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Tronox Inc. (NYSE:TROX)

Q4 2012 Earnings Call

February 21, 2013 8:30 AM ET

Executives

Brennen Arndt - Vice President, Investor Relations

Thomas Casey - Chairman and Chief Executive Officer

Daniel Greenwell - Senior Vice President and Chief Financial Officer

John Romano - Senior Vice President and President, Pigment and Electrolytic

Trevor Arran - Senior Vice President and President, Mineral Sands

Analyst

Gregg Goodnight - UBS

Hassan Ahmed - Alembic Global

Hamed Khorsand - BWS Financial

Ian Corydon - B. Riley & Company

Michael Nolan - JPMorgan

Kieran Daly - Macquarie

Joseph Stauff - Susquehanna

Brian Reilly - Barclays

Richard Hatch - RBC

Operator

Good day, ladies and gentlemen, and welcome to the Tronox Limited Q4 2012 earnings conference call. (Operator Instructions) I would now like to introduce your host for today's conference call, Mr. Brennen Arndt. You may begin, sir.

Brennen Arndt

Thank you, and welcome everyone to Tronox Limited fourth quarter 2012 conference call and webcast. With me today are Tom Casey, Chairman and CEO; and Dan Greenwell, Senior Vice President and Chief Financial Officer. Tom, will begin the call with a review of our performance. Dan will then report on our financial position. And following, Dan and Tom will provide our outlook and complete the call by taking your questions.

We'll be using slides today as we move through the conference call. Those of you listening via Internet broadcast on our website should already have them. And for those listening via telephone, if you haven't already done so, you can access them on our website at tronox.com.

Let me begin with a reminder that our discussion today will include certain statements that are forward-looking and subject to various risks and uncertainties, including but not limited to, the specific factors summarized in our Form S-4 dated May 4, 2012, our most recent Form 10-Q and other SEC filings. This information represents our best judgment based on today's information. Actual results may vary based on these risks and uncertainties, and the company undertakes no obligation to update or revise any forward-looking statements.

During the conference call, we will refer to certain non-U.S. GAAP financial terms, which we use in the management of our business including EBITDA and adjusted EBITDA and adjusted earnings per diluted share. EBITDA represents net income before net interest expense, income tax and depreciation and amortization expense. Adjusted EBITDA represents EBITDA as further adjusted for non-cash, unusual and non-recurring items, adjusted earnings per diluted share represents EPS adjusted for unusual or non-recurring items on a fully-diluted basis, a reconciliation is provided in our release.

And it's now my pleasure to turn the call over to Tom Casey. Tom.

Thomas Casey

Thanks, Brennen, and thank you all for joining us this morning. As you saw in the release we put out yesterday, our fourth quarter results came in generally as we had outlined to you a couple of weeks ago in our press release. While, the fourth quarter continued to challenging, we did report topline growth compared sequentially to the fourth quarter, which as we mentioned then was, we view as significant.

Our mineral sands segment sales increased 16% sequentially, despite the impact of three forecast iron ore shipments that were either delayed or cancelled in the fourth quarter and one of the shipments actually went on January 7. And for the first time since 2005, fourth quarter sales volumes in our pigment segment were higher than those of the third quarter, an increase of 2%. Though, this sequential difference was modest, we view it in what is normally a seasonally lower quarter as positive indication.

We also believe that the fourth quarter was essentially the material conclusion of the destocking period by our pigment customers. The integration of our pigment and mineral sands businesses continues to make great progress and is on or even ahead of plan, but as we reviewed with you previously, it's full advantages are not reflected in our financial performance, in part, because of the way that the accounting regulations cause us to treat in a company transactions. And I will talk about that more in a minute.

In the fourth quarter, as has been and will continue to be the case, our reported pigment segment margins reflected a 100% market priced feedstock purchase contracts. Our average cost of feedstock booked in the fourth quarter was $1,623 per metric ton. We believe this is a significantly higher price than other pigment producers who continue to benefit from under market priced feedstock purchased under legacy contracts.

However, as we've also discussed before, most of these legacy under market price contracts have or are expiring and our feedstock costs are moving in the opposite direction. There is significantly declining as a result of our acquisition. In 2003, almost all of our feedstock consumption will be internally produced and therefore we will fundamentally change our ore structure to our benefit, by capturing the margin that we previously paid out to unaffiliated suppliers.

As feedstock prices rise for the industry generally, it's obviously a significant advantage in our mind to have our feedstock cost going down, while our competitors are going up.

We believe a number of other factors will also contribute to a successful performance this year in our mineral sands segment. As we've mentioned before, we had a 140,000 metric tons of slag that we sold last year pursuant to a under market price contract that we entered into back in the bottom days, the dark days of the mineral sands business.

40,000 tons of that production is no longer under contract, that is our obligation to deliver it at below market prices expired at the end of 2012 and the balance, the 100,000 ton balance of that contract expires at the end of 2013.

Second, and as I'll explain this more in a minute, we are carrying approximately $57 million of mineral sands gross profit that has been reported at the segment level as profit margin, but has not been recorded as profit margin in our consolidated income statement. This will flow through our income statement at the Tronox Limited consolidated enterprise level income statement beginning in the first quarter as the pigment that was made from these mineral sands feedstock is sold.

And finally, our assured purchases of our mineral sands production at a higher level that might be the case in another line of soft pigment market, de-risks our production in the mineral sands segment and allows us to enjoy the economies of scale that come from a fuller efficient production schedule.

Although, we continue to remain cautious about the financial performance in the first half, we believe that sales volumes are increasing. We are aware of the announcements by others in the pigment production business. And of course, we don't necessarily follow that the price announcements of any one else, we do our own analysis. We're in the market with our own customers and we make our own decisions, but we are clearly aware of those announcements and we view them as an encouraging sign about the prospects for the market.

