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Executives

Joseph Rupp – Chairman, President and CEO.

John Fischer – VP and CFO

John McIntosh – VP and President of Chlor Alkali Products Division.

Larry Kromidas – Assistant Treasurer and Director of IR.

Analysts

Don Carson – Merrill Lynch

Frank Mitsch – BB&T Capital Markets

Christopher Butler – Sidoti

Edward Yang – Oppenheimer

Mike Judd – Greenwich Consultants

Sergey Vasnetsov – Lehman Brothers

Charles Jobson – Delta Partner

Causus Caretano [ph] – Goldman Sachs

Richard O'Reilly – Standard and Poor's

Barrett Eiman [ph]

Olin Corporation (OLN) Q2 2008 Earnings Call Transcript July 25, 2008 10:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Olin Corporation earnings conference call. My name is Nora and I'll 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 instructions) I would now like to turn the presentation over to your host for today's conference, Mr. Joseph Rupp, Chairman, President, and Chief Executive Officer of Olin Corporation. Please proceed, sir.

Joseph Rupp

Good morning and thanks 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.

Sales for the second quarter of 2008 were $428.3 million compared to $266.2 million in the second quarter of 2007. Net income from continuing operations in the second quarter of 2008 was $35.5 million or $0.47 per diluted share compared to $21.9 million or $0.29 per diluted share in the second quarter of 2007. Chlor Alkali earnings improved 27% compared to the second quarter of 2007, which reflects the contributions and synergies of the Pioneer acquisition and improved pricing. These favorable developments allowed the business to overcome lower volumes and higher costs, primarily in the areas of freight and electricity.

Winchester second quarter pre-tax earnings of $9.5 million represent a record second quarter for the business. Winchester’s results reflect the combination of improved volumes and pricing.

The second quarter 2008 results include $9.7 million of environmental expenses, which are approximately 90% higher than the first quarter 2008 level and approximately 70% higher than expected in the third quarter 2008. The decreased level of environmental expenses in the second quarter 2008 primarily represented cost of that decrease. The increased levels of environmental expenses in the second quarter 2008 primarily represented costs for remediation in a former manufacturing location.

Second quarter 2008 results also include approximately $5 million of non-cash stock-based compensation expense which reflected the positive performance of our stock during the quarter. This level of expense is approximately twice the level experienced in the first quarter of 2008.

Second quarter 2008 results included an $800,000 pre-tax pension curtailment charge associated with the transition of our McIntosh, Alabama Chlor Alkali hourly work force from a defined benefit pension plan to a defined benefit contribution plan.

Finally, our second quarter 2008 tax rate included approximately $800,000 of favorable adjustments related to the resolution of prior period issues.

Third quarter 2008 earnings are projected to be in the $0.65 to $0.70 per diluted share range which would represent the best quarterly result from operations since the 1999 spin-off of Arch Chemicals. We expect the Chlor Alkali results will improve compared to the second quarter driven by higher operating rates and improved ECU netbacks. The seasonal strength of the industrial bleach business is contributing to the higher operating rates.

Winchester results are expected to be in line with the results experienced in the first two quarters of 2008.

Finally, as we mentioned previously, we expect environmental and pension expenses to decline in the third quarter compared to the second quarter.

Now to a more detailed discussion of the businesses beginning with Chlor Alkali. Chlor Alkali products earned $70.4 million in the second quarter which includes a $24.3 million contribution from the Pioneer operations. The contribution from Pioneer includes the benefits of the synergies realized. The impact of these synergies was approximately $10 million in the second quarter. Chlor Alkali products' earnings in the second quarter of 2007, which did not include the Pioneer operations, were $55.3 million. ECU netbacks were $590 in the second quarter of 2008 which compares favorably with the second quarter of 2007 Olin-only ECU netback of $510.

The operating rate in the quarter was 89% which compares unfavorably to the Olin-only operating rate of 97% experienced in the second quarter of 2007. Chlorine and caustic soda shipment volumes increased 54% year-over-year due to the inclusion of Pioneer. However, on a pro forma basis including Pioneer in 2007, volumes were 8% lower in the second quarter of 2008 compared to the second quarter of 2007. This reduction in volumes resulted from the lower levels of overall chlorine demand across most customer segments.

During the first half of this year, demand for caustic soda remained strong. However, caustic soda supply was constrained because of reduced operating rates driven by weakness in chlorine demand resulting in a significant supply and demand imbalance. This imbalance, along with increased freight and energy costs, resulted in unprecedented caustic soda price increase announcements.

During the second quarter, Olin announced four caustic soda price increases that totaled $410 per ton. This brought the total number of caustic soda price increases announced in 2008 to five with a total value of $490 per ton.

