Q4 2005 Results Conference Call
Mark Davis
Good morning, ladies and gentlemen. Thank you for joining us for our conference call and webcast this morning.
Joining me today are Vic Wells and Rohit Bhardwaj. As we announced in early January, Vic will be retiring at the end of March and Rohit will replace him. Vic has done an outstanding job as CFO since our IPO in 2001 and has helped to guide us through the significant expansion of Chemtrade and several financings. I would like to thank him for the great contribution he’s made to Chemtrade. We’re also pleased to have found Rohit to take over the reins, and I know he’s looking forward to establishing the same kind of positive relationships that you have had with Vic.
The other significant senior management change we announced in January was that Dave Masotti joined Chemtrade as President and COO. Dave replaces Claudio D’Ambrosio who is currently on medical leave, but will not be able to return to full time duties.
Both Dave and Rohit bring impressive track records to Chemtrade and I’m looking forward to working with them as we navigate through some immediate issues but, more importantly, work towards improving Chemtrade’s long-term growth and performance.
For today’s call, we’ll follow the usual format. Vic and I will review the fourth quarter results and our outlook for 2006, after which we’ll answer any questions you may have.
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Before I commence the review, I would remind you that our presentation contains forward-looking statements that are based on current expectations, and are subject to a number of uncertainties and risks, and actual results may differ materially. Further information identifying risks, uncertainties and assumptions can be found in the disclosure documents filed by the Fund with the securities regulatory authorities, available at www.sedar.com or on the Fund’s website.
The fourth quarter results were disappointing. Chemtrade generated distributable cash of $9.7 million or 29 cents per weighted average unit. A number of one-time events, including Hurricane Rita, adversely affected 4th quarter distributable cash by about 10 cents per unit. I’ll detail these items in a minute. In addition to these one-time costs the most significant issue we faced in the fourth quarter was the continued escalation of costs affecting the production of SHS. Both the one-time events and the cost escalations affect our SPPC segment.
The good news was that Pulp Chemicals and International continued their strong performances, both posting solid year over year improvements.
I would like to give you the details on the one-time events, as we do not think that our 4th quarter results are indicative of our earnings run rate. First, Hurricane Rita.
As you will recall, since our Beaumont plant was in the direct path of the hurricane, we closed down operations on Thursday, September 22. By October 15 we had carried out critical repairs and were ready to restart the plant. We implemented a controlled ramp-up to regular operations and by October 21 we were back to full production. There were some residual operating challenges and supply issues after the restart, which was a common experience for most businesses in the region. Some of our large regen customers are still experiencing occasional operating interruptions that are not unusual when plants like these are quickly shut down and then restarted. These customers may have some additional downtime in the 1st quarter to ensure that their operations can run smoothly during the high gasoline demand season in the summer. Regarding our own plant these issues seem to be behind us; we are back to normal operations and will undertake any further repairs that may be required during our regularly scheduled maintenance turnaround.
Hurricane Rita’s financial impact on our fourth quarter was material. We estimate that the effects of the hurricane, including the plant downtime and market disruptions, reduced distributable cash by US$2.1 million, or about 7.5 cents Canadian per unit. As we have noted previously, Chemtrade carries business interruption insurance. After the policy deductible of about $300,000, we expect to recover a significant portion of the balance when we submit our claim. Since the claim is not yet finalized we have not included any of the expected recovery in 2005 income.
Before moving on to a review of our operations, there were two other one-off costs in the 4th quarter that affected distributable cash. We incurred a one-time property tax reassessment of $0.7 million, or about 2 cents per unit, and legal costs related to the liquid SO2 anti-dumping action that were over $0.3 million, or another 1 cent per unit. The tax reassessment was for property tax on our Leeds facility. Although we acquired the facility at the end of 2002, we were not effectively reassessed until the end of 2005. Since the reassessment covered 3 years it amounted to a material amount. Although the anti-dumping legal costs were expensive, they were also worthwhile as the SO2 dumping proceedings have now been dismissed.
Clearly, these one-time events, amounting to about 10 cents per unit, significantly affected our 4th quarter results but they should not be recurring. Our biggest on-going challenge remains the impact of high raw material costs on our SHS operations, so I’ll start by commenting on certain key aspects of our Sulphur Products & Performance Chemicals business segment.
SPPC’s 4th quarter EBITDA was $8.7 million after deducting $3.2 million for the costs of Hurricane Rita and the property tax reassessment. I’ve already covered these but also want to give a little more colour on our SHS products.
From a volume perspective, SHS sales volumes were pretty much in line with the 4th quarter last year. However, our costs were significantly higher. As we indicated in our 3rd quarter call, the hurricanes that hit the US gulf coast were having an effect on many of the raw materials we use to produce SHS. To give you a better idea of the problem, raw material and energy costs for our SHS operations in the 4th quarter of 2005 were about $2.5 million higher than the 4th quarter of 2004. This reflects higher costs for all our key inputs – primarily caustic soda, sodium formate, and natural gas, but other raw materials were also affected. For reference one industry publication has indicated that caustic soda costs in Q4 2005 were about $200 per ton higher than 2004 and we use about 5,000 tons per quarter to make SHS.