We continue to believe the market will strengthen from a financial point of view in the second half. Again, we believe that sales volumes will increase in the first half. We believe that there will be a lag between when that reflects itself in financial performance as inventories are worked down, and plant utilization rates work themselves backup.

And therefore, that allow sales volumes will increase in the first half, the financial performance impacts of those sales volumes may not be felt for a lag, which will be a quarter or two. So we remain optimistic about the performance in the second half from a financial point of view. We expect the advantages of our integration will contribute to our being able to enjoy a more rapid recovery, higher margins and cash flows and net income, than others not similar restructured.

So let's now turn to our fourth quarter results. This was I think covered on Slide 4 of the PowerPoint that Brennen mentioned. In the fourth quarter revenue was $482 million. It was up 26% versus the $383 million in prior year quarter and was 1% lower than the $487 million in the third quarter of 2012.

Adjusted EBITDA of $71 million in the fourth quarter compares to $139 million in the year ago quarter and $134 million in 2012, we'll talk about this segment EBITDA in a minute. Adjusted net loss was $45 million or $0.40 per diluted share versus adjusted net income of $71 million or $0.89 per diluted share in the year ago quarter.

Adjusted earnings per diluted share in the current quarter were based on a 113.3 million fully diluted shares outstanding versus the 77.9 million fully diluted shares outstanding in the year ago quarter. For the full year of 2012, revenue of $1.832 billion was up 11% versus the $1.651 billion of the prior year. Adjusted EBITDA, up $503 million was 2% higher from the $492 million in the prior year. And on a pro forma basis in 2012, Tronox generated $2.1 billion in revenue and adjusted EBITDA of $741 million for an EBITDA margin of 35%.

So let's now look at some of our operating segments in more detail. First, in the mineral sands segment, which is now we'll cover on Slide 5. Mineral sands revenue of $316 million was $264 million higher than the revenue of $52 million in the year ago quarter.

Obviously, the acquired businesses contributed substantial revenue that was $251 million in the fourth quarter. Excluding the acquired businesses, revenue of $65 million increased 25% versus the prior year quarter. The revenue increases in mineral sands, driven by higher selling prices, and partially offset by lower rutile volumes and lower zircon sales volumes and prices.

An encouraging sign towards in the mineral sands business and the zircon business in particular, was the more than doubling of zircon sales volume from the third quarter to the fourth quarter. Although prices were down 33%, the volume of sales finally showed some from life and doubled from Q3 to Q4.

Even at the lower prices, the 33% lower prices that the sales took place on an average, zircon remains a higher margin product for us and zircon revenue overall, net of the increase in volume and the decrease in price, increased 45% from Q3 to Q4. And since it is a high volume, a high margin product for us, obviously, recovery in zircon will be helpful.

The mineral sands adjusted EBITDA was $154 million in the fourth quarter, and that's after taking a $9.6 million lower cost or market LCM inventory write-down, pertaining to our pig iron inventory in South Africa. Income from operations of $26 million increased 44% versus the $18 million in the year ago quarter.

Moving to the pigment segment, which is covered on Slide 6. Fourth quarter pigment revenue of $256 million was 21% lower than the $325 million in the year ago quarter. Selling prices declined by 15% on a constant currency basis between those two periods and sales volume declined by 6%.

Recall that the fourth quarter of 2011 was a very strong one in our business and it was essentially the last strong quarter, compared sequentially to the third quarter of 2012, volumes in the fourth quarter improved by 2% and selling prices declined 10.7%. Sales volume gains were realized in Asia-Pacific compared to both the year ago quarter and sequentially, and we view that also as a hopeful sign.

Adjusted net EBITDA was a negative $58 million in the current quarter after taking a $35.2 million lower of cost or market LCM inventory write-down and again including the 100% market price or the entire production of the pigment segment as we recorded.

Segment income from operations moved from $104 million in the year ago quarter to a loss of $85 million in the current quarter that year-on-year decline in earnings was the result of lower sales volumes, increased feedstock costs, and lower production rates. We estimate that the year-on-year impact of the lower production rates at our plants, which moved a year ago from approximately 90% to in the fourth quarter approximately 75%, reduced our EBITDA in the segment by a total of $16 million.

Our pigment market conditions were soft in the fourth quarter, and as I said earlier we expect financial performance improvements to lag sales volume increases as inventories are worked down. We see a number of reasons supporting our view that supply and demand conditions in the second half will become more favorable. Let's just summarize some of them.

We believe that the paint, coatings, and plastics customers that we serve have largely completed their destocking programs. We are encouraged by the pace of U.S. construction starts and permits as well as auto sales data. The first quarter is normally a seasonally low quarter and that is compounded in the Asia-Pacific region by the Chinese New Year, which is ending. The fourth quarter was also a seasonally low quarter, and so we think that our sequential sales improvement is indicative of a more positive future going forward.

The effect of rising feedstock prices on our competitors pricing policies. We think the timing of the working down of the level of finished goods pigment inventory held by TiO2 producers will contribute to a recovery, stronger recovery as that inventory is worked down. And of course as the inventory gets worked down, the plant utilization rates will increase, and even without price increases, increase in plant utilization rates will increase margin.

As a result, we expect tighter supply demand conditions to be reflected going forward, as we've said into the second half of 2013. And over the medium-to-long term, we continue to believe the industry supply demand fundamentals will support an extended period of strength for the mineral sands and pigment value change, despite the current soft period.

I'm now going to turn call over to Dan Greenwell, for what would be his final report on our financial position. And as we reported last week, Dan announced his resignation effective March 31. This is a resignation that we accepted with regret, and it's a decision by Dan and his family, made for personal reasons.

Dan has made substantial contribution to our company, among the most important of which is they've built a very strong finance team that will continue on. While he led our global finance team, he played a leadership role in the acquisition of the mineral sands business, our refinancings. Unfortunately he's been doing that, while he's also been commuting back and forth to his home and his family.