As we discussed in our first quarter earnings call, the timing of an announced market price increase impacts Olin's ability to immediately implement the increase.

During the first quarter, the $80 per ton price increase was not totally reflected in the published first quarter market indices, causing many customers to see implementation in the third quarter. Similarly, the most recently announced $160 per ton price increase was not reflected in the published second quarter market indices, delaying its implementation until the fourth quarter.

During our first quarter earnings call, we also discussed provisions in some of our caustic soda contracts that limit the amount of increase that can be implemented in a specific quarter.

The impact of these limitations will be to delay the implementation of some of the announced price increases. While we have seen unprecedented levels of caustic soda pricing during the second quarter, we have continued to experience weaker chlorine prices. Chlorine prices in Olin's system declined in the second quarter of 2008 compared to the first quarter and we expect the decline to continue through the balance of 2008 and into the first half of 2009.

However, taking into account all of these issues, we currently expect ECU netbacks in Olin's system to improve sequentially well into 2009. We have also experienced improved pricing for two of our value-added products, bleach and hydrochloric acid. Year-to-date price increases of $270 per ton for bleach and $30 per ton for hydrochloric acid have been announced and implemented. Bleach and hydrochloric acid combined represent approximately 15% of the ECUs Olin produces and sells, and these products are not reflected in our netbacks.

We expect our operating rate in the third quarter of 2008 to improve to the low-to-mid 90% range due partially to the seasonal strength of our bleach business. Third quarter bleach shipments are expected to increase 20% compared to the second quarter of 2008 and over 50% compared to the first quarter of 2008.

During the quarter, Chlor Alkali business continued to face higher costs, specifically electricity and freight costs. Freight cost which as a reminder are reflected as reduction in our ECU price, increased 23% in the second quarter of 2008 when compared to the second quarter of 2007. Year to date, the freight component of our ECU netbacks has increased to 33% compared to the first half of 2007. As a further point of reference, 2008 freight costs are approximately 70% higher than they were at the beginning of 2005.

Second quarter 2008 electricity prices represent an increase of approximately 15% compared to the first quarter of 2008 and the second quarter of 2007.

Electricity costs in the Olin system are typically higher in the second quarter of the year compared to the first quarter. The significant increase in the price of natural gas experienced in the second quarter generated a larger than normal increase and as a point of reference, the utilities that supply electricity to our Henderson, Nevada and St. Gabriel, Louisiana facilities depend heavily on natural gas.

During the second quarter, the joint venture bleach plant we established last fall with Trinity Manufacturing reached full production rates have became profitable. We invested approximately $11.6 million in the facility and are responsible for marketing the bleach. The location of this facility complements our existing bleach business. Also during the quarter, we announced that we are evaluating the possibility of constructing a Salt-to-Bleach plant in Northern California. This represents an additional opportunity to expand our leading position in industrial bleach.

We continue to make excellent progress in achieving synergy savings from the Pioneer acquisition and we now believe it is likely that we will exceed the $40 million per year objective that we identified at the end of the first quarter. As a reminder, during the first quarter, we increased the synergy forecast from $35 million to $40 million per year.

During the second quarter, the shutdown of the Dalhousie, New Brunswick facility was completed. This shutdown will generate $8 million to $10 million of annual cost savings that we began to realize in the second quarter. These savings are a part of the total $40 million per year of projected synergies. Finally, we are beginning to realize the benefits of rationalizing the size of the combined Olin and Pioneer railcar fleets. By the end of 2008, we expect to be operating as a combined company, with 5% to 6% fewer railcars as a sum of the separate companies prior to the merger. This represents projected annual cost savings in the $2 million to $3 million range.

Now turning to Winchester. Winchester’s second quarter sales of $116 million of earnings of $9.5 million represent record second quarter results for the business. These compare to sales of $100 million and earnings of $5.6 million in the second quarter of 2007. Winchester also turned in record first quarter results. The second quarter earnings reflect the combination of higher selling prices and improved volumes, which were partially offset by higher material and commodity metal prices. Winchester experienced improved volumes to commercial customers and law enforcement customers, reflecting contracts that were awarded in 2007. These more than offset lower sales to military customers. Lower level of military sales in the quarter reflects the timing of deliveries under these contracts. The cost of commodity metals and other raw materials continues to be a major challenge for the Winchester business. During the second quarter, the spot price for copper averaged approximately $3.80 per pound which compares to the approximately $3 per pound price that occurred at the end of 2007.

Steel prices have increased steadily over the past two years and we experienced an additional 30% increase effective July 1. Steel represents approximately 5% of Winchester’s material costs.

