Robert Gibney – VP, Corporate Affairs
Mary Mikkelson – SVP and CFO
Tom Adams – Chairman and CEO
Tronox Incorporated (TRX) Q2 2008 Earnings Call Transcript July 30, 2008 10:00 AM ET
Good day, ladies and gentlemen, and welcome to the Tronox Second Quarter Earnings Conference Call. My name is Heather, and I will be your coordinator for today. At this time all participants are in a listen-only mode. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to your host for today's presentation, Mr. Robert Gibney, Vice President, Corporate Affairs. Please proceed, sir.
Thank you, Heather, and good morning, everyone. Welcome to the Tronox second quarter 2008 investor conference call. With me today are Tom Adams, Chairman and Chief Executive Officer; Mary Mikkelson, Senior Vice President and Chief Financial Officer, and from our Investor Relations and Communications team, Debbie Schramm.
Today's call includes prepared slides that can be accessed on our website at Tronox.com by selecting ‘Webcasts and Events’, and then ‘Second Quarter Earnings’ under the ‘Investor Relations’ tab. Today's call will be a listen-only format with no question or answer period following the end of our prepared remarks. As we continue to evaluate strategic alternatives for improving our business and addressing the ongoing challenges we face, and given that these initiatives are still being developed, we are not prepared at this time to answer questions regarding this process, our strategies or long-term outlook. However, we do want to provide investors with details about our performance in the second quarter and expectations for the third quarter, so we are hosting our call with prepared comments only.
Our comments today will contain forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements include those statements shown on Slide two and include words such as will and expects or similar words. Please note that actual results or events may differ materially from our expectations or projections. Information concerning some of the factors and risks that could cause material differences is identified in the Risk Factors section of the Company's 10-K and other SEC filings.
First on today's agenda Mary will review our financial and balance sheet items. I will then review the second quarter results, followed by Tom who will provide his perspective on the quarter and highlight our progress on key strategic initiatives we have underway. We expect to complete this morning's call at half past the hour.
At this time, I would like to turn the call over to our CFO, Mary Mikkelson. Mary?
Thank you, Robert. As we previously disclosed, we were successful in working with our lender group to secure a waiver and subsequent amendment to the credit agreement for our senior secured credit facility. This was necessitated by the unexpected impact in the second quarter of rapidly escalating input costs including process chemicals, freight and energy, and the unexpected production difficulties we experienced at our German and Australian facilities. Our amended leverage ratios are shown on Slide four.
In connection with the amendment, the Company paid the consenting lenders a fee of 75 basis points. The fee paid for this amendment are expected to be capitalized and amortized over the remaining life of the credit facility. Our interest rate for the credit facility did not change as a result of this amendment, and remains at LIBOR plus 350 basis points, plus an additional 50 basis points for the quarter following a quarter in which our consolidated quarterly leverage ratio is equal to or exceeds 4.25 times during 2008. Therefore, based on our leverage ratio of 4.95 times for the quarter ending June 30, 2008, our interest rate for the third quarter will be LIBOR plus 400 basis points.
We are pleased that a majority of our lender group supported Tronox in this amendment request. However, there can be no assurance that we won't be in default under the credit agreement in the future. If Tronox were to be in default under the credit agreement, our ability to borrow would be impaired, and the lenders could declare a default, which would ultimately cause all amounts due under the credit agreement to become immediately due and payable.
As many of you are aware, our financial covenants become more restrictive in 2009. Due to uncertainties regarding the continued escalation of input costs, we only requested the current amendment through the end of 2008. Due to these uncertainties and the global economic outlook, we are unable to predict with a reasonable level of certainty at this time if we will be able to achieve our financial covenants in the first half of 2009.
As a result, accounting guidance requires that our long-term debt be reflected in current liabilities in our June 30, 2008 balance sheet. This does not mean that our debt is callable at this time. The classification is driven only by accounting guidance but we have full access to and availability under our revolver at this time.
We are continuing to push for price increases while finding ways to further reduce our costs, manage our cash flows, and reduce our debt in an effort to improve our leverage ratio. We are also exploring opportunities to refinance our debt and/or will continue to work with our lender group for further amendments as they may be needed. However, there can be no assurances that we would be successful in refinancing our debt or obtaining another amendment should that be required.
At June 30, 2008, total outstanding debt was $540.1 million, which included $69 million outstanding on the Company's $250 million revolving credit facility. Cash and cash equivalents at June 30 were $23.3 million, resulting in net debt outstanding of $516.8 million.
