Oct 26, 2010
Executives
Joseph Rupp – President, Chairman and CEO John Fischer – VP and CFO John McIntosh – VP and President, Chlor Alkali Products Division
Analysts
Frank Mitsch – BB&T Capital Ed Yang – Oppenheimer Christopher Butler – Sidoti & Company Don Carson – Susquehanna Herb Hardt – Monness Eugene Fedotoff – Longbow Research Scott Blumenthal – Emerald Advisers Richard O’Reilly – Standard & Poor’s Jeff Gates – Gates Capital
Operator
Good day, ladies and gentlemen, and welcome to the third quarter Olin Corporation earnings conference call. My name is [Crystal], and I will be your operator for today.
At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session.
(Operator instructions). As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the conference over to your host for today, Mr. Joseph Rupp, Chairman, President, and CEO.
Please proceed.
Joseph Rupp
Good morning. And thank you for joining us today.
With me this morning are John Fischer, Senior Vice President and Chief Financial Officer; John McIntosh, Senior Vice President of Chemicals, and Larry Kromidas, our Assistant Treasurer and Director of Investor Relations. Last night, we announced that net income in the third quarter of 2010 was $31.8 million or $0.40 per diluted share, compared to $39.4 million or $0.50 per diluted share in the third quarter of 2009.
Chlor Alkali third quarter 2010 segment earnings of $44 million increased 69%, compared to the second quarter of 2010, and represented the fourth consecutive quarter of sequential earnings improvement. The improvement reflects increased product volumes compared to the second quarter of 2010.
The third quarter 2010 Chlor Alkali operating rate was 91%, which was the highest level since the third quarter of 2007 and higher than both the second quarter 2010 rate of 83% and the third quarter 2009 rate of 74%. The third quarter 2010 Chlor Alkali results included a record level of bleach sales, which were 21% higher than the third quarter of 2009.
Winchester’s third quarter earnings of $18.8 million are lower than the record earnings of $23 million achieved in the third quarter of 2009. The decline reflects the combination of lower commercial volumes and higher commodity costs.
Third quarter 2010 charges for environmental investigatory and remedial activities after giving consideration to recoveries of costs incurred and expensed in prior periods were $8.6 million, an increase of $3.1 million compared to the third quarter of 2009. Third quarter 2010 earnings included $200,000 of pre-tax recoveries of environmental costs incurred and expensed in prior periods.
Now, that’s compared to $44.3 million of recoveries in the third quarter of 2009. Third quarter 2010 results also include approximately $7 million of favorable income tax adjustments.
Fourth quarter 2010 net income is forecast to be in the breakeven to $0.05 per diluted share range. Chlor Alkali expects to see improved pricing in the fourth quarter reflecting the positive impact of several recent price increase announcements.
However, fourth quarter 2010 Chlor Alkali segment earnings are expected to decline compared to the third quarter of 2010, as weaker seasonal demand is expected to more than offset the improved pricing, but are expected to be significantly higher than the fourth quarter of 2009 segment earnings. Fourth quarter forecasted Chlor Alkali earnings also reflect the cost associated with planned outages at four manufacturing plants, Olin manufacturing plants.
Earnings in the Winchester segment are expected to be in the breakeven range, reflecting typical weak fourth quarter demand. Charges to income for environmental and remedial activities in the fourth quarter of 2010 are expected to decline compared to the third quarter of 2010.
Fourth quarter earnings were also expected to include approximately $2 million of pre-tax recoveries of environmental costs incurred and expensed in prior periods. Now let me discuss Chlor Alkali and Winchester segments in more detail.
First, Chlor Alkali. During the third quarter of 2010, the operating rate for Chlor Alkali business was 91%, which is the higher rate we’ve experienced since the third quarter of 2007.
The improvement in the operating rate in the second quarter was driven by the bleach business. Bleach volumes, which increased 26% compared to the second quarter of 2010, and 21% from the third quarter of 2009, were a quarterly record.
During the quarter, approximately 43,000 tons of chlorine or 10% of our available capacity was sold as bleach. The higher operating rate also reflects a slight improvement demand for chlorine and an improvement in demand for hydrochloric acid.
Third quarter chlorine demand in our system was negatively impacted by a full 90-day average at a major customer. We expect a 30-day outage from this customer in the fourth quarter and a two-week outage for another major chlorine customer in the fourth quarter as well.
Hydrochloric acid volumes increased 5% from the second quarter and 32% from the third quarter 2009 levels. Hydrochloric acid sales represented approximately 8% of our available third quarter 2010 capacity.
During the third quarter of 2010, there was one seven-day outage at one of our Chlor Alkali facilities. During the fourth quarter, there are planned outages at four of our manufacturing locations.
We expect these fourth quarter outages to negatively impact Chlor Alkali earnings for the quarter to the tune of $4 million to $6 million. We also experienced a significant increase in the sales of potassium hydroxide in the third quarter of 2010.
Sales of potassium hydroxide increased 25% compared to the third quarter of 2009, and during the third quarter of 2010, the combination of potassium hydroxide, bleach, and hydrochloric acid accounted for approximately 25% of the Chlor Alkali division sales. Our ECU netback in the third quarter of 2010 was approximately $465, which is a 1% decrease from the second quarter of 2010 and reflects the combination of a slightly lower chlorine price, higher freight cost per ECU and an improved caustic soda price.
The increase in freight cost per ECU was higher than we had anticipated and reflects the combination of lower pipeline sales of chlorine due to outage at a major customer for the entire quarter and continued rail rate increases. Caustic soda prices increased significantly during the third quarter and we anticipate this trend to continue throughout the fourth quarter of 2010 and into the first quarter of 2011.
We expect our fourth quarter of 2010 ECU netback to reflect some benefit of August caustic soda price increases totaling $85 per ton, with the balance being carried over into the first quarter of 2011. We also expect that the benefit from the September $50 per ton caustic soda price increase will be realized in the first quarter of 2011.