In the second quarter, Winchester did see moderation in the price of lead. The average spot price for lead declined from approximately $1.30 per pound in the first quarter of 2008 to $1.05 per pound in the second quarter of 2008. In spite of this decline, the price of lead remains approximately 400% higher than pre-2004 levels.

Though Winchester continues to experience strong overall consumer demand, there have been reactions to the higher level of product prices. Ammunition distributors have become more cautious buyers and have been delaying orders while other customers have been trading down from higher quality, higher performance products to more standard products. During the quarter, Winchester completed the relocation of approximately half of its military packing operations from its East Alton, Illinois facility to its Oxford, Mississippi facility. This relocation which involves approximately a hundred jobs is expected to be completed in the third quarter and is expected to generate annual cost savings of approximately $2 million.

Our second quarter results and our third quarter outlook continue to demonstrate the benefits of the acquisition of Pioneer that was completed in the third quarter of last year. During the second quarter, these benefits have allowed us to overcome the overall weak demand for chlorine, plus the increasing electricity and freight costs. Further, it allows us to forecast record operating results in the third quarter. We are continuing to realize the expected synergies, and they are expected to enhance our results further as we move forward. The Winchester business has successfully overcome escalating cost and should benefit from its ongoing cost reduction programs. I remain optimistic about Olin’s prospects for the balance of 2008 and as we look forward to 2009. Now I would like to turn the call over to John Fischer, our Chief Financial Officer, who will review several financial items with you. John?

John Fischer

Thank you, Joe. First, I would like to discuss a few items on the income statement. Selling and administration expenses increased 9% or $2.8 million during the second quarter of 2008 compared to the second quarter of 2007. The increase is attributable to the inclusion of the Pioneer operations in the second quarter 2008 results. As a point of reference, Pioneer incurred SG&A expenses in the second quarter of 2007 of $9.7 million compared to $5.2 million in the second quarter of 2008.

Legal and legally-related expenses were $2.4 million lower in the second quarter of 2008 and the combination of defined benefit and defined contribution pension plan expenses declined by $3.1 million. These SG&A expense reductions were partially offset by higher incentive expenses which were primarily the result of mark-to-market adjustments on stock-based compensation. During the quarter, Olin’s common stock appreciated 32% or $6.40 per share. Every $1 change in the Olin stock price changes stock-based compensation expenses by approximately $400,000. Stock-based compensation expense in the second quarter of 2008 was $4.9 million compared to $3.3 million in the second quarter of 2007.

Corporate and other expenses in the second quarter of 2008 declined by $3.7 million from the second quarter of 2007 primarily due to lower- defined benefit pension plan expenses and lower legal and legal-related costs. This will partially offset by the higher stock-based compensation expenses and a higher environmental expenses.

Second quarter 2008 environmental investigatory and remediation expenses were $9.7 million compared to $7 million in the second quarter of 2007 and $5.1 million in the first quarter of 2008. These costs relate primarily to remedial and investigatory activities associated with former waste disposal sites and past operations. Increased level of environmental expenses in the second quarter primarily represents cost for remediation at a former manufacturing location. We currently expect that these expenses in the third and fourth quarters of 2008 will be 30% to 40% lower than the second quarter and we continue to believe that full year charges for environmental, investigatory and remedial activities will be approximately 25% lower than full year 2007 expenses.

Total company defined benefit pension plan income was $1.9 million during the second quarter of 2008 compared to expenses of $8.3 million in the second quarter of 2007. The second quarter 2008 income includes the $800,000 curtailment charge Joe mentioned earlier. This conversion from a defined benefit pension plan, with defined contribution plan which impacted approximately 200 McIntosh, Alabama hourly employees, is consistent with our strategy to further reduce the risks associated with our defined benefit pension plan. Year-over-year improvement in defined benefit pension expense reflects the impact of the $100 million voluntary contribution made in May of 2007, favorable investment returns earned in 2007 at 25 basis points increase and the discount rate used to value liabilities, an increase in the amortization period for plan losses and the impact of the plan freeze for salaried and non-bargained hourly employees that became effective January 1, 2008.

The $10.2 million decline in defined benefit pension plan expense was partially offset by higher defined contribution pension plan expenses of $1.6 million beginning 2008. All salaried and non-bargained hourly employees, in addition to all employees hired after January 1, 2005 were participating in the defined contribution plan.

So far this year, the defined benefit pension plan has generated approximately break-even returns. This level of returns has preserved the over-funded positions that existed at December 31, 2007. The2008 performance reflects the actions taken in 2007 to reduce the plans exposure to equity investments and increases exposure to fixed income investments.

