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Olin Corporation (NYSE:OLN)

Q2 2009 Earnings Call

July 28, 2009 10:00 am ET

Executives

Joseph D. Rupp - Chairman of the Board, President, Chief Executive officer

John E. Fischer - Chief Financial Officer, Vice President

John L. McIntosh - Vice President and President - Chlor Alkali Products Division

Larry Kromidas - Assistant Treasurer and Director of IR

Analysts

Frank J. Mitsch - BB&T Capital Markets

Christopher W. Butler - Sidoti & Company LLC

Edward H. Yang - Oppenheimer

Donald Carson - UBS

Michael Judd - Greenwich Consultants

Greg Goodnight - Unidentified Company

Christine McDuffie (ph) - Goldman Sachs

Michael Waferman (ph) - Morris & Cabot (ph)

Good day, ladies and gentlemen, and welcome to the Olin Second Quarter 2009 Earnings Conference Call. My name is Michelle and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator's instructions) As a reminder, this conference is being recorded for replay purposes. And I would now like to turn the presentation over to your host for today's call, Mr. Joseph Rupp, Chairman, President and CEO. Please proceed.

Joseph D. Rupp

Thank you. Good morning, and thank you for joining us today. With me this morning are John Fischer, Vice President and Chief Financial Officer; John McIntosh, Vice President and President of our Chlor Alkali Products Business; and Larry Kromidas, our Assistant Treasurer and Director of Investor Relations.

Last night we announced that net income in the second quarter of 2009 was $27.8 million or 36 cents per diluted share, compared to $35.5 million or 47 cents per diluted share in the second quarter of 2008. During the second quarter of 2009, the Winchester business achieved the highest level of quarterly sales and earnings in the history of the business. These results reflect the continuation of the stronger-than-normal demand that began in the fourth quarter of 2008. Winchester earnings doubled in the second quarter of 2009 compared to the second quarter of 2008, driven by commercial sales, which increased 33% year over year. Chlor alkali earnings declined 32% in the second quarter of 2009 compared to the second quarter of 2008. This decline reflects lower shipment volumes of both chlorine and caustic soda, which declined 32% year over year. ECU netbacks in the second quarter of 2009 declined slightly compared to the second quarter of 2008. The second quarter 2009 chlor alkali operating rate was 70%, which was slightly improved from the first quarter 2009 rate of 65%, but well below the second quarter of 2008 rate of 89%. Third quarter 2009 earnings per share are forecast to be in the 20 cents per diluted share range. This forecast includes an anticipated $44 million pretax recovery of environmental costs incurred and expensed in prior periods. The combination of the precipitous decline in caustic soda prices and the continuation of weak demand will likely result in a third quarter segment loss in the chlor alkali business. ECU netbacks are expected to decline approximately 40% in the third quarter of 2009 when compared to the second. Winchester expects continued strong demand in the third quarter of 2009 with earnings comparable to the second quarter, which were well above historic levels.

During the second quarter, the chlor alkali business, and more specifically, the caustic soda business, began to catch up to the overall economy. From the perspective of Olin, in a declining economic environment, the chlor alkali business typically lags the general economy by 1-2 quarters. While we saw the overall economy decline beginning the fourth quarter of last year, these declines were not fully evident in our business until the second quarter of this year. The declines, which we expect to continue into the third quarter, are most evident in demand for caustic soda. While these declines are following a normal cyclical trend, the rate of decline has been more rapid than we have experienced in prior cycles. We believe this rate of decline reflects the severity of the slowdown in the overall economy. That said, we're clearly entering a cyclical trough period for the business sooner than we anticipated, and our third quarter outlook obviously reflects this.

Now let me discuss the chlor alkali and Winchester segments in more detail. First chlor alkali. The three major issues our Chlor Alkali Products business continued to face during the second quarter were the weak demand environment that we began to experience during the fourth quarter of 2008, the resulting impact on caustic soda prices, and the lack of visibility. As I just mentioned, combined chlorine and caustic soda volumes declined 32% from the second quarter of 2008, and during the first six months of 2009 these volumes have declined 31%. During the second quarter, we experienced some improvement in chlorine demand compared to the first quarter, but we saw continued declines in caustic soda demand. At this juncture, chlorine demand exceeds caustic soda demand. We believe, however, that the quarter-over-quarter increase in chlorine demand only reflects normal seasonal patterns. The weakness in chlorine demand is reflected in the 32% year-over-year decline in chlorine shipments to vinyl's customers. The 59% decrease in shipments to urethane customers and the 23% decrease in shipments to titanium dioxide customers. The decline in demand is also reflected in our operating rate, which was 70% in the second quarter of 2009 compared to 89% in the second quarter of 2008. Our third quarter 2009 operating rate is currently projected to be in the 70-75% range.

