Tronox Holdings plc (TROX) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Tronox Limited Q2 2012 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference, Mr. Brennen Arndt. You may now begin, sir.

Thank you, Kevin, and welcome to Tronox's second quarter 2012 conference call and webcast. Tom Casey, Chairman and CEO, will begin our call with a review of second quarter performance. Following Tom, Dan Greenwell, Senior Vice President and Chief Financial Officer, will report on our financial position. Tom will then provide our outlook for the full year 2012 and we'll complete the call by taking your questions. I'll remind you that our discussion today will include certain statements that are forward-looking and subject to various risks and uncertainties concerning specific factors summarized in Tronox's 2011, Form 10-K, our most recent Form 10-Q and other SEC filings. This information represents our best judgment based on today's information. Actual results may vary based on these risks and uncertainties. During the conference call, we will refer to certain non-GAAP financial terms, including adjusted EBITDA and EBITDA, which we use in the management of our business. EBITDA represents net income before net interest expense, income tax and depreciation and amortization expense. Adjusted EBITDA represents EBITDA as further adjusted for unusual or nonrecurring items, including restructuring charges related to our Chapter 11 proceedings and our merchants and other nonrecurring costs and expenses. It's now my pleasure to turn the call over to Tom Casey. Tom?

Thank you very much, Brennen. And for those on the call, I apologize in advance if there are some technical issues. I'm calling in from South Africa. Brennen and Dan are both in the U.S. So hopefully this will work well. And I thank all of you for joining us this morning. Since our last earnings call, Tronox had successfully completed our acquisition of the mineral sand assets from Exxaro Resources and created the world's largest fully integrated mineral sands and pigments company. We believe Tronox now has the unique ability to optimize the upstream and downstream sides of our business, maximizing returns for the entire enterprise no matter where we stand within the business cycles. While the transaction with Exxaro was completed at the middle of June and our second quarter results only reflect a couple of weeks of earnings from the combined business, we are seeing the advantages of the vertically integrated structure each and every day. For example, while our demand for the higher-grade chloride feedstocks, such as natural rutile and synthetic rutile is down due to the TiO2 industry reducing operating rates, demand for slag has remained relatively strong. Tronox, therefore, has the unique ability to capture margins wherever it occurs on the supply chain while utilizing all of our natural and synthetic rutile internally and at the same time, continuing to sell chloride and sulfate slag to pigment manufacturers where margins remain relatively stronger. This is just one example of the powerful synergies this transaction provides Tronox. Turning now to our second quarter results. We reported revenue of $428.9 million and adjusted EBITDA of $146.2 million. Our EBITDA performance largely reflected our last quarter as a nonintegrated producer as purchased ore costs increased by approximately $600 per metric ton above those in the first quarter. These added costs outweighed stable selling prices and slightly lower sales volumes we experienced during the second quarter. While demand for titanium dioxide continued to be impacted by the continued weakness in the Eurozone, China and to a lesser extent, North America, demand for our mineral sands products, other than zircon, are meeting our expectations. Despite the combination of this tepid global economic conditions, customer destocking and some thrifting, adjusted EBITDA was up 24% from the same quarter last year. We delivered this performance at a time when pigment volumes for the quarter were down 24% year-over-year and pigment pricing for the quarter was up 27% year-over-year. For the first half, pigment pricing was up 29% over last year's levels. On a pro forma consolidated basis, we have reaffirmed our forecast for 2012 revenue to be between $2.5 billion and $2.6 billion and an adjusted EBITDA margin of between 35% and 34% therefore leading to a forecast of adjusted EBITDA of between $875 million and $962 million. We also believe that we'll generate approximately $550 million of unlevered free cash flow before taxes cost of risk performance. We expect to deliver this substantial EBITDA and free cash flow generation even in a market whose volumes have already declined approximately 24%, as I said, and in which we assume level volumes and modestly low prices for the balance of the year. This level of EBITDA and free cash flow performance validates the financial strength of our new company even in challenging markets and illustrates clearly the strategic merit in our combination of the mineral sands and pigment businesses. We believe we are in a differentiated position in this market, and we'll retain relatively stronger in both -- we'll retain relatively stronger performance in both the current soft conditions and even more so as the market strengthens again. And we continue to be positive about the mid- and long-term growth rates of the TiO2 market. The fundamental material demand drivers in our business have established themselves over many years as being highly correlated with GDP and these have not changed, nor has supply changed. The industry continues to face significant constraints in expanding production over the medium to long term and the present softness in demand will only reaffirm that condition. We won't speculate precisely on whether the current economic uncertainty will give way to a normal demand environment whether in the latter part of this year or next year. But we do know that even when demand recovers, there is simply not enough pigment production or ore supply to support an influx of demand beyond what we saw only a few quarters ago. In addition, TiO2 plants is a capital-intensive undertaking that requires mastery of complex, proprietary technology and which remains a major hurdle particularly for the chloride process production plants. Therefore, we continue to believe that the industry's strong structural fundamentals will support an extended period for strength for the TiO2 industry. In the second quarter, between headwinds of higher ore prices and continued soft TiO2 demand reduced our earnings, as I said, but they also served as an affirmation of the importance of our vertical integration strategy, which will be in full force from now through the end of the year. Moving forward, we will be able to harness strength in the ore industry rather than being susceptible to it. New Tronox is a stronger and more balanced operation that can capture strength and better manage risk wherever it exists in our supply chain. We are now only the titanium products company with more ore supply than our pigment production requires. And we also have a broad range of feedstocks giving us the flexibility to optimize our ore supply to maximize Tronox at the enterprise-level financial strength. I'll turn now the call over to Dan Greenwell for a report on our financial position, and we'll come back to speak a little after Dan has concluded. Dan?

