Q3 2006 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 is Rohit Bhardwaj, our Chief Financial Officer. Rohit and I will review the third quarter results, 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.
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Overall, we were satisfied with Chemtrade's financial performance in the third quarter. As we will talk about in a minute, we are very pleased to be able to explain to you the steps we have concluded which will improve and stabilize a key portion of our earnings going forward.
Distributable cash generated during the third quarter was $13.3 million, or 40 cents per weighted average unit. Revenue and EBITDA were $148.7 million and $16.7 million respectively. As with the prior two periods this year, higher revenue for the quarter was the result of acquiring the Refinery Services, Phosphorous Specialties and Kemmax assets last year. The earnings increase from these assets was largely offset by higher raw material costs and lower volumes in our SHS business and other factors that Rohit will outline later.
In general terms, our refinery services assets ran hard during the quarter and continued to benefit from the additional money we spent in the first and second quarters to improve the long-term reliability and efficiency of our two key plants, Beaumont and Shreveport.
There is still room for improvement and we continue to work on making all of our facilities more reliable and efficient.
Pulp Chemicals had another solid quarter with strong demand for sodium chlorate. Our SHS business recorded seasonal volume improvements compared to the second quarter, but still lagged last year.
These positive achievements were offset by the continuing issue of lower volumes and higher raw material costs on our SHS business, particularly powder, and by a lower contribution from Sulphur Products due to operating issues at Inco following its maintenance turnaround.
The most significant event of the quarter was the repositioning of our powder SHS business, which we announced yesterday. I would like to provide some more detail about this important change. Rohit will discuss the impact on our financial results, but let me outline how these actions will improve our business and the quality of our earnings.
We announced two related but independent decisions. First, we plan to cease production at our SHS powder plant by year-end, as that plant is no longer financially viable. Secondly, we have entered into a long term supply and marketing arrangement with Zhongcheng which will supply us with the powder SHS necessary to supply our existing and future customer base.
Let me provide you with a little history and perspective about both of these decisions.
When we acquired the SHS business in 2002 we acquired four manufacturing facilities and an excellent customer base that includes most of North America's large pulp and paper producers. Three of the four plants produce liquid SHS, including a liquid plant in Leeds, South Carolina. The fourth plant, also located in Leeds, produces powder SHS.
As discussed in our conference calls over the last two years, our SHS products have been negatively affected by increased raw material costs and a shrinking demand base. The majority of these issues affected our powder business due to its use of certain raw materials (natural gas, caustic soda and sodium formate) and the newsprint customers this product served.
Despite excellent efforts by our employees, the outlook for key raw materials (especially sodium formate) and market demand led us to decide that this plant is not economically feasible and will cease production about the end of this year.
Most of you are familiar with the impact that significantly higher raw material costs have had on our SHS business. As we noted on our last call and in other presentations, raw material costs were $4 million higher in the second half of 2005 compared with the second half of 2004, and in the first half of this year, $2 million higher than in the same period last year. In the latest quarter, raw material costs were almost $2 million higher than the same quarter last year.
The majority of these cost increases affected our powder SHS earnings. Although caustic soda prices and natural gas prices are moving down, sodium formate remains high, largely as a result of North American plant closures. The decreased supply of formate has resulted in higher prices for that input and we do not see that situation improving. In fact, we expect formate prices to continue to rise due to the structural reduction of formate supply in North America.
The other factor that has impacted our SHS business is the contraction of the newsprint market, which has been under duress for a number of years. Demand has been decreasing since 2002, and this year demand is about 6% lower than it was last year.
This combination of factors has put pressure on the powder SHS business for some time. Although we have successfully improved operating efficiencies, negotiated strenuously with our raw material suppliers, and implemented some price increases, these initiatives were simply not enough to offset the impact of the higher costs.
Despite the imminent cessation of production at our Leeds powder facility, from a customer perspective, this should have no effect on their supply of product or the service provided by Chemtrade. Further, our Leeds liquid SHS facility will continue to run and service customers. This is a good operation and it does not use sodium formate as a raw material.
We are very pleased to announce that we have entered into a innovative long term supply and marketing agreement with Guangdong ZhongCheng Chemicals, Inc. Ltd. ("ZC"), which is the world's largest, and, we believe, lowest cost producer of powder SHS. Under the arrangement, ZC becomes Chemtrade's exclusive supplier of powder SHS. Chemtrade becomes ZC's exclusive SHS marketer in Canada, the United States and, for non-textile uses, in Mexico. Chemtrade and ZC have also entered into other supply and marketing rights for other geographic markets around the world.