We also experienced a decrease in demand for both hydrochloric acid and potassium hydroxide. These also reflect significantly weaker end-market demand. Two of our largest markets for hydrochloric acid are steel production and oil and natural gas drilling, and the largest market for potassium hydroxide is agricultural chemicals. The bright spot in the business was the year-over-year improvement in bleach shipments, which increased 13% in the second quarter of 2009 compared to the second quarter of 2008, and they've increased 12% during the first six months of 2009. Bleach accounted for approximately 10% of the chlorine shipped by Olin during the second quarter of 2009, and as we've said before, bleach is an attractive market for Olin for several reasons. Bleach consumes both chlorine and caustic soda, is a value-added product that typically commands a $100-200 premium in the market when compared to that of chlorine and caustic soda, and in addition, because bleach typically contains 80-90% water, it is both expensive and difficult to ship long distances, which makes the geographic location of our manufacturing plants an asset in serving these regional markets.

We continue to look at opportunities to expand this business. During our first quarter earnings remarks we described an erratic ordering pattern for chlorine, and during the second quarter we have seen that extend to caustic soda. Large chlorine customers continued to have significant variations in order size from month to month. On the caustic side, likely in reaction to declining prices, we have seen customers reduce inventory levels and place orders on an as-needed basis only.

For the past six months, caustic soda pricing has been negatively impacted by several factors. Early in 2009, the significant difference between caustic soda prices in Asia and caustic soda prices in North America created an export opportunity for Asian producers. The increase in export shipments that occurred put pressure on North American prices. This situation was, in our view, compounded by North American production levels that while approximately 25% lower in the first half of 2009 when we compare it to 2008, they still exceeded the level of caustic soda demand, and this put further pressure on caustic soda prices. And finally, in a market where prices are declining, it is not unusual for the consumers of caustic soda and the large distributors to reduce inventory levels in anticipation of lower prices. This has occurred throughout the first half of 2009, and this results in higher inventory levels at the producers, which further pressures prices. As a point of reference, Olin's caustic soda inventories have been approximately 70% higher than normal during the first six months of 2009.

Recently we have seen positive signs for our caustic customers, that their inventory levels have bottomed out. Our ECU netback in the second quarter of 2009 was $585 compared to $590 in the second quarter of 2008. The second quarter 2009 netback was lower than we had forecast, which reflects a larger-than-expected decline in caustic soda prices. We experienced a $190 decline in caustic soda prices from March to June. And that said, the year-over-year second quarter 2009 caustic soda prices actually increased compared to the second quarter of 2008. This increase was more than offset by year-over-year declines in chlorine prices.

We currently expect ECU netbacks in the third quarter of 2009 to be significantly lower than the second quarter of 2009 due to a continued decline in caustic soda prices. We're forecasting a 40% decline in our ECU netbacks. Due to the nature of our contracts, the positive impact of chlorine price increases in our system typically lags the announcement by two quarters. Chlorine prices in the third quarter of 2009 are expected to improve compared to the second quarter, with a continued improvement into the first quarter of 2010. And as a reminder, there were three chlorine price increases totaling $300 per ton announced during the second quarter.

In spite of the weak volumes, we continued to see freight costs increase during the second quarter. Freight costs per ECU increased 9% during the second quarter of 2009 when compared to the second quarter of 2008. A positive for the business is electricity costs: The lower operating range we have running significantly increases the opportunities to optimize these costs. And as a result, electricity costs per ECU produced declined 12% in the second quarter of 2009 when compared to the second quarter of 2008. In the second quarter of 2009, electricity costs per ECU were also lower than the first quarter of 2009.

During the second quarter, we continued to make progress toward the completion of our Saint Gabriel, Louisiana conversion and expansion project. The project will be completed late in the third quarter, and it has experienced some delays due to higher-than-normal water levels in the Mississippi River, which delayed the installation of a Bryant pipeline. The Saint Gabriel facility, which represents approximately 10% of our total chlor alkali capacity, has been idled since the fourth quarter of 2008. At current demand levels, the Saint Gabriel startup will require a curtailment or idling of other facilities in our system.

Finally, during the second quarter of 2009, a bill was introduced in the United States House of Representatives, which, if enacted, would ban the production of chlor alkali products using mercury-cell technology two years from the date it is enacted into law. A companion bill was introduced in the United States Senate earlier this month. Olin currently operates two facilities which utilize mercury-cell technology, totaling approximately 350,000 ECUs, or 18% of our capacity. Olin has and continues to operate these facilities in full compliance with all rules and regulations. We are closely monitoring the progress of these bills, but it is too soon to estimate the likelihood of enactment and therefore to determine what impact they will have on Olin or the chlor alkali industry.

