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Axiall (NYSE:AXLL)

Q2 2014 Earnings Call

August 06, 2014 10:00 am ET

Executives

Martin Jarosick - Executive Director of Investor Relations and Strategic Planning

Paul D. Carrico - Chief Executive Officer, President and Director

Gregory C. Thompson - Chief Financial Officer and Principal Accounting Officer

Analysts

Brian Maguire - Goldman Sachs Group Inc., Research Division

John J. Hirt - Citigroup Inc, Research Division

James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division

Edlain S. Rodriguez - UBS Investment Bank, Research Division

Hassan I. Ahmed - Alembic Global Advisors

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

Christopher W. Butler - Sidoti & Company, LLC

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Operator

Good morning. My name is Brandi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Axiall Corporation Second Quarter Earnings Conference Call. [Operator Instructions] Thank you.

Mr. Jarosick, you may begin, sir.

Martin Jarosick

Thank you, Brandi. And good morning, everyone. Welcome to today's conference call to discuss Axiall's second quarter 2014 financial results. Joining me on the call today are Paul Carrico, President and CEO; and Greg Thompson, Chief Financial Officer.

There are presentation materials available for your reference on our website, and our press release issued yesterday afternoon with our second quarter financial results contains the forward-looking statement which is incorporated into and considered a part of this conference call. The discussion during the call will contain forward-looking statements reflecting Axiall's current view about future events. These statements involve risks and uncertainties that may cause actual results to differ. Axiall does not undertake any obligation to provide updates to these forward-looking statements.

This presentation also contains certain non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measure are provided in the earnings press release and the presentation materials available on our website.

For additional information, please refer to Axiall's filings with the SEC.

Now I'll turn the call to Paul Carrico. Paul?

Paul D. Carrico

Thank you, Martin. And good morning, everyone. Thanks for joining us today.

This morning, we'll comment on our performance for the second quarter, but before I do that, I'll directly address the operational issues at our PHH VCM facility. As we've previously disclosed, we had an outage at this facility, starting in December of last year. Since that time, we have completed a number of actions to include a full investigation into the cause of the fire and completion of the repairs to the unit and, finally, significant organizational changes to our management and operations team. As with most events such as this in a complex chemical manufacturing operation, the cause of the fire was the result of more than one factor. In this case, the event occurred during a furnace restart. Due to failures in both the restart procedures and control technologies, there was a hydrocarbon release. The hydrocarbons ignited when they came into contact with the air, resulting in a fire that damaged the furnace and surrounding equipment. Importantly, the safety and monitoring systems performed as designed, and we were able to contain the issue without any injuries to plant personnel.

As we've previously disclosed, our initial assessment was that we could make the required repairs to the unit and return it to service, targeting a start date earlier in the second quarter. However, as we executed the plan to return the unit to service, we determined that some associated equipment that had been targeted for simple repairs needed replacement rather than a repair. With this additional work included, we were able to return the unit to full operations in late June. There have not been any material issues with the unit since that time, and the unit operated at full rates throughout July.

I want to emphasize that I do not believe that this issue was caused by a lack of capital investment in these assets, nor do we believe that improving the operational reliability of these assets will require materially more capital than has historically been invested in these assets. The fact that this particular unit had a failure prior to the merger and another one in December of last year compelled me to look deeper into our organizational structure. Failures of this type and frequency are completely unacceptable to me and not consistent with my expectations for our chemical operations. Clearly, there is room for significant improvement going forward. With that in mind, we are approaching the future on many fronts to improve our performance. Specific to the organizational aspects of the site, we have made many changes, and I'll address some of the more important ones.

We split the manufacturing and commercial leadership responsibilities in our chemicals division. I have appointed George Biltz as the executive reporting to me, responsible for chemicals and manufacturing excellence. George joined us last year after a more than 30-year career with the Dow Chemical company. He and I will work together to lead the changes necessary to improve our manufacturing reliability.

