UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

 

Commission file number 1-32669

 

TRONOX INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

 

 

One Leadership Square, Suite 300

211 N. Robinson Ave, Oklahoma City, Oklahoma 73102

(Address of principal executive offices)

 

 

Registrant’s telephone number, including area code:

(405) 775-5000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirement for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (see definition of “accelerated filer” in Rule 12b-2 under the Exchange Act). (Check one):

 

Large accelerated filer o     Accelerated filer þ     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of July 31, 2007, 18,539,722 shares of the company’s Class A common stock and 22,889,431 shares of the company’s Class B common stock were outstanding.

 

Tronox Incorporated

 

Form 10-Q

 

Table of Contents

 

 

TRONOX INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share data)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

TRONOX INCORPORATED

CONDENSED CONSOLIDATED BALANCE SHEETS
(In millions, except share data)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

TRONOX INCORPORATED

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
(Unaudited)

 

 

The accompanying notes are an integral part of these financial statements.

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

Tronox Incorporated (the “company”), a Delaware Corporation was formed on May 17, 2005, in preparation for the contribution and transfer by Kerr-McGee Corporation (“Kerr-McGee”) of certain entities, including those comprising substantially all of its chemical business (the “Contribution”). The company has one reportable segment representing the company’s pigment business. The pigment segment primarily produces and markets titanium dioxide pigment (“TiO₂”) and has production facilities in the United States, Australia, Germany and The Netherlands. The pigment segment also includes heavy minerals production operated through our joint venture. The heavy minerals production is integrated with our Australian pigment plant, but also has third-party sales of minerals not utilized by the company’s pigment operations. Electrolytic and other chemical products (which does not constitute a reportable segment) represents the company’s other operations which are comprised of electrolytic manufacturing and marketing operations, all of which are located in the United States. The company has in the past operated or held businesses or properties, or currently holds properties, that do not relate to the current chemical business.

 

The terms “Tronox” or “the company” are used interchangeably in these condensed consolidated financial statements to refer to the consolidated group or to one or more of the companies that are part of the consolidated group.

 

Formation

 

The Contribution was completed in November 2005, along with the recapitalization of the company, whereby common stock held by Kerr-McGee converted into approximately 22.9 million shares of Class B common stock. An initial public offering (“IPO”) of Class A common stock was completed on November 28, 2005. Prior to the IPO, Tronox was a wholly owned subsidiary of Kerr-McGee. Pursuant to the terms of the Master Separation Agreement dated November 28, 2005, among Kerr-McGee, Kerr-McGee Worldwide Corporation and the company (the “MSA”), the net proceeds from the IPO of $224.7 million were distributed to Kerr-McGee.

 

Following the IPO, approximately 43.3% of the total outstanding common stock of Tronox was held by the general public and 56.7% was held by Kerr-McGee. The holders of Class A common stock and Class B common stock have identical rights, except that holders of Class A common stock are entitled to one vote per share, while holders of Class B common stock are entitled to six votes per share on all matters to be voted on by stockholders.

 

On March 8, 2006, Kerr-McGee’s Board of Directors declared a dividend of the company’s Class B common stock owned by Kerr-McGee to its stockholders (the “Distribution”). The Distribution was completed on March 30, 2006, resulting in Kerr-McGee having no ownership or voting interest in the company.

 

 

These statements should be read in conjunction with the audited consolidated and combined financial statements and the related notes which are included in the company’s Annual Report on Form 10-K for the year ended December 31, 2006. The interim condensed consolidated financial information furnished herein is unaudited. The information reflects all adjustments (which include only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position and results of operations for the periods included in the report.

 

The following prior-year amounts have been reclassified to conform with the current-year presentation. Where applicable, changes to line item amounts in the company’s Condensed Consolidated Statements of Operations are disclosed. These changes had no impact on income from continuing operations or net income.