Now turning to Winchester: During the second quarter, Winchester experienced a continuation of the higher-than-normal levels of demand that began in the fourth quarter of 2008. We continued to see elevated demand across the majority of the product lines, including rifle, pistol and rimfire ammunition. We also continued to see a weakness in powder-actuated tool volumes, which are directly related to the construction activity. Winchester's record second quarter 2009 sales of $140.6 million represents a 21% increase over the second quarter of 2008. Commercial sales increased by 33%, which reflects a 34% increase in units shipped. Contract sales, which include military and law enforcement activities, increased 5% in the second quarter of 2009 when compared to the second quarter of 2008.

In addition to the record level sales, Winchester continued to see its backlog increase. The commercial backlog at the end of the second quarter of 2009 was $240 million, which represents a 62% increase from the backlog level at the end of the first quarter of 2009, and it's more than triple from last year's level. Total backlog, including military and law enforcement contracts at the end of the second quarter, was $395 million. A word of caution on the backlog: It has been our experience in the aftermath of periods of heavy demand that some of the commercial backlog is ultimately cancelled by our customers.

The higher level of demand allowed Winchester to exceed our prior expectations and for the second consecutive quarter realized the highest level of quarterly earnings in the history of the business. Winchester earned $19.1 million in the second quarter of 2009 compared to $9.5 million in the second quarter of 2008. The prior record quarterly earnings were $17 million in the first quarter of 2009, and the record quarter level prior to that was $11 million.

Winchester's segment earnings during the first six months of 2009 of $36.1 million exceed the previous full-year record earnings of $32.6 million. Winchester's quarterly results benefited not only from the higher volumes, but also improved pricing, lower commodity costs, and other material costs.

Winchester expects to experience lower commodity and other material costs in the third quarter of 2009, when compared to the second quarter. The question we continue to be asked about the Winchester business is how long can this last? The third quarter 2009 will represent the fourth quarter of this increase in demand, and as the backlog numbers I just discussed indicate, there is no apparent end in sight. The conditions that typically fuel an increase in ammunition purchases, the threat of regulatory action and economic uncertainty, both continue to be prevalent in the market.

It's important for me to commend the Winchester organization, I believe, on how well they have performed over the past several quarters. There have been significant manufacturing logistical challenges in managing a 30% increase in a commercial volume, and they have occurred without incurring unfavorable cost variances. As Winchester's results illustrate, they have been very successful.

In summary, the rate of decline in the chlor alkali industry was more rapid than we expected, and we are disappointed by our third quarter 2009 outlook. That said, I believe actions taken during the second quarter within the industry to idle capacity and to increase chlorine prices bodes well for the long term. Within Olin, we have left our St. Gabriel facility idle, and we are preparing to idle additional capacity. As we move through the balance of 2009 and into 2010, we will reduce both costs and capital spending aggressively.

We are well positioned financially with a strong balance sheet as we enter into the cyclical trough in the chlor alkali business. Our balance sheet and cash management remain strong, as evidenced by our quarter-end cash balance, which increased by $24 million during the second quarter of 2009 into $192 million.

Now I'd like to turn the call over to our Chief Financial Officer, John Fischer, who will review several financial items with you. John?

John E. Fischer

Thank you, Joe. First, I'd like to discuss a few items on the income statement. Selling and administrative expenses increased $500,000, or 1%, in the second quarter of 2009 compared to the second quarter of 2008. The increase was primarily due to a $2.9 million increase in legal and legal-related settlement costs. A significant amount of these legal costs relate to the recovery of environmental costs that were incurred and expensed in prior periods, which we anticipate realizing in the third quarter.

The balance related primarily to legal costs for other legacy environmental sites, both former manufacturing and waste disposal sites. The increase was offset by decreased management incentive costs of $2.6 million, primarily related to favorable mark-to-market adjustments on stock-based compensation. The favorable mark-to-market adjustment reflects an approximately $2 per share decline in the Olin stock price during the second quarter.

Second quarter 2009 selling and administrative expense decreased by $3.1 million compared to the first quarter of 2009 due to a lower level of bad debt expense. During the first quarter of 2009, both the chlor alkali and Winchester businesses encountered credit issues in their customer base. These issues did not occur in the second quarter.

Second quarter 2009 environmental investigatory and remediation expenses were $7.2 million compared to $9.7 million in the second quarter of 2008.