Joe Breunig will continue to lead commercial matters for the chemicals business.

I believe this change will allow for the needed increased focus on manufacturing excellence without compromising the needed level of attention to the important commercial aspects of our business.

We have appointed a new manager for the Lake Charles site, and we have streamlined the Lake Charles management structure to improve coordination and accountability. We have also made other management changes in Lake Charles down to the unit management level, including the PHH unit.

Along with these organizational changes, we have looked at our equipment and organizational processes and made changes in those areas also. Many of these changes have already been made in our Plaquemine complex. And I highlight these changes so that you better understand how important I believe these matters are. As I said earlier, the unplanned outages at PHH are totally unacceptable to me and not close to what I've been accustomed to with our chemical operations over the years.

We've learned painful lessons from these failures. However, I'm confident the changes we have made will have the needed impact on our reliability. Be assured that if they do not, I am prepared to and will make whatever additional changes are needed to remedy the situation.

So now let's discuss second quarter results.

Axiall generated $128 million of adjusted EBITDA in the second quarter compared to $197 million in the second quarter of last year. Our second quarter results were negatively impacted by 4 key items.

First, ECU values have fallen considerably since this time last year, particularly on caustic. Our realized prices for the second quarter were materially lower than the same period last year and reduced adjusted EBITDA by $40 million. Second, our extended downtime at PHH reduced EBITDA by about $25 million from lost sales and higher maintenance expenses. Third, our Aromatics operating income results were approximately $12 million lower than the second quarter of 2013 due to lower operating rates and lower margins. And finally, natural gas was higher by about $0.60, which equates to about $10 million of higher cost.

These impacts were only partially offset by higher PVC margins and synergy capture. As we've entered the third quarter, we are seeing some relief from these headwinds. First, PHH is running at full rates. Second, PVC prices have held the 3 price increase announcements from the first quarter, and there's a price increase in the market for August. While PVC prices have improved, they fall far short of the value needed to offset the higher ethylene and lost ECU values. This is being reflected in the domestic spot market, as producers seem to be avoiding that market in this environment. The export market continues to be available, but there is the same challenge there, as costs should continue to push pricing higher. Then third, natural gas costs have come back under $4.

On the call in February, we expressed our belief that the ECU value was at or near the bottom. Now 6 months later, we still believe that. The ECU value has risen considerably since this time last year, mostly driven by heightened competitiveness in the market as new capacity was moved to secure volume contracts for 2014 supply, and in particular, due to the use of the spot market to place volumes.

For the second quarter, the industry was near the operating rates of 1 year ago despite all the capacity shifts. For the future, it appears that some forecasters and recent publications suggest consumer demand is increasing, which will eventually flow through to improved supply-demand balances for the ECU in general. Longer term, we continue to believe that the supply-demand balance for the ECU will be positively impacted by the natural gas advantage North America enjoys. There will be continuing opportunities for the industry to export both caustic and PVC. However, so far this year, we've experienced only modest increases in domestic and export demand for caustic, which does dampen the push for further caustic price increases.

At this time, I'll turn the call over to Greg to review our financial results in greater detail.

Gregory C. Thompson

Thank you, Paul. Good morning, ladies and gentlemen.

Let's look at our operating performance for the quarter. We reported net income attributable to Axiall of $27.2 million for the second quarter of 2014 compared to net income attributable to Axiall of $72.8 million for the second quarter of 2013.

In the press release, we list a number of adjustments related to purchase accounting, merger and integration activities. After adjusting for these items, we reported adjusted net income of $33.5 million for the second quarter of 2014 compared to adjusted net income of $84 million for the second quarter of 2013. In the second quarter of 2014, we generated $128.1 million of adjusted EBITDA compared to $197.9 million in the second quarter of last year.