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

In connection with the company’s adoption of the transition provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 158, Employer’s Accounting for Defined Benefit Pension and Other Postretirement Plans), the 2006 financial statements included in the company’s Annual Report on Form 10-K contained a misstatement in the presentation of other comprehensive income (loss). The unrecognized prior service cost and actuarial loss totaling $95.5 million recorded in the company’s Consolidated Balance Sheet as of December 31, 2006, should have been presented only as an adjustment to the balance of accumulated other comprehensive loss as of December 31, 2006, and not as part of comprehensive income (loss) for the period then ended. The presentation in the company’s Consolidated and Combined Statement of Comprehensive Income (Loss) and Business/Stockholders’ Equity for the year ended December 31, 2006, and in the related Notes to Consolidated and Combined Financial Statements will be revised in the company’s Annual Report on Form 10-K for the year ending December 31, 2007, to reflect comprehensive income of $28.5 million for the year ended December 31, 2006, versus comprehensive loss of $67.0 million previously reported.

 

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes, (“FIN 48”). The company adopted FIN 48 as of January 1, 2007. FIN 48 clarifies the application of SFAS No. 109 by defining criteria that an uncertain tax position must meet in order to be recognized in an enterprise’s financial statements. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The guidance required application through recognition of a cumulative effect adjustment to opening retained earnings in the period of adoption, with no charge to current earnings for prior periods. The results for prior periods have not been restated. As a result of the adoption of FIN 48, the company recognized a $9.3 million charge to the January 1, 2007, balance of retained earnings. The total amount of unrecognized tax positions at January 1, 2007, was $60.7 million.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The company is reviewing SFAS No. 157 to determine the impact on its financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — including an Amendment of FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. The company is currently assessing whether or not the provisions of SFAS No. 159 will be implemented and what the financial statement impact would be, if any. If the company chooses to implement SFAS No. 159, the effective date would be January 1, 2008.

 

 

The components of other income, net are as follows:

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following tables set forth the computation of basic and diluted earnings per share from continuing operations for the periods indicated.

 

 

 

Stock options outstanding of approximately 786,000 at June 30, 2007, were “out of the money,” thus, antidilutive. The average exercise price of these antidilutive options was $14.69. Since the company incurred a loss from continuing operations for the three months and six months ended June 30, 2007, no dilution of the loss per share would result from an additional 1.6 million potentially dilutive shares outstanding at June 30, 2007. The company also incurred a loss from continuing operations for the three months ended June 30, 2006; thus, no dilution of the loss per share resulted from 2.2 million potentially dilutive shares outstanding at June 30, 2006.

 

 

Accounts receivable, net, consists of the following:

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Inventories, net, consist of the following:

 

 

Property, plant and equipment, net, consists of the following:

 

 

Other long-term assets consist of the following:

 

 

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Accrued liabilities consist of the following:

 

 

Other long-term liabilities consist of the following:

 

 

 

The company has investments in Basic Management, Inc. and Subsidiaries (a corporation in which the company has a 31% interest, whose combined financial statements include The LandWell Company, L.P., a limited partnership in which the company has a 29% direct interest). The amount of equity in net earnings of these investees the company has recognized is disclosed in Note 3. Summarized unaudited income statement information of the significant investees is as follows:

 

 

 

The company is required, under the terms of the credit agreement, to remit a certain percentage of excess cash flow (“ECF Percentage,” as defined in the credit agreement) as a prepayment of the principal. As a result, in addition to the normal quarterly installments, the first such annual mandatory payment, in the amount of $11.1 million, was paid in April 2007 based on the ECF Percentage for the fiscal year 2006.

 

The terms of the credit agreement provide for customary representations and warranties, affirmative and negative covenants, and events of default. In March 2007, the company requested and obtained approval for an amendment to the financial covenants in the credit agreement. The amendment maintains the original Total

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Leverage Ratio and the Interest Coverage Ratio (both as defined in the credit agreement) at 3.75:1 and 2:1, respectively, through December 31, 2007. For fiscal year 2008, the Total Leverage Ratio must be no more than 3.50:1 and the Interest Coverage Ratio must be at least 2.5:1 in the first two quarters and 3.00:1 in the last two quarters. The amendment did not modify the limit on capital expenditures, which is $130 million in 2007 and 2008.