We thank him. We understand and regret the decision, but we understand it. And we thank him for his contributions and we wish him the very best going forward. Dan will be with us till March 31. He remained actively responsible for our 2012 reporting. He will join with me in sighing our 2012 10-K, which we expect to file early next week, and he'll continue to lead our evaluation and perspective refinancing under more favorable terms and conditions given the debt market.

Our search for his successor has begun and we expect to have a CFO in place in the second quarter. Dan?

Daniel Greenwell

Thank you, Tom, and good day to everyone. I am pleased to be with you today to report on our strong financial position we bring into 2013. First, our regular quarterly dividend. Earlier this week our board declared a regular quarterly dividend of $0.25 per share, representing a current yield of approximately 5%, payable on March 20, 2013, to shareholders of record of the company's Class A and Class B ordinary shares at the close of the business on March 6, 2013.

Moving to the corporate and other segment, and the major line of items on our income statement and balance sheet. Corporate and other revenue was $31 million in the fourth quarter of 2013 versus $40 million in the prior-year quarter. Corporate and other includes our electrolytic manufacturing business.

Electrolytic and other chemical products net sales were $4 million higher than the year ago quarter, as higher sales volumes of manganese dioxide and sodium chlorate were partially offset by reduced revenue from our former relationship with Exxaro in the Tiwest joint venture.

Corporate and other expenses in the quarter were $9 million as compared to $13 million in the prior-year quarter. Selling, general and administrative expenses for the company in the fourth quarter were $32 million or 7% of revenue, down from $40 million or 10% of revenue in the year-ago quarter and $60 million or 12% of revenue in the third quarter of 2012.

On December 31, 2012, gross consolidated debt was $1.645 billion and debt net of our strong cash position was $929 million. Interest and debt expense was $25 million versus $9 million in the year-ago quarter, primarily due to interest on the senior notes issued in the third quarter of 2012 and the term loan that was refinanced in the first quarter of 2012.

Depreciation and amortization in the quarter was $88 million. We estimate that annual depreciation and amortization in 2013 will be in the range of $290 million to $310 million. Regarding our tax rate, as I reported last quarter, our estimated effective tax rate should be in the range of 8% throughout 2013, and for 2014 and thereafter in the 15% to 20% range.

Next, the non-controlling interest line. As we reported last quarter, this component of equity on our balance sheet represents the amount of Exxaro's 26% ownership of the South African interest fees as required by the country's Black Economic Empowerment legislation. In our 10-Qs and 10-Ks we provide revenue generated by our South African operations, which should enable you, after making your own assumptions regarding profit margins, to estimate our non-controlling interest. Before a further clarification, Exxaro does not contribute to capital or share cost of our South African operations.

Regarding capital expenditures, we estimate our capital spending for 2013 will be in the range of $200 million to $250 million. Going forward, we expect that annual capital spending for the next three years will be in the range of $100 million to $120 million for maintenance capital, plus $100 million to $130 million each year for the Fairbreeze mine development in the years 2013, '14 and '15. And finally, as Tom mentioned, we're evaluating the refinancing of our term loan, given the current debt market environment and our strong cash position.

Thank you. I'll turn the call back to Tom Casey.

Thomas Casey

Thank you, Dan. Let me just, before I open it up to questions, talk a little bit about our view of the outlook for the business. As Dan outlined, we start from a very strong financial position. We closed the year with $716 million in cash, that's after we returned approximately $600 million cash to the shareholders last year in the form of merger consideration, share buybacks and regular dividends.

In addition, we funded $166 million in capital expenditures last year as well as of course our general operations. We believe that we're now in a position to more fully demonstrate the value of our vertical integrated structure and the material cost advantage it will give us.

We are the only company that can capture full margins at both feedstock and pigment levels, wherever that margin shifts in the supply chain. This will give us not only a differentiated financial strength to withstand downturns, but also the pricing flexibility to enjoy upside that no other pigment or feedstock produces have. As a result, we believe we have more strategic flexibility than others in our industry.

Coupled with our strong financial position, we have the ability to pay a regular dividend, as Dan has indicated, we have just approved. That yields an attractive return, while at the same time we are regularly evaluating strategic opportunities to expand our scale relative to the market without necessarily expanding supply in that market.

We believe we are well positioned to grow and intend to continue to explore opportunities to do so. Not only can we improve the cost structure of an acquired business by shifting internally sourced feedstock to their production, but we also have and we've talked about this before, we have substantial U.S. tax benefits available to us enable higher cash retention in a potential combination. We remain very confident in the long-term value creation potential of our business and we are committed to deliver that value to our shareholders.

With that, I thank you for your time and attention. And we'll be happy to answer questions. I would also point out that we recently, as Dan pointed out, our board met earlier this week, and we have a number of people here with us, including John Romano, who is the President of our pigment segment; and Trevor Arran, who is the President of our mineral sands segment. So if you ask particularly challenging questions, I'll probably turn it over to them.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Gregg Goodnight with UBS.

Gregg Goodnight - UBS

You commented about downstream inventories, would you give us an idea of where producer pigment inventories are right now or where do you see the industry? And when do you see the need for your company to kick-up rates to meet demand?

Thomas Casey

We would normally be running at this time of the year between 50 and 55 days of finished goods inventory and our most recent calculation was that we are running at 81 days of finished goods inventory. I think that's lower than where we have been, so the inventories are working down. I can't speak to other producers whereas I think some of them had actually spoken on their calls about their own inventory levels. So that's where we are. What other part of that question would you like?

Gregg Goodnight - UBS

When do you believe that it will be necessary to kick-up operating rates?

Thomas Casey

We are sitting right now on 25 to 30 days of extra sales in inventory and we're running the plants at approximately 75% utilization. I think it will probably take a quarter of increased sales to let us work through that to the point where we get to increased utilization rates. That's why we have consistently said, since we begun to talk about 2013, that we expect to see sales performance increase before financial performance increases.