Prior to the hurricanes, we (and industry experts) had predicted that caustic prices would peak in the 3rd quarter of 2005. It now appears as though the peak has been delayed until the 1st quarter this year after which pricing should start to decrease. Again, based on industry reports caustic is expected to be about $125 per ton less expensive in the 4th quarter than it is in the 1st quarter of this year.
We also announced in early December that high energy and raw material costs had forced one of our sodium formate suppliers to announce that it was closing its US plant. Although we have been able to obtain alternate supply, this closure has resulted in higher pricing.
In short, the 4th quarter was a very tough time for controlling our raw material and energy costs. We continue to pursue both cost reduction initiatives and price increases. As we noted in December, we announced a 6 cents a pound increase in the price for SHS, and we are grateful to our customers who understand the substantial increase in costs we are facing and who are working with us to find reasonable solutions. The fact remains, however, that even though we have been able to implement price increases they are well short of recovering the increasing costs.
Turning now to regen acid, natural gas is also a major input to this product but, as we explained on the last call, a key element of all the regen contracts is a price adjustment mechanism for changes in natural gas costs that permits us to adjust our customer’s pricing to account for changes in gas costs. The change in pricing occurs in the following quarter, so there is a lag effect until the pass-through of gas costs takes effect. Accordingly, the higher gas costs in the 4th quarter affected our margins, but we should recoup this when the price adjustments take effect in the 1st quarter this year.
The rest of our SPPC products performed well. As a final point, apart from the impact of Rita, the Peak businesses are performing according to our expectations and we believe will make a solid contribution to Chemtrade going forward.
Turning now to Pulp Chemicals, Pulp had another very good quarter, with volume and revenues well ahead of last year. Similar to the 3rd quarter, the plant ran at full rates, reflecting Canfor’s plants running at close to full capacity and the new long-term third party customer we added in the first half of 2005.
Our Pulp Chemicals salt supplier indicated that it could not currently agree to extend the prevailing agreement beyond the existing term of December 31, 2006. We continue to dialogue with this supplier and pursue other alternatives to ensure that our operations will not be affected regardless of our existing supplier’s actions.
International finished an excellent year on a strong note. Earnings were well ahead of the same period last year, reflecting the contribution from Kemmax, the sulphur removal business in Germany that we acquired in May 2005, as well as a solid performance from the BCT Chemtrade business, which again was able to benefit from some spot acid sales.
I’ll now hand the call over to Vic for a more detailed review of the financial results for the quarter and year-to-date, after which I’ll have some comments on the outlook for 2006.
Vic Wells
Thank you, Mark and good morning ladies and gentlemen.
Before reviewing the results, I would like to point out that the per unit amounts for distributable cash for all periods mentioned are calculated using the weighted average number of units outstanding during those periods. The relevant numbers are detailed in the news release.
The Peak acquisition, which closed August 2nd, also means that the consolidated results are not directly comparable with the 4th quarter and full year results for 2004.
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For the three months ended December 31, 2005, cash available for distribution was $9.7 million, or 29 cents per unit, generated from revenue of $114.1 million and EBITDA of $15 million. In the 4th quarter of 2004, distributable cash was $9.7 million, or 41 cents per unit, revenue was $85.6 million, and EBITDA was $12.1 million. Net earnings for the 4th quarter were $3.1 million which was the same as last year.
For the year ended December 31, 2005, EBITDA and distributable cash were $58.9 million and $43.2 million, or $1.58 per unit compared with $54.3 million and $43.1 million, or $1.87 per unit in 2004. Net earnings for the year were $13.2 million compared with $16.4 million in 2004. Net earnings for 2005 reflected higher amortization and interest costs following the Peak acquisitions, and the three one-time incidents totaling approximately $3.5 million mentioned by Mark. In addition, we recorded an unrealized gain of $1.5 million in connection with certain foreign exchange contracts which were marked to market.
As Mark mentioned, we estimate the impact of the hurricane on the business was $2.1 million U.S. in the 4th quarter, and another $0.5 million U.S. in the 3rd quarter, for a total of $2.6 million U.S., or approximately $3 million Canadian. Our business interruption insurance policy covers losses in excess of approximately $300,000, and we expect to recover a substantial portion of the balance. As Mark noted, we have not yet submitted our claim and our results do not reflect any recovery for this future claim.
Looking at segmented results, SPPC generated revenue of $68.2 million in the fourth quarter compared with $48.2 million in 2004, and EBITDA of $8.7 million compared with $8.5 million a year earlier. The higher revenue reflected the additional revenues from the Refinery Services and Phosphorous Specialties businesses, partially offset by reduced sales of other SPPC products, primarily SHS. The lower EBITDA from SPPC reflected these factors as well as the higher raw material and energy costs in Performance Chemicals that Mark referred to.
Pulp Chemicals reported 4th quarter revenue of $13.9 million compared with $12.2 million in 2004, and EBITDA of $5.9 million versus $5.0 million the previous year. These improvements reflected improved operating rates at Canfor, as well as the additional volume from our new third party customer.