Taking a look at the Chlorovinyls segment. We reported $121.6 million of adjusted EBITDA in the second quarter of 2014 compared to $177.6 million of adjusted EBITDA in the second quarter of 2013. This decrease was primarily driven by 3 large factors. First, ECU values were substantially lower than the same period last year, resulting in a $40 million decrease in adjusted EBITDA. Second, our extended outage at PHH reduced EBITDA by $25 million from lost sales and higher maintenance expenses. And finally, natural gas was higher by about $0.60, which equates to about $10 million of higher costs. These impacts were only partially offset by higher PVC margins and synergy capture.

Related to synergies, as you'll recall, we categorize synergies into 3 buckets: operating rate, procurement and logistics and SG&A. The operating rate synergy is measured across the full year by comparing our operating rates for Axiall to the operating rates achieved before the merger by the separate companies. We achieved this target in 2013. However, so far in 2014, the operating rate synergies have been overwhelmed by the unplanned outage at PHH. Now that PHH is back running at full rates, we expect to be back at the run rate target for operating synergies by the end of the year. The other 2 buckets of synergies are cost based, and in the second quarter, we achieved $23 million of synergies in these areas.

As you recall, in February earlier this year, we increased our annualized run rate synergy target for year-end 2014 from $115 million to $140 million. We are confident we will meet this target.

One final comment on the outage at PHH. We maintain insurance for these sorts of events, and we have begun to collect some of the property damage portion of that insurance. With respect to the business interruption loss, we retain the exposure for the first 60 days of any business interruption loss. We are not in a position today to provide an estimate of the potential recovery on the business interruption portion of our insurance claim, but we have been and will continue to work with our insurers on this matter and are confident we can arrive at an acceptable resolution with them.

We have also recently been sued in Louisiana state court in connection with the event. It is very early in this litigation. The litigation was filed last week, and so we are not able to provide an estimate of our exposure in this litigation, if any. Of course, we will vigorously defend this and any other litigation related to this matter. We also have insurance for such claims. If there are losses related to these claims under that insurance, we retain the first $25 million of such losses.

Now turning back to the operating results.

Our Building Products segment reported adjusted EBITDA of $24.7 million in the second quarter of 2014 compared to $28.2 million in the same quarter of last year. U.S. volumes continued the trend from last year and were up 18%, while Canadian volumes declined 9%. And currency impacts were unfavorable.

On a constant currency basis, total Building Products sales increased by 3%. The decrease in adjusted EBITDA was primarily due to the impact of the weaker Canadian dollar; higher distribution costs, mainly trucking related; and higher selling-related costs. The higher selling expenses are related to the ramp-up in sales activities needed to roll out innovative products such as select siding and Zuri decking.

For the second quarter of 2014, Aromatics generated negative $7 million of adjusted EBITDA compared to $4.6 million of adjusted EBITDA in the second quarter of 2013. The decline for this business in the second quarter was primarily due to lower export sales volumes of phenol driven by significant new phenol capacity additions in Asia during 2013, which also resulted in lower domestic cumene sales volume. Additionally, we had an inventory holding loss of $4.6 million during the second quarter of 2014.

SG&A expense for the second quarter of 2014 was $79 million compared to $76.6 million for the second quarter of last year. Our net interest expense was $19.1 million for the second quarter of 2014 and $19.4 million for the second quarter of 2013.

For the second quarter of 2014, we reported a provision for income taxes of $10.9 million at an effective tax rate of 28%. For full year 2014, we expect an effective tax rate between 25% and 30%. For cash taxes, we expect to pay a similar proportion of adjusted EBITDA as 2013, plus an incremental approximately $25 million due to a change in U.S. tax law, which currently eliminates bonus depreciation.

The total FIFO impact was a negative $6 million for the second quarter of 2014 compared to negative $9 million for the second quarter of 2013. The FIFO impact for both periods was split pretty evenly between Aromatics and Chlorovinyls.