And the basis for that separation is exactly this period we're talking about now, which is when inventories get work down and plant utilization rates get back to work back up. I would remind you that as soon as the plant utilization rates begin to improve and increase the rate, margins increase automatically, because we're beginning to share more fixed costs or fixed costs over more units, which improves the margin per unit. And then as we get up to 85% to 90%, we expect prices will be rising and that will be a further compounding of the margin enhancement that we expect.

Gregg Goodnight - UBS

You also mentioned that zircon volumes have picked up. I note that prices went down pretty substantially in 4Q. Are zircon prices still in the $1,300 ton range, are they improving? And how much headwind do you see on a year-over-year basis for Zircon in 2013? I mean how much drag is it going to help on your EBITDA?

Thomas Casey

First of all, zircon is a very high margin product. So I don't consider it a drag. I can't see it as a tailwind. Not as much as the tailwind as it was in 2011, I now can see that part. But it did as I said in the main part of the call, the volume doubled in Q4 versus Q3. The sales prices were down, I said about the third and the calculation is 32.7%.

I think that $1,300 per ton of zircon is probably higher, slightly higher than we're seeing right now and it might not be a bad entire 2,000 average for zircon across the whole year. But for right now, it's probably a touch high. And so I'd say, the issue of the prospects I mean a very substantial amount of zircon was produced and inventoried in the last four or five quarters. And so I don't think that we'll see zircon prices recovering to the 2011 levels for a very substantial period of time if ever, but certainly not in 2013.

Operator

Our next question comes from Hassan Ahmed of Alembic Global.

Hassan Ahmed - Alembic Global

Obviously, a bunch of moving parts over the course of the last couple of quarters, be they pertaining to the industry or Tronox with regards to integration of the mineral sands operation and alike. I mean in the past under more normal sort of conditions, you've done a really good job in sort of outlining the earnings power of call it the new and improved Tronox.

But I guess there is a fair degree of confusion as far as the near-term goes, with de-stocking and lower operating rates and alike. But as I sort of look at your Q4 results, two things turned out, one is on the mineral sand side of things. You did slightly north of $150 million in EBITDA and on the pigment side of things, it was a negative EBITDA.

So I'd like to assume that eventually the industry isn't going to keep sort of operating on the pigment side, if they are running at a negative EBITDA run rate, right? So let's say that that goes to zero, even in a sort of mucking broader macro environment. Now if I annualize that $150 million that you did in mineral sands that gives me $600 million or so.

Then I track on certain sort of other things that you have mentioned in your press release. The unbooked feedstock margins, the savings that you generate so on lesser outside purchases and alike. And in the very near-term I come up with something sort of slightly north of $700 million in EBITDA. So a very long winded sort of statements, but my question is am I missing anything?

Daniel Greenwell

Well, Hassan, I think if you look at the mineral sands EBITDA as a separate segment, and you say that's the amount that you mentioned. If you add the 57 back into that, you'd be double counting, because it's already in there. Now on a consolidated basis, you are correct. But you can't just assume that mineral sands' reported EBITDA includes that deferred profit or that deferred gross margin that sits in there right now on a consolidated basis. Obviously it does not.

But really, where that's generated from is from the following. As you know, as soon as we had the acquisition, we started bringing our own material into our pigment operations, which really is a fairly long-lead time, and these are just approximations, but you have about 30 days on the water to transport it. You keep between 30 and 45 days of ore inventory at the plants. And then if you'd use Tom's 81 days or 80 to 90 days on inventory, you have a fairly lengthy period, where the ore that we shipped from South Africa and Australia as it moves into the pigment plant, you have to defer all of that gross margin. And this is what I call priming the pump.

From a consolidated basis, we don't get to recognize that margin until the pigment tons are sold. And so now that we've fully supplied our pigment operations or realistically from July onwards, now we've got the value chain fully or the inventory fully built with our own pigment. As we start to continue to supply and roll the pigment sales out, we'll be able to recognize that. Unless inventory levels built in the pigment sector, you'll have no more increase in that deferred gross margin. So it will come through the income statement on a regular basis every month.

Hassan Ahmed - Alembic Global

Again, sort of trying to zero-in on sort of pigment negative EBITDA side of things. And as I said there and sort of hear the calls, Q4 calls of variety of your competitors, and EBITDA margins, single digits, guiding to almost breakeven EBITDA margins come Q1, which probably will be the lowest point in the near term cycle, right? Now again, a couple of these guys have come out and announced some price hikes. So my guess is that post-Q1, at the very least, these marginal producers should return to breakeven if not higher levels of profitability, is that so?

Thomas Casey

Obviously, we're not going to talk about what the other guys are going to do. But I would point out something that I made before, the point I made before, I certainly agree with your premise that people are not going to remain in business at prices, which produce negative EBITDA and burn cash. So they only have two choices; they can raise price, if they can; or they can go out of business, they can shutdown supplies. So we don't know which is more likely and we can't make decisions for other people, obviously.

But we've said that our average feedstock cost per ton in the fourth quarter was $1,623. Now, we are unlike any of the other pigment manufacturers, because we book every ton at market, whether we buy it at market or whether we transfer it from ourselves, we price it at market.

So to the extent that the report you've seen about financial performance from others include at least some legacy ore prices, that they are facing a headwind, as those contracts roll off, their ore prices are increasing, whereas ours, as I said before are decreasing, because we'll be starting. We've not planned to pump on this integration recapture of growth margin and ours will be coming down.

So relative to our competitors, we feel very good. Our ore prices will be declining at the exact same time as theirs are increasing. If they respond to the increased cost by raising price, then that's fine with us, because our margins then obviously will just improve.