Second quarter 2009 expense includes approximately $800,000 of recoveries from third parties of costs incurred and expensed in prior periods. These expenses related primarily to remedial and investigatory activities associated with former waste sites and past operations. As Joe mentioned earlier, we are anticipating a $44 million pretax recovery in the third quarter of environmental costs incurred and expensed in prior periods.

Without giving consideration to the anticipated $44 million recovery in the third quarter, we currently expect full-year 2009 charges for environmental investigatory and remedial activities will be in the $20-25 million range. As a further point of reference, we believe that additional cost recoveries of environmental expenses incurred and expensed in prior periods are possible. The timing of these recoveries, which have the potential to be material, is difficult to predict. We last experienced material and environmental recoveries in 2005.

On a total company basis, defined benefit pension plan income was $4.8 million during the second quarter of 2009 compared to $1.9 million of defined benefit pension plan income in the second quarter of 2008. Second quarter 2008 defined benefit pension plan income included an $800,000 curtailment charge associated with the conversion of our Macintosh Alabama chlor alkali hourly workforce, from a defined benefit pension plan to a defined contribution pension plan.

We are not required to make any cash contributions to our domestic defined benefit plan in 2009, and also believe it is unlikely we will be required to make any cash contributions in 2010.

Defined contribution pension expense in the second quarter of 2009 was $3 million compared to $2.4 million in the second quarter of 2008.

During the second quarter of 2009, there were approximately 20% more employees participating in the defined contribution plan than there were in the second quarter of 2008.

The tax rate for the second quarter was 37.9% compared to 35.2% in the second quarter of 2008, and 37.2% in the first quarter of 2009.

The second quarter 2009 tax rate included several out-of-period adjustments that increased second quarter 2009 tax expense by $1 million. Based on these items and our revised outlook for the business, we now forecast the full year 2009 tax rate to be in the 35-36% tax range.

Now, turning to the balance sheet. As Joe mentioned, cash and cash equivalent to June 30th, 2009 were $192.2 million, compared to $186.4 million at June 30th, 2008, and $168.6 million at the end of March 2009. The year-to-date increase in working capital during the first six months of 2009 has been approximately $50 million less than the first six months of 2008. The slower increase reflects the higher than normal level of Winchester activity in the fourth quarter of 2008, which resulted in higher-than-normal beginning of the year levels of receivables.

Working capital has also been affected by the lower levels of chlor alkali sales during the first six months of 2009, partially offset by higher caustic soda inventories. Olin typically experiences a $50-100 million increase in working capital during the first two quarters of each year due to the normal seasonality in the ammunition, vinyls and bleach businesses.

Capital spending during the second quarter of 2009 was $37.8 million compared to $39.3 million in the second quarter of 2008. Year-to-date capital spending has totaled $87.6 million compared to the first six months of 2008 spending of $62.4 million.

Approximately 71% of the second quarter and 66% of the year-to-date spending in 2009 has been for the St Gabriel, Louisiana conversion and expansion project.

We expect capital spending in the third and fourth quarters of 2009 will be approximately 50% lower than the first and second quarter 2009 levels.

We have reduced our full year 2009 forecast to the $130-$135 million range from our previous forecasts of $135-$140 million. We now expect full year 2009 depreciation expense to be in the $75 million range.

On July 23rd, Olin's board of directors declared a dividend of $0.20 on each share of Olin common stock. This dividend is payable on September 10th, 2009 to shareholders of record the close of business on August 10th, 2009. This is the 331st consecutive quarterly dividend to be paid by the company.

Before we conclude, let me remind you that throughout this presentation, we have made statements regarding our estimates of future performance. Clearly, these are forward-looking statements, and results could differ materially from those projected. Some of the factors that could cause actual results to differ are described without limitations in the risk-factor sections of our most recent form 10-K, and in our second quarter earnings release. A copy of today's transcript will be available this afternoon on our website in the investors section under "calendar of events." Earnings press release and other financial data and information are available under "press releases."

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

(Operator's instructions) Your first question comes from the line of Frank Mitsch of BB&T Capital Markets. Please proceed.

Frank J. Mitsch - BB&T Capital Markets

Good morning, guys. On the environmental recovery, refresh our memory. 2005, the recovery then, was that order of magnitude was something like, what, $15-20 million?

John E. Fischer

It was $48 million, Frank.

Frank J. Mitsch - BB&T Capital Markets

Oh, it was $48 million.

John E. Fischer

Yes.

Frank J. Mitsch - BB&T Capital Markets

Right, so it was a similar size to what you realized this time. And when you talk about referring to prior periods, how far back are you going in terms of these recoveries?