Thank you, Tom, and good morning to everyone. Tom has highlighted the factors influencing the business during the second quarter and our outlook for the second half of the year. I would like to first mention a couple of unusual items in the quarter in income, which resulted from the acquisition of the mineral sands business. And then I'd round out our discussion of the top line with a few comments about product selling prices and volumes and about the impact of titanium ore costs on our bottom line. Then I'll follow with additional comments about our operating results, tax rates and future capital spending. Second quarter of 2012 included 2 unusual items in net income, as well as the transaction-related costs in selling, general and administrative expenses. First, included in the period is a onetime gain of $1,061,000,000 on the purchase of the mineral sands business. This gain is derived because the total consideration transferred was determined for accounting purposes to be less than the fair value of the net assets acquired. Therefore, the deemed excess of the value of the net assets acquired over the purchase price has been recorded as a bargain purchase gain in the quarter. The bargain purchase again is not taxable for income tax purposes. The purchase price allocation is preliminary and based on valuations derived from estimated fair value assessments and assumptions used by management. The final purchase price allocation is pending the finalization of appraisal valuations of certain tangible and intangible assets acquired which may result in adjustment to the preliminary purchase price allocation and the gain on the bargain purchase. Second, the period includes a tax benefit of approximately $88 million directly associated with the company's newly implemented Australian holding company structure. As part of the company's redomiciling in Australia and the ownership changes of several entities in the organizational structure, the company was able to obtain a tax basis step-up on certain existing international operations. Because this basis change did not pertain to the an entity acquired in the transaction with Exxaro, this net tax benefit was recorded through tax expense and did not impact the company's gain on the bargain purchase. Second quarter net income available to common shareholders was $1.17 billion or $13.67 per share compared to last year's $66.2 million or $0.85 per share. Year-to-date net income available to common shareholders was $1.26 billion or $15.50 per share compared to last year's $76.4 million or $0.98 per share. Revenues of $429 million in the second quarter of 2012 were effectively the same as prior year. Included in the current year revenues were third-party sales of $30.5 million associated with the newly acquired business for the 2-week period. Increased pigment prices of 23.5% generated $66 million of revenue. Volume declines more than offset the price increase for the quarter. Year-to-date revenues of $863 million increased 6.9% and newly acquired revenues noted earlier. Increased pigment prices of 29.3% for the 6 months generated additional revenues of approximately $161 million while volume decline of 20.5% lowered pigment revenues by $142 million. Sequential comparison of the second quarter of 2012 compared to the first quarter of 2012 shows similar pigment pricing while volumes decreased by approximately 4%. We have had a strong focus on cost control, production management and inventory levels. We believe our inventory positions are well placed and at the right levels to meet third quarter anticipated demand as we bring our operating rates to levels that allow for efficient management of working capital. The year-over-the-year [ph] increase to second quarter selling, general and administrative expenses was $64 million and is directly associated with the mineral sands acquisition. The increase was due primarily to the accrual of $38 million of stamp duty and other property transfer taxes, the acceleration of vesting of restricted stock of $21 million, and legal and professional fees of $13 million. These costs should be significantly reduced in the remainder of the year. Tronox's effective tax rate should be in the range of 8% to 12% for 2012 and throughout 2013 and 15% to 20% for several years thereafter. During the acquisition planning, we implemented multiple tax strategies to lower the effective tax rates and the amount of cash taxes paid. A key aspect of this optimization strategy included the reorganization of Tronox subsidiary ownership structure for our international operation. This new structure will provide cash saving benefits in the future in the form of lower tax payments. Our tax planning initiatives should provide benefit in future periods. As a result, we estimate 2014 effective annual tax rate between 15% to 20%. We expect to realize these effective tax rates for the next several years. You may have noticed that we now have a new component of equity on our balance sheet called noncontrolling interest. This caption represents the amount of Exxaro's 26% ownership of the South African entities as required by the BEE legislation. We estimate our capital spending for the second half of 2012 will be in the range of $60 million to $80 million. First half capital spending was approximately $49 million. We anticipate that future capital spending for the next 3 years will range between $90 million to $110 million of maintenance capital plus $100 million to $110 million each year for both phases of the Fairbreeze mine development in years 2013 through 2015. As we noted earlier, the purchase accounting step-up values will require depreciation, depletion and amortization. We estimate that annual depreciation, depletion and amortization will be in the range of $190 million to $210 million for the newly acquired mineral sands businesses. Additionally, inventory values were written up approximately $270 million to fair market values in the purchase accounting and will be amortized as the inventory is sold. We estimate additional noncash amortization will likely occur within the next 9 to 15 months. Many people asked whether Exxaro's reported equity earnings from Tronox can be reviewed in the same context as our U.S. GAAP statements. The short answer is no. Exxaro reports their financial statements in accordance with IFRS and there can be material differences in timing, recognition, accounting principles and valuations. At this time, I'd like to turn the call back to Tom Casey. Tom?