International’s results for the 4th quarter are not directly comparable with 2004 because of the acquisition of Kemmax, the sulphur removal business in Germany that we purchased on May 1, 2005. International revenue for the 4th quarter was $32 million compared with $25.1 million in 2004, and the increase was due primarily to Kemmax. EBITDA for the period was $2 million compared with $1.5 million in 2004. We continue to be pleased with the integration of Kemmax into our international business.
Maintenance capital expenditures for the 4th quarter were $1.9 million and $4.4 million for 2005. In addition, in 2005 we spent $0.9 million on certain Peak housekeeping projects and to complete the Pulp Chemicals anode project, both of which were pre-funded. We also spent $0.8 million on two growth capital projects. One project was the infrastructure required to service the new customer demand Pulp Chemicals obtained in the second quarter while the other project involved an SHS dissolving facility permitting us to pursue liquid customers in geographic areas where we could not previously compete.
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Finally, an update on our U.S. dollar hedging program. As we have noted in earlier reports, because our US and International operations reports in US dollars, the Fund is exposed to fluctuations in the Canadian/US dollar exchange rate. The Peak acquisition added another US-based business. At the Fund’s expected exchange rates in 2006, we estimate approximately 60% of both EBITDA and distributable cash are generated in U.S. dollars. To manage the predictability of our cash flows, we have entered into a series of foreign exchange contracts that hedge that portion of Chemtrade’s U.S. dollar based cash flow that is expected to be converted into Canadian dollars. As of December 31, 2005, approximately 76% of planned transfers for 2006 and 68% of 2007 planned transfers had been effectively hedged at $0.8311 and $0.8303, respectively.
I’ll now hand the call back to Mark.
Mark Davis
Thank you, Vic.
The financial results for the 4th quarter were disappointing. Having said that, for the reasons mentioned, the 4th quarter was affected by a number of unusual factors. We continue to believe that the underlying business is sound, and that the acquisitions we made in 2005 – Kemmax and Peak – have added long-term value. Kemmax has provided incremental earnings since we purchased it, and the Peak businesses, save for the impact of Hurricane Rita, are also contributing in line with our expectations.
As I said, the 4th quarter input costs for SHS products were $2.5 million higher than the previous year, and for 2005 as a whole, about $5.7 million higher than in 2004. To put our 4th quarter in perspective, if you added back the approximately 10 cents per unit of one time items I outlined before, we would have generated about 39 cents per unit of distributable cash. Further, we would have achieved this result despite the extremely high raw material and energy costs we incurred following the hurricanes.
The major issue facing Chemtrade is the historically high cost of energy and raw materials and their impact on our SHS products. We said in our 3rd quarter and subsequent press release in December that raw material and energy costs were too volatile to project at that time. Although costs are still high, we believe that we now have better visibility on these costs for 2006.
Although it’s impossible to predict accurately when raw material and energy costs will decrease, or to what extent, our current view is that pricing levels will probably remain high for the first two quarters of 2006, and then begin to move down in the latter half of the year. As I said at the beginning, industry reports are predicting caustic prices to trend down and be approximately $125 per ton lower in the 4th quarter than the 1st quarter this year.
For the first half of the year we face not only this higher raw material and energy cost environment but three major maintenance programs – at Leeds, Shreveport and Beaumont plants –are also scheduled during the 1st or 2nd quarter. In the second half of 2006 we will expect not only lower costs but also the seasonal up tick in regen and SHS demand and additional sulphur products from our largest sulphur products supplier. Together these events mean that we should generate more distributable cash in the second half of the year than we will during the first 6 months.
Based on these assumptions, we intend to make monthly distributions of 12 cents per unit, effective with the February distribution declaration, for the remainder of the first half of 2006 and then, if conditions evolve as we expect, increase the monthly distributions to generate a going forward annualized rate $1.50 - $1.65 as previously indicated. We will make this determination when our 2nd quarter results are released.
Thank you for your attention. Vic and I would now be pleased to answer any questions you have.
OPERATOR: Your first question comes from Barbara Gray of Blackmont Capital. Please go ahead with your question.
BARBARA GRAY: Thank you. Good morning, guys.
MARK DAVIS (Chief Executive Officer, Chemtrade Logistics Income Fund): Hi Barbara.
BARBARA GRAY: I’ve just got a few questions for you. First, on the Beaumont, Texas plant, I’m just doing the math here for showing the impact in Q3 versus Q4 and it looks like the EBITDA impact per day was double in Q4. Can you tell me why that would be?
MARK DAVIS: No, in short, it was down for nine days and…
VICTOR WELLS (Vice-President, Finance, and Chief Financial Officer, Chemtrade Logistics Income Fund): Nine days.
BARBARA GRAY: Nine days in Q3 and you said it was 500 million, or 500,000.
MARK DAVIS: Five hundred thousand.
BARBARA GRAY: So that's 56 per day.
MARK DAVIS: It was down for 21 days.
BARBARA GRAY: Net to 2.5 million, which is 117 per day.
