MANAGEMENT DISCUSSION SECTION
Operator: Good day and welcome to the Olin Corporation Second Quarter 2006 Earnings Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Chairman, President, and CEO, Mr. Joseph Rupp. Please go ahead, sir.
Joseph D. Rupp, Chairman, President and Chief Executive Officer
Good morning and thank you for joining us today. With me this morning are John Fischer, Vice President and Chief Financial Officer; John McIntosh, President of our Chlor Alkali Products division; and Larry Kromidas, Assistant Treasurer and Director of Investor Relations.
Last night, we announced that net income in the second quarter of 2006 was $33 million or $0.45 per diluted share compared with net income of $32.1 million or $0.45 per diluted share in the second quarter of 2005. Sales in the second quarter were $826.4 million compared with $593.7 million in the second quarter of 2005. Earnings per diluted share in the first half of '06 were $0.92 per diluted share compared to $0.97 per diluted share in the first half of 2005.
First half 2006 sales of $1.55 billion increased from $1.15 billion in the first half of 2005. Sales increased by $232.7 million from the second quarter of 2005 due primarily to the impact of higher metal prices. Second quarter earnings of $0.45 per diluted share reflected continued strong performance from our Chlor Alkali business. Though pricing for both chlorine and caustic soda decreased from the first quarter, Chlor Alkali achieved its second highest quarterly earnings level ever.
Winchester's results improved substantially over the second quarter of 2005, and helped to offset lower metals profits. Total company pension costs increased due to the impact of a lower discount rate and the higher amortization of plan losses, primarily investment losses on plan assets from prior periods.
In the third quarter of 2006, Olin expects earnings to be in the $0.60 per diluted share range, which includes approximately $21 million of reduced income taxes associated with the settlement of the tax treatment of capital losses generated in 1997 and other tax matters. Third quarter 2005 earnings per diluted share of $0.44 included an $18.9 million pre-tax gain associated with recovery of environmental costs and land sale gains. After giving consideration to the one-time items in each year, third quarter 2006 results are expected to improve over the third quarter of 2005.
Now let's turn to Olin's segments results for this past quarter and I will begin with Chlor Alkali products. Sales for the quarter of 2006 were $169.5 million and that compared to $158.3 million in the second quarter of '05. The increase in sales reflects an 11% increase in chlorine and caustic prices, which was partially offset by an 8% decrease in chlorine and caustic volumes. Volumes in the second quarter of 2006 were similar to the first quarter of 2006.
Second quarter 2006 volumes include the impact of a 7-day planned maintenance outage at our Niagara Falls facility. Chlor Alkali products earned $67.2 million in the second quarter of 2006; that represents the second highest quarterly earnings level ever and it is compared to $64.8 million in the second quarter of 2005. The second quarter of 2006 ECU netback was $560 which compares favorably to the second quarter of 2005 netback of $505. We expect our ECU netback to decline in the third quarter of 2006 compared to the second quarter, but to be higher than the third quarter of 2005. Full-year 2006 ECU netbacks should exceed 2005 levels.
During the second quarter, the announced $35 per ton caustic price increase and then $25 per ton chlorine price increase were both rescinded. We recently announced plans to invest approximately $12 million to expand our capacity to produce bleach at three of our manufacturing locations. These expansions, which we expect to come on stream in 2007, should improve our captive use of both chlorine and caustic soda, and improve our profitability per ECU.
During the second quarter, freight cost per ton of product shipped, increased approximately 20%, compared to the second quarter of 2005. We continue to evaluate investments to help improve the effectiveness, and to lower the cost of transportation and logistics.
Now, turning to metals. Metals second quarter 2006 sales were $571.2 million and that compared with $355 million in the second quarter of 2005. The increase was due primarily to higher metal values. The average price of copper increased from $1.53 per pound in the second quarter of 2005 to $3.37 per pound in the second quarter of 2006. Total metals volumes increased to 5%, reflecting an 8% in the rod business and a 4% increase in strip business. Ammunition and electronics shipments increased 13% and 51% respectively, while automotive, building products and coinage shipments declined, automotive by 7%, building products by 2% and coinage by 11%.
Metals segment income during the second quarter of 2006 was $8.7 million, compared to $13.3 million in the second quarter of 2005. Second quarter 2006 metals earnings included a $2.3 million insurance recovery related to the 2004 brass mill fire. The year-over-year decline in metals earnings is primarily due to the 120% increase in copper prices and an 18% increase in natural gas and electricity costs.