Hassan Ahmed - Alembic Global

And one final one if I may around debt covenants. Obviously, the dividend yield is very healthy right now north of 5% as you mentioned on the call. If you could just remind us, is there a critical sort of net debt to EBITDA ratio or in turn sort of a depressed EBITDA level at which point your bondholders essentially start questioning the chunkiness of the dividend?

Daniel Greenwell

We don't think we have covenant issues as we talked about. We have $760 million of cash. We can deploy that in a longer way, but also in discussions with refinancing. So the market seems to have an appetite for the term loans and bonds right now that we find very attractive. So I think it would be our intention to explore those opportunities and get the best terms and conditions for the company. But I don't believe we'll have any covenant issues at all.

Operator

Our next question comes from Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial

Just wanted to touch on pricing here. So you're talking about utilization is at 75% from your comparable levels. What's going to drive pricing as we go forward? I mean, utilization is still, you still have room there. There is inventory channel. What gives you confidence that you can actually see pricing go up with Q3 or Q4 this year?

Daniel Greenwell

Well, three factors. One is that two of our competitors have already enough price increases in Q1. So obviously, they are seeing the pressure of increasing costs and to Hassan's points earlier they're not going to tolerate running their businesses at a cash loss. And so they're going to raise prices. Let's see what happens. Nobody can tell what the market is.

But even beyond that which is, and I think that's a powerful factor, I mean, there are others who are in a position, where they're either are going to be raising prices or they're going to be having the short supply or they're going to be running at cash losses and obviously that's not a desirable situation for them. So that's the first factor.

The second factor is as sales volume increase, which we expect to be to happen then the inventory inevitably gets worked down just like all inventories that are over your average, they get worked down if you don't increase production but sales volumes do increase. And as they work down to normal levels, then the only way we will be able to meet the increased demand is by increasing production.

When we increase production, the margins will increase automatically simply by sharing more of the fixed cost; although more units and as this industry gets to 85% to 90% utilization rates, then supply gets tight enough, that prices tend to rise. And that's the premise on which we believe prices will rise through the year.

Hamed Khorsand - BWS Financial

I guess, the better question is I have seen the industry and some of the producers try to pass along price increases and the stickiness factor has really evaporated over the last few quarters, so what's the confidence here that it's going to stick this time around?

Thomas Casey

Because as starting in the fourth quarter of 2011, the customers to whom those price increases were being passed along, who have been in charge, had built dramatic inventories. And those inventories have not been worked down. And so if they want to continue to produce paint or plastics or paper coatings or whatever product they produce that requires TiO2 and they have no inventory of TiO2 with which to produce their end product, they're going to have to buy it. If you see Sherwin-Williams and PPG and Ben Moore and Akzo and Valspar go out of business then we'll have a problem, but if you don't, and they seem to be doing quite well, and looking good with housing and auto sales increasing, we will be fine.

Hamed Khorsand - BWS Financial

And last question. What's the risk that we could see more reformulations, more transfers as far as the different kind of feedstock goes this year, especially if the prices go up?

Thomas Casey

We've done an analysis of the cause of the decline in sales volumes over the four, five quarters. And we think some of it was the result of reformulations, either using less TiO2 per gallon or per unit. We don't think any significant portion of it was the result of our customer's buying Chinese imports, for example. We think some was a result of reformulations or thriftings maybe if total volume was down 17%, maybe 3% to 4% or 5% of that was attributable to reformulations or thriftings. And less than 1% was the Chinese imports in the balance which is the 12% 13%, 14% was destocking of these inventories I've just mentioned.

So I think there has been some that will continue. I'm not sure it's going to get significantly greater, because, obviously, when our customer's change the formulation, there is a cost. If they use, I don't want to say, inferior but a material that has different characteristics than our material than it changes the ultimate characteristics of their own product. And their tolerance or their willingness to do that particularly at these pricing levels is going to be, I think less than it was a $1,000 a ton ago.

Operator

Our next question comes from Ian Corydon with B. Riley & Company.

Ian Corydon - B. Riley & Company

What's the right SG&A run rate to use going forward?

Daniel Greenwell

Probably, on an annualized basis, we have probably about anywhere between 160 to 180 depending on what market, the activities we're in with respect to growing the business organically, things like that. So I think that's probably a good range to use.

Ian Corydon - B. Riley & Company

And in the first quarter, is it reasonable to think that mineral sands revenues will be up sequentially just because those delayed shipments finally hit or would that be partially or more than offset by lower selling prices?

Daniel Greenwell

We mention that there were three shipments that were scheduled for December that didn't go, or for the fourth quarter that didn't go. One of them did go in January. I think the other two are probably cancelled, not postponed. I think that revenue, Trevor, what do you think revenue would be up slightly?

Trevor Arran

I think it will come out in the wash at the end term and not between what we've lost in some those shipments and some of the pricing softness that we've seen. But I think it should not more or less be on even Q.

Daniel Greenwell

So approximately, comparable?

Trevor Arran

Yes.

Daniel Greenwell

It would be incorrect to assume that all of the three and fourth quarter shipments that we talked about that didn't go will be added to a normal first quarter, that part, Ian, would be incorrect.

Ian Corydon - B. Riley & Company

And then you mentioned that you're buying 15,000 metric tons of feedstock externally in 2013. What's the reason for that? And then do you still expect to sell around 200,000 metric tons of feedstock on the open market?

Daniel Greenwell

The reason for that is that we have a relationship that we value with the mineral sands producer. And we had a contract that was in effect in 2012, that we had a balanced of our commitment to them, and we want to honor our commitments generally and in particular to this particular supplier. And so that's a reason we'll take it. We will consume the balance of all of our pigment production requirements internally.

And so that will be somewhere in the order of 450,000 tons, 500,000 tons, whatever we end up producing in the pigment unit. We have 100,000 tons to under contract to this other party that we have to deliver on. We have demand into the non-pigment market, which was primarily the rutile into the welding and other non-pigment markets. So we expect to sell close to 200,000 tons over and above what we buy, what we consume internally. That's on our steady state size. That's assuming we stay the same size we are now.