MARK DAVIS: And then that’s when our plant was off, but the likely answer is that, or the answer I think is that our customers that I said were experiencing some start-up difficulties of their own.
BARBARA GRAY: So that would have continued throughout the quarter.
MARK DAVIS: Right.
BARBARA GRAY: Okay. And they’re back to normal levels now?
MARK DAVIS: As I said, Barbara, through the call, is that all of them are still experiencing occasional issues with having to starting up, you know, they took down and started up their plants very quickly, as we all did.
BARBARA GRAY: Right.
MARK DAVIS: And so as a general statement, everyone is operating at full speed but also as a general statement, I think everyone is experiencing more operating hiccups than they normally would have had they not had to do that.
BARBARA GRAY: Okay. Do you think that’s going to continue through the first quarter or how long is that going to be an issue for?
MARK DAVIS: Again, I think I said that we expect it to take some additional downtime in the first quarter and then level out.
BARBARA GRAY: Okay. And with respect to the caustic soda price hedge, the price of natural gas has come down about half from its peak from just over 15 bucks; but yet we have seen caustic soda prices yet to peak, so how is that going to work? Because I know you’re putting in place the hedge in July of ’06 tying the price of caustic soda to the price of natural gas.
MARK DAVIS: Well, what we have, and I think the group will recall, is starting in Q4 of ’06 our caustic price is determined by the price of natural gas.
BARBARA GRAY: I thought it was July ’06.
MARK DAVIS: No. It’s fourth quarter.
BARBARA GRAY: Okay.
MARK DAVIS: Okay. And at the time we entered into that agreement, we had intended to go out and actually hedge natural gas price to get certainty for our price of caustic. Since that time we’ve actually purchased the Peak business which itself, as we’ve said, buys a lot of natural gas and passes through changes in natural gas contractually, so it's effectively contractually hedged. So we have not yet decided now, if you look at Chemtrade as a whole, whether or not we want to additionally hedge the gas used to determine the caustic price or whether or not we have enough of a hedge contractually since the regen business is a big purchaser of natural gas.
BARBARA GRAY: So you have an option on that because there were two parts to the agreement and that was the second phase of the agreement. So you’re not contractually obligated to…
MARK DAVIS: We’re not contractually obligated to hedge.
BARBARA GRAY: And do you still get the discount that you’ve been getting?
MARK DAVIS: Yes.
BARBARA GRAY: And how long, and that’ll last until July.
MARK DAVIS: Until Q4.
BARBARA GRAY: Okay. Next question, with respect to the pulp customer, you mentioned they cannot extend their agreement beyond the end of ’06. What percentage does that customer account for of the profit?
MARK DAVIS: What I indicated was that the current supplier of one of our raw materials, being salt.
BARBARA GRAY: Okay.
MARK DAVIS: Okay.
BARBARA GRAY: Yes.
MARK DAVIS: It's not extending right now.
BARBARA GRAY: Is it easier to find an alternative supplier?
MARK DAVIS: Yes.
BARBARA GRAY: And last question, what’s your capex forecast for ’06, maintenance capex?
MARK DAVIS: Yes. Sorry, we're just actually looking at…
BARBARA GRAY: Okay. I’ve got 6.7 million.
MARK DAVIS: I’m going to say it's approximately 7 million and the right number is probably in our MD&A. But it’s in that ballpark.
BARBARA GRAY: Thank you.
MARK DAVIS: You’re welcome.
OPERATOR: The next question comes from Chris Blake, of Scotia Capital. Please go ahead with your question.
CHRIS BLAKE: Good morning, gentlemen.
MARK DAVIS: Good morning, Chris.
CHRIS BLAKE: Just wanted to ask two or three questions here. I was wondering if you could comment on the… I guess you commented already on the volume with respect to the sodium hydrosulphite but I was wanting to get a sense of the volumes and pricing environment for the quarter for both the acid side as well as you said the sodium hydrosulphite lines were flat, but in terms of pricing, I’d be interested to get your feedback on that, as well as your expectations for 2006 for both those products.
MARK DAVIS: We indicated sodium hydrosulphite volumes as we said were relatively the same. If you want an 80/20 rule is 80 per cent of the issues with sodium hydrosulphite is on the cost side, which is what we indicated. There was some downward movement in pricing in the fourth quarter versus previous year due to us going out actually and signing up our customers with longer term contracts which we talked about in one of these calls before.
So having said that, the price increase we announced after we started facing these cost pressures and have been trying to implement in 2006 have met with some success. So that’s probably the answer I can find to give you for sodium hydrosulphite.
For sulphuric acid, the market remains good. It’s not quite as snug as it used to be but pricing remains firm, and again as we've talked on other calls is that we expect additional volumes of sulphuric, via Inco, in the second half of this year.
CHRIS BLAKE: So have you seen any volume pick up from Voisey’s Bay in Q4 or do you expect any in…
MARK DAVIS: Well, it’s two things with Inco. One is they have their maintenance turnaround in the second quarter of this year, which obviously produces supply in the first half. But secondly, it is not so much Voisey’s as they have to increase their SO2 capture by December 31st of this year so they want to make sure they can do it so they’re going to be producing additional quantities of acid in the second half of the year as they start capturing more SO2 gas.