John E. Fischer

We're going back into the 1950s.

Frank J. Mitsch - BB&T Capital Markets

(Laughter) Actually, I wasn't around then. All right, so I think, John, you eluded that we might possibly see more of these down the line as well?

John E. Fischer

We said additional recoveries that are material are possible, yes.

Frank J. Mitsch - BB&T Capital Markets

All right. Okay, thanks. And then, I think you indicated that absent these recoveries, the spending that you've been doing right now is ticking along at a normal rate.

John E. Fischer

Yes, that's correct.

Frank J. Mitsch - BB&T Capital Markets

All right. I think you're talking about chlorine price hikes, three of them being implemented as we speak here in the third quarter, perhaps some in the first quarter. But I guess from your perspective, you're likely to see most of those increases in the first quarter?

John L. McIntosh

Frank, this is John McIntosh. Let me talk just a minute about chlorine price increases and chlorine contracts to try and put those two things in perspective.

There were two price increases in May and one in June, so all three second-quarter price increases in aggregate total $300 a ton. Those increases have now been reflected, starting in indices that were published in July, which is the beginning of the third quarter. You may remember that our contracts have lags built into them, and so in a general sense, increases announced in any quarter would typically be recognized in a subsequent quarter, and then quarters after that we would get some realization of value. So in this specific case, we have second quarter announcements. They are being recognized in published pricing for the third quarter, and we should start to see the impacts of those in both Q4 and in Q1 of 2010. This isn't a ceiling issue for us; it's just a normal contract lag issue.

Frank J. Mitsch - BB&T Capital Markets

All right. Great. And John, if you look at where caustic prices are falling here in the third quarter, it would almost suggest that you would see a bottoming of the ECU prior to year-end with chlorine moving up. Is that how we should think about that?

John L. McIntosh

I think it's just as likely that that will be the case, Frank, that we would see it by the end of the year. A lot has to deal with the phenomenon of inventories. Caustic inventories are high, and those inventories are being reworked now or being worked out of the producer system, and I think that's putting some additional pressure on pricing. But hopefully, that phenomenon will be over, and we will see the trough before the end of the year.

Joseph D. Rupp

I think, Frank, just to come back to the – this is Joe. John's point is the inventory has got to clear out, and that's really where we are. We're expecting those inventories to clear out here in the last two quarters of the year. When that happens, we'll have bottomed out.

Frank J. Mitsch - BB&T Capital Markets

I think you were suggesting that it was more of an issue at the producer level than at the customer level right now.

Joseph D. Rupp

What's happened is that the customers aren't ordering, and it's backed up with the producers. That's what's happened. So we have to clear our inventories out. Customers have managed their inventories to almost zero levels because they're anticipating – have been anticipating – lower pricing, and so they're going to wait until they think pricing is close to the bottom before they replenish.

Frank J. Mitsch - BB&T Capital Markets

All right, great. Joe, I think in your remarks you talked about some cost-reduction efforts in the latter part of the year. Is there any way that you could quantify that for us?

Joseph D. Rupp

We won't, but we'll be quantifying that as we move forward, Frank.

Frank J. Mitsch - BB&T Capital Markets

All right, great. Thanks, guys.

Joseph D. Rupp

Thank you.

Operator

Your next question comes from the line of Christopher Butler of Sidoti & Company. Please proceed.

Christopher W. Butler - Sidoti & Company LLC

Hi, good morning, guys. I just wanted circle back on the pricing environment. Some of this you touched on, but we're looking at customers reducing inventory; we're looking at imports that were coming in from Asia. Both of these things would seem that given enough time should dissipate to some degree. Is that your expectation, and will that help solidify caustic soda prices?

John E. Fischer

Chris, this is John. If you look at caustic soda demand in the first half of 2009 and compare it to 2008, you know, every market segment has double-digit decreases in demand led by aluminum, pulp and paper that bear an excess of 20%. So that has created the obvious demand backdrop for caustic inventories across North America that have increased, creating a situation where pricing pressure has caused this precipitous drop in caustic pricing. Those things will work themselves out. The timing is unclear, but we expect that there will be some beginning of return to demand in some of those key sectors, and we obviously expect that inventories will be worked out.

Christopher W. Butler - Sidoti & Company LLC

And as far as the imported caustic, have you seen a slowdown on that front?

John E. Fischer

That's just relatively dried up. For sure, imports from China have really gone back to the normal historical operation mode, where they're importing into the West Coast, where they traditionally have. There are very few imports into the East Coast. There is some material coming in from Europe, but in Europe their situation is not good either. Demand is down, inventories are high for the European producers, and so in some cases they're trying to import products into the Eastern US. But the current pricing for caustic in North America really precludes much capability for anybody to import successfully.