Thanks very much, Dan. I'm told, by the way, that I may have misspoken when I was reaffirming our forecast guidance for the year by saying that we were forecasting an adjusted EBITDA margin of between 35% and 34%. If I said 34%, I was mistaken. I meant we're reaffirming forecast EBITDA margins of between 35% and 37%, which is what we announced several weeks ago so no change to that. And I apologize if I misspoke and added to any confusion. As previously announced, we have the company's Board of Directors on June 29, 2012, approved the 5:1 stock split for holders of both classes of our common stock. That was effective as of the close on July 20. The split is now reflected in our stock price and will make Tronox, we hope, more assessable to a wider range of investors. During the second quarter, we reaffirmed our desire to return capital to shareholders as we generate substantial cash. In keeping with this goal, management has received board approval for a series of initiatives. We adopted a policy stating the company's intent to issue a quarterly dividend of $1.25 per share on a pre-split basis payable on August 13 to shareholders of record on July 13. The quarterly dividend will therefore be paid out a 25% -- $0.25 per post split share while the board has also announced its intent to continue to pay a similar regular dividend on a quarterly basis. On June 29, the company's Board of Directors also authorized the purchase of up to 2.5 million Class A shares of our stock. To date, we have repurchased $21.2 million worth of shares at a weighted average cost of $116.06. During the second quarter, we repurchased 17,000 shares and thereafter the second quarter, we repurchased an additional 164,800 shares. We have a strong and conservative balance sheet, and we are committed to optimizing it. The company anticipates a new debt financing, as we have said, between $750 million and $1 billion in the second half of 2012. The timing of such debt offering is always under consideration and remains contingent on credit market conditions. With that, I'll be happy to open up the line for any questions that any of you have.

[Operator Instructions] Our first question comes from Hassan Ahmed with Alembic Global.

Two questions. One on the inventory side of things. Obviously, the volumes as far as TiO2 go continue to be weak, call it, third quarter running. But if I take a look at the first half volumes on the coatings company side of things, they continue to be quite strong. So I just wanted to get your feel of what inventory levels look like on the coatings company side of things.

Hassan, this is Tom. We obviously don't have complete visibility or even necessarily accurate visibility into coatings inventories. We believe from our experience in looking at their sales increasing in terms of volume of units, gallons of paint sold, and their purchases from us declining that they are destocking and have continued to destock through this period. I think there have been some statements by management of at least some of the large paint companies that their inventory levels are declining as they have gone through this process. So while we don't -- I can't give you a definitive answer to that, that's our view.

Fair enough. Now the second one on pro forma EBITDA. I know, obviously, you guys have given 2012 pro forma EBITDA guidance of, call it, $875 million to $960 million. Just wanted to get a sense of what that pro forma EBITDA looked like in the first half of this year. Is it fair to assume, I mean, as I run my numbers, I see it as being roughly around $540 million or so, is that fair?

I'll defer to Dan on the accounting. But as Dan said in his statement, because the Exxaro numbers are calculated under IFRS and ours are calculated under GAAP, presented under IFRS and GAAP, that there will be some adjustments to convert to their first half EBITDA to what it would be in our pro forma first half EBITDA.

Sure, but I just wanted to get the ballpark sense, frankly.

Well I think that's the ballpark. It's going to be around there in the ballpark.

In the ballpark, okay, fair enough. So obviously, inherent in the second half guidance in line with your statements about sort of continued -- at least in the forecast that you're saying to come up with your guidance, some volume weakness, some pricing declines, so obviously the EBITDA will sort of come down first half to second half.

Yes, that would be a fair assumption to make.

Our next question comes from Hamed Khorsand with BWS Financial.

Just touching base on the inventory question here, what is a reasonable question for you going forward?

I'm sorry, what the pigment level? Is that what you're asking? The pigment...

No. At the whole -- at the entire company level.

Dan, this involves the enterprise reported inventory so do you want to take or do you want to take an answer for that?

Sure, sure. What you see is on our balance sheet you see a very substantial amount of inventory, approximately $1.1 billion. Keep in mind that a fairly sizable portion of that was acquired inventory, roughly $622 million at the time of acquisition, so just a little bit over half of those was acquired inventory from the mineral sands acquisition. As the ore prices went up during the quarter, that ore cost is now inventoried in our inventory. So while volumes are not inconsistent with what they've been in prior quarter and even at year end, the average cost of the inventory has gone up. So I think from a volume perspective, we're managing our quantities fairly effectively, and we indicated that we would bring production volumes down in the second half. We do have a lot of expensive ore in that inventory. So I would expect to see the inventory values come down as we move through the third quarter and, of course, into the fourth quarter. But keep in mind that we're amortizing a large portion of that fair value adjustment. We'll be amortizing that on a relatively quick basis. And also, do keep in mind that inventory balance consists of all of the ilmenite, the 2 stockpiles, 2 primary stockpiles that we have in Australia and in South Africa, I think 500,000 tons of ilmenite, which is more than a year's worth in Australia and same with the piles of ilmenite that we have sitting in South Africa. So a lot of it is long-term ilmenite that we used to feed those furnaces at the end of mine life. So there is some value, quite a bit of value in that.

