MANAGEMENT DISCUSSION SECTION
Operator: Good day, everyone, and welcome to the Olin Corporation's Third Quarter 2006 Earnings Release Conference Call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Chairman, President, and Chief Executive Officer, Mr. Joseph Rupp. Please go ahead, sir.
Joseph D. Rupp, Chairman, President and Chief Executive Officer
Thank you. Good morning and thank you for joining us today. With me this morning are John Fischer, Vice President and Chief Financial Officer; John McIntosh, President of our Chlor Alkali Products division; and Larry Kromidas, our Assistant Treasurer and Director of Investor Relations.
Last night we announced that net income in the third quarter of 2006 was $56.2 million or $0.77 per diluted share compared with net income of $31.4 million or $0.44 per diluted share in the third quarter of 2005. Third quarter 2006 earnings include a $24.8 million reduction in the income tax expense associated with the settlement of the tax treatment of capital losses generated in 1997 and other tax matters. Third quarter 2005 results included pre-tax environmental recoveries of $18 million and a pre-tax gain on the sales land of $900,000. Sales in the third quarter were $851.9 million compared with $599 million in the third quarter of 2005. Our third earnings per diluted share of $0.77 represent our highest quarterly earnings per share since the 1999 spin-off of Arch chemicals and exceeded our forecast of $0.60, primarily due to better than expected results in each of our 3 businesses and the benefit from the tax settlement.
Chlor alkali experienced stronger than expected volumes during the quarter; while metals experienced better pricing than anticipated, and Winchester benefited from lower cost. Earnings in each business also improved over the third quarter of 2005. Third quarter 2006 results include the impact of a scheduled 5 day outage in our McIntosh Chlor Alkali facility that includes the Sunbelt partnership, it also shorter planned outages that are Augusta and Charleston Chlor Alkali facilities.
In the fourth quarter of 2006, Olin expects to be in the $0.25 per diluted share range which reflects normal seasonal weakness in each of our businesses. Fourth quarter 2005 earnings per diluted share of $0.45 included $30.4 million of pre-tax gains associated with environmental recoveries and a $2.5 million gain related to asset retirement obligations which were partially offset by a $10.5 million pre-tax charge associated with an accounting change. For the full year 2006, we expect Chlor Alkali and Winchester earnings to improve over 2005 levels. And we anticipate metals earnings to exceed 2005 results when – we include the LIFO inventory gain.
Now lets to Olin segments results over the last quarter, I am going to start to Chlor Alkali products. Sales for the third quarter of 2006 were $169.1 million compared to $151.5 million in the third quarter of 2005. The increase in sales reflects a 5% increase in chlorine and caustic volumes and a 5% increase in chlorine and caustic prices. Third quarter 2006 volumes were similar to the second quarter of 2006 and reflect the impact of the plan 5 day outage at our McIntosh facility which as I previously stated includes Sunbelt and the shorter scheduled outages that are Augusta and Charleston facilities. You may recall at the third quarter of 2005 volumes were negatively impacted by the three hurricanes which cost shut downs of our McIntosh Alabama facility and disrupted both transportation systems and customer operations.
Chlor Alkali products earned $63 million in the third quarter of 2006 which compares favorably to the third quarter of 2005 earnings of $57.3 million. The third quarter ECU netback was 540 which compares favorably to the third quarter 2005 netback of $515. We expect the ECU netback to decline in the fourth quarter of 2006 and to fall below the fourth quarter of 2005 level. However, we anticipate that full year 2006 netback will exceed 2005 levels. Fourth quarter 2006 Chlor Alkali earnings are expected to be similar to earnings in the fourth quarter of 2005. We are implementing the $25 per ton chlorine price increase announced in the third quarter.
Third quarter 2006 Chlor Alkali segments earnings with a highest third quarter earnings in the history of Chlor Alkali business these earnings were achieved in spite of continued increases in both freight and electricity cost which increased 18% for freight and 14% for electricity higher then the third quarter of 2005. We now believe full year 2006 earnings in our Chlor Alkali segment will be higher then our 2005 record earnings.