CHRIS BLAKE: Right. Okay. Now, that’s great. Second question, you obviously clarified your issue with respect to distributions and your range there for ’06, so I was just wondering if you could give us a sense of the underlying pricing assumptions for both natural gas and caustic that underline your guidance issue today?
MARK DAVIS: Well, you know, the…
CHRIS BLAKE: I guess for an average of 2006.
MARK DAVIS: Yes, frankly I think that natural gas has been moving every day, right? So it’s our assumption that natural gas is going to average about 10 bucks for ’06 and caustic, as I said, should be moving down through the year, so in Q4, it's $125 a tonne cheaper than Q1.
CHRIS BLAKE: Okay.
MARK DAVIS: I’d be happy to be proven wrong by natural gas as long as it’s being proven wrong in the right direction.
CHRIS BLAKE: Right. You mentioned your business interruption insurance policy will hopefully cover or reimburse you for the hurricane. And you mentioned you haven’t submitted your claim yet, but do you when do you expect to submit the claim and receive the reimbursement? Is that some time in ’06?
MARK DAVIS: Yes, we certainly expect it to be in ’06. I’m just looking at Vic as I answer. It's my understanding actually that the interruption claim could cover, you know, damages for a period up to a year.
VICTOR WELLS: The indemnity period, Chris, is a year, so we’ve got obviously a period of time to continue to reassess the losses. But we are working on the claim. I would expect to have that prepared by the end of the second quarter. And the reimbursement…
MARK DAVIS: Will come in due course.
VICTOR WELLS: Will come in due course is a good answer.
CHRIS BLAKE: Okay. And just lastly, I wonder if you could provide an update on where the legal proceedings with Marsulex now stands and how much you’ve accounted for in terms of legal fees you expect to incur during 2006.
MARK DAVIS: The action right now is that the parties have exchanged pleadings and it hasn’t gone any further than that. And we really haven’t incurred any significant legal fees in ’06. We'll just have to see where the proceedings go.
CHRIS BLAKE: Okay. Very good. Thank you.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Damir Gunja, of TD Securities. Please go ahead with your question.
DAMIR GUNJA: Good morning.
MARK DAVIS: Good morning, Damir.
DAMIR GUNJA: Just following up on the Marsulex question, have any of the agreements with Marsulex been breached – for instance, the Oregon agreement?
MARK DAVIS: If you read our pleadings, you’ll see that we allege that they’ve breached certain agreements. So far actually, they continue to supply us with acid under the Oregon agreement which is probably the agreement that has the most, would have the most financial effect on us.
DAMIR GUNJA: Okay. Just another one. The 2.5 million in increased costs I guess in the quarter between caustic, formate and gas and possibly some smaller other items, to the extent that you can, can you give us maybe even a percentage sort of the pie that came from each of those?
MARK DAVIS: Yes, well, what I try to indicate is obviously for competitive reasons there's certain things we don’t want to do. But regarding the $2.5 million, I indicated on the call that actually the market guys say that caustic actually is $200 a tonne higher year over year and we use about 5,000 tonnes a quarter. So if you want to assume that of the $2.5 million, a million of it was caustic, that gets you a bunch of the way there. And frankly we’d rather not break out the rest of it.
DAMIR GUNJA: Okay. Thanks.
OPERATOR: Your next question comes from Bert Powell, of BMO Nesbitt Burns. Please go ahead with your question.
BERT POWELL: Thanks. Mark, I just wanted to go back and look a little bit closer at the peak and the impact natural gas. So the pricing that you’ve experienced this quarter obviously would have been quite high with respect to natural gas, which heading into this quarter should be significantly lower. But where was the point of departure? I’m just trying to figure out what would have been the cost assumptions for natural gas for pricing purposes in the quarter. And can you help us understand a little bit better, is that kind of the average that natural gas experienced in the quarter is what set you up for the next quarter?
MARK DAVIS: Yes. I mean in short, it’s more or less a weighted average cost of gas. Having said that, what’s interesting is if you actually take a look at the weighted average cost of gas based on, I think these guys buy off the Houston ship channel as opposed to Henry Hub, but you know, whatever it is. Price actually came down substantially near the end of December…
BERT POWELL: Yes.
MARK DAVIS: Okay. And if you actually think about the logic of it …. If we were offline for three or four weeks in October, after you calculate your weighted average cost of gas and it comes down in December, is actually is our price driver through our formula for the first quarter is probably not as high actually as you would anticipate.
BERT POWELL: Okay. Okay. So we would have seen maybe $7 in…
MARK DAVIS: In December.
BERT POWELL: In Q3 and then a lower effective, closer to 11 versus 14 as the price set for Q1.
MARK DAVIS: Yes. I mean, directionally, your numbers are right. I actually don’t know what the real numbers are. But you know, that would have been the direction of the movements.
BERT POWELL: Okay. I’m just trying to get a sense as to what that’s going to impact on the positive side this quarter.