Okay. And Tom, I have one other question there. Given the current state of demand right now for pigments, you were talking about a flattish or even down Q3 and seasonally Q4 is down as well. So are we talking about Q1 as potentially being the turning point as far as this situation goes in the TiO2 industry?

I wish I could tell. As I said, we didn't forecast. For purposes of the guidance, we assumed that there would be no improvement in performance in calendar 2012 just because we felt that was the conservative approach to take to it. Clearly, there are signs that U.S. housing is recovering and that level of activity appears to be picking up with U.S. housing. The GDP in the United States is obviously not doing well. It's not clear where it's heading. I think the last report was 1.5% growth. That's not very exciting. Europe is in recession and the Eurozone macroeconomic risks are affecting business there. China, as you know, they clearly saw to put the brakes on their economy, particularly in the housing and construction sectors at the end of 2011 in order to provide the housing bubble and inflation from getting out of hand. They have now appear -- from at least from our perspective, they appear to have reoriented their policies and are now more stimulative. So the question is when U.S. housing and China stimulation begins to flow through the economies and then flow through our sectors. Obviously, your judgment can be as good as mine on that. But for purposes of what we are planning, we're not planning that it happens in 2012 although there's at least some possibility that we might see it towards the end of the year.

Our next question comes from Gregg Goodnight with UBS.

Dan, a question on EBITDA. Are you going to provide EBITDA by segment in the future? And do you have a breakdown of EBITDA in the second quarter by segment?

We do, Gregg. What we'll do is we'll provide it by the individual segments. We will provide it and I think the piece that we did for the second quarter we indicated that the newly acquired business made a contribution in the second quarter on our press release. You can see that in the press release. A majority of that came from the mineral sands.

Okay, great. A question for Tom. In your second quarter prerelease, you guided to year-over-year pigment pricing as up 15% and that seems like a long time ago. Now there's been a sort of news flow that suggests that the pigment prices remain under pressure. Do you believe that, that 15% year-over-year guidance is still a good benchmark or if you're a betting man, do you think that's going to be a little lower or a little higher than what you'd previously said?

That assumption of 15% year-over-year included an assumption that prices would decline somewhat in the second half of 2012. And we think that, that's the case. We don't expect dramatic declines and there will be different levels of price performance in the different regions of the world. But in general, on average, sort of a weighted average basis, we expect them to decline on mid-single digits and we still expect that. So we're not changing that.

Okay. That's great. Just one last question if I could for Dan. You mentioned your guidance on effective tax rate 8% to 12% in 2012 and then going up to 15% to 20%. So that -- when you say effective cash tax rate, I assume you mean the cash tax rate rather than the book tax rate.

The cash and the book tax rate will approximate each other. We said in the comments said that 2012 and 2013 should be in the range between 8% to 12% so that would be effectively cash and book both. And then in 2014 and beyond, we indicated it would be between the 15% and it'll move up a little bit. It'll be between 50% and 20% on '14 and beyond.

Our next question comes from Oren Shaked, Credit Suisse.

Tom, how would you characterize the industry's supply response to the current environment? And then also, secondly, how quickly do you think that you can move forward with the debt financing? And maybe associated with that, why not simply just tender for the stock given the constraints of buying it back in the open market?

Those are multiple questions. What's the industry response to demand? I can tell you what our response has been, which is coming out of the third quarter of 2011, we were operating in -- with very inventory low levels. And so on the fourth quarter, we replenished them and then began to slow production. And we continue to slow production on the pigment level because we see no particular value of building inventories over the levels that they have achieved. The economics of that decision are a little bit more favorable now than they have historically been because as a largely fixed cost industry, when you slow production, there was much less fixed cost absorption and therefore, your EBITDA suffered. With ore feedstock being price is rising very, very dramatically, the balance between fixed and variable costs has changed significantly a bit for being able to slow production has a different and a more relatively positive financial impact. So that's what we have done. We think that others have done the same. I can't speak for them. I don't know what precisely they have done with all their plants. But our sense is that others have responded to do a market in the same way we have generally. With respect to the bond offering, we have some accounting that we have to deal with, with the mineral sands, the bond offering memorandum would require some pro forma numbers that in turn require Exxaro mineral sands numbers to be presented on a GAAP basis so we can be pro forma consolidated. That -- it just takes some time. There's no issues there, simply the mechanics of having that carveout done and the consolidations, eliminations and adjustments performed and reviewed, the question is whether or not that will all be done in time given where the market is in mid-August. And I simply don't know. But obviously, we're working hard on it. We're looking at it and our intention is so long as the capital market stays strong, which they appear to be relatively speaking right now, that we want to pursue that. We've said that from the beginning that we continue to have that view. We are not committed to try to wait around to seek the bottom possible interest rate. We think that as a BB-rated company, we'll have access to the markets. We'll get a favorable interest rate, but normalizing balance sheet will improve the overall cost of capital and increase the return on equity. And so we will move when we think that the capital markets are favorable, but we don't try to pause it to the optimal state. And the question of a tender, we are constrained by 2 factors with respect to how we buy back or multiple factors. As 2 of them are under Australian law, we are precluded from buying back more than 10% of our shares on any rolling 12-month period, which would be limit us to approximately $2.6 million. In addition, Exxaro and Tronox signed an agreement in connection with the transaction in which Exxaro is limited to a 45% ownership limit. I think they have said it's their intention to creep up to that limit, and then we'll see what, if anything, happens after that. So we would not want to tender or have a buyback program that either exceeded Australia law or exceeded the them standstill limitations. Under Australian law, we are allowed to make -- or sorry, one of the other features of the Australian law as it applies to us now is that we're limited to making open market purchases. Under that law, however, we are allowed to go to the shareholders and ask for a vote to increase the amount of shares that we buy back and to alter the form of the buyback. That is to enable us to buy in forms other than open market purchases, which might include a tender offer. So that option is available to us and we are aware of that and we're considering completely the bond deal where to happen and obviously, that would give us the financial ability to be more flexible in how we buy back. And then if I were to decide and then recover it and convene a shareholder meeting and seek authority to do so. If we decide any of those of those questions, obviously, we'll make that public when we decide it.

