over the next 2 quarters?

I think if you look at raw materials in Refractories business, majority of the raw materials -- it's about $2 million of savings year-over-year. The majority of that's MgO and I think that's probably sustainable through the third quarter and into the fourth but then again, we're starting to purchase some raw material. Energy savings for -- mostly in Performance Minerals, so most of the energy we buy and consume is in the Processed Minerals and Specialty PCC. That's been about $1 million, $1.2 million. We've also taken some steps to try to lock-in some of that cost savings through conversion to natural gas. We do consume #6 and #2 fuel oil and with the prices of natural gas, we've taken some steps in our Specialty PCC business to move over to natural. So looking to make some investments to lock-in those lower costs.

When you say you are working towards converted to natural gas, does that mean a lot of changes within your facilities? Or can you already go between the 2 of them and you have not fully moved over to natural gas?

Rosemarie, we're primarily making quite a major conversion at one facility up in Adams, Massachusetts and I'm going to ask Doug Mayger to kind of describe that because it is a major project. Doug?

Yes. Rosemarie. We converted one of our kilns, large kilns over to natural gas. It was fired before #6 fuel oil. Just to put that in perspective, the natural gas savings for the second half of the year will be in the neighborhood of $1 million.

Okay. So this is on top of the $1 million to $2 million that Doug just talked about?

No, I think you're additive [ph]. So we're still going to consume -- so we've seen some #6 oil decreases over prior year. So we've captured that in this quarter. You're probably going to look at a little bit more than that because we're converted gradually. It does have an effect -- could have an effect on some of the lime, so we're moving over gradually. There could be some additional savings of that $1 million, but it's not a direct replacement, Rosemarie.

Yes, the other thing to keep in mind, we just started this up 2 weeks ago, Doug?

Two weeks ago, right.

So we're in the early stages of it, but so far, it looks pretty promising and we'll have a better feel in about 6 to 8 weeks in terms of what it's delivering for us.

What is behind the raising cost of lime?

Lime cost increases, largely energy driven and so what you're seeing is really a timing impact. Our lime costs, our lime prices or cost to us are based on energy that is an average over 1 year or 6 months prior. So really, when you're looking at lime costs in Europe in terms of increases there, it's based on the lime cost that was the 6 months prior, which really includes November through April, which lime -- our energy prices were much higher then. They only started to come off late in April or June. So that benefit of lower energy prices on our lime cost won't be seen until the adjustments next year.

Okay. And then on the refractory, a lot of the furnaces were relined in the first quarter, and so that affected your second quarter if I understood properly. How long does it take before they need some maintenance after having been newly relined and would we -- would you benefit from it in the third quarter even if the capacity utilization is lower? Could you help me on that?

Yes, we're going to ask Han Schut to address that, Han?

Yes, Rosemarie, thank you. Yes, so we had 6 relines in the second quarter and of course, it depends on when they took place in the second quarter, what will be the effect on the third quarter. But typically, it will -- it is 2 to 3 months before you are back to the consumptions levels that you saw before.

Okay. So that could affect some of the shut down of the lower capacity utilization, correct?

Yes, and we have built that into what Doug shared with you in that range of 10% to 15%.

Okay. And then lastly on the FulFill side, Joe, you talked about the potential of $2.5 million to $3 million of operating income from the new FulFill agreement. Is that a full-year number for 2013?

Yes. It would be if they track this line the way we believe they should, then it would be taking their contribution in the fourth quarter and basically annualizing them.

And it's something -- actually, your earlier question about sustaining margin levels, there are a number of things that will help to sustaining as you -- as we look through some of the downward pressure's on the business like steel utilization and lower volumes there. We will have things working to improve above that, like our FulFill 325 going into next year, like the significant savings in natural gas versus lime and the overall general improvement in the Performance Minerals business, which has done a very good job of raising its margin levels pretty much across the board with an exception or two. So again, you're seeing in the -- what's coming up against us is pretty normal in Doug Mayger's business, where you have a seasonal decline. And I would submit to you that the margin levels on a relative basis for that business are at a good level and we do believe we can sustain those next year.

Okay. Yes, I was going to ask you last for your crystal ball on 2013 looking at the bottom line.

That for -- we would appreciate your help with that in terms of maybe you have a better crystal ball and that is part of what I think is confronting many companies today, the ability to translate Europe into economic impact on the U.S. but really, economic impact on all world markets and what effect that is going to have, and that is still playing out right now and we're -- what we're sharing with you is the best we're able to see right now.

There are no further questions at this time. I'll hand the program back over for any further comments or closing remarks.

I just want to thank everybody for joining us today, appreciate it.

That concludes the call. Thank you very much.

Thank you, everyone, for joining. You may now disconnect.