Now turning to our Metals business. Metals third quarter 2006 sales were $578.2 million compared with $347.1 million in the third quarter of 2005. The increase was due primarily to higher metal values. The average price of copper increased from $1.70 per lb in the third quarter of 2005 to $3.54 per lb in the third quarter of 2006. Total metals volumes were essentially flat in the third quarter of 2006, compared to 2005; although, we experienced a 5% increase in the rod business which was offset by a 4% decline in the strip business. Ammunition and electronic shipments increased by 7% and 26% respectively, while automotive decreased by 15%, building products decline by 2% and coinage decline by 19%.
Metals segment income during the third quarter of 2006 was $7.3 million compared with $2 million in the third quarter of 2005. The year-over-year improvement in metals earnings is due to improved product pricing and the cost benefited the first quarter restructuring which more than offset the negative impact of the 108% increase in copper prices and a 12% increase in natural gas and electricity cost, the negative impacts of these increases compared to the third quarter of 2005 was approximately $6 million. For the first 9 months of 2006 the negative impacts of these increases was approximately $16 million.
Metal segment income for the 9 months ended September 30th, 2006 after getting consideration to the $13.5 million LIFO inventory gain is $6 million lower than the first 9 months of 2005. This is due to the impact of higher cost including higher metal, and utility cost which have more than offset improved product pricing, sales volumes, and other cost reductions. We continue to pursue further improvements in the cost structure of our metals business. We have initiated a planned inventory reduction program and our distribution business in our East Alton facility and we are continuing to analyze additional cost reduction measures including the further facility closures or consolidations. Last week we announced we were considering the possible closure of our New Haven Copper facility. This facility is located in Seymour Connecticut and as you know we completed the closure of Waterbury Rolling Mills facility and the downsizing of our Watertown distribution center and so we had count reduction in the second quarter of this year. We expect fourth quarter 2006 metals earnings to decline compared with the fourth quarter of 2005 as the impact of lower volumes and higher metal cost are more then offset improved product pricing.
During October we have seen a slowdown in demand for both automotive customers which primarily impacts a strip business and building products which impacts the entire metals group. Due to seasonal factors the fourth quarter is typically the worst or the weakest quarter of the year in the metals business.
Let's turn to Winchester, Winchester third quarter 2006 sales were $104.6 million compared with a $100.4 million in the third quarter of 2006. The increase reflects higher selling prices which increased to approximately 8 million year-over-year that were partially offset by lower volumes. We believe that that third quarter sales volumes were negatively impacted by customer buying ahead of the July 1 price increase. Winchester segment income in the third quarter was $5.9 million compared to 4.7 million in the third quarter of 2005. The favorable impact of increase selling prices and lower operating cost, more then offset lower sales volumes and continued increase in commodity and other material cost The unprecedented levels of commodity material prices specifically lead and copper continue negatively effect Winchester's profitability. During the third quarter of 2006 lead prices increased to approximately 50% in the end of the second quarter, and have increased an additional 16% during the first month of the fourth quarter.
On an annual basis Winchester consumes 4 times as much lead as we do copper. As a point reference, copper prices have more than doubled since the third quarter of 2005. In a continuing effort to combat the increasing material cost during the third quarter Winchester announced a price increase of 10% on non-metallic products and 13% on metallic products to be effective December 1st. Winchester has now announced 8 price increases since the beginning of 2004. During the third quarter Winchester's major US competitors also announced price increases. Winchester's fourth quarter earnings are projected to be in a small loss to break-even range reflecting a normal seasonal pattern. The fourth quarter is typically Winchester's weakest. In the fourth quarter of 2005 Winchester had a loss of $300,000.
In summary, both our third quarter and year-to-date 2006 performance results have exceeded 2005 levels. After giving consideration to unusual items our third quarter of 2006 earnings improved approximately 50% from third quarter of 2005 levels and our year-to-date earnings have improved to approximately 15%, even after absorbing approximately $10 million of higher pension cost.