The next question comes from Caroline Learmonth with ABMA (sic) [ABSA] Capital.

It's kind of ABSA Capital. Three questions. First one, on zircon. Obviously, we're seeing a lot lower volumes than might have been anticipated. Can you just comment not necessarily about the rest of the year, but structurally where do you see zircon in the medium term, in the longer term? And should we be rethinking our longer-term view or do you still see over a medium term view volumes covering to a sustainable -- a reasonable, sustainable level? And secondly, tied in with that, you talked a bit about your segmental disclosure. Can you give us any indication under the revenue line or EBITDA line, zircon versus other products, how important is it for you on a sustainable basis as a percentage of the whole? And then just finally can you remind us on where you are on special dividends?

Okay. With respect to zircon, I think we issued a statement a couple of weeks ago in which we basically agreed with our [indiscernible] characterization that zircon sales were down between 25% and 50% from their original 2012 expectations. And my view is that we're at the higher end of that range in terms of zircon sales against expectations through the first half of the year. Longer term, I think that the prospects for zircon remain very heavily dependent on China in particular and Asia Pacific generally, housing and construction -- building construction. Zircon's largest application in the world is as an element of tiles. Tiles are largely used in the Asia Pacific architecture and housing construction. And so when the Chinese government seeks to stop the growth of new housing construction, then obviously it's going to have an impact on not only the paint that goes on the walls in those new buildings but on the zircon that goes in the tiles in those circles. As we remain confident in the long-term prospects for titanium dioxide pigment because we think that it generally tracks GDP growth, we also remain confident in the long-term prospects for zircon. With respect to the share, zircon, I think we have disclosed zircon as contributing approximately 16% of the pro forma combined EBITDA of the company. I'll stand at the end of what we intend to do with respect to any anymore specific disclosure. But I can tell you that I recall that we have disclosed about 16% of EBITDA. With respect to special dividends, what we have said was that when we were first introduced this subject publicly, the stock was at a much different price than it is now. We said that we intended to normalize the balance sheet because we think that has corporate finance advantages, and the use of proceeds would be largely [indiscernible] to the shareholders, and at that point that predominant use of these proceeds in the form of a special dividend made more sense to us. As the share prices has become more volatile and has declined, we have said that we intend to go out first and buy back shares that will still -- even if we buy back the 3 million shares, let's say, just to pick a number, that still needs a substantial amount of proceeds from the bond offering available. And at that point, we would then think about a special dividend.

Okay. Sorry, can I just check? It was 16% of EBITDA, 1-6, for zircon?

That was 1-6.

Yes. That was pro forma of 2011.

On a pro forma consolidated basis, right, for last year.

Our next question comes from Charlie Rose with Cruiser Capital.

There seems to be -- last night there was a call from Asia from a marketing consultant in the pigment and mining industry. And they went through 3 issues that are negatively affecting the business that are temporary, but they talked about them, obviously, the destocking process, the issues of some substitutability of chloride-based pigments, which you have talked about both. And then the more interesting discussion was the Chinese and they're selling excess material outside their home market. They talked about, about 550,000 metric tons being sold outside their Chinese economy. And I wanted to get your thoughts on where the Chinese are. He actually brought up the issue that the Chinese government has a law on their books that they have to have a certain amount of chloride capacity in place over the next few years and that the Chinese would essentially have to restructure their business. So I'd like to get some temperature from you as to what you think about the Chinese currently, where you think the Chinese are going and what effects it would have on pricing and on utilization rates in the industry.

Okay. We obviously have soft [ph] answer the relative percentages of these various causes. And I have spoken about destocking and thrifting or substitution, as well as aggregate demand. And I think the current situation is the result of the product of some of all of those factors. I think there is a macroeconomic decline in the demand for coatings and also for plastics. And I think actually the data that we have indicates exactly decline in demand so that the macro level for plastics is greater than the decline for paint and coatings. And I think also that the decline within those industries is disproportionately felt by some of the smaller companies, or the smaller and medium companies in the world. We also have looked at these factors that Charlie mentioned. So in addition to coatings, so the aggregate demand being down, there has been some Chinese capture, particularly on the sulfate market. And that happens for the reasons that the consultant mentioned, I think he mentioned. That is China over -- in recent times, China produced about 1.5 million tons of pigment, almost all of which was sulfate and the 8% of which -- 99% of which is sulfate. And the domestic consumption was about 1.5 million tons. And during those years, about 250,000 tons of Chinese-produced pigment came out of the market and about 250,000 tons went into the market. So it was relatively self-sufficient market in that sense. As Chinese consumption declined because of these governmental policies to break -- for the break on the economy generally and housing specifically, we don't think the Chinese production will decline commensurably with the Chinese consumption. So that supply then went out into the market and caused an excess of supply first in Asia-Pac, which is largely a sulfate-consuming market, secondarily in Europe, which is not quite as -- not quite as much of a consumer of sulfate product as Asia but much more so than the United States, and less so in the United States. So the numbers there are not huge, we don't think. Thrifting at some and destocking are the major portions. In the thrifting category, we think that there has been some blending of sulfate-processed pigment into the formulations of the paint companies. And we think also that they have reduced the amount of TiO2 in some of their quality brands. The public statements by those -- by the executives of those companies is that they have done so, but that there's a limit of the amount -- sort of the aggregate amount of TiO2 that they can reduce in their formulations without unacceptably affecting quality of the products that they sell, which they're not prepared to do. And that sort of aggregate level, just from listening to what they're saying, appears to be somewhere in the mid-single digits, so 5% or 6%.