 

Concurrent with the IPO, Tronox Worldwide LLC and Tronox Finance Corp. issued $350 million in aggregate principal amount of 91/2% senior unsecured notes due 2012 in a private offering. The company and all of its other 100%-owned domestic subsidiaries fully and unconditionally and jointly and severally guarantee the notes. The issuers, Tronox Worldwide LLC and Tronox Finance Corp, and all subsidiary guarantors are “100% owned” by the company.

 

 

Comprehensive income (loss), net of taxes, consists of the following:

 

 

 

The reconciliation of the federal statutory rate to the effective income tax rate applicable to income (loss) from continuing operations is as follows:

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The company adopted the provisions of FIN 48 as of January 1, 2007. As a result of the adoption of FIN 48, the company recognized a $9.3 million charge to the January 1, 2007, balance of retained earnings. The gross amount of unrecognized tax positions at January 1, 2007, was $60.7 million. If recognized, the net benefit associated with approximately $54.5 million of that reserve for unrecognized tax benefits would affect the effective income tax rate.

 

The net increases in unrecognized tax benefits, during the three and six month periods ended June 30, 2007, which would affect the effective income tax rate were $5.2 million and $6.3 million, respectively. Both of these amounts include tax related to our German income tax audit for the years 1998 through 2001 as well as interest and the effect of foreign exchange translation.

 

The company anticipates a decrease of approximately $2.2 million, during the next twelve months, in the unrecognized tax benefit primarily related to transactions involving the effects of foreign currency translation and transfer pricing for tax positions where the statute will lapse.

 

The company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the six months ended June 30, 2007, the company recognized approximately $2.3 million in gross interest, including the effect of foreign exchange translation. Of this increase, $1.6 million of interest was recognized during the three-month period ended June 30, 2007. As of January 1, 2007, the company had approximately $7.9 million accrued for the gross payment of interest and penalties. The equivalent amount at June 30, 2007, was $10.4 million.

 

The Internal Revenue Service has completed its examination of the company’s U.S. Federal income tax returns for all years through 2002 and is currently conducting an examination of the years 2003 through 2005. The years through 1998 have been closed with the exception of issues for which a refund claim has been filed. A German audit is being conducted for the years 1998 through 2001. No periods have closed with respect to Australia, Germany, Switzerland or The Netherlands (periods subsequent to the acquisition in 2000). The company believes that it has made adequate provision for income taxes that may be payable with respect to years open for examination; however, the ultimate outcome is not presently known and, accordingly, additional provisions may be necessary.

 

 

The following table presents pretax loss from discontinued operations by type of cost and total after-tax loss from discontinued operations for the periods indicated:

 

 

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The following table presents the components of net periodic pension and postretirement cost and total retirement expense for the periods indicated:

 

 

 

 

The company’s Long Term Incentive Plan (“LTIP”) authorizes the issuance of certain stock-based awards including fixed-price stock options, restricted stock awards and performance awards, among others. In January 2007, the compensation committee of the Board of Directors authorized the issuance of approximately 460,000 stock options, 171,000 restricted stock-based awards and 5,000,000 performance units. Performance units are awards that management intends to settle in cash at the end of a three-year performance cycle (as defined in the LTIP). The contractual life and vesting period for performance units directly relate to the performance cycle and are generally three years. Performance units are liability awards (as defined by applicable accounting guidance) and are based on achievement of specified shareholder return targets, including a comparison to the returns of peer group companies for the same performance period. Liability awards are required to be remeasured on a quarterly basis until the settlement date at the end of the vesting period. Employees terminating their employment due to retirement, death or disability, retain the right to receive a pro-rata payout under the performance units awards.

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The company estimates valuation assumptions for stock option and performance unit awards. For stock options, the company uses the Black-Scholes option-pricing model and significant inputs and assumptions are summarized in the table below.