Finally, after the first of the year, we should also realize additional improved pricing resulting from the caustic soda contracts in our portfolio that are re-priced on an annual basis. As a reminder, the realization of price increases in our system can lag the market by as much as six months.
As a result, on a sequential basis, we expect the absolute dollar improvement in our ECU netbacks to be greater from the fourth quarter of 2010 to the first quarter of 2011 and from this year’s third quarter to fourth quarter. Electricity costs in the third quarter of 2010 were approximately 6% higher than both the second quarter of 2010 and the third quarter of 2009.
This reflects the combination of the significantly higher operating rate that we experienced in the third quarter of 2010 and the higher seasonal electric rates that we typically experience in the third quarter, especially in our southeastern plants. We do expect electricity cost per ECU produced to decline in the fourth quarter of 2010 compared to the third quarter.
I mentioned earlier that third quarter freight cost per ECU were higher than we had expected. These costs which we expect to decline in the fourth quarter were 4% higher than the third quarter of 2009 levels and 13% higher than what we experienced in the second quarter of 2010.
Freight cost per ECU in our system have doubled since 2006 and have averaged in excess of $100 per ECU since the beginning of 2008. Freight costs are and will continue to be a significant challenge facing the business.
One of our strategies to address rising freight cost is to increase the percentage of our chlorine that is either shipped by a pipeline or barge and to increase the percentage that are shipped in downstream products. Growth in our bleach business is a component of our freight avoidance strategy.
But its biggest contribution is in the value it adds above what the sales of chlorine and caustic individually creates. During the third quarter of 2010, the premium realized bleach sales exceeded the chlorine and caustic soda netback in excess of $200 per ton.
Since the fourth quarter of 2007, we have experienced on a year-over-year basis, eight consecutive quarters of volume growth in bleach shipments at a rate in excess of 10%. Third quarter 2010 bleach sales by volume when compared to the third quarter of 2008 bleach sales by volume have increased 47% and the three-year compounded growth rate has been 45%.
We continue to see bleach as a value-added growth opportunity for Olin. In the prior quarters, we have discussed a low-salt, high-strength bleach investment at our McIntosh, Alabama facility.
This project which has an estimated cost of between $17 million and $20 million is expected to be completed by the third quarter of 2011. We are also evaluating two additional low-salt, high-strength bleach investments.
We’d expect subsequent low-salt, high-strength bleach investments to be less expensive than the McIntosh project. We also continue to increase our fleet of railcars that are dedicated to the shipment of bleach.
And as I said earlier, during the third quarter, 11% of our Chlor Alkali production capacity was utilized in the manufacture of bleach. Over the next two to three years, it’s our objective to have during peak seasonal periods 20% of our ECU capacity utilized making bleach.
We continue to investigate additional opportunities to expand our bleach business. Over the past several quarters, we’ve discussed legislation that has been introduced in both the United States center (inaudible) has representatives which if enacted would ban the production of chlor alkali products using mercury-cell technology two years from the date the bill are acted into law.
Over the past 90 days, we have not seen any new developments regarding the legislation. At this point, we believe the bill will not be addressed in a lame duck session, it will need to be re-introduced in the next Congress.
We also believe there will be an attempt to eliminate the production of chlor alkali products using mercury-cell technology by the issuance of rules by the Environmental Protection Agency. Either way Olin believes there is a reasonable likelihood that mercury-cell technology used in the production of Chlor Alkali products will be phased out at some point in the future.
And as a reminder, Olin currently operates two mercury-cell plants with a combined capacity of 350 tones or 18% of our total capacity. Our decision to convert or shutdown these facilities is a function of each facility’s individual attributes which includes their customer base, their sustainability and the proximity of customers, the cost inputs at the facility and the co-products at facility manufacturers such as potassium hydroxide, bleach and hydrochloric acid.
We expect to begin making decisions regarding our mercury-cell facilities no later than the first quarter of next year. During the third quarter of 2010 – let me talk about Winchester.
During the third quarter of 2010, the Winchester business started to experience a slowdown in demand, the surge levels that began in the fourth quarter of 2008. Third quarter 2010 sales of $157.5 million were 6.4% lower than third quarter of 2009 as commercial volumes declined approximately 6%.
Winchester also experienced a 61% decrease in its end of the quarter commercial backlog compared to a year ago and has now seen its commercial backlog decline for five consecutive months. The third quarter decline in commercial sales was partially offset by military, law enforcement and industrial sales, which increased 3% in the third quarter of 2010 compared to the third quarter of 2009 and these sales have increased 10% during the first nine months of 2010 compared to the first nine months of 2009.
The military and law enforcement backlog has remained strong and was 4% higher at the end of the third quarter of 2010 than it was at the end of the third quarter of 2009. Because of the strength and the growth of military and law enforcement business we believe that the overall financial performance of the Winchester business, once the surge in commercial sales is finished, will exceed the financial performance that was experienced prior to the start of the surge.
Winchester earned $18.8 million in the third quarter of 2010 compared to the record $23 million earned in the third quarter of 2009. In spite of the year-over-year decline, the third quarter of 2010 earnings represents the second best third quarter ever for Winchester.
And as a point of comparison, Winchester earnings in the third quarter of 2008 and 2007 were approximately $10 million each. The third quarter 2010 year-over-year decline in Winchester earnings reflects the combination of the lower level of commercial sales, higher commodity and other material costs partially offset by improved pricing.
On a year-over-year basis, Winchester’s acquired cost of commodity metals increased across the board. The price of copper increased approximately 4%.
The price of zinc increased approximately 30% and the price of lead increased approximately 14%. And as a reminder, Winchester utilizes approximately three times as much lead as we do copper and approximately three times as much copper as we do zinc.