So addendum. Just a follow-up on a different subject. If there was an ability for your agreement with Exxaro to be altered with respect to either the 45% threshold or the issues relating to Exxaro participating in some type of tender offer for shares by the company, how much stock would you have an appetite to buy if that nirvana situation evolved? And directing the cash flow -- I'm sorry, directing the bond offering towards the stock more than directing it in a more -- to a manner and partially the stock and partially towards special dividend distributions, what type of appetite could the company have to buy back its own stock? Would it be 5 million shares, 6 million shares, 7 million shares or would it still be only at the 2-million-share level?

I think, Charlie, that depends entirely on the price of the shares and our view of the value of the shares at any given time. So I can't -- I wouldn't tell you a specific number now that would be applicable to all fronts. But I would say that we believe in -- the one thing actually, let me add in one additional factor. Exxaro has said that they intend to be buyers themselves. And we have had a very preliminary conversation with them some months ago about can they enter proportionally into a tender offer [ph] the aggregate shares over the standstill limited 45%. I think they're open to that. There's nothing to share with you. But they're open to that. But I also recognize that a cash sale by them would involve a taxable realization event and, therefore, that there are some costs to them of participating in that transaction, so that will have to be addressed. But the more broad question of how much shares we have an appetite of to buy back is a function of where the share price is, where value is, how much capacity we have on the balance sheet, what we think we need to use the balance sheet for, given our foresight into the foreseeable future. So I can't give you a specific amount. But generally speaking, that amount, if it's a good use of shareholder resources and corporate resources, we can [ph] to look at.

Our next question comes from Michael Glover [ph] with Cormex.

I guess the question -- I have 2 questions. One, probably a quick one around the Fairbreeze extension. I looked in the Exxaro filings. They're talking about commissioning starting in 2015 now, in March of '15. And how does that change your view over the stockpiles and inventory? And are you prepared, I guess, to start using the other attrition material? I think, you needed to build a new plant for that, and where is that in CapEx and so forth? And then just around big picture supply demand, it seems like your guidance implies an operating rate mid-80% level. Is there any historical precedent for that, especially for that going on for what will look like 5 quarters, I guess, by the time we get out of the end of the year? Or is this really an unprecedented time period?

This is Dan Greenwell. Can you hear me? [Technical Difficulty]

Okay. I'll go back to your question. You talked about operating rates. I think you indicated that might be about the 80% or so. And has the industry in general operated at those rates? From our view of things over time, there's been short periods where they've operated at those rates but not for extensive periods. Can they operate at those rates? I'm sure they can. And it is something that I think when you look at the demand side of things, we're going to have to operate at whatever rates that demand requires. So that's not an uncomfortable position for us. Obviously, we'd like to be operating in the high 90s. But we've reconfigured some of our activities, and I think we can do it profitably without all the fixed cost overhang.

And I guess to the point, has that -- I guess 5 quarters of I'd say low 80s. I don't know exactly or whether you guys sort of report that way, but the math sort of gets you there. And has that ever happened? It just seems like this is a very long destocking. This is really what...

Yes, sure it's happened. I mean, you look at some -- back in 2008 and '09 with the financial crisis, we operated at low. It's an industry in general did as well. And then earlier, in earlier periods, they did as well. So I think the...

For 5 quarters?

Pardon me?

For 5 quarters at those levels?

Well, I don't know if you can say we're operating at 5 quarters at that level. We've had various levels of operations. We brought it down, as Tom indicated, in the -- towards the end of the fourth quarter of last year. We brought rates down. I don't want to say that they were in the 80s or -- we don't disclose our operating rates. But we pulled them back. We pulled them back a bit. And we're pulling them back a little bit more right now.

And then on Fairbreeze, is that the new target as March 15 has it up and running?

Well, there were 3 certain pieces of it that we're undertaking right now. I think we've got a long lead time. We've got one more permit we have to get. We can start some activities on it. The exact month and day, I don't think we're particularly worried about. It could be the end of 2014. It could be early 2015. You question with respect to do we have ilmenite to run that facility, absolutely, we do. We have a fairly large stockpile of ilmenite at KZN itself to operate that for, I guess, almost over a year, about 15 months' worth, about 15 months' worth. And then obviously, we've got material over at Namakwa as well, a part of it fully attritioned, a part of it unattritioned. The unattrition piece we're putting the plant together right now. That should be operational in the fourth quarter of this year to the first quarter of next year, somewhere around that timeframe. And to the extent that we need to supplement KZN's material for that Namakwa material, we'll bring it over from Namakwa, should we need to.