The tax rate for the second quarter was 35.2% which included $800,000 of favorable adjustments associated with the resolution of prior period issues. We now forecasted the full year 2008 rate including the favorable adjustments associated with the resolution of prior period issues will be in the 35% to 36% range.

Now turning to the balance sheet, cash and cash equivalents of June 30 of 2008 were $206.9 million compared to $257.1 million at June 30, 2007 and $332.6 million of December 31, 2007. The year-to-date decline in cash and cash equivalents reflects the combination of normal seasonal growth and working capital predominantly in the Winchester business and the impact of higher selling prices. We continue to forecast the cash and cash equivalents will decline during 2008 as a result of the high level of projected capital spending primarily reflecting the St. Gabriel conversion and expansion project. We also expect working capital to increase approximately $40 million during 2008 reflecting the combination of higher sales volumes, higher selling prices, and the increase raw material cost in Winchester and higher selling prices in Paraguay.

Capital spending during the second quarter was $40.5 million, approximately 50% of which was associated with the St. Gabriel conversion and expansion project. As a reminder, this project is expected to be completed in the first quarter of 2009 and is expected to generate annual cost savings of approximately $25 million. We are continuing to forecast for year 2008 capital spending to be in the $200 million to $210 million range.

Second quarter 2008 depreciation expense was $17.6 million and we continue to project full year depreciation expense into 2008 of approximately $70 million. Annual depreciation expense is expected to increase approximately $10 million with the completion of the Saint Gabriel project.

Yesterday, Olin’s Board of Directors declared a dividend of $0.20 on each share of Olin common stock. The dividend is payable on September 10th 2008 to shareholders of record at the close of business on August 11th 2008. This is the 327 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 estimate 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 described without limitations in the risk factor section of our most recent Form 10-K and in our second quarter earning’s release. A copy of today’s transcript will be available this afternoon on our website in the investors section under Calendar of Events. The earnings press release and other financial data and information is available under press releases. Operator we are now ready to take questions. Nora?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Don Carson from Merrill Lynch. Please proceed.

Don Carson – Merrill Lynch

Yes, thank you. I’d like to walk through just the ECU pricing outlook, I know there is some pluses and minuses but on the caustic front, Joe, you mentioned that the last $160 increase which is not in the industry indices, you won’t get till Q4. But looking at the approximately the other $240 of increase you had in the quarter, just wondering what the timing of realization is there given some of the contract caps you have and also some of the takeaways in terms of lower chlorine prices and higher freight costs. So, if you could just perhaps walk us through how you see –

Joseph Rupp

Don, I will talk you through that. What we did mention is we are forecasting higher ECU prices well into 2009 and John will give you a little bit on the contracts, John?

Don Carson – Merrill Lynch

Okay.

John Fischer

Don, just to give you a sense of what’s been reflected in pricing indices so far, of the $490 of announced price increases that occurred in the first half of 2008 on caustic, only $140 of that number has been reflected in one of the price indices that I looked at yesterday. So, there is a significant amount of the pricing announcements that have been announced so far, it will continue to be reflected in these indices as we move through the third quarter and into the fourth quarter. We expect indices in the end of July to reflect a significant jump from where they were at the end June but overall, we expect to continue to see even with no further price increase activity, the caustic pricing indices to go up through the balance of this year and end of the first of next year and based on our typical quarter lag experience that we tend to see, we would expect those price – the caustic size molecule on an index basis to move up into the first half of ’09. We do expect to continue see chlorine prices drop. We – as mentioned in the remarks, they dropped in the second quarter. We expect to continue to see those prices decline but I would make a point that at 89% operating rates, historically, which is what the industry reported in the second quarter, we would have seen chlorine price increases that were more significant in terms of the magnitude than we’ve seen in the second quarter and that we’ve seen reflected in our system as well.

Don Carson – Merrill Lynch

And John, what’s the impact of the caps that you have in place? What percentage of your contracts does that cover and what is status of renegotiating those caps? I know some people had approached you perhaps to give up some of the cap this year and return for on going limits next year.

John Fischer

We have had a couple of occasions where – beginning in July 1, where we’re operating with improved pricing from customers who wanted to, I guess, stretch the pain out a little more than having to face it all at the beginning of the year. So, we’ve seen that phenomenon impact our system. We still will have some limitations through the balance of this year but that’s another reason why we believe that we’ll continue to see overall ECU pricing gains well into 2009.