I'm going to turn it over now to John Fischer, our Chief Financial Officer who will review several financial items. John.
John E. Fischer, Vice President and Chief Financial Officer Thank you, Joe. First I would like to discuss a few items on the income statement. Selling and administrative expenses decrease by $3.5 million in the third quarter of 2006 compared to the third quarter of 2005. The decrease is due to lower legal and legal-related cost and a favorable mark-to-market adjustment on stock based compensation. As you recall in 2005, we experienced higher legal and legal-related cost associated with legacy environmental matters, including environmental cost recovery actions. These decreases where partially offset by increased pension costs, stock option expenses, and the fees associated with the July 2006 debt exchange.
Total company pension expense for the quarter was $9.8 million compared to 6.6 million during the third quarter of 2005. The increase is due primarily to the impact of a lower discount rate and the amortization of investment losses incurred in prior periods. Full year 2006 pension expense is currently forecasted to be approximately $13 million higher than 2005. During the third quarter an $80 million voluntary contribution was made to our pension plan. The contribution was timed to optimize the tax deductibility and have the effect eliminating a third quarter 2006 estimated tax payment. The pension contribution will be accretive to earning in both the fourth quarter of 2006 and in 2007. Also during the quarter the Pension Protection Act of 2006 was signed into Law. This Law which is intended to protect the beneficiaries of defined benefit pension plans will require plan sponsors to fund un-funded plan liabilities more rapidly.
We are still assessing the impact of the law on our plan, but believe be earliest any mandatory contributions will be required, will be 2008. During the quarter a $24.8 million reduction in income taxes was recorded associated with the settlement of certain issues related to the periods 1996 through 2002. After giving consideration to the settlement, the effective tax rate during the quarter was 33%. This compares favorably to the first and second quarter of 2006 rates of 38% and 36% respectively.
Reduction is due to the elimination of interest accruals associated with the tax issues settled in the third quarter and the utilization of certain state tax credit. For the full year 2006 after giving consideration to the third quarter tax settlement we believe the effective tax rate will be 36%. During 2007 the domestic manufacturing deductions which were included in the jobs creation act of 2004 increases from 3% to 6% which will further reduce our effective tax rate.
Looking at the balance sheet, cash and cash equivalents increased $25.8 million during the third quarter of 2006 which includes cash outflows for the $80 million voluntary pension plan contribution made in the quarter and the $18.8 million cash premium paid as part of the debt exchange. Working capital declined by $31 million but is increased $64 million year-to-date. The increase in working capital continues to reflect the increase cost of copper and zinc. As a further point of reference, since the beginning of 2004 the per pound price of copper has increased from $1 to $3.46 and the price of zinc has increased from $0.44 to $1.54 per pound. These increases have cost a $76 million increase in Olin investment and working capital, partially offsetting this has been a 4 day or approximately 8% improvement in our day sales outstanding. Year-to-date cash taxes of $79.4 has been paid compared to 2.4 million during the same period in 2005. During 2005 we were able to utilize net operating loss carry-forward which resulted in the minimal level of cash tax payments. Capital spending during the quarter was $17.3 million and for the nine months is been $48 million. The largest part of our capital spending continues to be directed at the Chlor Alkali business, approximately 60% of the year – to date spending has been in the Chlor Alkali segment and for the full year we expect approximately 65% of the company's capital spending to be in Chlor Alkali. Based on the investments to expand the bleach business and to our enhance our transportation assets we are now projecting full year capital spending to be in the 85 to $90 million range. Yesterday the board of directors declared a dividend of $0.20 on each share of Olin common stock the dividend is payable on December 11th 2006 to shareholders of record at the close of business on November 10th 2006. This is the 320th consecutive quarterly dividend to be paid by the company.
Before we conclude, let me remind you that through out 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 in our quarterly reports on Form 10-Q and in our third quarter earnings release. A 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 and information.