Ian Corydon - B. Riley & Company

And we should assume that that 15,000 metric tons, does that above market level is correct?

Thomas Casey

I mean, it's at market levels in the fourth quarter of 2012.

Operator

And next question comes from Michael Nolan with JPMorgan.

Michael Nolan - JPMorgan

You sound positive as it regards the company and the industry for 2013 especially in the second half. With the share price now down 28% since you repurchased 10% of the company in the last quarter, I was surprised that we didn't have any discussion or anything in the press release regarding current thinking by management as regards share repurchase. Could you explain how your thinking has evolved in terms of the past few quarters, in terms of capital allocation as it relates to the balance sheet as opposed to business?

Thomas Casey

I mean, I wish I was cognizant and then that way I wouldn't have bought it at 25, we would be buying it 15 or 18 or whatever we ended up touching. But we felt we had an obligation to deliver, promise to return capital to shareholders, which we have talked about as soon as we came out of bankruptcy and as I said in the press release and in the comments earlier, we think we returned $600 million in cash or a little bit less than $600 million in cash to shareholders in 2012 between the $12.50 merger consideration that we paid to the Tronox Inc. shareholders, the $325 million or so of share buyback and the $60 million, something of dividends.

We think we sort of discharged the obligation that we felt to return capital to shareholders in '12. Going forward, we cannot buyback any more shares unless Exxaro participates proportionally, without putting Exxaro over the 45% ownership limit that they are contractually bound to stay under.

In the merger agreement documents themselves, there is standstill on Exxaro for three years, post the closing prohibited from exceeding 45% ownership level. We're there now at just under 45%. There I think the last number I saw was 44.6% or something. So in essence, if were to buy shares under Australia law those shares are cancelled. And if they are cancelled that means that everybody else's ownership increases proportionally. And that would Exxaro over 45% which would then breach the standstill agreement, which we are not prepared to do.

Exxaro has made it's own decisions about whether or not it would be willing to participate proportionally and it has obvious consequences on it from a cash received point of view from an income statement point of view as they book the transactions and I can't make those judgments, so far they have not expressed any interest in selling any of there shares. So I would assume going forward that there are no more buybacks to come.

The dividend is it's at $1 a share, on an annual basis a quarter a share declared per quarter and we intend to continue to pay that. That leaves us with $700 million of cash on the balance sheet and we view that as more than what we need to run the business in its current form for the foreseeable future.

But we also view it as an attractive strategic opportunity to have some dry powder on the balance sheet as opportunities may present themselves. Because as we talked about a couple of calls ago, as we look at pricing in this market and that cost rising for other people in this market, we think there will be opportunities and we want to keep some capability to pursue them when they present themselves.

Operator

Our next question comes from Kieran Daly with Macquarie.

Kieran Daly - Macquarie

I've got a question on zircon quickly. It's headline-grabbing to say that sales in the fourth quarter doubled compared to the third quarter because I think your volumes of zircon in the third quarter were down like 75% year-on-year in the previous year. So you said, it's off a very low base, although it may have doubled. So I'd just like you to confirm that that is the case, that that volumes are still exceptionally low here.

And then also just to check, we have seen Iluka, Rio Tinto talking about cutting back zircon volumes. Obviously that's quite difficult because you core mine these mineral sands, it's difficult to cut back on zircon because you're just mining it anyway. But is there something you are doing around how much zircon you are producing in order to minimize it? Because I mean, otherwise stocks are just going to for yourselves are just going to build quite steadily and there's plenty of stock around other producers are doing at the moment anyway?

Thomas Casey

Let's do the first question, first, which is Kieran's correct characterization of aggregate volumes in the zircon market are down dramatically. To put some data on that, the year-to-date, for the 2012 total sales was slightly less than 50% of the total year of 2011 sales, so down 54% for us.

The fourth quarter '12 was down 30% from the fourth quarter '11. So it is off a small base, that's right. It did double, that's also right. And the decline on quarter-on-quarter is less for the fourth quarter of '12 compared to the fourth quarter of '11 than it was for the full year. So we think what that shows is yes, we're down from a small base but we're heading in the right direction and performance is improving.

I mean the sales folks that are actually in the market are more upbeat about demand, particularly at these prices which is I said were down about a third year-on-year. February is tough, it's obviously a soft month for China because of the holiday, but as they come back and get into full business mode again, that would be an indication of where we are in the zircon market. But your point about, it's from a low basis is true, but the fourth quarter was the highest quarter of sales of any quarter in 2012 and it's down less annually quarter-on-quarter than the year as a whole. So all those things indicate, I think we're heading in the right direction.

With respect to managing the production of zircon, everybody, every producer, you're right that they are co-products. So if you continue to mine for titanium feedstock generally speaking, you're going to get the zircon whether you want it or not. Every producer has different ways of adjusting their production.

I think Iluka has spoken about what they are doing in part to reduce zircon production. Rio has spoken. We are running our minds in ways that are designed specifically to reduce the amount of zircon production. We can do that by shifting back and forth between parts of our mine. We can do it by moving, mining to a part of the deposit field that has less zircon relative to other parts.

We can do it by changing our separation plan practices. There are number of different ways to do it. I think it's also of a fair point to say that you can't completely control the production but you can affect some of it in terms of short relative scale, so more than just incremental but it's not complete.

Operator

Our next question comes from Joseph Stauff with Susquehanna.

Joseph Stauff - Susquehanna

Can you comment just in general how to think about working capital in 2013 on out, given kind of the different layers, obviously you're under contract for feedstock. That will roll off at the end of this year. You've got capacity that you are building in South Africa. How do we think from an aggregate perspective in terms of your use of working capital? Will it be a source do you think by the end of the year and/or use? Can you help us untangle how to think about that?