The negative impact of these increases was approximately $6 million compared to the second quarter of 2005. We expect third quarter 2006 metals earnings to improve compared to the third quarter of 2005 as the savings from the restructuring actions taken during the first quarter start to be realized. During June, the shutdown of the Waterbury Rolling Mills operations was completed and the ongoing operations have been transferred to East Alton.
Third quarter results in metals were typically weaker than the first and second quarters, due to scheduled maintenance shutdowns at our facilities and in our customers' facilities. Although the restructuring actions have created benefits, further improvements in our metals business are required, we believe both the strip and rod industries in the United States continue to experience operating rates well below 80%, which creates a difficult pricing environment. As a result, we continue to analyze additional cost reduction actions including further facility closures or consolidations as well as inventory reduction programs.
Now let's turn to Winchester. Winchester's second quarter 2006 sales were $85.7 million compared to 80.4 million in the second quarter of 2005. The increase reflects the combination of higher selling prices, which increased approximately $4 million year-over-year and higher commercial volumes. We believe some of the strengths seen in the second quarter commercial sales resulted from customers buying ahead of the July 1st price increases. Winchester segment income in the second quarter was $3.3 million compared to a breakeven level in the second quarter of 2005. The favorable impact of increased selling prices, higher sales volumes and lower manufacturing costs more than offset the continued increase in commodity and other materials costs. Winchester's profitability continues to be negatively impacted by the unprecedented levels of commodity material prices and specifically, copper and lead. Since the beginning of 2004, Winchester has announced seven price increases in an attempt to offset these costs.
During the second quarter of 2006, Winchester realized approximately $4 million of price increases compared to the second quarter of 2005, and approximately $7 million during the first six months of 2006. To further address Winchester's profitability, we have initiated a comprehensive cost reduction program to improve the efficiency and effectiveness of our manufacturing, customer service and distribution activities. We are being assisted in this process by an outside firm and have focused on labor-intensive operations and products. We expect third quarter 2006 earnings to improve from the second quarter and to be in line with the third quarter of 2005. We also continue to forecast that Winchester's 2006 earnings will improve over 2005 levels.
Before I turn the call over to John, I'm pleased to report that we have completed an exchange offer for $125 million of our $200 million debt issue that matures in 2011. Prior to the exchange, approximately 80% of our outstanding debt was due in 2011. The new notes which mature in 2016 have a coupon rate of 6.75% compared to 9 1/8% on the old notes. In conjunction with the exchange which will be slightly accretive to earnings, a cash payment of approximately $19 million was made.
Now let me turn the call over to our Chief Financial Officer, John Fischer. John?
John E. Fischer, Chief Financial Officer and Vice President
Thank you, Joe. First, I'd like to discuss a few items on the income statement. Selling and administrative expenses increased $2.8 million in the second quarter 2006 compared to the second quarter 2005. The increase is due primarily to higher pension expenses, higher compensation costs, including stock option expenses, which were partially offset by lower legal and legal-related costs. For the full year, stock option expenses will be approximately $3 million.
Total company pension expense for the quarter was $10.8 million compared to 6.1 million in 2005. This increase is due to the impact of the lower discount rate and the higher amortization of plan losses from prior periods, primarily investment losses. Full-year 2006 company-wide pension expense is projected to be approximately $41 million compared to 26 million in 2005.
The effective tax rate during the quarter was 36.3%, which is lower than the first quarter rate of 38%. The lower rate reflects the favorable impact of the settlement with the Internal Revenue Service, which allowed an interest charge previously included in the rate to be eliminated. We continue to forecast a full-year 2006 effective tax rate of 37%.
Now looking at the balance sheet. Cash and cash equivalents declined by $88.9 million during the second quarter 2006. During the quarter, we invested $26.6 million of cash in higher yielding, but liquid short-term investments to improve returns. At June 30, 2006, we had a total of $76.6 million of these investments. Accounts receivable balances increased $34 million during the quarter, and have increased $116 million since the end of 2005, which reflects the combination of increased volumes in each business and the increased cost of copper and zinc.
Our investment in working capital increased approximately $40 million during the second quarter and has increased approximately $95 million during the first six months of this year. Approximately 40 and $50 million of these working capital increases are attributable to the higher cost of copper. As a further point, since the beginning of 2004, the increased price of copper has caused a $90 million increase in Olin's investment and working capital. I would like to note that days sales outstanding have declined by four days in 2006 compared to 2005. Inventories also increased in the second quarter primarily due to Winchester's normal seasonal build.