This agreement will benefit North American customers, Chemtrade and Zhongcheng. Our North American customers will receive the product they want, on time and with Chemtrade's high level of customer and technical service. Chemtrade's infrastructure permits Zhongcheng to more quickly and more cost effectively expand in the North American SHS market than it could have on its own.
From Chemtrade's perspective it allows us to continue profitably serving our customer base and to access opportunities to expand our business while eliminating our manufacturing risks.
Let me describe the ZC Agreement. It is similar in many respects to other Chemtrade agreements. It is a seven-year agreement under which ZC agrees to sell Chemtrade product for various destinations at fixed prices for the term of the contract. These prices will be adjusted up or down based upon certain factors including the RMB / U.S. dollar exchange rate and movements in aggregate sales price.
From Chemtrade's perspective, this agreement isolates us from all typical manufacturing risks including exposure to raw material costs, incurrence of capital costs to maintain assets, and any environmental risks inherent in manufacturing. Further, any movement in the price at which the product is sold to our customers is also mitigated by the contract with ZC, which will adjust the price we pay ZC for its product based on a percentage of the change in the market price we receive for selling the product.
By eliminating our exposure to manufacturing risks, this agreement should drastically reduce the volatility of our earnings from powder SHS while still capitalizing on Chemtrade's strength of providing quality product and services to our customers.
On a going forward basis, we expect this new relationship will increase the predictability of our earnings and be positive to our 2007 distributable cash.
I'll now hand the call over to Rohit for a more detailed review of the financial impact of the repositioning and the results for the quarter, after which I'll have some concluding remarks.
Rohit Bhardwaj
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 acquisitions of Refinery Services and Phosphorous Specialties, which closed August 2, 2005, means that the consolidated results are not directly comparable with the third quarter for 2005, and these acquisitions, together with the acquisition of Kemmax in the second quarter of 2005 means that the year-to-date results are also not directly comparable.
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For the three months ended September 30, 2006, cash available for distribution was $13.2 million, or 40 cents per unit, generated from revenue of $148.7 million and EBITDA of $16.7 million.
In the third quarter of 2005, distributable cash was $13.6 million, or 48 cents per unit, on revenues of $125.8 million, and EBITDA of $18.4 million. It is important to note that the 48 cents of distributable cash generated during the third quarter of 2005 included approximately 3 cents related to a one-time foreign exchange gain associated with the financing of the Peak acquisition.
For the first nine months of this year, distributable cash was $37.5 million, or $1.12 per unit compared with $33.6 million, or $1.33 per unit last year.
The principal reasons for the revenue increases over last year were the 2005 acquisitions, offset by lower revenue from SHS products and by the effects of the stronger Canadian dollar.
Net loss for the third quarter of 2006 was $10.4 million, compared with net earnings of $3.2 million last year. The main reason for the loss during the quarter was the decision to record a non-cash charge of $15.6 million with respect to impairment in the net book value of property, plant and equipment used to manufacture powder SHS.
As we have been previously mentioning, the cash flows associated with these assets have been declining due to rising input costs and reduced demand. These cash flows now can no longer support the net book value of these assets.
The decision subsequent to the quarter end to discontinue production of powder SHS is expected to result in costs of approximately $4 million. These costs, which will consist of severances and other costs required to properly and safely wind down production, will be recorded in the quarter ending December 31, 2006.
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Turning now to the segmented results for the third quarter, SPPC generated EBITDA of $12.3 million in the third quarter compared with $12 million last year. The major reason for this slight increase was the contributions from the Refinery Services and Phosphorous Specialties acquisitions, as the third quarter of 2006 had an additional month of contribution relative to the same quarter of 2005.
Unfortunately, the benefit was partially offset by the continuing negative impact of reduced SHS revenues and increased raw material and freight costs. In the third quarter, raw material costs alone were almost $2 million higher than the same period last year, and the majority of this was directly related to the production of powder SHS.
SPPC results were also adversely impacted by lower contributions from Sulphur Products as a result of lower production at Inco following their maintenance turnaround. Their operation is now running well and we are receiving the increased amount of sulphur products that we had anticipated.
Results from our Refinery Services assets were in line with expectations. All the facilities performed well and were able to take advantage of the high production summer months and increased demand for regen services.
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Pulp Chemicals had another solid quarter, reflecting steady demand from Canfor and other customers. Results were in line with last year. Revenue was $13.4 million compared with $13.5 million in 2005, and EBITDA was $5.7 million for the quarter, compared with $5.8 million last year.