 

 

For performance units, the company uses a Monte Carlo simulation model to estimate fair value at the end of each reporting period. This model uses multiple input variables to determine the probability of satisfying the award’s market conditions. Inputs into the model include the following for Tronox and peer group companies: total shareholder return from the beginning of the performance cycle through the measurement date, volatility, risk-free rates and correlation of Tronox’s and peer group companies’ total shareholder return. The inputs are based on historical capital market data. The total fair-value-based obligation associated with awards expected to vest is further adjusted to reflect the extent to which employee services necessary to earn the awards have been rendered. Compensation cost for any given period equals the increase or decrease in the liability for awards outstanding and expected to vest.

 

For the three months ended June 30, 2007 and 2006, compensation expense related to all stock-based awards, totaled $1.8 million and $1.5 million, respectively. For the six months ended June 30, 2007 and 2006, compensation expense related to all stock-based awards totaled $4.9 million and $5.5 million, respectively. Accelerated compensation expense resulting from awards issued to retirement eligible employees totaled $1.5 million and $1.3 million, respectively, in the six-month periods ending June 30, 2007 and 2006.

 

 

The following table summarizes the contingency reserve balances, provisions, payments and settlements for the six months ended June 30, 2007, as well as balances, accruals and receipts of reimbursements of environmental costs from other parties.

 

 

 

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Management believes, after consultation with its internal legal counsel, that currently the company is reserved adequately for the probable and reasonably estimable costs of known environmental matters and other contingencies. However, additions to the reserves may be required as additional information is obtained that enables the company to better estimate its liabilities, including liabilities at sites now under review. At this time, however, the company cannot reliably estimate a range of future additions to the reserves for any individual site or for all sites collectively. Reserves for environmental sites are based, among other factors, on assumptions regarding the volumes of contaminated soils and groundwater involved, as well as associated excavation, transportation and disposal costs.

 

The company provides for costs related to contingencies when a loss is probable and the amount is reasonably estimable. It is not possible for the company to reliably estimate the amount and timing of all future expenditures related to environmental and legal matters and other contingencies because, among other reasons:

 

 

Current and former operations of the company require the management of regulated materials and are subject to various environmental laws and regulations. These laws and regulations will obligate the company to clean up various sites at which petroleum, chemicals, low-level radioactive substances and/or other materials have been contained, disposed of or released. Some of these sites have been designated Superfund sites by the U.S. Environmental Protection Agency (the “EPA”), pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) or state equivalents. Similar environmental laws and regulations and other requirements exist in foreign countries in which the company operates.

 

Following are discussions regarding certain environmental sites and litigation of the company.

 

Environmental

 

Henderson, Nevada

 

In 1998, Tronox LLC decided to exit the ammonium perchlorate business. At that time, Tronox LLC curtailed operations and began preparation for the shutdown of the associated production facilities in Henderson, Nevada, that produced ammonium perchlorate and other related products. Manufacture of perchlorate compounds began at

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Henderson in 1945 in facilities owned by the U.S. government. The U.S. Navy expanded production significantly in 1953 when it completed construction of a plant for the manufacture of ammonium perchlorate. The U.S. Navy continued to own the ammonium perchlorate plant, as well as other associated production equipment at Henderson, until 1962, when the plant was purchased by a predecessor of the company. The ammonium perchlorate produced at the Henderson facility was used primarily in federal government defense and space programs. Perchlorate that may have originated, at least in part, from the Henderson facility has been detected in nearby Lake Mead and the Colorado River, which contribute to municipal water supplies in Arizona, Southern California and Southern Nevada.