Operator, we are now ready to take your questions.
QUESTION AND ANSWER SECTION
Operator: Thank you. [Operator Instructions]. Our first question Frank Mitsch with BB & T Capital Markets.
Q – Frank Mitsch: Good morning.
A: Good morning Frank.
Q – Frank Mitsch: Hey Joe you talked about different price increases in your Winchester business metallic versus non-metallic, can you breakdown the overall roughly what percent of Winchester is metallic versus what percent Winchester is non-metallic?
A – Joseph Rupp: We don't really break down Frank, but when we say non-metallic, we are really talk about shot show [ph] which is one segment, than metallic is one that have showcase along with them.
: Okay. And when would you anticipate these price increases get realized?
A: They're effective December 1.
Q – Frank Mitsch: All right. And, you know I understand that there are lot of catalogs and so forth that you know get published anyway, so that perhaps the price increases don't go into effect right away. Is that one way to look at it, that it gets phase in or you're confident?
A: Phased in, yes.
Q – Frank Mitsch: And then, can you talk about you know you guys won a big military contract last year. Can you talk about how that's impacting Winchester business and when might we see a bit more of an impact on the bottom-line?
A: What we're seeing Frank is that our military sales are still running in that 15 to 18% range. And we're seeing impacts of the military contract that we got you know offset by the ending of these emergency buys that we experienced over the last 2 years. And there is a little bit more phase in that second source that will be current as we go in the first quarter of next year.
Q – Frank Mitsch: All, so 1Q which part [ph] your bigger impacts than we're seeing right now in the second half of '06?
A: That's fair.
Q – Frank Mitsch: All right. And then, I thought I read in the release that you guys had a few turnarounds in your Chlor Alkali business and my expectation was that there wasn't a heavy turnaround quarter in the fourth quarter '06, is that correct?
A – John McIntosh: Frank, this is John. We have a couple of turnarounds that we're going to take in the fourth quarter. But the amount of outage is significantly than it would have been in the third quarter results.
: Fine, so that will that be a very positive sequentially for Olin in particular then in terms of plan outages?
A: Yes.
A: For capacity available, yes.
Q – Frank Mitsch: Then you were talked about, I guess, modest decline in the ECU in the fourth quarter versus the third quarter, is that correct?
A: Yes.
A: Yes.
Q – Frank Mitsch: All right, which is not too much of the price given that if the costs have come down a little bit from the peaks that we saw in the summer time? Lastly John Fischer you're talking about the pension act, and we're calculating I guess that at the end of year – last year you were like $310 million on the funded and today you are about $249 million on the fund, when do you anticipate that you would have to get that to zero or how many years and is that the right way for us to look at that, can you provide a little bit more color behind the pension funding issue and what that might required in terms of input from Olin?
A – John Fischer: There is an absence of specific rules yet out of the government, the general write up on the pension act said that the full funding would be required in steps, there's actually a requirements to reach a 92% trash hold than a 94% trash hold and that was stated to be required over a 7 year period.
Q – Frank Mitsch: All right. So, what are you saying is that you don't have to be at 100% within 7 years?
A – John Fischer: You would have to be at a 100% within 7 years.
Q – Frank Mitsch: But there are two intermediate steps in terms of 92, 94 et cetera?
A – John Fischer: Yes, I think there's actually an intermediate step every year.
Q – Frank Mitsch: Okay. And as you calculated there is nothing required for '07 from you?
A – John Fischer: That's as we understand it today, that's correct.
Q – Frank Mitsch: All right terrific. Thank you.
A: Thank you Frank.
Operator: Our next question Don Carson with Merrill Lynch.
Q – Donald Carson: Thank you. John, first on the house keeping item, I saw on the cash flow that there is a reversal of last year deferred tax is in, what exactly was that?
A – John Fischer: That all related to the tax settlement that created the $24.8 million gain.
Q – Donald Carson: Okay.