Now let's discuss working capital. We define controllable working capital as accounts receivable plus inventory, less accounts payable. Compared sequentially, controllable working capital increased by $42 million from March 31, 2014, to June 30, 2014, primarily due to the seasonal increase in sales volumes, plus the ramp-up of PHH. Compared to the second quarter of last year, controllable working capital decreased approximately $104 million, primarily driven by lower sales in both Aromatics and Chlorovinyls.

On the cash flow statement, you will note that there's $38 million of cash provided by operating activities for the second quarter of 2014 as compared with $70 million for the second quarter of 2013. The decrease is primarily due to lower operating income.

Capital expenditures were $44.7 million for the second quarter of 2014 compared to $39.2 million for the second quarter of 2013. For 2014, we expect to invest about $200 million in total capital expenditures for maintenance and organic growth projects.

Before we open up the call for Q&A, let me make a few comments concerning our outlook for the third quarter.

Compared sequentially to the $128.1 million of adjusted EBITDA we reported in the second quarter of 2014, we see 3 positives: lower maintenance costs and increased sales volumes, all due to the higher operating rates at PHH; and lower natural gas costs. We expect these positives to be partially offset by higher ethylene costs. However, when you compare conditions today to conditions in the third quarter of last year, when we reported $175 million of adjusted EBITDA, we see 3 significant negatives: ECU values are materially lower, natural gas costs are materially higher, and ethylene costs are materially higher. We expect these significant negatives during the third quarter to be partially offset by lower maintenance spending and higher sales volumes.

Now we will open the call to your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Brian Maguire with Goldman Sachs.

Brian Maguire - Goldman Sachs Group Inc., Research Division

If I'm just adding up some of the -- what might be considered nonrecurring items for the quarter, it looks like you start with $128 million of EBITDA you reported. You'd add back the $25 million from the plant outage and maybe $6 million from the FIFO hit, and you get around $160 million. Is that kind of representative of what you think you would have done without the FIFO and plant outage?

Gregory C. Thompson

Yes, I think that's in the range.

Brian Maguire - Goldman Sachs Group Inc., Research Division

Okay. And then obviously, when you think about the bridge to the third quarter from there, you mentioned natural gas is down probably, I don't know, maybe $0.60, $0.70. So that seems like that could maybe add about $10 million. You mentioned ethylene may be a little bit of a headwind, but I know there's a PVC price increase for August. If you were to get that price increase through, do you think that would offset the ethylene and so you'd really just kind of have the lower nat gas benefit?

Paul D. Carrico

Yes, the price increase is really going to wind up being towards the tail end of the quarter, by the time you get all the implementations of those prices. So I think the bigger issue is that the ethylene numbers are here and now, so to speak, in terms of the price changes. So that's going to be a bit more of a factor than being totally offset by the PVC price increases.

Brian Maguire - Goldman Sachs Group Inc., Research Division

Okay. And if I could just shift to Aromatics. It looks like we're kind of at a point where we're generating some EBITDA losses. That seems more, I would say, structural than cyclical with some of the added capacity that came in, in Asia. How are you guys thinking about this business longer term? Are there some strategic actions you can take? And maybe can you just comment on what kind of other options you've got for the business going forward?

Paul D. Carrico

Yes, I'd say, over the last couple of years, we have seen a pretty good return on the relatively low capital base in that business, but as you mentioned, there are structural differences in the business globally that make it a little bit less optimistic in terms of the forecast. So we need to take a fresh look at that and look at the -- our options there. I would say that we've done this in the past, but it's time to take a renewed look at it and see what the choices are. I'm not sure that the negative numbers will hold, as we do have quarterly variations when you look at year-to-date. But still, the returns look pretty small there, so we're more aggressively looking at what our choices are now.

Operator

Your next question comes from P.J. Juvekar with Citi.

John J. Hirt - Citigroup Inc, Research Division

This is John Hirt, on for P.J. today. You mentioned substantially lower ECU prices year-over-year in the second quarter. I'm curious if you observed any change in either chlorine or caustic soda prices on a sequential basis in the second quarter.