Just on the salt supply, to the extent that you have alternative sources, my understanding is you’d be relatively indifferent with respect to pricing since Canfor, your pricing at cost passed through at Canfor, correct?
MARK DAVIS: Yes, 70 per cent are sold on the volume, 65 per cent.
BERT POWELL: Sixty-five per cent.
MARK DAVIS: Well, whatever Canfor’s take is.
BERT POWELL: Right. Okay. Okay, so you are incented to make sure you continue to get good pricing on salt?
MARK DAVIS: Right. The way the agreement is designed to work is despite the fact that we could actually pass it through to Canfor, you know, we like to do what’s good for them, too.
BERT POWELL: Okay. On Peak, I know, Rita messed things up this quarter. This seasonally would be a weaker quarter from a volume perspective anyways?
MARK DAVIS: Yes, second and third quarters should be the big quarters in the regen business.
BERT POWELL: Okay. Okay. So we should see an uptick in the middle of next year?
MARK DAVIS: Yes, when we talked before about a half year and a half year is because you know, the second and third quarters are strong, as over a half-year basis it averages out but definitely second and third are stronger than the first and fourth.
BERT POWELL: Right, okay. And just on with Celanese kind of getting out of the pentaerythritol market and the impact on sodium formate pricing, can you give us a sense as to have you locked in for this year and where you might be relative to the pricing last year?
MARK DAVIS: First, can we compliment you on your pronunciation of pentaerythritol?
BERT POWELL: I told you I’d get it.
MARK DAVIS: There’s a bunch of competitive dynamics in the market, so frankly I don’t really want to go very far on price but I want to say… I guess what I can say is this, is that we haven’t had any difficulty getting supply and from the people that are in the pentaerythritol market is a relationship where it has to work for both of us or neither of us could actually make the products that we want to make because we are a big home for the by-product formate from pentaerythritol. So although there has been an increase in costs from what we have historically experienced, the increasing cost is not an astronomical increasing cost.
BERT POWELL: Okay. And on the SHS, the pricing that you would have locked in, earlier in your commentary you talked about perhaps the pricing pressure due to the fact that you locked in. That would have been on the powder side, correct?
MARK DAVIS: Well, actually, what I really meant by that is we went and locked in customers early in 2005, so when the prices on raw materials ran up in Q4 is, you know, that’s where we were.
BERT POWELL: Right.
MARK DAVIS: And that doesn’t stop our ability from raising pricing in 2006, which was our price increase announcement and what we are busy implementing now. So you see, we are not like, it’s not like we’re locked into long-term pricing. The pricing is actually governed by normal supply- demand economics, not necessarily contractual provisions.
BERT POWELL: Okay. In 2004 and 2005, you did respond to some competitive pressures.
MARK DAVIS: Exactly.
BERT POWELL: On the powder side, perhaps more so in terms of giving your customers a bit more price certainty, correct?
MARK DAVIS: No. That’s fair.
BERT POWELL: Okay, so and that’s probably, is it fair to say that's where you’re seeing most of the pressure in terms of the cost pricing mismatch in the sodium hydrosulphite business?
MARK DAVIS: No, actually. We’re seeing a lot of it there for sure, but again if you look at the huge run-up in caustic as caustic is a big raw material to both.
BERT POWELL: To both. Yes, okay, fair enough.
MARK DAVIS: And you just can't catch it that fast.
BERT POWELL: Okay. Okay, and just quickly, you said there were three major maintenance programs going on Leeds, Beaumont…
MARK DAVIS: And Shreveport.
BERT POWELL: And that'll be Q1?
MARK DAVIS: No, Q1-Q2. It’s all first half of the year. My recollection is actually, my recollection is Beaumont is Q1 and Shreveport and Leeds are Q2, but they’re all first half for sure.
BERT POWELL: And this will coincide with an Inco maintenance program as well, correct?
MARK DAVIS: Exactly.
BERT POWELL: Do you have a sense at this point, Mark, as to what the incremental volume will be on acid from them in the second half relative to the second half of ’05?
MARK DAVIS: Yes, well, we’ve always said that we thought when Inco had to capture the extra gas, there’s an extra 90,000 or 100,000 tonnes of acid that’s going to come online. So if you want to assume it's a half-year basis, it’s 50,000 tonnes.
BERT POWELL: And as a percentage, just help me to understand.
MARK DAVIS: Ten per cent.
BERT POWELL: So 10 per cent on an annualized basis is what we can see as an uptick.
MARK DAVIS: More than that. Inco produces about 600,000 to 650,000 tonnes of acid a year. So you can do the math on what 90 or 100 is.
BERT POWELL: Okay. Perfect. Okay, thank you very much.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Gerry Hannochko, of Genuity Capital Markets. Please go ahead with your question.
GERRY HANNOCHKO: Hi. Good morning. Most of my questions have been caught already but I just wanted to circle back to the SHS side. Could you quantify or just give a little bit of direction on the size of the formate price increases? Are we talking 1 or 2 per cent or is this 25, 50 per cent?