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International reported revenue of $62.1 million for the third quarter this year compared with $47.3 million last year. Both periods included the Kemmax acquisition and the increase reflects the generally higher volumes of all product lines.
As noted on previous calls and in the MD&A, however, because a significant portion of the group's sales of sulphuric acid is derived from contracts that match buyers and sellers, the margins remain relatively constant.
The decrease in EDITDA from $2.7 million to $2 million is primarily because last year's results included income related to a customer with whom the group no longer does business, and the impact of the stronger Canadian dollar.
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Corporate costs for the third quarter were $3.3 million compared with $2.1 million last year. As previously disclosed, corporate costs were lower last year due to the inclusion of a one-time foreign exchange gain of $0.9 million with respect to bridge financing associated with the August 2005 acquisitions. The remainder of the increase in 2006 third quarter corporate costs reflects the increased scale of the business following the August 2005 acquisitions.
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Total capital expenditures for the third quarter were $0.8 million in 2006 and $1.4 million in 2005. Capital expenditures for the third quarter of 2006 include approximately $0.4 million of spending that was pre-funded when we bought the Refinery Services assets last year. You may recall that we pre-funded a total of $1 million at the time of the acquisition. We have now essentially spent the entire amount that was pre-funded.
Maintenance capital expenditure for the first nine months of 2006 was $3.3 million compared with $2.5 million for the first nine months of 2005. The increase in the nine-month maintenance capital spending reflects the additional capital requirements related to the 2005 Acquisitions.
The lower spending in the third quarter this year compared to last year reflects timing of projects, and we expect our maintenance capex for the year to come in at about $6 million. As we indicated on the last call, we believe our annual spend going forward will be approximately $7.5 million.
I'll now hand the call back to Mark.
Mark Davis
Thank you, Rohit.
As you have heard, our Refinery Services, Pulp Chemicals and International businesses all continued to perform well in the third quarter. We continued to be adversely affected by the volume and cost pressures on our SHS business, and particularly the powder business that we have been referencing over the last several quarters.
While our team worked diligently to improve those aspects of the SHS business we could control, and successfully introduced operating efficiency improvements, these initiatives were not enough to make our powder business more profitable.
The solution we announced today is the right one for Chemtrade going forward. The new arrangement will not only improve the amount and quality of our earnings, it will also allow management to re-direct attention to more positive growth aspects of the business.
During 2006 we have taken several significant steps to strengthen and improve our businesses.
We spent the capital necessary to improve the reliability of our production facilities, and with the ZC arrangement have eliminated our risks of manufacturing powder SHS while still being able to profitably supply our customers. These and other initiatives carried out in 2006 should make our earnings and distributable cash stronger and more reliable in 2007.
Thank you for your attention. Rohit and I would now be pleased to answer any questions you have.
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OPERATOR: Thank you. Ladies and gentleman, we will now conduct the question and answer session. If you have a question, please press star followed by one on your touchtone phone. You will hear a tone acknowledging your request. Your questions will be polled in the order they are received. Please ensure you lift the handset if you are using the speakerphone before pressing any keys. One moment please, for your first question. Your first question comes from Barbara Gray from Blackmont Capital.
BARBARA GRAY: Hi. Good morning guys.
MARK DAVIS (CHIEF EXECUTIVE OFFICER): Good morning, Barbara.
BARBARA GRAY: I’ve actually got quite a few short questions here. First of all, the customer contracts. Back in February of ‘05, you guys said that you locked in your powder SHS customers, and at that time you said you locked in 60% of your customers out to or beyond 2006. How many are now locked in, I guess beyond 2006, and how many out for three years or five years?
MARK DAVIS: I frankly don’t know, Barbara. Most of these customers did not turn over annually because, again, the supply chain is important to them. But I don’t know what the percentages are right now.
BARBARA GRAY: Okay. And are you changing any of the terms of the contract with your new supply agreement?
MARK DAVIS: No.
BARBARA GRAY: Okay. And with respect to the supply agreement, in terms of pricing, are you in a benefit because we have, I mean caustic soda costs have come down 30%, are you going to have any exposure to that?
MARK DAVIS: We will have exposure for our liquid sodium hydrosulfite products. The raw material costs, up or down, will have no effect on us with respect to powder products.
BARBARA GRAY: And with your exposure, is that correct that the powder SHS Leeds plant is 45,000 tonnes, and you’ve got a total of 90,000 tonnes of SHS capacity. So, are you reducing exposure to caustic soda by about half?