We completed two land sales right at the end of the quarter and had $3.2 million of net proceeds available on June 30 to reduce our outstanding term loan balance. An additional $8.8 million of net proceeds was received late in the day on June 30, so it was not available to reduce our term loan until the first week of July.
Due to our increased cost of goods sold during the second quarter we had to increase the borrowings under our revolver and ended the second quarter with an outstanding balance on the revolver of $69 million. While we are closely managing our cash, we do expect to continue to utilize the revolver in varying amounts throughout the balance of the year.
During the second quarter of 2008 we used cash flows in our operating activities of $11 million, principally due to our operating results. As you can see in the Cornerstone working capital chart on Slide six, our working capital on a cash-to-cash basis is eight days below the same period in the prior year with the most significant reduction being in inventories as we reduced our inventory level in the second quarter.
As you know, the euro and Aussie dollar continued to gain strength against the U.S. dollar, which does have an impact on our working capital balances. Referencing our Cornerstone working capital components of receivables, inventory, and payables our working capital is approximately $20 million higher at June 30, 2008 as a result of the current exchange rates compared to the rates in effect at the same period in 2007. We continue to reduce working capital every day and expect to achieve our year-end target for 2008.
Our SG&A expense in the second quarter was $27.2 million, a $2.8 million decrease compared to the second-quarter of 2007 due primarily to lower compensation and benefit costs resulting from our restructuring and cost reduction initiatives. In May, we announced a workforce reduction to further reduce our SG&A costs moving forward. This reduction resulted in the elimination of approximately 70 positions across the Company, including open positions that will not be filled, and will result in an annual savings of approximately $8 million.
We recorded a one-time restructuring charge to cover severance and other one-time costs associated with this reduction in force of $4.2 million during the quarter. Our 2008 projection for SG&A expense continues to be in the range of $108 million to $111 million.
Interest expense in the second quarter of 2000 was $12.7 million, slightly higher than prior year. We've increased our projection for 2008 interest expense slightly to be in the range of $48 million to $52 million, reflecting the higher interest costs we are incurring.
We continue to manage our capital expenditures very closely and spent $7.3 million in the second quarter of 2008 and have spent $15.6 million year-to-date. This is well below our historical spend rates and reflects our continued focus on extracting more from our existing assets and actively managing our capital spend until a time when market conditions improve. We project our 2008 capital expenditures to be in the range of $45 million to $48 million, which is down slightly from prior estimates. We believe this amount will provide adequate maintenance capital for our operations to continue to run safely and efficiently.
Our depreciation and amortization in the second quarter was $29 million, and we project full year 2008 D&A to be in the range of $115 million to $117 million.
Our effective tax rate for the quarter on continuing operations was 33%. Due to the NOLs we have in many jurisdictions and our projected taxable earnings, we are expecting a very nominal cash tax rate for the year.
Our financial reserves for environmental remediation at June 30, 2008, for all active and inactive sites totaled $183.8 million, a net increase of $2 million from the prior quarter. This increase was due to an increase in our environmental reserves of $10.2 million, partially offset by payments on projects during the quarter.
The increased reserves included a $6.2 million reserve for our Henderson, Nevada facility for the estimated costs associated with the ongoing eco site investigation work where we are now required by NDEP to perform four times the number of samples to complete testing and analysis. We believe that the insurance policy we have for this site will cover the majority of these costs and as such we have increased our reimbursement receivable for Henderson by $5.7 million.
We also increased our reserve for the former Cleveland, Oklahoma refinery site by $3.8 million for recently completed engineering estimates to complete the necessary excavation and disposal of additional impacted soil from this site. This charge is recorded as part of our discontinued operations.
At the end of June we had receivables for reimbursements of approximately $63.1 million. During the quarter we received $11.7 million in reimbursements, including $11.3 million from the Department of Energy and $400,000 from Kerr-McGee Anadarko. We also recorded receivables of $7.3 million, reflecting future reimbursements from our insurance providers just discussed, and additional reimbursements from the DOE and Kerr-McGee.
Please keep in mind that our receivables do not include approximately $27 million in anticipated future reimbursements due Tronox by the DOE for work yet to be completed at the West Chicago site. As a reminder, we only record receivables for this site as we spend cash for the remediation. We are unable to recognize future expected receivables because we are not entitled to the reimbursement until we actually expend the funds. Annually, we submit our expenditures to the DOE for review and audit, and then reimbursements are approved by Congress each year through the appropriations process. It is expected that the DOE will continue to reimburse us 55% of our cost at this site.