Don Carson – Merrill Lynch

Okay. And then John, just an industry comment, what impact, if any, are you seeing from the pending Shintech startup as they place that caustic in the market? And with these kind of prices, are you seeing any demand destruction, any caustic users trying to switch to soda ash which I know is also tight, just your comment on those two aspects.

John Fischer

The Shintech startup where as for most people expected there to be kind of a psychological impact on pricing is really become a non-event, and it’s our understanding that most of the caustic that will come out of that plant once it starts up will either have to be used to pay back other people on the industry or exchange caustic with them based on the delay in their start-up schedule and/or will be caustic that will be exported out of the U.S. to meet export obligations that they have. So, we really don’t expect their start-up, which we understand is sometime very soon, to have any material impact on the North American market. As a matter of fact, in some cases, it will help with the serious, serious imbalance we have, especially with all the force majeure announcements that have already occurred late in the second quarter and in the third, early in this quarter. In terms of demand destruction, we haven’t seen it yet, but the substitution that is most logical that you mentioned, which is soda ash for caustic, we haven’t seen any of that occur yet and I think the reason is just exactly what you said. Soda ash availability is such that no one can commit to a long term and continuing supply of soda ash, and so security of whatever alkali agent that you are using tends to become the overriding issue and people are really forced to continue to use caustic if that is what they are currently contracted to use.

Don Carson – Merrill Lynch

Thank you.

John Fischer

Thanks, Don.

Operator

And your next question comes from the line of Frank Mitsch from BB&T Capital Markets. Please proceed, sir.

Frank Mitsch – BB&T Capital Markets

Close enough on the name of the company. Bad sign. Good morning, gentleman.

Joseph Rupp

Good morning.

Frank Mitsch – BB&T Capital Markets

Joe, you mentioned that in your outlook that you thought Winchester, which show similar results to what it did in the first and the second quarter and obviously those are very strong results, traditionally, however, the third quarter is the best quarter for the Winchester business, so are you being a little a bit conservative there or are you kind of maxed out, can you talk a little bit about what’s going on there?

Joseph Rupp

Yes. What we’re seeing Frank is in the third quarter, we are going to see some pretty healthy hits from pricing, particularly in the area of steel and resins that we are not going to have a chance to be able to offset our cost– we are not going to have a chance to offset from a pricing point of view. We also will anticipate potentially as we get out further that there is some moderation as we talked about from a lead perspective that may start to offset that as we get out the fourth quarter. The other concern we have a little bit was the commercial shooter – is what we talked about is that they are buying down and also the distributors are fairly cautious about what’s going to happen with this hunting season and we know that in the fishing category, for example, that that has slowed down considerably and so were trying to reflect what we think is reality as we get to the third quarter.

Frank Mitsch – BB&T Capital Markets

Well, with the cost of food being what it was, I would think hunting would be up. But, yes, you got to drive pretty far to get to some of those fields. And the discussion regarding the synergies from the Pioneer transaction, I believe you said that you’d raised your expectation from $35 million to $40 million, you think you’re going to exceed that this year, so the question is– and you mentioned that the Dalhousie shutdown being about $10 million in of itself. What do you think that could get to?

Joseph Rupp

Greater than $40 million.

Frank Mitsch – BB&T Capital Markets

All right.

Joseph Rupp

We scored on that. What's happened there is that we’re real pleased. Originally we came out with a 35 number. We felt really good about what occurred so far in the first nine months here and saw the $40 million number and our sense is that we can get past that $40 million number, Frank, and we are not getting up to $50 million.

Frank Mitsch – BB&T Capital Markets

Okay. That’s fair. And then lastly, I know you guys aren't super big on the aluminum side but what percent of your caustic sales now are on the aluminum market?

John Fischer

Frank, this is John. We export very little caustic currently, although we will look to export more post the start up of the converted and expanded plan at St. Gabriel. But historically before the acquisition, Olin exported no caustic and right now we really don't have the ability to satisfy all of our North American contract accounts and still have caustic to export. As I said, we see that changing with the expansion and for us, the logical market and one of the fastest growing markets for exporting caustic will be South America.

Frank Mitsch – BB&T Capital Markets

All right. So I'll look of that to be a 2009 event, not necessarily an '08 event.

John Fischer

That’s correct.

Frank Mitsch – BB&T Capital Markets

All right. Thank you guys.

John Fischer

Thank you, Frank.

Operator

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

Christopher Butler – Sidoti

Hi. Good morning guys.

Joseph Rupp

Good morning.

Christopher Butler – Sidoti

Just sort of wanted to circle back on the ECUs, right in saying that if the markets expected there to be any impact on caustic from the Shintech startup, we'd probably already be seeing that reflected, right?

Joseph Rupp

I would think that's fair, Chris.