MARK DAVIS: It’s not 25 or 50 but as I said earlier for other competitive reasons, I really don’t want to go further than that.
GERRY HANNOCHKO: Okay. And then just another question, probably a bit early to tell, but does Canfor’s plans to spin out some of their pulp assets into a trust affect any of your agreements with them?
MARK DAVIS: No, it doesn’t.
GERRY HANNOCHKO: Okay. Thanks.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Horst Hueniken, of Westwind Partners. Please go ahead with your question.
HORST HUENIKEN: Good morning.
MARK DAVIS: Hi, Horst.
VICTOR WELLS: Good morning, Horst.
HORST HUENIKEN: The first question I’d like to explore is relating to your January SHS price increase. We know that most of it has stuck but we also know that it’s not fully offsetting your higher input costs. Can you explain what is preventing further SHS price increases? Where is the competitor or maybe some colour on who’s a tough competitor?
MARK DAVIS: Sure. I’ll try and do it quickly.
HORST HUENIKEN: Yes.
MARK DAVIS: As we've said before, some sodium hydrosulphite business is regional and some is North American wide. When it comes to regional plays, you have who else is competing with you in that market on a liquid basis, basically a liquid regional market. So you’re only able to increase prices so long as your competitor, who ought to be subject to the same kind of costs, also increases their price. Otherwise your customers try and chase suppliers.
HORST HUENIKEN: Got it.
MARK DAVIS: Okay. On the powder front, we’ve talked about the Chinese before and a general comment is increasing pricing too much too quickly could encourage your customers to actually look for alternative products or alternative technology which actually could have more long-term harm than the short-term benefit of jamming your customers on price. So you put all those things into a hopper and we take all that into account when we figure out how much price increase is reasonable and attainable.
HORST HUENIKEN: Would you say that your price increases are roughly matching what other competitors are doing or is there a whole variety of tactics being used?
MARK DAVIS: I think they are roughly matching. At least one of our competitors, who is Olin, had a price increase maybe a week or 10 days after we had announced ours, which is kind of hard to compare because they announced it on a different basis. But if you actually do all the right conversions, it was essentially the same as ours.
HORST HUENIKEN: Got it. Moving to the international side, I see your international revenues were 32 million in the fourth quarter, which is down substantially from the third quarter at 47 million. Is that solely a seasonal effect or are there other factors at play here?
MARK DAVIS: Less so seasonal in that we also mentioned actually they make good money because our BCT guys picked up spot volume. If you remember our other calls, we said they had difficulty finding spot volume because the market was tight.
HORST HUENIKEN: Yes.
MARK DAVIS: So if you wanted to assume that actually they have the ability to obtain spot volume means the market is getting weaker, then the sulphuric acid that they’re marketing is likely obtained at a lower price.
HORST HUENIKEN: Understood. One of the things I’m wondering is, are you able to break out what the contribution of Peak was to EBITDA in 2005?
MARK DAVIS: We don’t do that and we actually run the thing as an integrated business.
HORST HUENIKEN: Okay.
MARK DAVIS: Because it’s primarily a sulphuric acid business and one of the synergies we obtain is being able to actually pick and choose who we serve from where.
HORST HUENIKEN: Got it. In regards to the lawsuit, you did say that you exchanged pleadings and I’m just trying to understand what the next step will be and whether there’s a date attached to it.
MARK DAVIS: There is no date attached to it. The lawyers will tell you, and I forget, either there’s a demand for documents or examinations for discovery but there are no dates.
HORST HUENIKEN: Okay. Lastly, other than the tactic you’ve applied towards the distributions being lower in the first half of ’06 and higher in the back half – and I can understand why you’re pursuing that – are there any sort of other things operationally you’re changing to manage the situation you’re in right now?
MARK DAVIS: I mean, there’s a myriad of initiatives that our guys are going through to actually pursue additional revenue and to minimize costs where necessary.
But having said that, if your question is directed at are we doing anything extreme in order to actually make our numbers happen, I would say the answer to that is no. What we think our unitholders want and the business we want to run is a business that’s well positioned for the long term, not a business that actually seeks to eke out its money on a quarter-by-quarter basis. So we’re pursuing a whole bunch of initiatives that we believe have long-term benefits and not doing anything drastically short term which we think hurts business.
HORST HUENIKEN: Perhaps an adjunct to that, would it be fair for me to then assume if you are looking at let’s say some certain cost-cutting initiatives where possible, that there could be restructuring charges to go with that?
MARK DAVIS: I wouldn’t assume that. I think you’ve looked at our operations before. It’s not like there’s a lot of fat here to cut; so, no.
HORST HUENIKEN: Okay, fair enough. Thanks for your time.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Lorraine Gloster, of MGI Securities. Please go ahead with your question.
LORRAINE GLOSTER: Yes, I just wondered on your capex for this year, can you split down on what proportion you think would fall in the first half versus the second half, assuming it’s 7 million?
MARK DAVIS: I don’t have that handy, Lorraine. It’s got to be more than half in the first half. We don’t have that handy.