MARK DAVIS: That will be about right.
BARBARA GRAY: Okay. And you entered a caustic soda supply agreement back in July of ‘05, a long-term agreement with a major supplier of caustic soda; what happens to that contract?
MARK DAVIS: We are in discussions with that supplier about how to deal with that contract.
BARBARA GRAY: Are there going to be any negative financial implications?
MARK DAVIS: We don’t believe so, but we are not sure. To the extent that there are, actually it’s provided for in the charge we are taking to fourth quarter.
BARBARA GRAY: Is that the $4 million charge?
MARK DAVIS: Right.
BARBARA GRAY: Okay. The $4 million, is that a cash charge or is it a non-cash charge?
MARK DAVIS: That will be a cash charge.
BARBARA GRAY: Okay. And I guess when you did the initial acquisition from Clariant back in December of ’02, the rationale was you were going to integrate up the value chain using the SO2 that you got from your producer customers. What percentage of your SO2 supply are you using to produce powder SHS, and what’s going to happen to that?
MARK DAVIS: I don’t have the percentages off hand. As I said, we bought four facilities, we are shutting down one of them, so we still have the SO2 demand base from the other three…
BARBARA GRAY: But that one is the biggest one, the Leeds one, correct?
MARK DAVIS: That’s right. And we’re closing one of the two plants at Leeds.
BARBARA GRAY: Right.
MARK DAVIS: In rough numbers this is a 20% reduction.
ROHIT BHARDWAJ (CHIEF FINANCIAL OFFICER): On total SO2, maybe a little bit higher than that, maybe 30% or so.
BARBARA GRAY: Okay. So, what you do with your customers and with Inco and Falconbridge?
MARK DAVIS: We have to have discussions with Inco and Falconbridge on how to rationalize the SO2 markets.
BARBARA GRAY: Okay. And are there going to be any negative results from that or any financial costs for that?
MARK DAVIS: We don’t believe so.
BARBARA GRAY: Okay. And with the credit agreement, are there any covenants in your credit agreement that would be impacted by your $15.6 million write-down of the plant?
ROHIT BHARDWAJ: Barbara, there shouldn’t be any covenants that are impacted. We do have, as you know, a debt-to-EBITDA covenant. But that’s not directly an asset test, so we don’t anticipate any issues with this particular non-cash write-down.
BARBARA GRAY: Okay. And sorry, just two more questions here. With the contract with Guangdong ZhongCheng, what kind of margins or EBITDA you are going to get from it? Or did you sign the contract mainly because you had the contracts with your customers and you had to fill it?
MARK DAVIS: No. We expect the ZhongCheng contract to be profitable, but for various, obviously commercial and competitive reasons, we’re really not disclosing the profitability on the ZhongCheng contract, but it will be profitable for us.
BARBARA GRAY: Okay. And one last question. How are you going to fund the $4 million in cash costs in Q4?
ROHIT BHARDWAJ: These are funded from a combination of operating cash and from further drawing down on our lines of credit that we have.
MARK DAVIS: I think it’s fair to say, Barbara, that we are going to record the $4 million cost in the fourth quarter; but not all the cash will actually be payable in the fourth quarter.
BARBARA GRAY: Okay. Will some be going into Q1 or Q2, or how far you’re going to stretch it?
MARK DAVIS: Yet to know. But at least into the next year.
BARBARA GRAY: Okay. And will that impact your distributable cash line or how does that work?
ROHIT BHARDWAJ: Will it impact our bank line you mean, or …?
BARBARA GRAY: No. You know, how you report distributable cash …
ROHIT BHARDWAJ: That will be probably reported in two ways. We will report it as though it impacts distributable cash. We’ll also have a pro forma number, which will be distributable cash before restructuring or repositioning.
BARBARA GRAY: Okay. That’s great. Thank you very much.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Gerry Hammochko from Genuity Capital Markets. Please go ahead.
GERRY HAMMOCHKO: Oh, hi there. Just a couple of quick questions. How is the maintenance capital in 2007 going to be affected by the Leeds closure; is that going to drop it or is it just going to be kind of soaked up by additional spending through the Peak assets?
MARK DAVIS: We haven’t changed the number we forecasted going forward, Gerry. So if you remember a couple of quarters ago, we said we wanted to spend some more money on those plants. So, our forecast for ’07 is still about $7.5 million.