Daniel Greenwell

I'll make a broad statement first. Working capital or cash from operation should be positive, reasonably positive in 2013. So that's our broad statement and keep in mind that some of our inventory levels that are reported on our balance sheet had a substantial amount of purchase accounting write-up in those. For example, our inventory originally had roughly $209 million of inventory write-up and we have amortized approximately $170 million of that through the fourth quarter.

So we still have about $36 million sitting in our inventory that relates to purchase accounting write-up, which is basically an accounting entry. It is not a cash entry, type of thing. So that should work itself out over the next quarter or couple of quarters. So you'll see a lot of accounting value carry just in the inventory from that. With respect to receivables, I think our receivables are in good shape normal carry, as sales pick up those will grow. With respect to the unfavorable contract on ore that will continue through all of '13, so you'll see that.

With respect to normal trade payables in accruals, we expect normal cash flow. So in our view we've got a good balance of working capital management, don't see any particular issues, and I said overall, we should have a positive cash flow from operation. So I think we're in pretty good share there. And just on the construction efforts in South Africa in terms of building capacity, there's no working capital build over that period of time. You're just incurring largely CapEx until it's up and running. Is that fair to say?

Thomas Casey

That's correct. And I think the important thing for everybody to understand is that project we can move it ahead faster, if we want to. So we can spend more. And I think we've given the estimates of total project cost over three years spending period. We believe that that project will be self funding through the South African operation. So we don't anticipate putting any substantial capital in there. The timing will play an impact, if we do it faster we may have to for a short period time, but it should be self financing.

With respect to feeding the smelters and working capital, we have inventory on ground in South Africa that's a substantial, for example at KZN we have a fairly large stockpile that's currently a feeding the furnaces right now. And then of course, over Namakwa, we realize we have roughly 2.8 million tons of unattritioned ilmenite, which we built an attritioning plant that we're currently processing there. And that material, the unattritioned material for accounting purposes is valued zero on our balance sheet.

So I'll give you a broad brush view, is that it costs us roughly $50 to $75 to attrition that. So that will be our cost in there. So attritioned quantities on that is roughly 2.5 million tons of material that we have a view that will cost us between $50 to $75 to process it. And it's currently on our book at zero. So you will not have cash go out for working capital build in South Africa and will be able to supply the furnaces at KZN without difficulty at all. So I think we're in good position from a working capital point of view.

Joseph Stauff - Susquehanna

Can you comment in general especially being on this side of the pond, about just the operating environment in South Africa and if that has affected you guys in any way and if it has, where has it affected it? Can you just comment on that in general?

Thomas Casey

Our businesses are operating well in South Africa. We have good relations with our employees. Trevor and his team spent time to understand, to invest in energy and in keeping those relationships positive and treating people well. Remember that when you read about the platinum mines and the gold mines and all of that, those are very difficult mines to actually work in there. Deep underground, they're very demanding, they're arduous, they're in remote locations, so people tend to live in dorm-like places.

Our mines are in more developed areas. There's is more people there. There is township. They get to go home. It's relatively surface mining, so its relatively easier conditions. And we focus on trying to maintain good relationships and I think Trevor and his team have done a very good job of that and Exxaro, of course, before us invested a lot of energy in doing that.

So far we've been fine. We have no strikes. We have existing labor agreements that are in place that both sides are adhering to. We'll negotiate a new contract whenever this one comes up and it would be what it would be, but there is a lot of discussion in South Africa obviously about the political conditions and the governmental conditions, of regulatory conditions, and various policy proposals are being made by various people but if one looks at what is actually happening with respect to the government and policy and law and then our relationships with our own colleagues, I think what you'll see is a pretty much of a steady state.

You see the government is as with many other natural resource rich countries seeking to find the optimal balance between sharing the wealth of the natural resources that they have with the infrastructure of society generally, but not so much that it precludes effective and profitable business in their country. And South Africa, the ANC looked at these some of the more extreme suggestions over the last year and adopted a policy rejecting them. So that there is political risk every where in the world, but our sense of South Africa is we're certainly on day-to-day, its working fine and we have confidence about the future.

Operator

Our next question comes from Brian Reilly with Barclays.

Brian Reilly - Barclays

Just really quickly, obviously, appreciating all the qualitative commentary on your outlook, but I think it's fair to say that 2012 was a bit confusing. Obviously, a tale of sort of two halves and sort of exiting the year with a lot of puts and takes, I appreciate that, but close to $200 million of EBITDA. Is there anything I think more you could say on sort of 2013, '14, '15 in your earnings power? Again, I think people are a bit confused on sort of where EBITDA is trending, and if you could put any numbers around that I think that would be helpful?

Thomas Casey

That's something that corporate executives are really anxious to do, but for specific numbers, three years out. But let me tell you, how we think about it, all right. If you assume prices, prices at the peak were, John, $4,000 sold on average.

John Romano

A ton.

Thomas Casey

And prices now are closer to $3,000 a ton. So somewhat price stable and then the price now is a reflection of the fact that demand fell so sharply in 2012, again because we think the stocking was literally two-thirds or more of the explanation for that. So the stock are not infinite, therefore demand will restore and we think that's happening in the first half of 2013.

So let's assume prices go back to not a shortage condition, but rather a sort of mid steady state kind of condition. And I'm not predicting this, but just to think about how we think about the business. Assume it's just halfway between the peak and where we are now, so similar to $3,500.

We look at the conversion cost of our business, that is to say, what the total cost to take a ton of feedstock or in our case 1.1 tons, because that's what it takes us to produce a ton of titanium pigment and we add up all of the cost associated with that, and that is one element of the calculation. And the other is the cost of the feedstock itself.