A: We settled 7 years with the open tax issues.
Q – Donald Carson: Okay. And then Chlor Alkali question, what's the power cost outlook here, you did to I think 14% increase in power cost or there's some major utility contracts that come up over the course of the fourth quarter or into the first quarter that could lead to an acceleration in power cost. And the on the contract, on your customer contracts side, is there more opportunity to remove caps as contracts get renewed or is that pretty much all behind you know?
A – John McIntosh: On the electricity question, I guess the only comment I'll make is that we do have some contracts some of our electricity purchases that do have time of your components, so typically first quarter and fourth quarter have pricing that is lower then second and third quarter.
Q – Donald Carson: Okay.
A – John McIntosh: We don't have any electricity contracts that are coming up for re negotiations or renewal or then your future. In terms product contracts, we continue to have our portfolio, contracts in our portfolio expire and come do for re negotiation and we continue where we have the opportunity to negotiate for more favorable conditions which would included the elimination of any kind of caps or other price limitations. So that continues to be opportunity for us and as we start we look a quarter ahead as we start the new year that would be one way we typically see some of that impact.
Q – Donald Carson: But [ph] the opportunity is that sort of diminished relative to year ago well it seems you have a lot of caps coming of?
A – John McIntosh : I would say that it's – we probably have fewer opportunities in the future then we have had in the past, yes.
Q – Donald Carson: Okay. And Joe, a question on metals you talked how, you know no great surprise but auto and construction related demand is falling in the fourth quarter. I thought most of your construction exposure was more on the commercial side then on residential. Can you give the break-down on your construction mix?
A – Joseph Rupp: It's really on both side of it, Don, and it's more heavily weighted on the rod side then it is on the strip side. So we would anticipate there is an initiative that might be an impact more on the rod side of the business. But what happens is, on the rod side what we've seen in the past is that, when things start to stabilize that the remodeling and rehabilitation and all those kind of things and home improvement things have somewhat offset the decline in construction. Right now we are seeing a little bit of decline.
Q – Donald Carson: Okay, thank you.
A – Joseph Rupp: Thank you.
Operator: Our next question John Robert of Buckingham.
Q – John Robert: Good morning guys.
A: Good morning, John.
Q – John Robert: The decline in the brass demand, in the automotive, and housing market is that been anticipated in the last round of capacity reduction that you've done or if we continue for couple of more quarter on this earning decline, we have another round of right sizing that has to be done?
A – Joseph Rupp: I don't think it was totally anticipated to extend that we've seen the cut-backs at, the Big Three have done John, in the last you know announced for the first quarter cut-back and potential into the first quarter, and that's why we are continuing on evaluating us doing more right sizing.
Q – John Robert: Okay. And in the past couple of quarter, I think you included natural gas as one of drags on the brass earnings. And obviously we'd decline at least during the last quarter, was it meaningful to you in terms of any recovery or relief that you saw in the brass profitability?
A – John Fischer: Natural gas in three quarters of this year and our brass business has been essentially flat.
Q – John Robert: All three quarters? Are you hedged, there is been lot of volatility in natural gas.
A – John Fischer : Our first quarter was higher and it's come down. The second and third have been essentially flat and they were hedged, yes.
Q – John Robert: Okay. And how far out your hedges going, can you tell us kind of what he fourth quarter looks like?
A – John Fischer : Fourth quarter should be similar to the third quarter. We've typically hedge the entire winter strip.
Q – John Robert: Okay. Then effective Frank Mitsch question earlier, you know shotgun shells, it's only plastic on the casing; right, the base cups metal, the shot itself is metal, that's there,
A – Joseph Rupp: That's correct.
Q – John Robert: Right. So, that's why the price increase we really want all that different between what are you call non-metallic and what you call...
A – Joseph Rupp : Yes.
Q – John Robert: Right, okay. Thanks.
A – Joseph Rupp : Thank you, John.
Operator: Our next question Edward Yang with CIBC World Markets.