GERRY HAMMOCHKO: Now just in terms of the overall impact from this contract, are you going to be more profitable in ’07 from this contract on the powder SHS than you were in 2006 on it, or is this just going to be an improvement in the overall margins?
MARK DAVIS: Yes, we believe it is.
OPERATOR: Your next question comes from Horst Hueniken from Westwind Partners. Please go ahead.
HORST HUENIKEN: Good morning gentlemen.
MARK DAVIS: Good morning, Horst.
HORST HUENIKEN: I would like to first delve into the decision to shutter the powder SHS business. One of the things you obviously will continue to do is sell that product to your customers, and I’m wondering whether in order to maintain a reliable supply stream you need to now build inventories?
MARK DAVIS: Yes, we will build the inventories at various locations around North America.
HORST HUENIKEN: I’m just looking at it from a working capital perspective. Is that going to be a material increase in your working capital requirements that we need to model in?
ROHIT BHARDWAJ: Not really. If you think about it we already sell a fair bit of power into Canada, and all of it was made at the Leeds facility, so we have pretty high inventory levels. So it’s fair that inventories will increase, but not in a material fashion though.
HORST HUENIKEN: Okay. Thank you. My second question, I am wondering whether there is potential for customers to switch from powder to liquid; not clear that that is going to happen, but I am wondering whether that you see any potential for that?
MARK DAVIS: It’s something we’ve talked of for years – customers, as a general statement, would probably like to use liquid, but where some customers are located they can’t because of geography. Remember that the liquid stuff has a seven to 10 days shelf life.
HORST HUENIKEN: Right.
MARK DAVIS: Right. So there are some guys that will look to switch into the extent actually that we could supply them at our plants actually is – that’s good for us. But we don’t think that’s a short or medium term issue.
HORST HUENIKEN: Fair enough. I am wondering, now that you’ve made a decision with respect to your powder SHS business, might you also later be thinking about what to do with your liquid SHS business. Is there an opportunity to sort of hand that over in part to the Chinese supplier as well?
MARK DAVIS: Probably not for the same reasons that I really just mentioned, right, as you can’t get liquid from China because of how long it takes.
HORST HUENIKEN: Okay. Fair enough.
MARK DAVIS: Right. And again the liquid product has different dynamics not only for that but for raw materials costs. What really has hurt the powder production is the huge escalation that we see coming in sodium formate pricing, and you don’t use that raw material for liquid.
HORST HUENIKEN: Got it. Different topic perhaps for Rohit. What happened to the insurance claim?
ROHIT BHARDWAJ: Well, the insurance claim is progressing. We’ve had continued dialog as recently as last week. It’s following its normal process where the insurance company has hired a firm of accountants who are reviewing our claim in detail. As you can imagine it’s in some ways a complex claim, and there are quite a few issues that are being looked at right now. So it’s making progress, maybe not as fast as we would like, but it is making progress.
HORST HUENIKEN: Your answer sounds very similar to what you said three months ago. I am just wondering…
ROHIT BHARDWAJ: Well, I cannot – let me give…
MARK DAVIS: Isn’t consistency a virtue, Horst?
HORST HUENIKEN: You got that.
ROHIT BHARDWAJ: Of course there has been progress since last quarter. I think at last quarter they were just about to appoint a firm, we have now actually had meetings with that accounting firm. They’ve had their first review of all our information and there are, you know, follow-up information requests that we are right now fulfilling. So it has – if my answer is not more specific it’s not because nothing has happened, but there's nothing meaningful that I can add to right now.
HORST HUENIKEN: Okay. Separately, on currency, I noticed in your report that 2007 is already hedged; does this represent a change in your FX strategy?
ROHIT BHARDWAJ: No, our strategy, I believe is to go out 18 months at different percentages. So we may be slightly ahead of that right now, but no, it’s not really a fundamental shift in strategy.
HORST HUENIKEN: Okay. I will let some of the other analysts ask. Thanks.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Lorraine Gloster from MGI Securities. Please go ahead.
LORRAINE GLOSTER: Hi, yes. On the powder SHS side, was that unit operating at a loss then?
MARK DAVIS: No.
LORRAINE GLOSTER: So it was profitable. And what contribution did it have then, say, this year versus last year?
MARK DAVIS: Well, lower this year versus last year due to the raw material pressures, you know, a little bit of color, I guess what I said to Horst is looking forward to sodium formate pricing forecasts for 2007 would have actually taken that unit negative and we would never actually have operated the unit at a negative contribution.
LORRAINE GLOSTER: Thanks. So it was – but it was slightly profitable in Q3 then?