We continue to project our net environmental spend for 2008 to be in the range of $30 million to $35 million.
Regarding our ongoing mediation with the US EPA on the Manville, New Jersey site, the EPA has extended the tolling agreement until August 29 of this year. It has been extended to continue to work through the various issues and mediation process. And as a reminder, if the mediation is unsuccessful, we intend to vigorously defend our position.
At this time, I will turn the call over to Robert for his review of the second-quarter results.
Thanks, Mary. Turning now to Slide 10, net sales for the second quarter were $403.8 million or $37.3 million higher than the same period in 2007, mainly due to higher sales volumes, the effects of foreign exchange, and increased prices. Demand for our Titanium dioxide continues to be strong in Asia-Pacific, Europe, and Latin America, helping to offset continued weakness in the North American market.
Cost of sales on a year-over-year basis were higher by $67.2 million, mainly due to higher input costs, including process chemicals, freight and energy, the production difficulties experienced in our Uerdingen, Germany and Kwinana, Western Australian facilities, the effects of foreign exchange, and the increased sales volumes. As a result, gross margin for the quarter was $200,000 compared to $30 million in the 2007 second quarter.
As Mary mentioned earlier, our SG&A spend in the second quarter was $27.2 million, a reduction of $2.8 million from the same period of 2007. The reduction in force, which we completed during the second quarter resulted in a one-time restructuring charge of $4.2 million or $0.10 per share.
In accordance with FAS 142 the Company analyzes its intangible assets, including any goodwill or impairment on an annual basis during the second quarter. Current year's analysis resulted in a non-cash impairment charge of $13.5 million or $0.33 per share.
As we reported earlier in the quarter, land sales, primarily in the Henderson, Nevada and Oklahoma City area, provided a net gain of $12.4 million or $0.30 per share.
For the quarter, we recorded a loss from continuing operations of $29.9 million or $0.73 per diluted common share compared with a loss of $20 million or $0.49 per diluted share in the same period of 2007. Excluding one-time items, including the gain on land sales, our adjusted loss per share from continuing operations is $0.69 per diluted common share.
Turning now to the bridge on Slide 11, excluding one-time items, the quarter was impacted by the increased costs associated with higher input prices and the production difficulties at our German and Australian plants. Up to $0.62 shown on the costs column, over half or $0.32 relates to the production difficulties and natural gas disruptions. Improved pricing late in the quarter was not enough to offset these cost increases, and on a year-over-year basis our Project Cornerstone savings for the quarter while positive were down as compared to the savings we experienced in the second quarter of 2007. This graph does not reflect the cumulative $93 million Cornerstone savings to-date. Outbound freight costs were higher as a result of fuel surcharges and increased exports to Asia, and the United States.
In the next few slides I will walk you through the major inputs that have contributed to the run up in our costs. In process chemicals, which account for 15% to 20% of our manufacturing costs, prices in the second quarter continued to move higher. Caustic soda, sulfur, and a wide variety of other process chemicals saw increases. Sulfur, for instance, has reached an all-time high, rising from just $60 per metric ton a year ago to between $500 and $800 per metric ton today. While not a big input for our chloride plants, sulfur is a large cost component for our Uerdingen sulfate plant. An advantage this plant has versus many other sulfate producers is that we have our own sulfuric acid regeneration facility, which allows us to reduce our reliance on sulfur.
Looking at our other process chemicals, calcined petroleum coke prices continued to increase as crude oil costs and energy costs in general increased. Fuel-grade coke prices have reached historic highs on the back of record prices for coal and natural gas and the continued growth in demand for aluminum. Although we have reduced our annual domestic caustic soda usage by 60%, caustic soda prices continued moving higher in the second quarter and are now 50% higher than a year ago and are projected to move higher in the third quarter.
Chlorine prices are down approximately 15% versus a year ago and are one of the lone bright spots on the input side of the equation. Overall, process chemicals as a component of our manufacturing costs were approximately 15% higher versus the second quarter of 2007, and 5% higher sequentially from the first to the second quarter of 2008.
While freight costs moved higher as a result of surcharges and increased shipping fees, we have been successful in mitigating some of these increases through a number of projects across the Company. These include the dedicated drayage at our Savannah facility, which we put in place in the first quarter, which is saving over $200,000 per year in transportation costs.
During the second quarter we negotiated lower transportation and fuel surcharge rates for an inbound process chemical that will provide annual savings of $0.5 million. And beginning this quarter we will make changes to how we store our finished goods inventory, providing over $1 million in annualized savings.