You've got a plan within your $90 million to $110 million of CapEx, maintenance CapEx?

Yes, that's actually a little special project. I don't know that I would call that normal maintenance CapEx. That I would, again, put in the other bucket. That's more of this project, a specific project, probably about $40 million for that.

Okay. So it's $40 million that we'll see in '12?

You should see most of it in '12, yes.

Our next question comes from Malone Ma [ph] with Simplon Partners.

This is Tom McKay standing in for Malone from Simplon Partners. In the meeting you held last week with shareholders, you said that you had excess inventory stockpile that was worth, I think, $750 million to $1 billion. And my question is how much of that excess inventory did you acquire in the Exxaro transaction? And how much did you already own before the transaction

Okay. There's a -- I wouldn't call it excess inventory. I would -- it's basically ilmenite. You have various sources of ilmenite. The stock was specifically on a joint venture in Australia. We've got roughly 500,000 tons of fully attritioned ilmenite stockpiled in Australia. And typically what folks do, mining companies do, is they build that up as you get towards the end of life, end of mine life so that you can utilize that as you move to a new section or you transition. So there's about 500,000 tons in that. As you recall, we owned 50% of the joint ventures. So say that we acquired 50% of that in the acquisition. With respect to Namakwa and KZN, there are -- their quantities there that tally up to something close to that as well, we acquired all of that. The large pile of unattritioned ilmenite we have over at Namakwa, roughly 3.5 million tons, used to be attritioned. And that's what -- the last participant asked a question on that. We intend to attrition that, start attritioning that either in the late fourth quarter or early fourth quarter of 2012 or early first quarter of 2013. And we will run that and continue to attrition it and make that available. With your questions, if all of that was attritioned today at market prices, you would have somewhere probably between $750 million and $1 billion. Clearly, it's going to take us a period of time to attrition that material. So you can't sell it on the open market today nor would that be our intention today to dump it on the ilmenite market. We think that's a strategic asset for us long term. We think a lot of folks would love to have that position. And clearly, it provides us with a good stockpile of ilmenite to feed either the smelters at Namakwa or move over to KZN as we're transitioning to Fairbreeze.

I see. Let me just ask it a different way. The cost of the acquisition, 10 million shares, let's say, $120 a share pre-split, that's $1.2 billion. How much of that was stockpiled inventory acquired in the acquisition?

Well, we haven't specifically disclosed of the purchase price. We allocated in aggregate inventory. We allocated a fair value to the inventory of roughly $622 million. That piece of the inventory -- the unattritioned pile, we did not allocate any value to that in the purchase accounting.

[Operator Instructions] [Technical Difficulty]

The one other thought I had was you've said that you're about 125% backward integrated now. What do you view is the ideal balance of raw material production and TiO2 production? Is it 100% or is 125% backward integrated the ideal balance?

This is Tom. We like being long mineral sands feedstock forms because it gives us the ability to take advantage of shifting strengths in that market, and at the same time supply ourselves with the either the most advantageous in terms of reducing processing costs or the otherwise weak relatively weaker or comparatively weaker feedstock, which we have a lot of flexibility. So we like that position. And we intend to move our consumption at Kunana and Hamilton and [indiscernible] from their historical levels to levels that more precisely do that, that we absorb the mineral sands production and we prioritize the mineral sands feedstock types that might not otherwise be as strong in the market, and we sell the feedstock type that is strong in the market. So having more of that would be to our benefit. One of the I think -- one of the unique attributes of Tronox is that we are 1 of the 2 major suppliers of synthetic rutile in the world, and we are 1 of the 2 major suppliers of slag in the world. And we're the only one who produces both. And so we can move our consumption around between the 2 entirely at our discretion, basically. And I think that's a huge advantage when one feedstock -- as I mentioned in my comments, it's the higher quality, higher cost feedstocks get a little softer in demand. But the lower-quality, lower-cost feedstock therefore remains strong as pigment producers shifts their consumption from one to the other, we can handle that very well. In fact, we can leverage it. So we like being long. We think there's going to be opportunities to make money right where we are. It also provides us the opportunity if we were ever to expand either through acquisitions or brownfield expansions. We can feed the expansion with our own feedstock and even increase the advantage that we have. So it gives us a lot of flexibility, we like that. When I dropped out, there was a question on Fairbreeze and I just wanted to say that we received the approval from the -- it's called NEMA, which I believe stands for the National Environmental Management Agency (sic) [Authority] on the waterline, which is one of the important approvals we need. There is still an approval on water use that has to come out and the modification from the DMR. The DMR has already given us the fundamental approval on the mine itself and the water used presumably will be also influenced by this approval received yesterday. So we're making progress on those governmental approvals, and we feel good about the prospects of being able to turn that mine in when we talked about. I had heard that we've always talked about sort of late 2014 for that mine going into commercial operation. I was at the Exxaro earnings release today, and I know Dan said I think March 2015. It's sort of he was being conservative and probably had a different set of full production assumptions. But our view is as Dan -- I heard Dan say that we're not all that concerned in terms of 1 month, 2 months, 3 months. It's going to be around that period of time, and we have the stockpiles necessary to feed the KZN smelters for far more than that period of time. And so it's not a big issue for us in terms of keeping our production at the rates that we anticipate and we desire.