MARK DAVIS: Correct
LORRAINE GLOSTER: Okay. And just looking at that SHS then on EBITDA level I know you don’t split out the divisions, but looking at it between powder and the liquid on the EBITDA line, would powder account for say like a third of that EBITDA, or would it have been less?
MARK DAVIS: You just told me I don’t break it out, Lorraine.
LORRAINE GLOSTER: Yeah, but I’m not asking you to break down the number, just a percentage wise?
MARK DAVIS: That’s…
ROHIT BHARDWAJ: You are talking about just as a percentage of SHS, right?
LORRAINE GLOSTER: Yes.
ROHIT BHARDWAJ: So that’s in the ballpark, yes.
LORRAINE GLOSTER: Okay. Great. And then you were giving us the impact of the sodium formate and caustic soda together, I wondered if you could just give us now caustic soda. I guess that goes away, too, with the natural gas; is that right?
MARK DAVIS: That’s right.
LORRAINE GLOSTER: Okay. So these impacts going forward, how much was the impact then say like on the caustic soda for, I guess, when did that agreement, was it September when that agreement kicked in?
ROHIT BHARDWAJ: Yes, Q4 is the first quarter we are going to experience that new pricing. It’s based on Q3 natural gas, but it comes into effect with purchases in Q4.
LORRAINE GLOSTER: In Q4. Okay?
ROHIT BHARDWAJ: Yes.
LORRAINE GLOSTER: So for the nine months then, what was the impact. If you could just take out the sodium formate, what was the impact of the higher caustic soda prices then?
ROHIT BHARDWAJ: For the first nine months we’ve mentioned that total cost increases were in the ballpark of $4 million, and caustic is not a big portion of that.
LORRAINE GLOSTER: Okay. So $4 million for the nine months did you say or…
ROHIT BHARDWAJ: For the nine months it was $4 million. That includes some natural gas from earlier in the year; a big chunk of that is sodium formate; and caustic is not a very big element in that.
LORRAINE GLOSTER: Okay, I’m not sure I got this then. What was the impact of the caustic soda then for the nine months?
ROHIT BHARDWAJ: Caustic soda, as I mentioned is not a huge number, maybe it’s 10% of that number.
LORRAINE GLOSTER: 10%, okay. All right. So it’s not that material.
ROHIT BHARDWAJ: No.
LORRAINE GLOSTER: And then, just if you just remind me on this international customer that went away on the Pulp side; who was that?
MARK DAVIS: Not on the Pulp side. Went away on the International side. So it’s a German refinery we used to handle and no longer handle.
LORRAINE GLOSTER: And what quarter did they go away?
MARK DAVIS: It would have only been the third quarter last year. So their results would not have been reflected in the fourth quarter.
LORRAINE GLOSTER: Okay. And then on the CapEx side, you gave what the maintenance CapEx expectations were for the fourth quarter and, well, for 2006 and 2007. What kind of growth capital are you expecting in the fourth quarter and in 2007?
MARK DAVIS: Not material at this stage.
LORRAINE GLOSTER: Okay. Thank you.
MARK DAVIS: Thank you.
OPERATOR: The next question comes from Bert Powell from BMO Capital Markets. Please go ahead.
BERT POWELL: Great. Thanks. Mark, obviously, looking forward, you expect things to not get better and you’ve entered into this agreement with ZC. If you go back and look at the profitability out of the powder business over the last 12 months, and look at that compared to what you would expect to do with ZC, would that be still more positive with the ZC contract or would you expect that to be less?
MARK DAVIS: We believe it will be more positive.
BERT POWELL: It will be more positive. Okay. And if we look at the end markets for SHS powder, you are clearly saying you’ve been hit by input cost, and then the newsprint side of the business. Just looking back at liquid, end market demand for that product at this point in time, I would assume you still have some newsprint exposure there?
MARK DAVIS: Sure. Newsprint is still the dominant demand for both of those products.
BERT POWELL: Right. Okay. So that business is still going to be subject to pressures on that point?
MARK DAVIS: Yes. Conversely, arguably you are seeing peak caustic pricing.
BERT POWELL: Right.
MARK DAVIS: And peak zinc pricing, both of which actually should benefit us as they come down.
BERT POWELL: Right. And we have seen caustic prices come down, right, from Q4 last year. And if we look at the pricing today that’s available in some of the trade magazines, and thinking about that in the context of your switchover to natural gas base pricing this quarter, would it be reasonable to expect that that pricing switchover would reasonably approximate what’s going on in the spot market today? Or would it be more positive for you with the switchover to natural gas pricing?