Also this quarter we are implementing new domestic motor carrier rates and expect to reduce our costs by over $500,000 per year. These projects, along with others, are helping to offset record high freight rates.
Inbound freight rates continue to be of concern. However, rates are projected to decline late this year and into 2009 and 2010 as a large number of new vessels currently under construction hit the seas and help provide relief for the tight bulk shipping market.
Our outbound freight rate costs are 16% higher on a year-over-year basis and essentially flat sequentially from the first to the second quarter of 2008, reflecting the savings we are experiencing from the various projects we have underway.
As a reminder, energy accounts for approximately 13% to 15% of our manufacturing costs with natural gas accounting for 51% of our energy needs, followed by electricity at 27%, and steam at 22%. Higher energy prices continue to negatively impact the business, but not only in our direct energy input such as natural gas, electricity, and steam, but also the flow through to freight and process chemicals.
While approximately 50% of our natural gas and steam costs are fixed for the year, we are experiencing rapid escalation in certain markets such as Europe where our uncontracted natural gas costs increased approximately 11% beginning of the third quarter versus the second quarter of this year. As you can see from the pie chart on the right, our energy challenges are global in nature with over 50% of our energy usage outside of the U.S. Sequentially, energy costs from the first to the second quarter rose just 3% as a result of the natural gas hedges and fixed-price contracts.
Regarding our Western Australian operations impacted by the Apache natural gas plant fire late in the second quarter, the pigment plant was able to contract with a third party for supplies of natural gas and diesel in order to keep the plant running at capacity. The third-party supply of natural gas was priced at approximately $30 per gigajoule, and we are hopeful the plant will be able to regain supplies of natural gas in the coming weeks at reduced prices in the range of $8-$10 per gigajoule.
A major Western Australian energy producer has recently taken the coal-fired electricity plant out of mothballs, allowing additional natural gas supplies to be sent to the market. The increased cost for the natural gas as a result of the Apache shutdown was approximately $2 million pre-tax in the second quarter.
We will see a similar impact for Q3 as Kwinana has been purchasing their natural gas requirements at these increased pricing levels for the month of July. We are in the process of pursuing insurance recovery and our insurance carrier has provided initial acceptance of the claim. This is still work-in-process, and we will provide an update at a later date.
Turning now to our results by segment on Slide 15, pigment sales for the second quarter were $374.4 million versus $340.2 million in the prior-year period due to higher TiO(2) sales volumes, the effect of foreign exchange and increased acid prices. Our Savannah, Georgia facility produces sulfuric acid, which it sells into the merchant market, and has benefited from the run-up in sulfuric prices, but also has experienced the increase in sulfur costs. While our revenue has increased, we have seen a corresponding increase to our cost of goods sold for this product.
Global pigment production volumes during the quarter were 143,100 metric tons compared with 147,600 metric tons in the second quarter of 2007. This decline in production volumes was mainly the result of the Kwinana and Uerdingen plant operational issues. During the quarter our five TiO(2) production facilities operated at approximately 90% utilization rate.
Pricing sequentially was flat in the first quarter. Late in the second quarter a number of global price increases were announced by Tronox, and we have been encouraged to see initial implementation in all three regions, and we are now working with our customers to implement the remainder of these increases.
For the 2008 second quarter, pigment reported an operating loss of $42.3 million compared with an operating profit of $3.7 million for the prior-year period. The decrease was due in large part to higher input costs, the effects of foreign exchange, and the production difficulties I mentioned earlier.
Moving now to our electrolytic and other chemical businesses, sales for the second quarter were $29.4 million compared to $26.3 million in the 2007 period. The $3.1 million increase in sales was due to higher sales prices.
Electrolytic reported an operating profit for the quarter of $800,000 compared with $600,000 in the second quarter of 2007. While pricing was better, higher energy and freight costs partially offset this gain.
We are very pleased with the progress on our EMD anti-dumping issue. We are in the last stages of the investigation with the Commerce Department's final determinations due on August 8, followed by the final vote at the end of September. We anticipate a positive result that should contribute to a favorable outcome for this business.
Before turning to call back over to Tom, I would like to provide an update on our land sales initiatives. We are continuing to make solid progress executing our land sales program focused on monetizing our stranded assets despite a very challenging real estate environment.