LORRAINE GLOSTER: Okay. And on your distribution of $1.44, your basis for that, are you using a 90-per-cent payout ratio to get to that number or what are your assumptions when you arrived at that number?
MARK DAVIS: I think, as you know, we’re not fixated on what our payout ratio is, although we have said that historically, we wanted to get back to a rate closer to a low 90-per-cent payout ratio. So we just think that that’s the more appropriate rate. It doesn’t necessarily mean it’s going to be a 90-per-cent ratio for the first half of the year because we do think we’d make more in the second half.
LORRAINE GLOSTER: Okay. And then if you’re going to the 150 to 160 in the second half, I’m assuming that’s because you think it’s more sustainable at that time. Is that going to be based on a 90-per-cent payout ratio as being your base assumption there?
MARK DAVIS: We’re comfortable in and about that rate. But it is not a requirement or a strict policy of ours that we pay out at that rate. But we have said before that that’s historically where we’ve been and we’d like to return there.
LORRAINE GLOSTER: Okay. On the caustic soda price, you were saying that by the fourth quarter of this year, the industry expects that caustic soda could be down 125 but just to get the basis for that, what is the assumption, industry assumption for caustic soda pricing in Q1-06?
MARK DAVIS: It is 425 to 455 – 430.
LORRAINE GLOSTER: Four thirty and that versus Q4-05 then?
MARK DAVIS: Versus Q4-’05?
LORRAINE GLOSTER: Yes.
MARK DAVIS: It’s probably up 60 bucks or something.
LORRAINE GLOSTER: Great. And then on the price increase that you did on the SHS business, did you say $0.06 per pound or what was the number you gave?
MARK DAVIS: Yes, $0.06 per pound.
LORRAINE GLOSTER: Six cents per pound. So was that a price increase that you did on the liquid and the powder or is that like an average that you gave for the entire SHS business?
MARK DAVIS: In the normal commodity chemical world, you announce a price increase across the board and then you go and get as much of it as you can.
LORRAINE GLOSTER: So it was introduced across, liquid and powder and so far, what’s the take rate on the powder side? I’m assuming liquid would have been easier.
MARK DAVIS: We have obtained good success on our price increase. I mean, frankly our customers understand the huge run up in costs and realize that although 6 cents is actually a big number to them, it comes nowhere near offsetting our cost increases.
LORRAINE GLOSTER: What kind of a percentage is that price increase?
MARK DAVIS: It’s about 10 per cent probably.
LORRAINE GLOSTER: And when was the last time that there was a price increase on SHS business?
MARK DAVIS: I’m going to forget. If you go back and look in the industry stuff, even us, we’ve increased prices twice since we bought the business.
LORRAINE GLOSTER: Yes.
MARK DAVIS: But I don’t remember when the one before this one was. Chances are it was in ’04 some time.
LORRAINE GLOSTER: Yes, okay. Fair enough. And then just on that powder SHS business, was that profitable in the fourth quarter?
MARK DAVIS: Was it profitable in the quarter? So far, we only believe in running profitable businesses.
LORRAINE GLOSTER: Yes. I’m assuming that there are points in which maybe they’re not profitable in a quarter.
MARK DAVIS: We continue to make money, just not as much money as we’d like.
LORRAINE GLOSTER: Okay. So even though the economics is certainly not good for powder SHS, you’re still making money in that segment?
MARK DAVIS: Yes.
LORRAINE GLOSTER: Okay, that’s perfect. Thank you.
MARK DAVIS: Thanks, Lorraine.
OPERATOR: Ladies and gentlemen, if there are any additional questions at this time, please press the * key followed by the 1. As a reminder, if you’re using a speakerphone, please lift the handset before pressing any keys. Your next question comes from Barbara Gray from Blackmont Capital. Please go ahead with your question.
BARBARA GRAY: Thank you. I’ve just got a follow-up question. With respect to the Peak business, what percentage of cogs is natural gas?
MARK DAVIS: I don’t know, but it is significant.
BARBARA GRAY: Significant as in more than half or…?
MARK DAVIS: I don’t know, Barbara. You know, one of the reasons I don’t know actually is that it’s contractually passed through, so we actually care about it but I don’t have the percentage off the top.
BARBARA GRAY: Okay. And with the pass through, is there quarter lag there?
VICTOR WELLS: Yes.
MARK DAVIS: Yes.
BARBARA GRAY: Okay. I’m just trying to figure out what the impact, I guess how much higher it’s going to be in the first quarter because of the decline in natural gas. So you can’t, we can’t say 25 per cent or 50 per cent or 75 per cent?
MARK DAVIS: No.
BARBARA GRAY: Okay. Thank you.
MARK DAVIS: Thanks.
OPERATOR: Mr. Davis, there are no further questions at this time. Please continue.
MARK DAVIS: As usual, thank you all for your attention and your questions.
And once more, just before we go, I’d like to publicly thank Vic for his efforts since the IPO, and, I’ll speak for Chemtrade at least, that we’ll miss him.
VICTOR WELLS: Thank you, Mark. I’ll miss you guys.
MARK DAVIS: See you all next quarter.
OPERATOR: Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may now disconnect your line.
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