MARK DAVIS: The spot caustic market?
BERT POWELL: Yeah. In other words, relative to what you would pay other prices, is it a favorable arrangement now?
MARK DAVIS: It would be more favorable for us to actually be buying on our gas formula than buying contract caustic price in the fourth quarter.
BERT POWELL: How much better are you talking, kind of 20% or as more as kind of 5%?
MARK DAVIS: I honestly don’t know offhand, Bert.
BERT POWELL: Okay. And just moving back to … were they the competitor that caused the pain in the first place?
MARK DAVIS: They were the biggest Chinese presence in North America, yes.
BERT POWELL: Okay. And is there anything in terms of volume commitments that you guys have in there? Are there any quality issues relating to servicing existing customers? Any pricing mechanisms for transport cost? Anything else that would give us some color on that contract?
MARK DAVIS: Well, the contract itself actually will be filed as a material contract in the next 48 to 72 hours or whatever the legal requirements are.
BERT POWELL: Okay. Perfect.
MARK DAVIS: So, there will be a bunch of good reading material for you soon.
BERT POWELL: Yes. Thanks. Looking at Inco now. Part of the discussion last year was in addition to the existing volumes, there potentially could be more related to stricter environmental rules. Rohit, I think when you mentioned in your commentary that you are seeing volumes move back up to prior expected levels. Are you referring to the new stepped up anticipated levels? Are you talking about relative to levels in the year ago period?
ROHIT BHARTWAJ: No. We are definitely talking about the additional volumes we were expecting to see that we didn’t see in the third quarter.
BERT POWELL: Okay. Now with CVRD now in the picture and admittedly it’s early days, but any thoughts as to their proclivity with respect to the contract that ends in ’08? What are some of the rumblings that you are hearing initially?
MARK DAVIS: We think that both Inco and we view our relationship as beneficial for both parties and continue to be optimistic that we’re going to see our way clear to figuring out how to extend or renew that contract.
BERT POWELL: Okay. Perfect. Thank you very much.
MARK DAVIS: Thanks.
OPERATOR: Your next question comes from Barbara Gray from Blackmont Capital. Please go ahead.
BARBARA GRAY: Thank you. I just have a follow-up question here. With ZhongCheng, I have assumed they're also impacted by the raw material costs, but how much lower is their cost structure than you guys?
MARK DAVIS: We don’t really know what their cost structure is. But if you Google ZongCheng you’ll find out that they are a fully integrated producer starting, actually, from coal. So the merchant market, for example, sodium formate requirement that actually affects our business, doesn’t affect them because they produce their own.
BARBARA GRAY: Okay. So what’s the benefit to them of signing the contract? And did you guys approach them or did they approach you, or how did that work?
MARK DAVIS: It was a mutual arrangement. Now the benefit to them actually is a bunch of extra volume.
BARBARA GRAY: But it’s at a lower margin, I am assuming, because you guys are taking some of it.
MARK DAVIS: The benefit to them is a bunch of extra volume and actually a quicker penetration of the North American market than they were able to do on their own. We believe because our customer base values our supply chain, our infrastructure, our technical service and other things like inventory management that we provide extensively that they had not been providing.
BARBARA GRAY: And what was their penetration of the North American market prior, or what is it right now?
MARK DAVIS: Oh, they were about 25% of our volume.
BARBARA GRAY: Your volume or North American volume?
MARK DAVIS: Of our volume.
BARBARA GRAY: Okay. I am just trying to figure out, because obviously your margins should be lower because you are not going to get the full benefit of being the full producer; is that correct or not?
MARK DAVIS: I think we've said, Barbara, that we anticipate making more money out of this contract than we have made out of our powder business for the last 12 months.
BARBARA GRAY: But if caustic soda prices went back to the levels they were two years ago, would that still be case?
MARK DAVIS: Yes, because of the sodium…
BARBARA GRAY: Because of sodium formate. Okay. Thank you very much.
OPERATOR: Your next question comes from Nima Billou from Bloom Investment Company. Please go ahead.
NIMA BILLOU: Good morning gentlemen.
MARK DAVIS: Good morning.
NIMA BILLOU: Just wanted to get an idea, with the new ZongCheng agreement, would you be going after additional customers or it’s just serving your existing base?
MARK DAVIS: No. It’s a basis for us to actually try to expand our business. So, we are going to do what we can to actually grow that business and acquire new customers.