Paul D. Carrico

Not -- there's lots of puts and takes because you talk about export and domestic and various different components of what the total sales values turn out to be, but we would say that, sequentially, the ECUs have stayed more or less stable.

John J. Hirt - Citigroup Inc, Research Division

Okay. And as you kind of look out over the next 6 to 12 months. I think you mentioned in your prepared remarks that demand is still relatively muted. Is there anything, as you look out over the next 6 to 12 months, that would lead you to believe that caustic prices could finally start moving upward?

Paul D. Carrico

I think caustic frequently acts in a little bit of a delayed fashion, plus you've got the added factor of the capacity additions, where folks are tending to move volume this year in -- rearrange contracts and participate in the spot market. So those kind of factors don't normally come together. And I guess, at this point, I'll just refer you to whatever the forecasters are saying out there in terms of recovery and when that might happen.

John J. Hirt - Citigroup Inc, Research Division

Okay. And just as a follow-up. If I look at natural gas prices, they've declined meaningfully over the past 2 months, and the forward curve has come down as well. So as you look out and LNG exports potentially are going to start up towards the end of 2015, would you consider locking in any of your natural gas requirements at this juncture?

Gregory C. Thompson

We will. And we actually do have some hedges that we have put in place to take advantage of the sharp move down in natural gas that, I guess, really started happening in the July time period. And so actually for the remainder of the third quarter, we're around half hedged. And for the fourth quarter, we're around 1/3 of our full requirements hedged. And it's pretty much at the kind of monthly-projection cost that you would see today. So we haven't done anything out longer term than that, but that's something that we'll certainly be looking at as the -- as we see where natural gas will settle out in the long term.

Operator

Your next question comes from with James Sheehan with SunTrust.

James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division

I was wondering if you could comment on Building Products trends in July. How have they held up?

Paul D. Carrico

Yes, on Building Products, actually for about the last 6 weeks or so, we've seen an increase versus the prior years. It's too early to call whether or not that is simply makeup for the first 6 months, when we were severely muted by the weather both in Canada and the U.S. But at least at this point, we think we're recovering everything that might have been lost. I think the question now, is there actually some step above that, that we might see by the time we get to the year end. And that's -- the jury is still out on that one.

James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division

Is that improvement in both Canada and the U.S.?

Paul D. Carrico

As a general comment, yes, more so in the U.S. Canada may be improving, but of course, it was in a bit of a negative situation earlier, so there was more room for some recovery there. But -- and the U.S. is going to be stronger, I think, in general. But yes, we see it in both areas.

James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division

And are you surprised at the weakness of caustic demand over the last couple of quarters? I was wondering if you could try to explain by end market where are -- where you've seen weakness. And how surprisingly weak was that for you?

Paul D. Carrico

I don't think that we lay that off on caustic demand. The operating rates really are not that different from last year. It's all about the activity in the market around these contracts and the use of the spot market for sales that producers are using to, I'll call it, rearrange volumes that were in place last year. So as a general comment, domestic is not too surprising at this point. I would say, globally, there continues to be a bit of a softness there. And that's one that perhaps -- that we look forward to seeing that come back at some point.

James Sheehan - SunTrust Robinson Humphrey, Inc., Research Division

Is that limited to alumina or paper and pulp? Or what kind of end markets globally are the softest?

Paul D. Carrico

Yes, I don't think we can segregate those out because it's more about the softness in general is there, but you have capacity in other regions that are there. And maybe they're not making a lot of money because their operating rates are generally lower substantially than what the American market is, but they're still getting by. So I wouldn't zone in on particular segments. It's just that when you look at the market in total, that there's a bit more growth needed there.

Operator

Your next question comes from Edlain Rodriguez with UBS.