So lead and copper has a big impact on our commodity costs. As we look forward in the Winchester business, we expect that the cost of commodity metals especially copper which has increased approximately 25% over the last 90 days would be a challenge.
Finally in the early August, Winchester announced that it was evaluating the possibility of relocating approximately 1000 jobs from its East Alton Illinois location to Oxford, Mississippi location. Under the terms of our East Alton labor contract, we’ve entered into decisional bargaining with our unions.
We expect that process to conclude in near future. As we look forward to the fourth quarter of 2010 and into 2011, I continue to believe that both our Chlor Alkali and Winchester businesses as well as the entire company are well positioned.
The Chlor Alkali business has positive pricing momentum, is continuing to realize growing benefits for bleach, potassium hydroxide and hydrochloric initiatives and investments. Our Chlor Alkali business will complete 2010 having been solidly profitable and is now going through the trough period of the cycle without losing money in any quarter.
This is a significant improvement from my experience in prior troughs in 1999 and 2002. 2010 for Winchester will be the second most profitable year in its history.
It has proven to be a solid complementary business to Chlor Alkali. Finally we have a strong balance sheet that provides us with the resources to pursue investments and the (inaudible) and opportunities that will enhance value.
Now I’d like to turn the call over to chief financial officer John Fischer who will review several financial matters with you.
John Fischer
Thank you Joe. First I’d like to discuss a few items on the income statement.
Selling and administration expense increased $2.1 million or 7% in the third quarter of 2010 compared to the third quarter of 2009. The increase was primarily due to the inclusion in the third quarter of 2009 of a $4.6 million favorable impact from the resolution of the Canadian Capital Tax matter.
This increase was partially offset by a decrease of $2.2 million in mark-to-market adjustments associated with stock-based compensation. Third quarter 2010 charges to income for environmental investigatory and remedial activities were $8.4 million, which includes the $200,000 of recoveries from third parties for environmental cost incurred in expense in prior periods that Joe mentioned earlier.
These expenses were approximately $3 million greater than we had forecast and reflect an acceleration of expense from the fourth quarter. During the third quarter of 2009, there were $38.8 million of credits related to environmental investigatory and remedial activities, which includes $44.3 million of recoveries of environmental costs incurred and expensed in prior periods.
After giving consideration to the recoveries in both the periods, year-over-year charges related to environmental, remedial and investigatory activities increased $3.1 million. For the full year 2010, we expect charges for environmental and remedial activities after giving consideration to recoveries, to be in the $20 million range, which is less than the 2009 charges of $24.1 million.
During the fourth quarter of 2010 we expect to realize approximately $2 million of additional recoveries of environmental costs incurred and expensed in prior periods. Over the longer term, we believe the opportunity exists for $15 million to $20 million of additional recoveries to be realized.
The timing of any additional recoveries is uncertain. On a total company basis, defined benefit pension plan income was $5.3 million in the third quarter of 2010 compared to $4.4 million of income in the third quarter of 2009.
We’re not required to make any cash contributions to our domestic defined benefit pension plan in 2010 and believe the earliest we may be required to make any cash contributions to that plan is 2012. As a reminder, we do have a small Canadian defined benefit pension plan to which we have made approximately $7 million of voluntary contributions in 2010.
Defined contribution pension expense was $3.3 million in the third quarter of 2010 compared to $3 million in the third quarter of 2009. As a reminder, our defined benefit pension plan is frozen to new entrants, all salaried, all non-union hourly and most union employees.
As a result, the majority of our active employees participate in the defined contribution pension plan. Included in our third quarter 2010 results was approximately $7 million of favorable adjustments associated with the expiration of statutes of limitation and the finalization of our 2009 federal and state income tax returns.
The tax rate during the third quarter of 2010, after giving consideration to the approximately $7 million of favorable adjustments, was 36.9%. The fourth quarter 2010 forecast includes an approximately $1 million reduction in tax expense associated with the reduction of evaluation allowance recorded against a foreign tax credit carry forward generated by our Canadian operations.
Now turning to the balance sheet; during the third quarter of 2010 we redeemed $18.9 million in industrial revenue bonds with maturities in 2016. The third quarter results include an early redemption premium of approximately $400,000 which was offset in part by the recognition of an approximately $300,000 gain on interest rates swaps applicable to these bonds.
Early in the fourth quarter of 2010, an additional $1.8 million of industrial revenue bonds with maturities in 2016 were also redeemed. The favorable impact of these redemptions on annual interest expense will be approximately $1.3 million.
Earlier this month, we completed a tax exempt variable rate bond financing totaling $70 million, which matures in 2024. We have options to borrow up to the entire $70 million in a series of draws through the end of 2011.
During October, $15 million was drawn. The proceeds from these bonds are required to be used to fund various capital projects at our McIntosh, Alabama facility.
Earlier Joe mentioned one of these projects to $17 million to $20 million investment in a low-salt, high-strength bleach facility which will be financed by these bonds. Cash and cash equivalents at September 30, 2010 were $393.4 million, compared to $388.4 million at June 30th, 2010 and a $376.6 million at September 30th, 2009.
During the first nine months of 2010, working capital increased approximately $64 million. In the chlor-alkali business, the increase in working capital reflects the increased sales volumes and improved pricing that were experienced in the third quarter.
While in the Winchester business, the increase in working capital reflects the normal seasonal increase in accounts receivable, increased inventories due to higher commodity costs and replenishment of inventories to pre surge levels. We expect working capital in both businesses to decline in the fourth quarter.
Based on our third quarter cash balance, the expected liquidation of working capital in the fourth quarter and the recent financing activities, we now believe that Olin will finish 2010 with a cash balance in the $450 million to $475 million range. Capital spending during the third quarter of 2010 was $21.7 million compared to $34.7 million in the third quarter of 2009.