 

Tronox LLC began decommissioning the facility and remediating associated perchlorate contamination, including surface impoundments and groundwater, when it decided to exit the business in 1998. In 1999 and 2001, Tronox LLC entered into consent orders with the Nevada Division of Environmental Protection (the “NDEP”) that require it to implement both interim and long-term remedial measures to capture and remove perchlorate from groundwater. In April 2005, Tronox LLC entered into an amended consent order with the NDEP that requires, in addition to the capture and treatment of groundwater, the closure of a certain impoundment related to the past production of ammonium perchlorate, including treatment and disposal of solution and sediment contained in the impoundment. A separate agreement reached in 1996 with the NDEP also requires Tronox LLC to test for various potential contaminants at the site, which is ongoing. The second phase of the site investigation including preparation of a risk assessment is expected to be completed by mid-2008. Results of testing may lead to further site characterization and remediation, the costs of which, if any, are not currently included in the financial reserves discussed below.

 

In 1999, Tronox LLC initiated the interim measures required by the consent orders. A long-term remediation system is operating in compliance with the consent orders. Initially, the remediation system was projected to operate through 2007. However, studies of the decline of perchlorate levels in the groundwater indicate that Tronox LLC may need to operate the system through 2011. The scope, duration and cost of groundwater remediation likely will be driven in the long term by drinking water standards regarding perchlorate, which to date have not been formally established by applicable state or federal regulatory authorities. The EPA and other federal and state agencies continue to evaluate the health and environmental risks associated with perchlorate as part of the process for ultimately setting drinking water standards. One state agency, the California Environmental Protection Agency has set a public health goal for perchlorate, and the EPA has established a reference dose for perchlorate, which are preliminary steps to setting drinking water standards. The establishment of applicable drinking water standards could materially affect the scope, duration and cost of the long-term groundwater remediation that Tronox LLC is required to perform.

 

Financial Reserves — As of June 30, 2007, reserves for environmental remediation at Henderson totaled $27.6 million, which included $2.7 million recorded in the second quarter of 2007 related to expanded sampling and the development of a risk assessment plan pertaining to the 1996 agreement with the NDEP. As noted above, the long- term scope, duration and cost of groundwater remediation and impoundment closure are uncertain and, therefore, additional costs beyond those accrued may be incurred in the future. However, the amount of any additional costs cannot be reasonably estimated at this time.

 

Litigation — In 2000, Tronox LLC initiated litigation against the United States seeking contribution for its Henderson response costs. The suit was based on the fact that the government owned the plant in the early years of its operation, exercised significant control over production at the plant and the sale of products produced at the plant, even while not the owner, and was the largest consumer of products produced at the plant. Before trial, the parties agreed to a settlement of the claims against the United States. The settlement was memorialized in a consent decree approved by the court on January 13, 2006. In February 2006, under the consent decree, the United States paid Tronox LLC $20.5 million in contribution for past costs. Commencing January 1, 2011, the United States will be obligated to pay 21% of Tronox LLC’s remaining response costs at Henderson, if any, related to perchlorate.

 

Insurance Reimbursement — In 2001, Tronox LLC purchased a 10-year, $100 million environmental cost cap insurance policy for groundwater and other remediation at Henderson. The insurance policy provides coverage after Tronox LLC exhausts a self-insured retention of approximately $62.3 million ($61.3 million self-insured retention, plus an additional $1.0 million retention for certain additional coverage under the policy) and covers only those costs incurred to achieve a clean-up level specified in the policy. As noted above, federal and applicable state

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

agencies have not established a drinking water standard and, therefore, it is possible that Tronox LLC may be required to achieve a clean-up level more stringent than that covered by the policy. If so, the amount recoverable under the policy may be less than the ultimate clean-up cost.

 

At June 30, 2007, the company had received $14.0 million of cost reimbursement under the insurance policy, and expects that additional estimated aggregate clean-up cost of $86.6 million less the $62.3 million self-insured retention to be covered by the policy (for a net amount of $24.3 million in potential reimbursement). Included in the $24.3 million is $0.7 million accrued in the second quarter of 2007 based on expected reimbursements. The company believes that additional reimbursement of approximately $24.3 million is probable, and, accordingly, the company has recorded a receivable in the financial statements for that amount.