Edlain S. Rodriguez - UBS Investment Bank, Research Division

Just one quick question, guys. In terms of PVC, with the price that's -- the price increase that's been announced, how do you see that playing out? Is it going to be -- if it's successful, is it going to be because PVC demand is decent, or is it going to be because ethylene prices are going up? So is it going to be cost push or demand driven?

Paul D. Carrico

Well, probably a little bit of both. There seems to be no doubt that the ethylene industry, with their particular outages and the number of those outages, is going to continue to strengthen the price there. And so that's materially adding to our cost base on the PVC side of the equation. But in addition to that, the supply-demand balance right now is probably effectively higher than what it appears superficially by the numbers that are reported. People either don't have ethylene or -- because of outages or lines out or whatever the case might be. Or they're looking at that and saying, at that kind of pricing that's available, that it doesn't make sense to push through to the PVC chain. So there's a little bit of both. Both of those would tend, though, to support higher pricing in PVC, which is a little bit of a contrary move compared to a lot of years when you get to the latter part of the year.

Edlain S. Rodriguez - UBS Investment Bank, Research Division

So just as a follow-up, so you think PVC demand is sufficiently strong that it can -- I mean prices can go up there?

Paul D. Carrico

Well, I go back to my comments on Building Products. We have a fairly diverse portfolio on Building Products, and what we see is something that's, as I said earlier, recovering at least what we lost in the first part of the year. So that kind of a demand situation would support PVC pricing continuing to move, particularly when you have costs going up. So...

Edlain S. Rodriguez - UBS Investment Bank, Research Division

Exactly, okay. And just quickly on Building Products: I mean the trend we've been seeing in the U.S., like extremely strong, and weakness in Canada, like does that stay for a while? I mean, how does that change over time? Or does that change anytime soon, like that trend we've been seeing, like the disparity between the U.S. and Canada?

Paul D. Carrico

I think we believe that the Canadian market was a bit more punished by the weather than the U.S. market earlier in the year but that it's recovering. When you get to the end of the year, though, we would still say it's somewhat negative, maybe not as negative as it was. The U.S. market, everything we see would indicate that it going to -- it's going to continue to be stronger than Canada and, certainly by the time you get to the year end, that it would be stronger. Again, it's -- my major question here at this point is whether or not this current move up is a makeup for earlier in the year or an actual step improvement in demand in total.

Operator

Your next question comes from Hassan Ahmed with Alembic Global.

Hassan I. Ahmed - Alembic Global Advisors

2 sort of slightly longer-term questions, 1 on some of these goings-on in Europe. We've seen obviously some consolidatory moves on the vinyl side of things. So my question to you is that -- and you've seen some U.S. players going into the European market. So the question really is that, is this the beginning of maybe sort of feeding some EDC or VCM into those, what are considered to be nowadays, marginal facilities in Europe and maybe that in turn resulting in a bit of a flattening out of the cost curve?

Paul D. Carrico

It's hard to say. I think you'd have to get a better answer from the folks that actually started those or made those investments. It's clear that Europe is disadvantaged both on the ethane -- or the ethylene side, as well as the chlorine side, particularly in vinyls. So something has to change over time. But it's also a market that's a bit more logistically challenged in terms of moving volumes in. So EDC would be one of those areas where that might happen. You can speculate that might be the case, much as you're seeing at least one producer try to move ethane over to produce ethylene. So those kinds of things will continue moving in that direction. And yes, I think they will improve their position, but mostly for purposes of domestic consumption. I doubt that, that transportation cost and that conversion cost and the plant locations make any kind of step-change improvement in their ability to move globally. It's more of a survival mode, I would say, with those facilities.

Hassan I. Ahmed - Alembic Global Advisors

Fair enough. And on the chlor-alkali side, again sort of slightly longer term. Let's assume that chlorine demand improves pretty meaningfully from here. Now as you're running your facilities harder and harder for that chlorine, obviously, you're creating more and more caustic. Now relative to yesteryears, where the export opportunity for caustic wasn't really available for us here in the U.S., do you feel that if more and more of this caustic is produced, there's enough sort of export demand out there to soak up all this excess caustic in a higher chlorine-demand environment?