For the first nine months of 2010, capital spending has been $53.4 million compared to $122.3 million during the first nine months of 2009. The year-over-year decline in capital spending reflects the completion of St.
Gabriel, Louisiana conversion and expansion project which was ongoing during 2009. Full year 2010 capital spending continues to be forecasted in the $70 million to $80 million range and 2010 depreciation expenses forecasted to be in the $85 million to $90 million range.
2011 capital spending is highly dependent on decisions regarding our plans using mercury cell technology. On October 21st, 2010 Olin’s Board of Directors declared a dividend of $0.20 on each share of Olin common stock.
The dividend is payable on December 10th, 2010 to shareholders of record at the close of business on November 10th, 2010. This is the 336th consecutive quarterly dividend to be paid by the company.
Before we conclude, let me remind you that throughout this presentation, we have made statements regarding our estimates of future performance. Clearly, these are forward-looking statements and results could differ materially from those projected.
Some of the factors that could cause the actual results to differ are described, without limitations, in our Risk Factor section of our most recent Form 10-K and in our second – third quarter earnings release. A copy of today’s transcript will be available on our website in the Investor section, under Calendar of Events.
The earnings press release and other financial data and information are available under Press Releases. And operator, we are now ready to take questions.
Operator
(Operator Instructions) Our first question comes from the line of Frank Mitsch with BB&T Capital. Please proceed.
Frank Mitsch – BB&T Capital
Good morning gentlemen.
Joseph Rupp
Good morning.
Frank Mitsch – BB&T Capital
Joe, you started out by saying that you’ve had your highest operating rates in chlor-alkali in three years and obviously there has been significant price momentum on the caustic side yet sequentially your ECU netbacks ticked down and I was just trying to reconcile that, I know that your freight cost went up and, was there consideration given the strength of the industry, given the tightness on the caustic side of freight surcharges to try and offset that, I mean obviously your freight situation is different from other folks in the industry who might be a bit more pipeline base and more concentrated and you guys have plants all over the place but can you talk a little bit about trying to offset those added cost in what appears to be tight market?
Joseph Rupp
We have been attempting Frank over the past couple of years to try to get surcharges into our freight with some success. I think the biggest issue here for us in this quarter was the fact that one is that the rail costs have gone up more than what we had anticipated and we have a major outage with a customers of pipeline customer which really changed our mix dramatically and got us from a cost perspective higher than what we had anticipated.
We did as you know have as I think I stated in the comments, we did reflect higher caustic soda prices and slightly – little bit slightly lower chlorine prices. So it was really the freight surprise and a little bit of down on the chlorine and the loss of this customer for us long period of time that affected the quarter.
Frank Mitsch – BB&T Capital
Any thoughts on what that – you mentioned that it was 90 days on the chlorine the pipeline of customer, and it’s going to be another 30 for the fourth quarter and then you said another customer two weeks. Can you quantify what that negative impact was in Q3 and what you would anticipate the negative impact in Q4 would be given that situation?
John Fischer
Frank it was enough that if the customer had not had an outage, we’re reporting a sequential improvement in netbacks.
Frank Mitsch – BB&T Capital
All right, it was enough to bring your netbacks lower. And as you look at the – well you are looking for a higher netback in Q4, but it’s just the volumes are going to be – volumes will be off sequentially?
Joseph Rupp
Yes, once we’ve got, as we got major customers take a major outages in Q4 and in addition to that as we pointed out, were taken outages as well. So those are big hits to us in the fourth quarter.
Frank Mitsch – BB&T Capital
And then you’re resetting some contracts, annual contracts in the first quarter of 2011. Is that correct?
Joseph Rupp
We are.
John Fischer
About 20% of our contracts will reset.
Frank Mitsch – BB&T Capital
All right, and that’s going to be obviously materially higher than what you went through 2010. And Joe, I was just – I was struck by the assertion that you guys want to make a decision on your mercury cell plants in the first quarter.
It seems to me that the quote, unquote gun to the head (ph) from Congress trying to push a bill through last year and then having it through nothing this year and as you said we’ll have a new Congress at the beginning of next year. It would appear that that trigger has been pushed down as you know, I mean Europe there doesn’t appear to be anything – anywhere near-term coming out of Europe.
What’s behind some of the thinking on making a decision that soon when apparently you don’t need to for a few years I guess.
Joseph Rupp
Well one of the points Frank is we’re going to start, we already are feeling pressure from the – on the regulatory side has happened on many other things. There is a tremendous pressure from the EPA which will be impactful for us and our thinking is that we need to clarify what we’re going to do if there is going to be any conversion we need some lead time to be able to do that.
So what we do is we need to make that decision.
Frank Mitsch – BB&T Capital
All right, all right. Thank you so much.
Joseph Rupp
Thank you.
Operator
Our next question comes from the line of Ed Yang with Oppenheimer. Please proceed.
Ed Yang – Oppenheimer
Hi good morning.
Joseph Rupp
Good morning.
Ed Yang – Oppenheimer
A couple of issues to go through but I think the most important focus seems to be on pricing and maybe pricing going forward. You mentioned that can you see some benefit, you see the biggest benefit from some of the announced industry price increases in the first quarter of next year and the biggest increase sequentially from the fourth quarter to the first quarter.
If you add in the all of the benefit from the $85 a ton price increases from August and the $50 a ton increase later for the first quarter and assume that your pipelines are offering normal, the mix is normal and you don’t see another step-up in freight cost. What will your ECU netback be by the first quarter of ‘011?
I know there is a lot of numbers of math there but.
Joseph Rupp
You always make such good questions.
Joseph Rupp
It will be higher. Normally we don’t forecast out in the first quarter there Ed, but what we would say is that what has happened a little bit is that some of the pricing that has reflected itself in our indices really didn’t start to take into the indices until the later part of this year in the like right now to the end of the fourth quarter – in the fourth quarter.