 

MSA Reimbursement — As of June 30, 2007, the company had a receivable of $0.5 million from Anadarko Petroleum Corporation, on behalf of Kerr-McGee, representing 50% of the amount of the remediation costs the company has incurred and paid. The receivable has been reflected in accounts receivable in the accompanying Condensed Consolidated Balance Sheets.

 

West Chicago, Illinois

 

In 1973, Tronox LLC closed a facility in West Chicago, Illinois, that processed thorium ores for the federal government and for certain commercial purposes. Historical operations had resulted in low-level radioactive contamination at the facility and in surrounding areas. The original processing facility is regulated by the State of Illinois (the “State”), and four vicinity areas are designated as Superfund sites on the National Priorities List (the “NPL”).

 

Closed Facility — Pursuant to agreements reached in 1994 and 1997 among Tronox LLC, the City of West Chicago and the State regarding the decommissioning of the closed West Chicago facility, Tronox LLC has substantially completed the excavation of contaminated soils and has shipped those soils to a licensed disposal facility. Surface restoration was completed in 2004, except for areas designated for use in connection with the Kress Creek and Sewage Treatment Plant remediation discussed below. Groundwater monitoring and remediation is expected to continue for approximately seven years.

 

Vicinity Areas — The EPA has listed four areas in the vicinity of the closed West Chicago facility on the NPL and has designated Tronox LLC as a PRP in these four areas. Tronox LLC has substantially completed remedial work for three of the areas (known as the Residential Areas, Reed-Keppler Park and the Sewage Treatment Plant). In June 2007, a Chicago-area newspaper published articles suggesting that certain Residential Area properties were not cleaned up adequately in the 1980s or the 1990s. The company believes the clean-up of all Residential Area properties to be adequate, as the EPA was involved indirectly in the clean-up. The EPA is in the process of verifying the work done on the residential properties.

 

Work continues at the other NPL site known as Kress Creek. The work involves removal of low level insoluble thorium residues principally in streambanks and streambed sediments. Tronox LLC has reached an agreement with the appropriate federal and state agencies and local communities regarding the characterization and cleanup of the sites, past and future government response costs, and the waiver of natural resource damages claims. The agreement is incorporated in consent decrees, which were approved and entered by the federal court in August 2005. The clean-up work, which began in the third quarter of 2005, is expected to be completed in 2010 and will require excavation of contaminated soils and stream sediments, shipment of excavated materials to a licensed disposal facility and restoration of affected areas.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $70.9 million for costs related to the West Chicago facility and vicinity properties. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time. The amount of the reserve is not reduced by reimbursements expected from the federal government under Title X of the Energy Policy Act of 1992 (“Title X”).

 

Government Reimbursement — Pursuant to Title X, the U.S. Department of Energy (the “DOE”) is obligated to reimburse the company for certain decommissioning and clean-up costs incurred in connection with the West Chicago sites in recognition of the fact that about 55% of the facility’s production was dedicated to U.S. government

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

contracts. The amount authorized for reimbursement under Title X is $365 million plus inflation adjustments. That amount is expected to cover the government’s full share of West Chicago clean-up costs. Through June 30, 2007, the company had been reimbursed approximately $304.2 million under Title X.

 

Reimbursements under Title X are provided by congressional appropriations. Historically, congressional appropriations have lagged the company’s clean-up expenditures. As of June 30, 2007, the government’s share of costs incurred by the company but not yet reimbursed by the DOE totaled approximately $17.7 million, which includes $1.2 million accrued in the second quarter of 2007. The company believes that receipt of the remaining $17.7 million in due course following additional congressional appropriations is probable and has reflected that amount as a receivable in the financial statements. The company will recognize recovery of the government’s share of future remediation costs for the West Chicago sites as it incurs the cash expenditures.