NIMA BILLOU: Because you’ll have the outsource capacity that to be able to do so?
MARK DAVIS: Exactly.
NIMA BILLOU: Okay. And with respect to declines, it was about 6% in volumes; that’s the total SHS business?
MARK DAVIS: No. That was actually the decline in newsprint production in North America ’05 versus ’06 for the first nine months. And newsprint is 50% of the demand for SHS.
NIMA BILLOU: Okay. And how does that translate into volume declines, is it one for one in terms of the SHS business?
MARK DAVIS: Well, that’s hard to answer only because it’s customer specific, and who serves those customers. So, I think it’s safe to assume a one for one kind of basis, but it isn’t that easy to track, because I think we said before as, if you’re served by a liquid plant near a specific mill is, you can’t do anything else with that liquid material, it doesn’t travel far.
NIMA BILLOU: Okay.
MARK DAVIS: But for modeling purposes I think one to one is fine.
NIMA BILLOU: But despite this you expect results to improve going forward because you are basically taking a large commodity risk out of it in the sense of the sodium formate price increases?
MARK DAVIS: That’s right.
ROHIT BHARTWAJ: But we also now make that into a variable cost as apposed to fully absorbed cost with baking in the absorptions on the lost volume. So therefore we don’t get hurt as much from a volume basis.
NIMA BILLOU: And the Leeds plant, was that 50% of your SHS capacity?
MARK DAVIS: That’s probably about right because remember, there's two plants there; liquid and powder.
NIMA BILLOU: What was powder alone?
MARK DAVIS: Powder alone was about 50% of the volume.
NIMA BILLOU: 50% of total SHS volume?
MARK DAVIS: Right. So that’s why the answer to your question is, yes, it’s about 50% of our total SHS volume.
NIMA BILLOU: But you guys are encouraged in the sense of taking that formate cost out of it, because looking down the road you think it’s going to render that facility unprofitable, and very soon?
MARK DAVIS: That’s right.
NIMA BILLOU: Okay. That’s it. Thanks very much.
MARK DAVIS: Thank you.
OPERATOR: Ladies and gentlemen, if there are any additional questions at this time, please press star followed by one. As a reminder, if you are using a speakerphone, please lift the handset before pressing any keys. Your next question comes from Lorraine Gloster from MGI Securities. Please go ahead.
LORRAINE GLOSTER: Yes. I just have a question on Peak. I just wondered if your expectations have been met, now that you’ve spent the money on those facilities. Has it met some of the expectations you had when you bought them back in August?
MARK DAVIS: Yes, we continue to be pleased with the operations of the Peak assets as we think we can continue to improve them. But by and large we’re quite content with what we have.
LORRAINE GLOSTER: Okay. That’s it. Thanks.
MARK DAVIS: Thank you.
OPERATOR: Your next question comes from Horst Hueniken from Westwind Partners. Please go ahead.
HORST HUENIKEN: Yes. Two follow-up questions. Mark, on the last quarter conference call you mentioned that the pricing of sulphur was still weak. I am wondering what you are seeing in terms of pricing in Q4 and next year at this stage?
MARK DAVIS: Frankly, I don’t remember saying that, but I think actually sulphur pricing should be coming down next year. I thought the comment I may have made on that about a couple of quarters ago was I thought I might have seen some weakness in sulphuric acid pricing. And contrary to that statement, we think that pricing is actually firmed up, and will remain firm.
HORST HUENIKEN: Okay. Perhaps my memory is failing me.
MARK DAVIS: Or mine.
HORST HUENIKEN: The other area is zinc. We had heard about your efforts to improve the efficiency of zinc in the liquid SHS process, just wondering where things stand with regards to that effort?
MARK DAVIS: Yes, we've done, I guess, a couple of things. I think we've been relatively successful in improving efficiencies by, you are talking, you know, 1%, 2%, 3% efficiency gains. So it’s good, but you won’t see it there. The big hedge there, as you may recall, is if you put zinc in one side you get zinc oxide out the other side. It’s not a complete hedge, but it’s about a 70% hedge?
HORST HUENIKEN: Right.
MARK DAVIS: So that, although higher zinc prices have hurt us, they don’t hurt us 100%. But we would definitely prefer lower zinc prices.
HORST HUENIKEN: Okay. Understood. And thank you.
MARK DAVIS: Thank you.
OPERATOR: Gentlemen, there are no further questions at this time. Please continue.
MARK DAVIS: Well, we would like to thank you all for joining us on the call today. And we look forward to talking to you again next quarter. Thank you.
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