In the second quarter, we successfully sold a number of parcels of 100%-owned property with net proceeds from sales totaling approximately $12 million pre-tax. The majority of this resulted from the sale of two parcels located in Henderson, Nevada and Oklahoma City. The Henderson parcel was located adjacent to the 53-acre parcel that had previously received a No Further Action letter, and we remain hopeful that we can close on this and other parcels in the Henderson area that we have – had in various stages of the sales process in 2008. The parcel sold in the Oklahoma City area was adjacent to our Technical Center. We're continuing to pursue further sales parcels – parcel sales in the Oklahoma City area with the expectation of additional sales by year end.
That completes the review of the second-quarter results. So I would now like to turn the call over to our Chairman and Chief Executive Officer, Tom Adams. Tom?
Thanks, Robert. In this unprecedented high cost business environment where virtually every input we purchase to manufacture and sell our products is rising to historic highs, we are focused on a number of critical projects to reposition the Company for future success. I would like to provide you an update on our Project Cornerstone and give you an outlook for the business and the industry.
As you will recall, we began Project Cornerstone in the summer of 2006. And to date we've reduced our cash costs by $67 million, and SG&A spend by approximately $26 million. Project Cornerstone continues to provide baseline cost savings and is on target to exceed our 100 million cumulative savings goal by the end of the year. In addition, we are on track to meet our working capital reduction target of $71 million this year also. Our employees continue to excel in their efforts to reduce our cash costs and be more efficient with our cash management.
We are encouraged to see the recent improvement in the TiO(2) market, notably the pickup in demand across the globe and recent successes in implementing price increases in all three regions. The pickup in demand coupled with high operating rates in the mid-to-low 90s, and inventory levels moving below seasonal norms, provides us with an increased confidence that pricing will continue to move higher in the third quarter.
The announced increases we are working to implement over the next few months amount to between 11% and 13%, which includes the June and July increases we announced. We believe these increases are supported by the tightening global supply-demand situation.
In Asia, for instance, lead times are now 60 to 90 days, and we expect to achieve substantial implementation of the July 1 increase across this region. We are hopeful that these increases will be enough to offset continuing cost increases the Company expects to experience in the second half of the year. We will continue to push for every penny of price improvement and cost reductions in order to improve our margins.
We continue to place a high priority on taking aggressive actions to improve our business during this timeframe of unprecedented challenges facing the TiO(2) industry. Our Project Cornerstone initiatives driven by our employees continue to drive efficiency and fixed cost reductions in our business. At our Uerdingen facility we have finalized our restructuring plan and are in negotiations with the works council regarding expected changes. While Project Cornerstone has been successful in reducing our consumption and baseline costs, it is simply not enough to offset record-setting increases, which we've experienced in virtually every input we purchase.
Improved product pricing is essential for us and the TiO(2) industry to begin a margin improvement turnaround. As I mentioned, we have double-digit increases on the table, and these will be critical for us to begin the process of margin improvement moving forward.
I am encouraged by what we have seen in the recent few months concerning TiO(2) pricing, but this early momentum must be sustained in order to ensure that TiO(2) industry remains viable long-term. Along with other input costs, we will maintain our focus on reducing our SG&A spend and tightly controlling our expenses given the uncertainty as to the timing of the U.S. economic recovery.
As we've stated before, we are evaluating all strategic options available to the Company, including, but not limited to the mitigation of our environmental liabilities and capital restructuring. We've added bench strength to the management team to help manage this process and I am pleased to welcome Dennis Wanlass to our team. His expertise in helping to turn around companies in difficult positions will be needed as we address our various initiatives. In addition, we have retained the investment banking firm, Rothschild Inc. to further assist us in evaluating our strategic options for the business.
This has been the most challenging business environment our Company and the TiO(2) industry has faced, and we must be prepared to take action to preserve the long-term viability of this business should conditions worsen in the months ahead. While we continue to make strides against difficult conditions, there is no assurance that we will be successful in pursuing strategic alternatives and other options or that the current price increases we are implementing will offset continuing cost increases, and other factors that the Company is unable to predict and that are beyond our control.
As Robert mentioned earlier, we continue to evaluate strategic alternatives for improving our business and addressing the ongoing challenges we face. Given that these initiatives are still being developed, we are not prepared at this time to answer questions regarding this process, our strategies or long-term outlook. However, we wanted to provide investors today with details about our performance in the second quarter and expectations for the third quarter. For these reasons we will not be taking Q&A this morning, and we hope you understand our position. We will certainly try to provide clarity around these strategic alternatives in the future.
And with that, I will now turn the call back over to Robert.
Thanks, Tom. A replay of this call will be available for one week through the Company's website and can be accessed at Tronox.com. Thank you for your interest in Tronox, and this concludes our call.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.