And that will have an impact on our pricing in the first quarter to a much greater degree than what we had originally thought.
Ed Yang – Oppenheimer
So your third quarter ECU netback of $465 doesn’t really include much of a benefit from the $85 increases in August and the $50 that’s on the table now?
John Fischer
Ed, this is John. It doesn’t really include any impact for that.
When you think about our pricing system we have to continue to focus on the fact that we lag and we lag sometimes up to six months. So the price increases announced in the third quarter which in total reflect a $135.
We will see how much of that gets reflected in industry price indexes in the fourth quarter. So we’ll wait through the fourth quarter to see what gets reflected, and then and only then in the first quarter of next year, we’ll be able to apply those reflected numbers into our portfolio of customers.
So that lag component is very important to remember when you’re trying to forecast our pricing and we’ve consistently said and empirically demonstrate that we lag prices going up, and likewise when prices are coming down, we lag prices coming down as well.
Ed Yang – Oppenheimer
And, John, the simple math would be then this $465 ECU netback that you had for the third quarter, if you’re adding a $135, that gives you a $600 ECU netback, I mean that’s 29% higher from what you’ve reported in the third quarter. How much of that would be, if you do get it after the lag, how much of that would be margin accretive, and would there be any sort of incremental costs associated with that?
John Fischer
Well, I think you have to recognize that price increases are never a 100% realized. So there is always a discount from what gets announced to what gets reflected in the indexes.
And for us at the operating rates that we’re running, there is an awful – there is a significant opportunity for that to add significantly to our margins.
Ed Yang – Oppenheimer
Okay, fair enough. And one positive surprise in the third quarter was your capacity utilization rate was quite high and the volumes were much stronger than expected.
I’m surprised that that was the case given the outage that you had on the chlorine side. If that customer had not been out, what would your utilization rates have been in the quarter?
John Fischer
Would have been another couple percent, 2% to 3% higher.
Ed Yang – Oppenheimer
Okay. And I know if you’ve mentioned this.
But in the past, you had given utilization rate in ECU netback items for the quarter out. Given all the puts and takes, I mean what is your expectation for utilization rates for the fourth quarter and ECU netback?
Joseph Rupp
Well, we’ve never given a specific netback number going forward, Ed. I would say that with the outages we talked about on the customer side and our side, we’re looking at mid-to-high 70% range for an operating rate.
John Fischer
An increasing price.
Joseph Rupp
An increasing price, yes.
Ed Yang – Oppenheimer
Okay. And just on the higher rail rates again, you mentioned that it was up 13% sequentially.
I mean that’s a pretty sizeable step up. Do you expect – is that more of a one time, well not a one time, is it a one-time step up or do you expect another increase sequentially from those – from that higher rail rate?
John Fischer
We would expect that we will not see a rate quarter-to-quarter increase of that magnitude, it gets going from Q3 to Q4. We actually said I think in the remarks, we expected freight cost to go down.
Ed Yang – Oppenheimer
Is that a function of mix?
Joseph Rupp
Yes.
John Fischer
It’s a function of mix, yes.
Ed Yang – Oppenheimer
Okay, all right, thank you very much.
Operator
Our next question comes from the line of Christopher Butler with Sidoti & Company. Please proceed.
Christopher Butler – Sidoti & Company
Hi, good morning, guys.
Joseph Rupp
Good morning.
Christopher Butler – Sidoti & Company
I wanted to go into a little bit more detail on the maintenance outages. I’m sure you said $4 million to $6 million is the expected impact for the fourth quarter.
Is that correct?
Joseph Rupp
That is correct.
Christopher Butler – Sidoti & Company
Is that pretax or after-tax?
John McIntosh
Pretax.
Christopher Butler – Sidoti & Company
All right, just wanted to be sure. Now does that include the anticipated 30 days from the outage from your customer and the 14 from the second customer or is that two distinct things?
Joseph Rupp
Two distinct things.
Christopher Butler – Sidoti & Company
And if we’re looking at the first 30-day customer, that’s a pipeline customer. The second customer, is that a pipeline customer as well?
Joseph Rupp
No.
Christopher Butler – Sidoti & Company
As far as where you stand on maintenance, how much of this decision was based on the fact that you were going to have customers that were out versus trying to get ahead of maintenance before next year. Could you just walk us through the thought process on maintenance?
It seems to me that there was – you did some of this last year and you did some in the second quarter, and aren’t these normally 18 month cycles?
Joseph Rupp
We have – we have outage cycles at our plants that vary from location to locations. Some of our newer facilities have extended outage periods in the 12 months to 18 months durations between the outages.
But some of the older facilities just by nature of the equipment typically requires six months to 12 month kind of maintenance outages to take care of critical equipment. In terms of when we schedule outages, it’s a function of many things including demand, including time of year, including contractor availability.
But as a rule, we tend to schedule our outages in what we call the nonpeak quarters, the first quarter and the fourth quarter, and we tend to – we take into account things like weather, we obviously don’t schedule outages especially in northern plants in December, January, February, March. So when we factor all of that in and overlay that on our expected demands for product in a given quarter that gives us some flexibility and we’re taking advantage of that in the fourth quarter, because we do have some significant customer outages to do some outage work in preparation for 2010.
Christopher Butler – Sidoti & Company
And looking at your utilization for the third quarter, you had mentioned that bleach was a big part of that story. The seasonality for bleaches, isn’t that a little bit more skewed towards the second quarter?
Joseph Rupp
It’s really second and third quarter. A lot depends upon whether you’re talking about industrial bleach or a bleach for a household use – but – and depending upon which part of the country you’re talking about.
But we see our peak bleach seasons or peak bleach quarters as the second and third quarters. And this year we’re bringing on really significant new customers, almost on a quarterly basis.
So that’s been partially behind the drive, the growth in bleach volumes.