Paul D. Carrico

I would say there's kind of a 2-part answer to that. First of all, there's a near term and a longer term. On the near term, it does depend a bit more on what that global demand improves to versus where it is today. And it's not like a light switch long term. It's a case of continual -- continually moving to a supply position from North America will be the preferred cost position place to do that. So the question becomes, is the market strong or weak? And today, the market is still there for U.S. producers because of their cost position to export. It's just that the pricing is not as attractive as it would normally be.

Operator

Your next question comes from Frank Mitsch with Wells Fargo.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

Paul, thank you so much for outlining what's going on, on the operations front, obviously a topic front and center given what has happened. So best wishes on having everything play out so we don't spend time on the calls talking about unplanned outages. Wanted to clarify commentary regarding the ECU and the operating rates. I believe you said that operating rates in Q2 were essentially flat year-over-year despite the capacity additions. So obviously, that is throwing more caustic into the marketplace. But as I look out at Q3 and Q4 in particular, won't we be seeing easier comps in terms of demand, given the major Latin American unplanned outage on the alumina front last year and, as we're looking year-over-year from a volume basis, that might actually be a positive for caustic?

Paul D. Carrico

Yes, I guess the challenge is putting it into the global perspective, not just South America. The global situation is that the demand is okay, as I said earlier, but not great. And the U.S. producer can overcome it by price because of the cost position. But to say that the demand will improve such that the global situation drives pricing to a better level is kind of the key question, and I don't know whether that will happen at this point.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

But in your perspective, obviously, the issue last year led to the decline in caustic pricing. It sounded like you were looking more at flattish type of ECUs in Q3. Is that fair?

Paul D. Carrico

I would say the momentum for either chlorine or caustic is somewhat muted on price increases right now. So I don't quite understand it because, as I said earlier, the operating rate is not that bad or not that deteriorated from last year. So it's just the mentality of when the North American producer seeks to get back to a more reasonable margin versus history than where we are today. And it goes back to these capacity additions and the moving around of the contracts in the spot market.

Frank J. Mitsch - Wells Fargo Securities, LLC, Research Division

And can you provide an update on the discussions with Lotte and what your thoughts are there now that we're a few more months into the FEED study?

Paul D. Carrico

My comment would be that everything has gone along as planned to this point. We continue to look forward to having a FEED study completed later this year or early next year, and get a board decision process at that point in time. So nothing is surprising at this point or changed, and we're on track with the schedule we previously laid out. I just wish I could make it 2 years instead of 4 years.

Operator

Your next question comes from Christopher Butler with Sidoti.

Christopher W. Butler - Sidoti & Company, LLC

Looking at the Building Products segment, could you talk to the distribution costs? I think you touched on that in your first remarks. And any benefit longer term from this upfront expense?

Gregory C. Thompson

Yes. I mean, it's something we haven't seen a whole lot of prior to the current quarter. It was a smaller impact than the other items that we mentioned. Currency was the largest. But we use a lot of trucking for -- in the Building Products segment, and we've seen that drivers -- companies getting drivers on-board has driven up -- has limited availability at times for getting trucks when we need them. And it also has caused some price -- some small price increases to be driven through by the trucking companies. So we're all -- we're looking at that and ways to mitigate that going forward, as well as our different modes of transportation.

Christopher W. Butler - Sidoti & Company, LLC

And as we look to the third quarter, you had mentioned that you're, I think, half hedged for natural gas. If you weren't half hedged, what would the sequential improvement have been, $20 million, or is that too much?