Finally, during the quarter, a $44 million tax payment was made as part of the IRS settlement. Total cash tax payments in the first half of 2006 have increased approximately $69 million compared to the first six months of 2005. During the first six months of 2005, we were able to utilize net operating loss carry-forwards and only minimal cash tax payments were made.
Capital spending during the quarter was $16.5 million and spending for this first six months has been 30.7 million. The largest part of the capital continues to be directed at the Chlor Alkali business. Based on the investments to expand the bleach business and additional investments in transportation assets, we are now projecting capital spending for the full year to be $85 million. On Tuesday, our Board of Directors declared a $0.20 per share dividend. The dividend is payable on September 11, 2006 to shareholders of record at the close of business on August 10, 2006. This is the 319th consecutive dividend to be paid by the company.
Before we conclude, let me remind you that throughout this presentation, we have made statements regarding our estimates of future performance. Clearly, these are forward-looking statements and results could differ materially from those projected. Some of the factors that could cause actual results to differ are described in our most recent Form 10-K and is updated on our quarterly reports on Form 10-Q and in our second quarter earnings release. The copy of our prepared remarks today will be available on our website in the Investors section under Recent Press Releases and Speeches together with the earnings press release and other financial data.
Operator, we are now ready to take questions.
QUESTION AND ANSWER SECTION
Operator: Thank you. [Operator Instructions].
And we will take our first question from Frank Mitsch with BB&T Capital Markets.
Q – Frank Mitsch: Good morning gentlemen.
A – Joseph Rupp: Good morning.
Q – Frank Mitsch: Joe, just to make sure we are on the same page here in terms of the guidance, $0.60 including the income tax gain, I mean, you are basically looking at something like $0.31 for the third quarter versus a cleaner number of 28 in the third quarter of a year ago, is that kind of where we should be looking at?
A – John Fischer: That's a fair calculation.
A – Joseph Rupp: Fair calculation.
Q – Frank Mitsch: All right. And then you mentioned that you have been investing in short-term notes to boost the yield. I am wondering – to boost your investment returns, I am wondering what – paying out a 4.9% yield, I am wondering how your calculations are looking with respect to, instead of investing in short-term notes, investing in OLN common equity?
A – John Fischer: I think Frank, this is John. We would say the same thing we have been saying about; our caution revolves around the potential impact of legislation on our need to fund our pension plan.
Q – Frank Mitsch: So, John, basically, we should take our key from Congress, if in fact they mandate full funding that's where the cash flow would go; if in fact they do not, then, the question I just asked becomes much more germane?
A – John Fischer: I think that's fair, yes.
Q – Frank Mitsch: And then lastly, I think you were talking about your ECU being up meaningfully 2Q versus 1Q, but guiding down for the third quarter versus the second quarter on the Chlor Alkali side, I assume you're talking about a very, very modest sort of seasonal decline, is it anything more major than that, and if so, what might be the factors behind that, for the third quarter?
A – John McIntosh: This is John. We, as we look at the third quarter now, we do believe we'll see ECU's trend down, but we think there will be more pressure on the caustic side of the ECU than there will be on the chlorine side. Chlorine demand appears to be strong pretty much across all the market segments. And industry operating rates, and operating rates within Olin's system look to be higher, were higher in the second quarter, look to be comparable in the third. And so, we see that putting some pressure on caustic pricing and caustic netbacks into the third quarter.
Q – Frank Mitsch: The export aluminum market for caustic is not very big for you guys, right?
A – Joseph Rupp: That's correct.
A – John McIntosh: No sir, it's not.
Q – Frank Mitsch: Okay, all right, terrific, thank you.
A – Joseph Rupp: Thanks Frank.
Operator: And we'll take our next question from Don Carson with Merrill Lynch.
Q – Donald Carson: Yes, just two questions, one just a follow-on on Chlor Alkali, what's your volume outlook for the third quarter given that you won't have the maintenance turnaround? And also wondering, what impact do you see from this lower aluminum price, since you don't do much in that market? And then on the pension John, there is some clarity, it would appear that Congress is talking about giving companies seven years to fund their pensions, which would seem to give you quite a bit of time where you could not only fund the pension, but certainly invest in your stock as well, what details exactly are you waiting for there?
A – John McIntosh: Let me answer, this is John McIntosh. Don, I will answer you question, first question on Chlor Alkali. We see volumes into the third quarter looking comparable with volumes in the second quarter. And we do have an outage in the third quarter scheduled at our McIntosh site. So, comparing outage impact from quarter-to-quarter in terms of actual ECUs not produced, the numbers are, from an outage impact, are relatively comparable.