Christopher Butler – Sidoti & Company
I appreciate your time.
Joseph Rupp
Thank you.
Operator
Our next question comes from the line of Don Carson with Susquehanna. Please go ahead.
Don Carson – Susquehanna
Yes, thank you. Joe, a question on Winchester, so I guess with the backlog decline, with results down, is this – I forgot how many quarters it is, but I know last time you had a six quarter boom as you know kind of gun owners respond to a gun unfriendly administration in Congress.
So you think that’s over and particularly with the prospects of a change at least in control to House this fall?
Joseph Rupp
We do Don. The surge lasted really eight quarters, started two years ago in November, and we feel the surge is over as we speak.
We still feel the business tobacco [inaudible] good backlogs when we compare back to like 2008 pre-surge, so which was a reasonable business level for us. And so our outlook for Winchester is still very, very good outlook for Winchester, it’s just not a surged outlook.
Don Carson – Susquehanna
Right, okay. And just to go back to Chlor Alkali.
A couple of question on bleach, are you still able to get roughly a $100, $120 premium to the underlying ECU or do you have contracts on bleaches well that they prevent full realization of those ECU price increases?
Joseph Rupp
We still can get the premium on the bleach, Don.
John McIntosh
We said in the third quarter that the premium actually Don exceeded $200.
Don Carson – Susquehanna
Okay.
John McIntosh
For ECU.
Don Carson – Susquehanna
But, presumably, that’s because – but again that’s exceeding your realized ECU price right now not a benchmark and your ECUs are limited themselves.
John McIntosh
That’s in excess of our ECU netback for chlorine costing.
Joseph Rupp
That’s right.
Don Carson – Susquehanna
Okay. And then a question for John McIntosh, on the – that six-month lag, how much of it is due to contract priced gaps versus how much of it is just the speed of which the various trade publications actually reflect the list price increases in their indexes?
John McIntosh
Generally speaking Don, it’s – there is not any influence at all, that’s cap driven. What is at play is a what I mentioned earlier, it’s all a function of the timing between when a price increases is announced in the subsequent when if it’s going to be recognized in price indexes it gets recognized, and those events will have to occur before we can apply that increase into our indexed contracts.
Don Carson – Susquehanna
So the absolute price gaps are the caps on how much you can the increase the contract by the head several years ago you’re able to eliminate all those in the recent cyclical improvement in Chlor Alkali.
John McIntosh
Generally we don’t have an issue with those anymore. We have hundreds of contracts they’re all different, but for the most part, we don’t have an issue with the limitation on that caps that is consistent with the kind of issues we faced in our past cycles.
Don Carson – Susquehanna
Okay. And then one final question.
Of the price increases announced in the first half of the year, how much of those did you realize on the caustic side, so how much of that would still be yet to come?
Joseph Rupp
There were – there was roughly a $150 for prices announced in the fourth quarter of last year and the first quarter of this year. And then there was a $35 price increase that was announced in the second quarter of this year.
I would say for the most part, we’ve gotten all we’re going to get out of the fourth quarter and first quarter price increases, there is still potential opportunity for the price increase announced in the second quarter, but it was by far the smallest of all of them, it was only a $35 increase in the caustic pricing. The big opportunity for us is the $135 of price increases that were announced in the third quarter that will be reflected in one way, shape or form in the fourth quarter in pricing.
Don Carson – Susquehanna
And how much better is your netback on a pipeline sale versus your netback on a sale that has to be shipped by rail?
Joseph Rupp
Well, I will just say as a rule, pipeline netbacks for us, because of the freight related issues are a positive. And to the extent we can try to maximize that as an opportunity we did.
Don Carson – Susquehanna
Okay. And then finally just on power cost, I know about a quarter of your power is ultimately indexed to gases, is that higher now that with St.
Gabriel now and have you fully realized those lower gas cost for your utility suppliers?
Joseph Rupp
It’s not much different now Don with St. Gabriel on, we were using numbers that were forecasted.
And prior to the conversion at St. Gabriel, we still bottle electricity for the plant that we shut down, so that hasn’t changed much.
And for the most part, current natural gas prices are being reflected in our electricity cost.
Don Carson – Susquehanna
Okay. And then one final question, I know that about 18% of your Chlor Alkali capacity is mercury cell.
I think the industry is about 4% or 5%. John what do you think that if other people are doing the same thing as you are that clearly that’s going to tighten Chlor Alkali operating rates, so to what extent you think you get a pricing offset to the lower volumes it might have post such a move?
John McIntosh
Well, I think the bias around the mercury cell capacity will be that at the end of the day there will be capacity taken out associated with the conversion process. That’s the way it’s happened.
In Europe, I believe it will happen with the same bias here in the States. Whether or not some of that’s already being reflected in pricing, I really have no way of knowing.
I think there’s a lot of uncertainty over how much of the capacity will be ultimately shut down. And I think until that gets clarified further, it’s hard to answer the impact question.
Don Carson – Susquehanna
Okay, thank you.
Joseph Rupp
Thank you, Don.
Operator
Our next comes from the line of Herb Hardt with Monness. Please go ahead.
Herb Hardt – Monness
Good morning.
Joseph Rupp
Good morning.
Herb Hardt – Monness
A couple of questions. What is your operating rate right now?
John McIntosh
Right now we’re operating in the low 80% operating rates.
Herb Hardt – Monness
Okay. And is it fair to assume that margins on the bleach business are better than the corporate average?
John McIntosh
I think that’s –
Joseph Rupp
Yes.
John McIntosh
That goes out with the premium I think.
Herb Hardt – Monness
Yes. And finally, have you any indications from the PVC producers that things are firming at all?
John McIntosh
I think there is two parts to that – two answers to that question and they’re concurrent answers. We’ve not heard from anybody that domestic vinyl demand is improving in any way, shape or form.