Our next question comes from David Lerner with Omega Advisors.

Thanks for giving some guidance for the rest of the year. I'd appreciate if you guys could elaborate on how you're thinking about 2013 EBITDA and EPS relative to 2012. And what factors are going to drive the differences there in terms of prices, volumes, costs? And then secondly, what are cash flows from operations in the quarter?

I'll leave the CFO question to the CFO, and I'll drop the 2013 question on the ground that you can't possibly believe that I would give you guidance for 2013 on this call at this time. I will tell you, however, in order to make this point again that when we look at our future financial performance, we think that the ability to capture margin at both levels of the supply chain due to one perspective or the other perspective buy ore at essentially the cost of extraction and processing is going to be a very powerful leveraging -- have a very powerful leveraging impact in our EBITDA and cash flow. And so we expect great strength out of this transaction, and that's obviously why we did it. For the specifics of 2013, we'll talk about that closer to the end of the year. Dan, do you have a comment on the cash flow from operations question?

No, we -- David, what we haven't done is included the cash flow in this earnings release. We're in the final stages of making sure we have the classification between the categories correct. So we haven't disclosed it this week. You should see it in next week's 10-Q that we file. So I would say we're finalizing right now and making sure we get all the categories proper Between the acquired companies and ourselves. And so to give a number right now, I'm just not prepared to do that.

Our next question comes from Ed Mally with Imperial Capital.

Just going back to the guidance on 2012 that you talked about. You're assuming mid-single-digit price declines for pigments in the second half. What's the underlying volume assumption that is associated with that?

We said that we expected volumes to be relatively constant, flat across the second half of the year, which will imply, I think, we've disclosed in our release and in these comments earlier that volumes are down more than 20% in the first half from the peaks in 2011. So volumes are down 20%-ish -- and then the prices down the way we've described.

And I guess as we sit here a month into the third quarter, are the trends that you're seeing thus far in 3Q consistent with those assumptions?

It's fairly early days. I think it's too early to even comment on the quarter.

Okay. And just final thing related to this. Any assumptions on feedstock sales to third parties that are embedded in that guidance?

Very, very little in terms of uncontracted. We have some contracts already, and those we have taken into account. But there's very little sort of spec feedstock sales. Some, but not a majority of it, not a major portion of it.

How material is the contracted portion?

Well, a lot of this is to us, right. We're going to be buying essentially the vast majority of the feedstock production in the second half. There are some other contracts which, like many feedstock suppliers are under market and are the remnants of contracts entered into in '08, '09 and '10, that some of which will roll off at the end of this year, the balance of which for the mineral sands business rolloff next year. And so there's still some of those contracts.

So those contracts for sales are other than that you're using internally. Do you see pursuing that as a continuing line of business from what you inherited? Or do you see potentially phasing those out?

If you look at the balance of production and consumption, our -- we reported that aside from zircon and pig iron, the mineral sands business produces, I think, the number 723,000 tons a year of titanium dioxide feedstocks. We consume -- our 465,000 tons of pigment production would consume, about I think, 512 is the number thousand tons of production of feedstock. And so we'll be long 211,000 tons anyway. That's where we stand if we entirely self supplied on the feedstock -- our feedstock for our own mineral sands business. In general, in terms of our policy going forward, we will always be selling to third parties for some of our mineral sands production. The feature that will change in these contracts, however, is that regardless of the term duration, in terms of our willingness to supply and the customers willing to buy, the pricing structure of the old contracts involved a base price set at a time the contract was entered into and then caps and collars around annual price increases for the balance of the term. I don't think there'll be caps and collars in any future for contracts.

Our last question comes from Kieran Daly with Macquarie.

Kieran Daly here from Macquarie. I'm asking more so an Exxaro perspective. But we've been quite used to getting some good historical numbers on volumes, feedstock volumes, zircon, et cetera, from Exxaro. And I know you guys don't talk about volumes very much, don't give out those numbers. Any plans for that to change in the future and give us some idea of volumes in terms of the feedstock zircon or even pigments?

Kieran, I was happy with Exxaro's release this morning, and I noticed in their book that the data that you talked about. As we get the new company together, we're going to look at the form of our disclosures and the amount of information we give, the form in which we give it and all of that. So I would say, I can't commit that we're going to do what Exxaro used to do. But it's a question that we're trying to grapple with right now. We have moved from a single segment reporter in old Tronox to at least the 2 segments of minerals and pigments now, and we're going to be considering how we disclose going forward. So I would ask you to keep an open mind on that until you see what we do.

I'm not showing any other questions.

All right. Thank you very much for all -- for your interest. I appreciate it. Again, our view is that we had a relatively strong quarter and it affirmed very, very strongly the power of our ability to participate at both levels of this supply chain, in both softer conditions and in robust conditions, which is what we expect to come forward. So we're very optimistic and upbeat about our business. I'm in South Africa, as I mentioned, meeting with our mineral sands leadership team and some of their folks. Trevor Arran, who runs that organization, is here with me. And we're very positive about our path going forward. So I thank you for your interest and your support. And we look forward to talking to you next quarter.

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.