Christopher W. Butler - Sidoti & Company LLC

In shifting gears to the mercury bill a little bit, the first thing that occurs to me, if I'm not mistaken, the bill was first proposed about a year and a half ago, a time at which 2012 seemed a more reasonable timeframe. As it continues to be reviewed, do you think 2012 is a reasonable timeframe for the final bill? And what kind of costs are we looking at to upgrade your two facilities?

John E. Fischer

The cost to upgrade our facility, as we have talked about in the past, is in the $800 to $1,000 dollar per ECU range, and as we indicated, we have 350,000 ECUs at these two facilities, the types of costs to upgrade. As far as 2012, we believe that's too tight a timeframe, but the government's going to decide what they want to decide.

Christopher W. Butler - Sidoti & Company LLC

Looking at the balance sheet a little bit, it seems that if we're looking at losses on the chlor alkali side, and they continue into 2010 to any degree, the leverage ratio, as far as you get governance, starts to become a bit of a question. You do have cash on the balance sheet. Do you expect that you'd use cash to reduce debts here looking forward?

John E. Fischer

Chris, the next time we have a debt payment is at the end of 2011, which is $75 million. I think if we did a forecast with the cash on the balance sheet, the liquidity of the company would clearly allow us to repay that. We do have debt covenents in our revolving credit agreement that are cash-flow based, and obviously a prolonged period of negative earnings could create some issues there. Those issues are not immediate.

Christopher W. Butler - Sidoti & Company LLC

I appreciate your time. I'll go back, thank you.

John E. Fischer

Thanks.

Operator

Your next question comes from the line of Edward Yang of Oppenheimer. Please proceed.

Edward H. Yang - Oppenheimer

Hi, good morning. I'd like to ask the previous questions maybe in a different way. In terms of chlor alkali pricing, chlorine price is up, caustic prices are down. Isn't that typically what you see at the start of a new chlor alkali cycle?

John E. Fischer

That is correct.

Edward H. Yang - Oppenheimer

Okay. When I look at industry ECU debt-backs this morning, they're up about 25% from a couple of weeks ago on a contract basis, and they're up on a spot basis as well. You've mentioned that you've seen pricing with somewhat of a lag versus the industry. Not to jump the gun, but this is the first sort of price increases we've seen for the entire chain in the last seven months or so. So is it possible that again we're kind of looking at the rearview mirror in terms of the chlor alkali bottom?

John E. Fischer

To come back to it, Edward, I think that the point that John McIntosh made earlier, which is that we've got to get the inventory cleared from a caustic perspective. I think that once we get that accomplished, then all of the above is true.

Edward H. Yang – Oppenheimer

Okay. And caustic prices on a spot basis, they're fallen about 93% from the peak, so I think mathematically you would start not to see any more downside there. If caustic prices do start to rebound, would the magnitude of the increases relative to your historical experience be similar to what you're seeing in the chlorine price increases currently? You know, chlorine prices on a percentage basis are up roughly a quintuple or so on a spot basis.

John E. Fischer

I would think that when you look at caustic prices going forward, you're going to have to have some demand in the segments where caustic is consumed, and you're going to have to have some general economic recovery across the entire economic sectors before you're going to see the dynamics for caustic price increases.

And so I think we've got the phenomena of inventory overhang to work through, and then we've got the phenomenon of some type of recovery in the economy that translates into a latent increase in demand for caustic, which typically lags economic recovery by a quarter or two.

Edward H. Yang - Oppenheimer

Okay. And, John, it sounds like your guidance for ECU net back in the third quarter is in the $351 range, and again, on your guidance it looks like the chlor alkali business will have negative margin. And comparing to previous periods when you had ECU net backs in that range, you were actually profitable — I mean, is the disconnect really just on a function of the plant utilization?

John L. McIntosh

Volume is the hugest impact on what we're talking about here.

Edward H. Yang - Oppenheimer

And lastly, on CapEx spend, it's obviously been very elevated from the St. Gabriel upgrade. In the past, I think you've talked about trough CapEx or maintenance CapEx around 75% of SG&A. Is that still the right number? I guess it's something around $55 million or so on a going-forward basis?

John E. Fischer

We would say maintenance capital right now, Edward, is probably in the $60-65 million range. We would expect depreciation going forward to be something in the $85 million range. (Interposing) the project is in the full-year number.