What we are seeing is because of low energy prices in the Gulf Coast, North American vinyls’ producers have an opportunity to export derivatives from the Gulf Coast into other parts of the world and they’re taking advantage of that opportunity and so that piece of demand is much better. But domestic vinyl demand has not improved.
Herb Hardt – Monness
Okay, thank you.
Joseph Rupp
Thank you.
Operator
Our next question comes from the line of Eugene Fedotoff with Longbow Research. Please proceed.
Eugene Fedotoff – Longbow Research
Good morning, guys.
Joseph Rupp
Good morning.
Eugene Fedotoff – Longbow Research
Just to follow-up on the previous question, you mentioned that export demand for PVC is still strong, can you comment on outlook for chlorine prices kind of next couple of quarters, where will you think prices, they’ll continue to decline or stabilize or maybe there’s potential for price increases?
Joseph Rupp
I don’t – I really don’t see a scenario at least in the next quarter or two, because of the fact that we’re in the quarters where we typically see the lowest demand and we don’t see any indication of improvement in demand for vinyls where there is a scenario that would lead to a price increase. I think it’s going to be quite honestly the other way, operating rates are going to continue to be reduced and that’s going to continue to put pressure on the caustic supply side and pressure on caustic pricing, upward pressure on caustic pricing and potentially some downward pricing on the chlorine side, which is mitigated by some – in some way by the fact that they can’t export derivates overseas.
Eugene Fedotoff – Longbow Research
Okay, thank you. And how much have you expected a decline in Winchester earnings in the fourth quarter they’ll get you to raw material – higher raw material costs, and how much of that will get you to lower volumes effect?
Joseph Rupp
It’s mainly volume.
Eugene Fedotoff – Longbow Research
So there was no impact on the – from –
Joseph Rupp
There’s some impact, but what happens in the fourth quarter, this is really a seasonal business, where inventory is built and then sold in the second and third quarter, and then that really tapers off in the fourth quarter. And that’s the historical pattern that get offset in the surge, where we didn’t – we didn’t have quite that, but now we’re back to the historical pattern.
Eugene Fedotoff – Longbow Research
Can I talk about the pricing initiatives for Winchester products and when do you think the prices they’ll catch up to the high raw material costs?
Joseph Rupp
What happens with that is we did take pricing action, I think it was April of last year was when our prices, yes of ‘10, of 2010, and then we will take a look at our pricing for this year. Normally, pricing activity occurs in the fourth quarter, and producers begin to announce that in the fourth quarter.
We’re aware of one producer who is out there as we speak right now who has announced a price increase.
Eugene Fedotoff – Longbow Research
So do you expect higher prices in the next year?
Joseph Rupp
We really don’t forecast that, what we would look like to think is that the industry takes into the account the costs of the commodities. And from the 2000 – previous cycle as commodities went up, prices went up.
Eugene Fedotoff – Longbow Research
Okay. And how much – what kind of savings are you expecting to realize from moving that production facility for Winchester?
Joseph Rupp
We really haven’t publicized that, because we’re in a confidential decisional bargaining with our unions. What we have stated in the past is that the manufacturing costs down in Oxford, Mississippi are roughly 60% of what they’re in East Alton.
Eugene Fedotoff – Longbow Research
Okay. And just a last question on tax rate, what are your expectations for the quarter?
John Fischer
From an ongoing perspective, we would say that the tax rate excluding adjustments from out of period is somewhere in the 36% to 38% range.
Eugene Fedotoff – Longbow Research
Right, thank you.
Operator
Our next question comes from the line of Scott Blumenthal with Emerald Advisers. Please proceed.
Scott Blumenthal – Emerald Advisers
Good morning. Thanks for taking my question.
Joseph Rupp
Good morning.
Scott Blumenthal – Emerald Advisers
Joe, the outages that you’re planning on taking in the Chlor Alkali segment Q4, those are directly related to the fact that you’re going to be having a couple of significant customers that are taking their own outages or are those they’re completely independent decisions from what’s going on?
Joseph Rupp
They’re independent. We would have taken these outages and then we – basically we have two distinct activities going on, we’re taking an outages at four plants, and we’ve got two major customers are taking outages.
Scott Blumenthal – Emerald Advisers
Okay.
Joseph Rupp
We would have taken our outage anyway.
Scott Blumenthal – Emerald Advisers
And those plants are servicing those major customers I guess, a couple of the plants that are being taken down?
Joseph Rupp
I think one is.
John McIntosh
One is and one really is not connected with the normal supply channel.
Scott Blumenthal – Emerald Advisers
Okay. And how long – I guess on average I understand that this varies – but how long does an outage last and how much capacity gets taken down for the quarter?
John Fischer
Well it depends upon the duration of the outages, and which plants they occur at because different capacities that every one of our locations, I mean this quarter we have one plant with a seven day outage and smaller outages at other locations. So.
Joseph Rupp
But it can range from.
John Fischer
Yes.
Joseph Rupp
Three to four days as long as seven.
John Fischer
Seven to 10 days.
Joseph Rupp
Seven to 10 days. So it just varies.
Scott Blumenthal – Emerald Advisers
Okay, that’s helpful, thank you. And notwithstanding I guess maintenance needs in Q4, when you talk about how much demand seasonally tends to drop Q3 to Q4 independent of obviously what you’re going to be doing with maintenance, just speak to demand.
Joseph Rupp
Well again demand across all segments is not – all things are not created equal and coming off of a lows that we’ve come off with, come off from looking at your year versus your comparisons its little difficult to figure that out, I mean we know the segments that we have seen significant improvement in volumes but just in a general sense over a cycle there is a seasonality to several of the segments that we serve and that seasonality is off in the first and fourth quarters and then at volume is stronger in the second and third.
Scott Blumenthal – Emerald Advisers
So I think historically it’s not usual to see the capacity drop into the mid-70s in the fourth quarter, fair?