Gregory C. Thompson

Yes, that's definitely too much. I mean, so the hedges, to be clear, are -- they're kind of right on top of where gas is currently. So we'll see how that develops. But no, I'd say the sequential improvement from the second quarter to the third quarter, it's much less than $20 million. It's -- based upon our normal run rate, it's probably $8 million or so kind of range or natural gas being lower in the third quarter as compared to the natural gas costs in the second quarter.

Christopher W. Butler - Sidoti & Company, LLC

And just finally, with your $200 million of capital spending, how much of that was due to the outage? And I don't -- I seem to recall that this is about where you were targeting capital spending already. So is there other work that was pushed off to next year?

Paul D. Carrico

Yes, I think that we just rearranged. There's always slack in our ability to rearrange the capital budget on certain items. And we just arranged it so that we will do spending in some more opportunistic areas either later this year or early next year.

Operator

[Operator Instructions] Your next question comes from Jeff Zekauskas with JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Ethylene spot prices are almost $0.70 a pound. Does that affect you? Does that touch you? Or does the change in spot not affect you?

Paul D. Carrico

The spot prices are an influence on our overall ethylene supply situation. And it's not the most significant factor but it is a factor, and it makes us evaluate choices about what we do on certain parts of our business. So it's not a positive to have that spot price increasing like that. But I think the bigger issue, though, is, by far, the ethylene normal transaction prices increasing too.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Is there any difficulty in you procuring your contract ethylene given all of the outages? Or do you find yourself adequately supplied?

Paul D. Carrico

We're more or less supplied at the rate that we expected for this time of year versus our contracts. So that's been not something that's influenced us, for instance, by the line outage or some other things that have gone on.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Is the -- when you compare the domestic PVC price to the offshore export price, are they very different? And which one may be higher, or which one may be lower, and by how much?

Paul D. Carrico

It varies month-to-month and quarter-to-quarter. You will see that both the domestic price increases and the export prices are moving up. And I'll say, the general comment over the last number of months, export prices have tended to be, when you net everything out, a little bit below the domestic price, but it remains to be seen whether or not that stays that way or not. Certainly, this ethylene move on the spot pricing and whatever will start to cause people to think again about the export side of the equation.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And when you think about industry operating rates in July in PVC, do you think they're very much different from the industry operating rates in June?

Paul D. Carrico

Well, it's a bit of a guess at this point, but I would be surprised if there's that much change. I think some people thought that they might improve because certain crackers would come back online and certain crackers wouldn't have outages, and they don't think about the ethylene side of the equation. None of those have played out correctly. They're most all delayed, or there's been the surprises. So if I had to guess right now, I would say it continues to be a bit on the lower side that what not might otherwise be possible, both because of supply and cost of ethylene.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And do you have a sense of where August might be? Do you think August is a continuation of the July trends? Or are there any indications that August might be stronger?

Paul D. Carrico

Everything I read, and I'll emphasize I read or hear from folks in the industry, suggests that there's not much change that's going to occur by the end of August. In fact, perhaps as we get later in the year, we will see what develops, but we're still in this mode where there's more -- particularly there's more outages than were figured at all at this point in the ethylene world, so...

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And then lastly, over time, your contract ethylene prices moved up as favorable, older contracts have expired. Is there any more of that to come? Or has that pretty much played out through your ethylene purchases?

Paul D. Carrico

No, there's another -- it's a quite a bit smaller slice, but that rolls off by the end of this year. And I think we've been fairly open that, come 2015, all of our contracts, more or less, are being replaced versus the past contracts. And so that will be a change as we go into next year.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

How much would that affect your costs?

Paul D. Carrico

I wish I could tell you, but those negotiations continue on. And they'll continue to play out over the next 3 or 4 months, and we'll just have to see what happens.

Operator

At this time, there are no further questions.

Martin Jarosick

All right. Thanks, everyone, for joining us. And we look forward to speaking with you again next quarter.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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Source: Axiall's (AXLL) CEO Paul Carrico on Q2 2014 Results - Earnings Call Transcript
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