Edward H. Yang - Oppenheimer

Okay. And lastly, on just potential uses for cash, you're sitting on almost $200 million of cash, you have an overfunded pension, the dividend is about $60 million a year, so that's pretty well covered, you've talked about bleach positively in your comments, and you've also mentioned previously other kind of acquisition areas. What's your thinking philosophically, Joe, in terms of fundamentals look kind of ugly right now, but is this precisely the right time to pick up the stressed assets?

Joseph D. Rupp

If we could find the right assets, Edward, we would go after them, to be quite honest about it, so if the question is do we still have an interest in expanding downstream into bleach, the answer is yes.

Edward H. Yang - Oppenheimer

And are any of the potential sellers, are they coming down in terms of price expectations?

Joseph D. Rupp

I suspect that most people's view of values is higher of what our view may be at this point in time.

Edward H. Yang - Oppenheimer

Okay. Thank you very much.

Operator

Your next question comes from the line of Don Carson of UBS. Please proceed.

Donald Carson - UBS

Yes, thank you. Just a question on bleach pricing and the impact on the third quarter ECU. Joe, you mentioned that bleach traditionally sells for $100-120 premium per ECU, but is that the case at these much lower ECU levels? And as you switch from a heavy bleach season in Q3 into Q4, what impact will that have on the ECU?

Joseph D. Rupp

Don, the premium for bleach typically tends to cycle, and in periods where ECU prices are dropping, that premium tends to be higher than it is when ECU prices are increasing. A lot of that's driven by the fact that there's a lot of bleach contracts that are annual contracts, especially in the municipal water treatment sector, so it tends to almost counter cycle with the direction for ECU pricing. So we're seeing that premium in our current bleach business via a more positive contributor.

Donald Carson - UBS

So, John, as that premium drops off, as you get into the seasonally slow fourth quarter for bleach demand, how much will that offset the positive impact of chlorine-contract price increases starting to roll through?

John E. Fischer

It will not be a significant offset.

Donald Carson - UBS

Okay. And, John, you had mentioned earlier that chlorine demand still remains quite weak. Do you think that pricing has peaked on chlorine? If you got up, say, to the upper-70%’s or 80% range for operating rates, would that result in chlorine prices kind of flattening out or even having to cut them in order to move more product, assuming that the dynamics of demand are there?

John E. Fischer

Well, I guess I would say that we looked at the — we've been on order control for chlorine for some period of time, and as we look at some of the market segments for chlorine demand, we have seen some very modest stabilization, if not slight improvement. However it's not sufficient because of where caustic inventories and caustic demand are to drive operating rates even higher, so we continue to see continued pressure on chlorine supply. And that's what drove the chlorine price increases in the second quarter. That number of increases and that kind of total, $300 a ton, is unprecedented for the chlorine side of the (inaudible) historically.

Donald Carson - UBS

I was going to ask, I mean, typically, how often are you caustic constrained on chlor alkali production? That's pretty rare, isn't it?

John E. Fischer

Very rare.

John L. McIntosh

This is real rare.

John E. Fischer

It's not happened probably since the last cycle since we were in the trough the last time, which was in the 1999-2001 time period.

Donald Carson - UBS

And so how would you see, as caustic demand improves and you can bump up chlor alkali production, how would you see chlorine price unfolding then?

John E. Fischer

Well, I think that it's going to improve the situation, but again, there's going to be the lag between when we actually see demand for caustic start to improve and that allows us to raise operating rates. And hopefully implicit with that will be an increase in demand for vinyls and the other key market segments where chlorine is consumed.

Donald Carson - UBS

Thank you.

Operator

Your next question comes from the line of Michael Judd, Greenwich Consultants. Please proceed.

Michael Judd - Greenwich Consultants

Yes, good morning. I just want to make sure I've got the right capacity numbers for you guys. So sort of on an annualized basis, in the second quarter you had approximately 1.7 million short tons, is that right?

John E. Fischer

If you don't include —

Michael Judd - Greenwich Consultants

Yeah. I'm excluding St. Gabriel. Is that right?

John E. Fischer

If you take St. Gabriel out on an annualized basis, it's about right. We're 1.95 million with St. Gabriel and half of Sunnyvale.

Michael Judd - Greenwich Consultants

And St. Gabriel has not been operating since when?

John E. Fischer

Since last November.

Michael Judd - Greenwich Consultants

Okay. And the plan is to bring it back up, did you say, in the latter part of the third quarter or fourth quarter? I'm sorry. I missed that.

John L. McIntosh

Third quarter, Mike. It's going to start up.

Michael Judd - Greenwich Consultants

When in the third quarter?

John L. McIntosh

The latter part of the third quarter it'll start up, in September.