Q – Donald Carson: John, just want to follow-on to that, what would you see as the impact of what's happening with your power costs, are you seeing a run-up in some of the excess power you have to buy over the summer months?
A – John McIntosh: We are, we've seen power costs go up for us, whether you're comparing year-over-year or sequential quarters. Some of it's just due to some fuel cost increases that are passed along as part of energy cost recovery rate mechanisms the utilities use. But a big piece of it is because our operating rates are, for the second quarter were 95%. And at that level, we're buying some of the higher priced power. And as we move into the summer months, we expect to see some electricity cost increases in the third quarter.
Q – Donald Carson: Okay, thank you.
A – John Fischer: And to answer your pension question Don, you are absolutely right about full funding would be required in seven years after transition. So, we think that would be somewhere around 2014, where full funding would be required and that would obviously, over the long run, increase our required contributions. The other element of the Bill that probably has more short-term impact is the potential for them to be utilizing a discount rate based on current market conditions and the duration of a plan's liability. The demographics of our plan is we have a fairly short duration relative to other plans. And if that goes through and we have a reduction in our discount rate, it could impact short-term, our need to put funds into our plan in the short-term.
Q – Donald Carson: Okay, thank you.
Operator: At this time, it looks like we only have one question left in the queue. [Operator Instructions].
And we will go next to John Roberts with Buckingham Research.
Q – John Roberts: Good morning guys.
A – Joseph Rupp: Hi, John.
Q – John Roberts: You are overexposed to caustic relative to chlorine, aren't you because of the Sunbelt joint venture?
A – John McIntosh: That's probably a fair assessment to say because of Sunbelt, yes.
Q – John Roberts: And then when you look at the results John, the total earnings change at Sunbelt was bigger than the total earnings change in Chlor Alkali products, that is, looked like the wholly-owned business was essentially flat, and the gain year-over-year came from Sunbelt; is that related to caustic year-over-year versus chlorine year-over-year?
A – John McIntosh: It's partially related to that, it's also partially related to – we had a more significant impact on freight rate increases in the not-in-the-Sunbelt business, than we did in the Sunbelt business.
Q – John Roberts: Okay. And then for the third quarter guidance, Joe, obviously the chemical business is going to be down sequentially, is Winchester going to be down sequentially because of this inventory build or pre-buy that they just had, it's normally up sequentially?
A – Joseph Rupp: It's going to be up John.
Q – John Roberts: It's going to be up in spite of that pre-buy activity?
A – Joseph Rupp: Yes.
Q – John Roberts: And is brass going to be up or down?
A – Joseph Rupp: Brass sequentially will be down, but that's normal for that time, with the plant turnaround, it will be better than it was a year ago.
Q – John Roberts: Okay. The, improvement in the electronic side of the brass business, is there anyone specific application driving that?
A – Joseph Rupp: It's more broad-based; it's all not automotive connector, but it's primarily electronic type of connector, which would be computer and a little bit of telecommunication as well.
Q – John Roberts: Okay. It's still way down from where it was down, like in 2000, I think electronics got up to almost 40% of the brass business?
A – Joseph Rupp: It's way down compared to that, that's why a little bit of movements give such huge percentage increases.
Q – John Roberts: Okay. And then lastly, do we know anything yet about pension expense for next year? That is, assuming that your pension plan performance is stable or flat for the rest of '06, do we know next year that we are going to have more a greater loss amortization coming into the P&L, so that the expense goes up almost sort of irrespective of other assumptions?
A – John Fischer: Pension expense in 2007 will be higher than it was in 2006, for exactly the reason you stated. And based on where we are in terms of the amortization of losses, 2007 would be the highest year for pension expense and we would expect it to decline from there.
Q – John Roberts: Okay, so you just think – you are coming off the tail of this bubble of losses?
A – John Fischer: That's correct.
A – Joseph Rupp: That's correct.
Q – John Roberts: Okay. Thank you.
Operator: [Operator Instructions].
And at this time, it looks like we have no further questions. I would like to turn the conference back over to Joseph Rupp for any additional or closing remarks.
Joseph D. Rupp, Chairman, President and Chief Executive Officer
Thanks for joining us, and we'll look forward to reporting our results at the end of the third quarter. Thank you.
Operator: This concludes today's conference. At this time, you may disconnect.
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