 

Ambrosia Lake, New Mexico

 

From the late 1950s until 1988, the company operated a uranium mining and milling operation at Ambrosia Lake near Grants, New Mexico, pursuant to a license issued by the Atomic Energy Commission (the “AEC”), now the Nuclear Regulatory Commission (the “NRC”). When the operation was sold, the company retained responsibility for certain environmental conditions existing at the site, including mill tailings, selected ponds and groundwater contamination related to the mill tailings and unlined ponds. Since 1989, the unaffiliated current owner of the site, Rio Algom Mining LLC (“Rio Algom”), has been decommissioning the site pursuant to the license issued by the NRC. Mill tailings, certain impacted surface soils and selected pond sediments have been consolidated in an onsite containment unit. Under terms of the sales agreement, which included provisions capping the liability of Rio Algom, the company became obligated to solely fund the remediation for the items described above when total expenditures exceeded $30 million, which occurred in late 2000. A decommissioning plan for the remaining impacted soil was submitted by Rio Algom to the NRC in January 2005 and was approved in July 2006. The soil decommissioning plan will take about one to two years to complete. The NRC is continuing to evaluate the current design for erosion control. The state of New Mexico has recently raised issues about certain non-radiological constituents in the groundwater at the site. Groundwater treatment was discontinued after approval by the NRC in February 2006. Discussions regarding these issues are ongoing, and resolution could affect remediation costs and/or delay ultimate site closure.

 

In addition to those remediation activities described above for which reserves have been established, as described below, Rio Algom is investigating soil contamination potentially caused by past discharge of mine water from the site, for which no reserve has been established.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $6.8 million for the costs of the remediation activities described above, including groundwater remediation. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Litigation — On January 18, 2006, Rio Algom filed suit against Tronox Worldwide LLC in the U.S. District Court for the District of New Mexico. The suit seeks a determination regarding responsibility for certain labor-related and environmental remediation costs. Though Rio Algom seeks no specific amount in its complaint, it has asserted that future groundwater remediation costs for which it believes Tronox Worldwide LLC has responsibility could be as much as $128 million. Tronox Worldwide LLC believes these costs are hypothetical and unsupportable. The case is currently in the discovery phase. On December 14, 2006, the parties participated in a court-ordered settlement conference. The parties did not reach a settlement at the conference. No trial date has been set. The company has not provided a reserve for this lawsuit beyond the above-mentioned remediation reserve because at this time the probability of a loss and the amount of loss, if any, cannot be reasonably estimated.

 

Crescent, Oklahoma

 

Beginning in 1965, Cimarron Corporation (“Cimarron”) operated a facility near Crescent, Oklahoma, at which it produced uranium and mixed oxide nuclear fuels pursuant to licenses issued by the AEC (now the NRC). Operations at the facility ceased in 1975. Since that time, buildings and soils were decommissioned in accordance with the NRC licenses. In limited areas of the site, groundwater is contaminated with radionuclides, and, in 2003,

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Cimarron submitted to the NRC and the Oklahoma Department of Environmental Quality (the “ODEQ”) a draft remediation work plan addressing the groundwater contamination. In 2005, the company began evaluating available technologies to address remaining groundwater issues. A remediation technology has been selected, and the company submitted for approval an amended plan to the NRC and the ODEQ in December 2006. The plan describes the remediation of the remaining groundwater issues. While there can be no guarantee that the plan will be approved, the company believes the plan represents an appropriate remediation technology.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $10.3 million for the costs of the remediation activities, including those currently under evaluation by the NRC and the ODEQ, described above. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

New Jersey Wood-Treatment Site

 