Michael Judd - Greenwich Consultants

Okay. So does that imply that — I mean, usually things slow down at the end of the year, so the operating rates should decline even further right, in the December —

Joseph D. Rupp

Mike, what we said from our perspective is that we will aisle other capacity as we bring that back up.

Michael Judd - Greenwich Consultants

Would it be the same amount that you — because I understand when it's up it's —

Joseph D. Rupp

250,000 tons of capacity when it comes out.

Michael Judd - Greenwich Consultants

So will you take out the like amount somewhere else?

Joseph D. Rupp

We will balance our system, yes.

Michael Judd - Greenwich Consultants

Okay, all right. Thank you very much.

Operator

Your next question comes from the line of Greg Goodnight. Please proceed.

Greg Goodnight - Unidentified Company

Good morning, gentlemen. You mentioned that you had a 12% year-over-year reduction in electrical cost. I'm assuming some of that at least comes from natural gas. My question is, do you hedge gas, and if you did, what was the impact in the quarter?

John L. McIntosh

We do buy natural gas forward. We've not disclosed the impact of that.

Greg Goodnight - Unidentified Company

You're not a big gas user.

John L. McIntosh

The majority of our electricity favorability comes from the fact that we're operating at lower demand across our system, lower operating rates, and so therefore we're able to optimize the use of power and avoid buying high cost peak-power prices.

Greg Goodnight - Unidentified Company

Sure. And really that was going to be my second question is, what, under your current operating rate configuration, percentage of your electricity is obtained from coal-based sources, hydro sources, and gas sources, just roughly?

John L. McIntosh

I haven't done that calculation at the current operating rates, but the top four fuel sources for us are coal, hydro, natural gas, and nuclear.

Greg Goodnight - Unidentified Company

Okay, all right. So looking forward then to the next quarter, if gas prices stay where they are and other energy sources stay where they are, would you expect the same sort of year-over-year benefit from low electrical costs?

John L. McIntosh

Yes.

Greg Goodnight - Unidentified Company

Okay. That's all I had.

Operator

Your next question comes from the line of Christine McDuffie of Goldman Sachs. Please proceed.

Christine McDuffie - Goldman Sachs

Yes. Do you expect working capital to be a source of cash for 2009?

John E. Fischer:

Yes. We do.

Christine McDuffie - Goldman Sachs

Can you give us a sense of magnitude on that?

John E. Fischer

We have not, no. But if you look at the year-over-year change in revenue in chlor alkali, that will give you a good sense.

Christine McDuffie - Goldman Sachs

Okay. And in the $44 million pretax recovery for the environmental charges, will that be cash that you receive?

John E. Fischer

That will be cash that we receive, yes.

Christine McDuffie - Goldman Sachs

Okay. And can you explain how that works? I don't quite understand how that process works. Do you take a charge and then the actual costs are lower and you get some kind of cash back?

John E. Fischer

If you look at the details of our corporate and other section in our balance sheet, we have a category called environmental costs. Those are costs that we incur to remediate legacy sites, primarily former manufacturing sites and former waste disposal sites. For a period of time in our history we had insurance covering those and we have made claims to recover those costs after they've been incurred to recover from the insurance companies.

Christine McDuffie - Goldman Sachs

Got it. And then, you guys use FIFO accounting, could you break out the impact of using FIFO accounting in this environment of rapidly declining caustic prices?

John E. Fischer

We do not use FIFO accounting; we use LIFO accounting.

Christine McDuffie - Goldman Sachs

Okay. And if you were to shut down some of your facilities when you bring St. Gabriel back up, could you give a sense for which facility those might be?

Joseph D. Rupp

We wouldn't say that at this point in time.

Christine McDuffie - Goldman Sachs

Okay, thanks.

Operator

Your next question comes from the line of Michael Waferman, Morris & Cabot (ph).

Michael Waferman - Morris & Cabot

Good morning. In trying to understand the potential impact of the mercury cell chlor alkali plant legislation, how does the percentage of Olin capacity compare to the percentage that your competitors would need to upgrade also, should that legislation come to pass?

Joseph D. Rupp

We have four mercury-cell plants. We have two, another competitor has one, another competitor has the fourth one, and as we stated, Michael, 18% of our capacity is mercury-cell capacity.

Michael Waferman - Morris & Cabot

Right, do you know what the other percentages are?

Joseph D. Rupp

No.

Michael Waferman - Morris & Cabot

Okay. That's all I had. Thank you.

Operator

And that concludes the question-and-answer session. I'll now turn it back to Mr. Rupp for closing remarks.

Joseph D. Rupp

Thank you for joining us today and we'll look forward to speaking with you in October with results of our third quarter. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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Source: Olin Q2 2009 Earnings Call Transcript

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