Christopher Butler – Sidoti

And looking at the chorine side of the equation, you said that you are expecting chorine to be down. Just to clarify, are you talking sequentially down here for the remainder of the year or down compared to 2007 levels?

Joseph Rupp

Sequentially down for the rest of the year.

Christopher Butler – Sidoti

So the stability that we may have seen here at the end of the second quarter, that's something that's temporary it sounds like.

Joseph Rupp

Well, we saw chorine price decrease from the first quarter to the second quarter and our forecast is that's going to continue. Although as I said earlier, it is definitely on a different trend line that we would've seen at this kind of operating rate and looking at it in comparing to a historical chorine price changes.

Christopher Butler – Sidoti

And shifting gears a little bit on the environmental expense, the remediation that caused the uptake in the quarter, could you give us a little color on this? Was this sort of a one shot and no longer a concern issue? Or is this an increase in projected cost on ongoing remediation?

Joseph Rupp

No, it was one shot on a site that we shouldn’t see repeat. I think, Chris, if you went back and looked at, for example 2007, there was quite a bit of deviation from quarter to quarter in terms of what our environmental expenses were. We had one very large quarter and I think that's what we saying we are going to have this year and that quarter was the second quarter.

Christopher Butler – Sidoti

And finally, just looking at the interest expense for the quarter, it was down from year-over-year and sequentially but debt remained fairly constant. Are we looking at just variable interest rates coming down here?

Joseph Rupp

Well, debt is actually down about $8 million year-over-year. In the first quarter, we repaid about $8 million of industrial revenue bonds. So, in terms of total debt, it should be down and that's what’s really driving it. The other thing is interest earned on cash balances is down just because short-term interest rates are down.

Christopher Butler – Sidoti

Thank you for your time.

Joseph Rupp

Thank you Chris.

Operator

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

Edward Yang – Oppenheimer

Hi. Good morning. I had a couple of modeling questions as well. First, from the CapEx outlook for 2009. If I recall that St. Gabriel expansion was in two stages. Will you be exercising the second phase of that expansion and what would be your CapEx guidance for 2009?

Joseph Rupp

We have made no announcement that we're going to exercise the second phase of St. Gabriel and I would expect at this point the capital spending will be at a much lower level in 2009, probably slightly higher than the forecasted level of depreciation.

Edward Yang – Oppenheimer

And the forecast level of depreciation is in the mid 70s?

Joseph Rupp

80. We're amounting about 70 now. St. Gabriel at about 10, so that would put us at 80.

Edward Yang – Oppenheimer

And is that the sort of the base CapEx going forward or are you going to basically switch that around depending on volumes?

Joseph Rupp

Something in the neighborhood of depreciation levels would be what we would consider to be based and then any expansion or investments would be on top of that.

Edward Yang – Oppenheimer

Okay. And there’s obviously a lot of puts and takes that goes into your overall corporate and other expense line item. When you factor all that in, what do you think your corporate and other expenses or income will be in 2008 and 2009?

Joseph Rupp

The two biggest drivers that are variable in corporate and other are environmental which we just talked about and we expect that to be down 25% year-over-year from 2007 to 2008. The other big driver is the defined benefit pension plan which if you look at the numbers should be down something in the neighborhood of $20 million 2007 to 2008. I do not see significant declines on the defined benefit pension plan going forward and I don’t see significant changes in our outlook on environmental going forward so I think –

Edward Yang – Oppenheimer

Okay. What about headquarters costs or (inaudible).

Joseph Rupp

Well, those tend to move around in a fairly narrow range and I wouldn’t see those changing dramatically year-over-year. We talked about legal and illegal related down this quarter but some base is up. Those are the things that tend to be variable.

Edward Yang – Oppenheimer

Okay, thank you and you spoke a bit about the – in response to a question on substitution on the customer side soda ash. I understand that – could you help me understand on the supplier side or are suppliers able to switch from potassium hydroxide to caustic or does that even make sense?

Joseph Rupp

No, there aren’t really very many applications at all. I’m sure not any of any significant quantity where that substitution is legitimate. And even with the high price of sodium hydroxide, potassium hydroxide prices are rising at an ever increasing rate as well because of raw material input pricing, so there's just – that’s not a substitution that really makes any sense.

Edward Yang – Oppenheimer

Okay, understood. And finally, I would love to get your opinion. Clearly, it’s a bit of an unusual situation in the industry with chlorine being so weak and caustic being so tight. Have you seen an environment like this in the past, and if you have, how has it resolved itself in the past and how does this all play out in the context of what could be a fairly uncertain economy?