So if you're operating at conversion cost of between $1,000 and $2,000 just to pick a broad range, and I think if you looked at data on cost, the actual production cost for these plants, then you would find some plants at the bottom-end of that range and some plants at the top. But let's just assume again for the sake of this hypothesis that you're talking about somebody whose functioning in the middle and cost you $1,500 a ton to convert the feedstock. It then costs the feedstock itself, we will recapture the margin remember.

So the only additional cost to us is the actual extraction and processing costs, which various people have estimated at anywhere between $50, as Dan said to attrition, the stock pile we have now. It's probably $600 or $700 maybe at the very expensive end for highly processed high-grade feedstock. Again assume something in middle for illustration, that's whatever it is, $350, $400 of cost on top of the $1,500, and you've got $200 of contribution margin to the overhead.

So essentially, you have $1,500 plus $400 plus $200, $2100. If the price is $3,500, that's a margin of $1,400 a ton. If your conversion costs are higher, if your feedstock costs are higher, as is the case we think with a number of other participants in the market, then obviously you're not going to have them. And then you just have to assume volume.

The way we think about volume is, volume goes back to relatively full utilization of the plants across the industry, plus new bills, and there are no new bills that we are aware of other than China, before 2015. DuPont just announced I think in their last call that they were deferring the expansion of Altamira.

There might be a few debottlenecking initiatives, which is 1% to 2% a year capacity attrition. There will be some Chinese sulfate production and there'll be some Chinese sulfate plants that go out of business net-net, that's probably not going to be a huge number in the next three or four years.

And you look at demand I think that we expect that demand will continue to grow at the normal historical rates, faster in the emerging markets than in the developed markets. So kind of on average a 3% sort of growth rate. And the industry right now is 6.5 million tons, so that's 200,000 tons a year of growth.

And you should do the math and figure out where you're going to be, and I think plant utilization rates conceivably are at 90% or so for that entire period of time, which means you're getting pretty good margins. You're getting some pricing, not 2011 pricing, but some pricing, and the numbers fall out of that. I don't know if that's helpful, but that's sort of all of the information I think I can give you right now.

Brian Reilly - Barclays

And then just maybe one more follow-up if I could more on the balance sheet side. You do make specific mention on, I believe it's Slide 7, around the evaluation of refinancing of the term loan, given and I'll just quote, current debt market environment and our strong cash position. I guess if you wouldn't mind, could you maybe clarify what you are thinking in terms of your existing north of $700 million cash position, as you look at a term loan that is about that size, obviously talked about, that does have strategic value for you? But would there be some contemplation of maybe slight term loan pay downs or delevering what the cash that was otherwise earmarked for things like special dividends and maybe strategic alternatives in the future as you look at that?

Daniel Greenwell

I mean when we look at our cash position, I think Tom was clear earlier when we said we don't need $700 million to run the business on day-to-day basis, but we'd like to keep some dry powder and may even add to that, but we'll just stop with where we're right now. So I think that's where we want to be.

With regard to the current debt markets, they're very attractive right now. I mean interest rates are pretty low. There is a strong appetite for credit out there, particularly from new credit. So I think we're looking at that. We're also looking at what covenants are required these days, and it looks to me that there is some flexibility on those. So we'll see what's out there, test the market on that as well.

And then with respect to special dividend, I think we were clear at the end of the third quarter that we don't anticipate making any special dividend at current time or in the near foreseeable future. So I don't think shareholders should expect to see a special dividend, but I think there is a better return on the funds that we have in a strategic position that we're at. I think we can grow the business organically and inorganically, and I think that's something we would look seriously at.

Brian Reilly - Barclays

And then maybe just one last one, again sort of on the heels of that. Obviously, one of your competitors has been pretty public around their intention to exit the business. Would there be any reason, and I don't want you to have comment specifically on that, but is there any reason that an asset in Europe would be attractive or not attractive to you guys? I know you have one plant in Netherlands just sort of the strategic landscape as you look at it, given what some of the public comments are out there in the market?

Thomas Casey

There are a number of assets that we think might be available, and I assume you're referring to Rockwood and to the Sachtleben portfolio. We know that quite well of course. And heard again, which is one of their three plants is one that we used to own. So we know it extremely well. We don't own it anymore. So that's something about our view.

But we know the facilities, and they have an interesting business, it's somewhat different from ours. It tends to supply relatively high quality material to different markets than we do. Those markets are generally speaking more stable than ours, they are more specialized. And so there is a reason for us to certainly think about that.

There are other assets either individually or in combinations, where also the owner might be willing to have a conversation. We haven't had any conversations with anybody yet. But it's a moment in the industry in which there maybe opportunities to create value through strategic activity rather than pay special dividends, which I would endorse and reiterate Dan's view that we do not intend to do or do buybacks, which I've already explained why we can't do or dramatically de-lever at this point.

We think that the best use of our potential resources is to at least consider value through strategic opportunities. If it turns out that they're not really available or they're not value creating, then we won't do it. But if they are, then we want to be in a position to do it.

Operator

Our last question comes from Richard Hatch with RBC.

Richard Hatch - RBC

Just to clarify on your plant utilization, so you're currently running about 75%. Do you see that getting up to 85%, 90% by the end of the year? Is that fair and a sort of a gradual ramp-up or what's your view there?

Thomas Casey

The premise of our performance, our view of 2013, which is that it gets betters as in the second half of the year, includes that exact assumption that we move up from the average utilization rate to a higher rate in that high 80s or low 90s range that you talked about. The 75% average, you should also be aware, we're not going to talk about the individual plant utilizations, but it varies across our plants. The lowest cost plants we're operating harder that is more completely than the higher cost plants, trying to capture the benefit of their efficiency.

Thank you very much everyone. We really appreciate your time as always. We will be back in touch with you and if not before, certainly next quarter. So thank you very much.

Operator

Ladies and gentleman, this does conclude today's presentation. You may now disconnect now and have a wonderful day.

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