Joseph Rupp
Fair.
Scott Blumenthal – Emerald Advisers
Okay, that’s helpful. And can you tell us or could you share with us again if you have in the past what the percentage of the sales volume that you’re shipping at this point, you’re shipping via I guess carrier versus pipe and barge.
Joseph Rupp
I don’t think we have disclosed that. I don’t think we have disclosed that in the past.
Scott Blumenthal – Emerald Advisers
Okay, and I guess moving on to repricing, those are going to be – you’re going to be repricing, I think you mentioned 20% of the contracts, these are going to be both pipeline and freight customers and also I guess regular chlor-alkali bleach customers, a combination there up.
John Fischer
That 20% was really in reference to our portfolio of caustic customers because that’s the molecule that has the positive pricing momentum at this point in time.
Scott Blumenthal – Emerald Advisers
Okay, that’s really helpful. And I guess my last question is just talking back to what Don had asked previously about mercury cell, if I recall it you have – there are certain high quality products that require at this point mercury cell technology and I was wondering if you’re going to be able to continue to produce those if there is another technology.
What kind of impact that would have on the overall sales of those types of products and your relationship with those customers?
Joseph Rupp
There were historically a few customers that required a purity level that could only be met by caustic from the mercury cell plant. However over the years, as customers have become more sophisticated in their processes and as improvements have been made in membrane technology yielding a higher purity membrane caustic, there really isn’t a customer base now that has to have mercury cell produced caustic.
Everyone can – everyone that needs high purity caustic is able to substitute for membrane grade product.
Scott Blumenthal – Emerald Advisers
Okay, and I guess one more if I may. Have you been previewed to any of the discussions regarding the regulation and if it does, as we all expect that some point pass, has there been a discussion about any compensation for those operating mercury cell technology plants or you just expected to eat that and kind of shut it down?
Joseph Rupp
I think we’d be expected to eat it and shut it down. There has been a lot of discussion about the timing etcetera, working with (inaudible) and with our trade groups etcetera to try to delay this but ultimately the – if there is a decision the cost will be on our watch.
Scott Blumenthal – Emerald Advisers
Well that’s a heck of a job creation program from the government?
Joseph Rupp
I would agree.
Scott Blumenthal – Emerald Advisers
Thank you.
Joseph Rupp
Thank you.
Operator
Our next question comes from the line of Richard O’Reilly with Standard & Poor’s. Please go ahead.
Richard O’Reilly – Standard & Poor’s
Thank you. Good morning gentlemen, thanks.
Joseph Rupp
Good morning.
Richard O’Reilly – Standard & Poor’s
Did you give us the absolute backlog in Winchester for commercial and the military segments?
John Fischer
We did not, no.
Richard O’Reilly – Standard & Poor’s
Okay, dollar wise or percentage wise.
Joseph Rupp
No, I think what we have stated Richard, it’s now back to what we would consider a normal backlog pre surge.
Richard O’Reilly – Standard & Poor’s
Okay fine, great. And a follow-up question on the annual repricing discussions.
Are these normal contract changes in repricing or you’re negotiating the contracts to get better terms?
Joseph Rupp
These are just the narrow part of the methodology that is present in some of the contracts we have, that allows repricing, renegotiation.
Richard O’Reilly – Standard & Poor’s
Okay, my memory from a few years ago, it’s that the last upturn you were able to achieve some success in changing the terms of your contracts. Are you at that level now, do you think you are at that level now, you can try that again?
Joseph Rupp
Well obviously pricing – price of caustic as a commodity has gone up in the last 12 months and so it’s our intent to make our contracts represent market pricing to the extent we can.
Richard O’Reilly – Standard & Poor’s
Okay fine, okay thanks a lot then.
Joseph Rupp
Thank you.
Operator
And our final question comes from the line of Roman Kuznetsov (ph) with Gates Capital. Please go ahead.
Jeff Gates – Gates Capital
Hi it’s actually Jeff Gates. Couple of quick questions.
The mercury conversion, are you still expectant to be about $300 million and what kind of cost or revenue synergies would you expect with that kind of an investment? And secondly what do you think the long-term sustainable operating margin is for Winchester?
John Fischer
Jeff, what we’ve said is the cost is between $800 and $1000 per ECU but it’s per ECU converted. And we haven’t made any decision or announcement regarding what we’re going to do.
So it could – one outcome is that we could shut down all of our capacity and we wouldn’t spend anything, and we wouldn’t get any savings. Typically there is some small level of savings when you convert from mercury to membrane in the form of lower electricity costs but it’s not a level of savings that would necessarily justify the investment.
If you look at Winchester historically, Winchester has earned $20 million to $30 million in good periods of time and that takes you back to the 2005 and prior periods, and we’ve said that we expect Winchester’s earnings on a recurring basis to be meaningfully higher than that going forward.
Jeff Gates – Gates Capital
And then last if I could, could you comment on your mix of electricity between derived from natural graft, coal, nuclear and hydro. What the mix that is?
Joseph Rupp
Yes, we really have pretty balanced portfolio. Natural gas, coal, nuclear and hydro make up in that decreasing order are mix of fuels and there is still balance across each of those components.
So we have the opportunity in some sense to not be impacted negatively by an over exposure to one fuel versus another.
Jeff Gates – Gates Capital
So you expect that mix to stay the same?
Joseph Rupp
Yes sir.
Jeff Gates – Gates Capital
Okay, thank you.
Joseph Rupp
Thank you.
Operator
This concludes today’s question and answer session. I would like to turn the call back to Mr.
Joseph Rupp for closing comments.
Joseph Rupp
I’d like to thank you for joining us today and we look forward to reporting our year-end to you in January. Thank you.
Operator
Ladies and gentlemen that concludes today’s conference. Thank you for your participation.
You may now disconnect, and have a great day.
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