Q – Edward Yang: Hi, good morning.
A: Good morning.
Q – Edward Yang: In auto, what's your exposure to the Big Three versus the Asian and German?
A – Joseph Rupp : We supply all the major automotive manufactures, all the transplants here in the US. So, we have had positive impacts on some of the transplants, which is been offset obviously by the negative impacts with the Big Three.
Q – Edward Yang: But, it is lot more skewed to the Big Three, I guess considering that...
A – Joseph Rupp : We normally break it out. But we have a favorable position with Big Three.
Q – Edward Yang: Okay. And Joe I keep hearing that you are an LVO candidate, has anyone approached you, and philosophically, are you open to go in private. And assuming any new owner may not want to keep all the assets together, are there any structural issue, like back-office or overhead that you would think to present [ph] separating metals in Winchester Chlor Alkali?
A – Joseph Rupp : Well, we normally wouldn't comment on that, on this – at that point in time.
Q – Edward Yang: And sort of the back-office and the structural issues over there?
A – Joseph Rupp : Essentially from a back-office perspective, we basically relocated our corporate headquarters two years ago from Norwalk, Connecticut to East Alton, Illinois and Clayton, Missouri and accomplish what you're talking about there, where we do start corporate overhead by about 40%, and then consolidated with our common services that support both corporate Winchester and our metals business.
Q – Edward Yang: Okay. And John on the pension and healthcare you mentioned its accretive to earnings, how much, you got a 9% rate of return assumption, is the benefit basically $7 million on an annual basis, which is that percent of $80 million?
A – John Fischer: And there is offset associated with the opportunity cost associated with using the cash.
Q – Edward Yang: Okay. And then, I guess, you have some turn assumptions for next year in terms of the underlying refunding in the pension and healthcare cost?
A – John Fischer : That's fair, correct.
Q – Edward Yang: Okay. Thank you.
A: Thank you.
Operator: [Operator Instructions]. We'll go next Sergey Vasnetsov at Lehman Brothers.
Q – Sergey Vasnetsov: Good morning.
A: Good morning.
Q – Sergey Vasnetsov: Couple of clarifications on pension plan. Could you please talk about your full year expected contribution in '06 and '07 to pension plan, cash contribution?
A – John Fischer : In 2006, we made the $80 million contribution that will be what we've made. And what we just said was we don't see any mandatory contributions under the new Pension Act until 2008; although, we haven't see all the final guidance on how that Act is to be implemented.
Q – Sergey Vasnetsov: So, just talking 6 with 18, right?
A – John Fischer : 80.
Q – Sergey Vasnetsov: 80, okay, got it. And so, I understand that you don't have any mandatory contribution that's why I asked you about your plans, what are your plans for '07?
A – John Fischer : We've not stated any plans other than, we are not – don't believe we're going to have any mandatory contributions until 2008.
: Okay. And secondly, I understand that there's uncertainty about pension reform that prevented you from deploying larger amount of cash in the balance historically. Do you think that you have enough clarity today to talk about your views, what will be the increase or share buyback?
A – John Fischer : What we said just now, was that we're still assessing the impact of the Act. A lot the interpretation that come out of the government that need – still needs to come out of the government in terms of the how the Act will actually be applied. How actual calculations will be done. We don't have any information now, we expect to receive that over the next 3 to 6 months, and then we'll be in a better position Sergey to answer your question.
Q – Sergey Vasnetsov: So, by early '07 you are telling, right?
A – John Fischer : I would say, yes.
Q – Sergey Vasnetsov: Okay. Thank you.
A: Thank you.
Operator: And due to time constraints that will conclude today's question and answer session. And right now, I like turn the conference back to management for any additional or closing remarks.
Company Representative
We just want to thank everybody for there participation and we will look forward to speaking with you in January when we report our full year earnings for 2006. Thank you very much.
Operator: And ladies and gentlemen now we'll conclude today's call. We do thank you for you participation. We ask that you disconnect your phone at this time.
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