Joseph Rupp

We have seen this in the past. This is a cyclical business and chlorine cycles and caustic cycles tend to not operate in sync and so there have been periods in the past when chlorine demand has been low and industry operating rates have been low and caustic has been in short supply and prices for caustic have increased. We’ve also seen that change when demand for chlorine picks back up, industry operating rates will then increase. That makes more caustic supply available and reduces some of the pricing pressure on caustic, but it also increases the pricing pressure on chlorine because of the increased demand.

So, what you see is different parts of the ECU, leading and lagging, but historically, we believe that the volatility between the low point of the market and the high point of the market is going to be significantly smaller in the future than it’s been in the past because of energy input costs and other considerations. And so we don’t expect dramatic changes in ECUs even though it may be caustic providing more value in one period of time or chlorine in a different period of time.

Edward Yang – Oppenheimer

Thank you. Appreciate those insights.

Joseph Rupp

Thank you.

Operator

Your next question comes from the line of Mike Judd from Greenwich Consultants. Please proceed sir.

Mike Judd – Greenwich Consultants

Yes, just missed a couple of numbers. You said the operating rate in the second quarter was 87%, was that right?

Joseph Rupp

89%.

Mike Judd – Greenwich Consultants

Okay, great. And the ECU price was – The net back price was?

John Fischer

590.

Mike Judd – Greenwich Consultants

Got it. Thank you.

John Fischer

You’re welcome.

Operator

Your next question comes from the line of Sergey Vasnetsov. Please proceed sir.

John Fischer

Good morning, Sergey.

Sergey Vasnetsov – Lehman Brothers

Good morning. In the past few years, we have been looking at energy and metal prices escalating, so I think chemical companies were rightfully jealous and upset. Now, no chemical was able to match it until recently caustic seems to be on this trajectory. So, is caustic the new copper?

Joseph Rupp

We understand that.

Sergey Vasnetsov – Lehman Brothers

No, seriously, is there some limit there, sky is the limit since 2000, might well collect a bargain in one year from now? When do you see some other mechanisms, conservation, et cetera kicking in to adjust for this?

Joseph Rupp

Sergey, historically, there has been a point at which either the economy or the price for caustic or a combination of both has provided some restraint on demand, but part of the dilemma we face now has really been driven by the supply side and by supply disruptions and availability issues from the producer community. And so, that over time will ultimately moderate itself as well. Another phenomenon we’ve seen in the past that’s tended to moderate or try to bring back in the balance the supply-demand for caustic has been material that’s been imported into the US from other geographies in the world, and although that phenomenon hasn’t been significant in recent quarters, if you look back far enough, there have been periods of time when the differential in the US – between US caustic prices and caustic prices in other parts of the world got high enough that it incentivized people to bring the export caustic into the US. Of course, the US has – the weak dollar provides some advantages to the US producers. So all of these things move independently but in aggregate I think we will tend to put some level of constraint upon – the trajectory will not be endlessly up, I guess, is another way to say it.

Sergey Vasnetsov – Lehman Brothers

So the balance mechanism would kick in either as far as decline of the industrial economy or recovery in the caustic price [ph]?

Joseph Rupp

Yes.

Sergey Vasnetsov – Lehman Brothers

Okay. Thank you.

Joseph Rupp

Thank you.

Operator

Your next question comes from the line of Charles Jobson from Delta Partners. Please proceed, sir.

Charles Jobson – Delta Partner

Hello everyone. Can you – have you thought about implementing that freight surcharge and breaking with industry practice or you’re still going to eat the freight increases?

Joseph Rupp

When we negotiate new contracts now, it is our philosophy going into those discussions to separate out the price of the product and all other costs which would include freight and fuel surcharges. And as we work through our portfolio of contracts, we will have some degree of success at doing that and then some degree – and that will give us some degree of flexibility in being able to more quickly pass on those costs, external really to the price of the product.

Charles Jobson – Delta Partner

Okay. How long or short a process is it going to be to get a significant amount of contracts switched over to that?

Joseph Rupp

Well, we have contracts that are three to five years in duration, so we’re talking about a contract cycle to work through our contracts of somewhere in the three-year plan period.

Charles Jobson – Delta Partner

Okay, thanks.

Joseph Rupp

Thank you.

Operator

Your next question comes from the line of Causus Caretano [ph] from Goldman Sachs. Please proceed.

Causus Caretano – Goldman Sachs

Hi, two quick questions for John. The first question with operating rates at normal levels and actually weaker than peak levels for sure, are you surprised by the frequency of unplanned outages? And then the second question is do you have any updates on the railroad issue for transporting chlorine, John?

John Fischer

The first question in terms of unplanned or unscheduled outages across the industry, I guess the only answer I have to that or perspective I have to that is, this industry has been pushed pretty hard from an output standpoint for several years and everybody has been dealing with the strain that puts on as producing assets and there have been and we’ve suffered in our own system some unplanned outages that have really disrupted the supply side. Hopefully, if everyone is focusing as we are on improved reliability, then that’s not going to be a continuing issue for the industry.

Your second question on update on rail, we mentioned in our comments that our freight rates have increased quarter-over-quarter 27% in the first half of the year, 30% something and we don’t expect those increases to go away and we’re working very diligently with our carriers and with other companies through trade associations to look for ways – to pursue ways to mitigate some of these very significant increases in freight cost.

Causus Caretano – Goldman Sachs

Thanks.

Operator

Your next question comes from the line of Don Carson from Merrill Lynch. Please proceed, sir.

Don Carson – Merrill Lynch

Hi. Just a follow-up in terms of cash flow and the balance sheet. As you get through the St. Gabriel capital expenditures, and also you are going to have some pretty strong cash flow generation for the next few years, you’ve already got pretty strong balance sheet, so what are your priorities in terms of use of your cash position and your cash flow? What capital expenditure opportunities do you see and what are your thoughts about returning cash back to shareholders either through a dividend increase or share repurchase?

Joseph Rupp

Don, our first option would be to continue to try to grow our chemical business. And from an M&A activity and from a strategic activity, you have to assume that we’re looking at ways that we could expand our business. And absent the opportunity to do that in this market, then as we get out into 2009, et cetera, then we have to consider what you’ve just talked about. We have to reward our shareholders in some form and that’s on our minds constantly. We prefer to do it by growing the business, but if we can’t do that then there’s other ways that we’ll have to reward shareholders.

Don Carson – Merrill Lynch

Joe, when you say grow the business in Chlor Alkali, so you would –

Joseph Rupp

I would prefer to say chemical, Don, because there’s limitations on what we may or may not be able to do from a Chlor Alkali perspective, but these Chlor Alkali are related business.

Don Carson – Merrill Lynch

Okay. All right, yes, that’s what I was wondering if you just sort of outlined your plans in Chlor Alkali, but I guess there’s just limited further consolidation opportunities there.

Joseph Rupp

Right.

Don Carson – Merrill Lynch

Great. Thank you.

Joseph Rupp

Thank you.

Operator

Your next question comes from the line of Richard O'Reilly from Standard and Poor's. Please proceed, sir.

Richard O'Reilly – Standard and Poor's

Okay. Thank you. Good morning, gentleman. Good morning, Larry. Another question for John, if he could give us an idea what the exposure of the system to natural gas power supply is and I think traditionally, Olin had a low exposure. Can you bring us up to date on that?

John Fischer

Let me try. If you stack the power exposure to the different fuels up in descending percentage with the coal being the highest, the top four are coal, hydro, natural gas and then nuclear. And although we haven’t given out individual numbers for each of those, I think it would be fair to say that coal and natural gas together represents slightly more than half of our fuel exposure. That obviously means hydro and nuclear represents slightly less than half.

Richard O'Reilly – Standard and Poor's

Okay. And just for clarification, the ECU price for the quarter came in slightly higher than what you have thought a couple of months ago. Was that on the rose price side or is it on the cost side? What was the improvement?

John Fischer

Well, I guess the improvement was a little a bit above. The 590 is the net number so it has freight already discounted from it. We had better mix than we have forecasted in the quarter and a little bit less of impact from the cost side, and our net backs were improved slightly.

Richard O'Reilly – Standard and Poor's

Okay great. Okay, good. Thank you guys.

John Fischer

Thank you.

Operator

Your last question comes from the line of Barrett Eiman [ph]. Please proceed.

Barrett Eiman

Just a question to make sure I heard you right, you said that of the improving Chlor Alkali operating income, $24.3 million is from Pioneer, and of that $24.3 million, $10 million is from synergies? Is that right?

Joseph Rupp

That’s correct.

Barrett Eiman

And the one other question, you guys don't – none of your products goes into – you don’t sell any PVC or VCM, correct?

Joseph Rupp

We do not but we sell chlorine into the vinyls.

Barrett Eiman

Right, which is used by that. Okay, thanks.

Operator

If you have no questions at this time, I would now like to turn the call over to Mr. Joseph Rupp for closing remarks.

Joseph Rupp

Thank you for joining us this morning and we look forward to reporting our results of our third quarter in October. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect. Good day.

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Source: Olin Corporation Q2 2008 Earnings Call Transcript
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