Tronox LLC was named in 1999 as a PRP under CERCLA at a former wood-treatment site in New Jersey at which the EPA is conducting a cleanup. On April 15, 2005, Tronox LLC received a letter from the EPA asserting it is liable under CERCLA as a former owner or operator of the site and demanding reimbursement of costs expended by the EPA at the site. The letter made demand for payment of past costs in the amount of approximately $179 million, plus interest, though the EPA has informed Tronox LLC that as of December 5, 2006, project costs are approximately $244 million, plus other future costs and interest and would consider resolving the matter for $239 million. Tronox LLC did not operate the site, which had been sold to a third party before Tronox LLC succeeded to the interests of a predecessor in the 1960s. The predecessor also did not operate the site, which had been closed before it was acquired by the predecessor. Based on historical records, there are substantial uncertainties about whether or under what terms the predecessor assumed any liabilities for the site. In addition, although it appears there may be other PRPs to whom notice has been given, the company does not know whether the other PRPs have any valid defenses to liability for the site or whether the other PRPs have the financial resources necessary to meet their obligations, if proven. Tronox LLC and the EPA have submitted the matter to nonbinding mediation that could lead to a settlement or resolution of the EPA’s demand. In the event the mediation process does not lead to an acceptable solution, Tronox LLC intends to vigorously defend against the EPA’s demand.

 

On June 25, 2007, the New Jersey Department of Environmental Protection and the New Jersey Spill Compensation Fund sued Tronox LLC and unnamed others in Superior Court, Law Division, Somerset County, New Jersey. The plaintiffs allege defendants are responsible for releases from the Federal Creosote Superfund Site that damage the state’s groundwater and seek natural resource damages, costs and other appropriate relief.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $35.0 million for the costs of settling the claim for the remediation activities described above. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time. The company has not provided a reserve for the New Jersey lawsuit because at this time neither the probability of a loss nor the amount thereof can be reasonably estimated.

 

MSA Reimbursement — As of June 30, 2007, the company had a receivable of $17.5 million representing 50% of the settlement amount that Anadarko Petroleum Corporation, on behalf of Kerr-McGee, has consented to contribute at or before the time the settlement, if accepted, becomes payable. The receivable has been reflected in accounts receivable in the accompanying Condensed Consolidated Balance Sheets.

 

Sauget, Illinois

 

From 1927 to 1969, Tronox LLC operated a wood-treatment plant on a 60-acre site in the Village of Sauget (formerly known as Monsanto) in St. Clair County, Illinois. Operations on the property resulted in the contamination of soil sediment, surface water and groundwater at the site with creosote and other substances used in wood treating. In 1988, Tronox LLC entered into a court-approved consent order with the Illinois Attorney General and Illinois Environmental Protection Agency. The investigation and feasibility study for sediments required by the

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

order are complete. Pond sediment removal was completed in 2007, with final pond closure and groundwater investigation expected to be completed in 2008.

 

Financial Reserves — As of June 30, 2007, the company had reserves of approximately $6.2 million for the remediation activities related to contaminated soils and sediments and pond closure. Additional groundwater characterization will occur upon completion of the soils and sediments removal. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Cleveland, Oklahoma

 

Triple S Refining Corporation (“Triple S”), formerly known as Kerr-McGee Refining Corporation, owned and operated a petroleum refinery near Cleveland, Oklahoma, until the facility was closed in 1972. In 1992, Triple S entered into a Consent Order with the Oklahoma Department of Health (later, the ODEQ), which addresses the remediation of air, soil, surface water and groundwater contaminated by hydrocarbons and other refinery related materials. Facility dismantling and several interim remedial measures have been completed. In 2006, the ODEQ approved the remedial design for soil and waste feasibility study, which includes construction of an on-site disposal cell. A feasibility study of surface and groundwater remedial measures is under review by the ODEQ. Duration of remedial activities currently cannot be estimated.

 

Financial Reserves — As of June 30, 2007, the company had reserves of approximately $3.7 million for the remediation activities described above, including the remedial measures recommended in the feasibility study currently under review. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Cushing, Oklahoma

 

In 1972, Triple S closed a petroleum refinery it had operated near Cushing, Oklahoma. Prior to closing the refinery, Triple S also had produced uranium and thorium fuel and metal at the site pursuant to licenses issued by the AEC.

 

In 1990, Triple S entered into a consent agreement with the State of Oklahoma to investigate the site and take appropriate remedial actions related to petroleum refining and uranium and thorium residuals. Investigation and remediation of hydrocarbon contamination is being performed under the oversight of the ODEQ. Remediation to address hydrocarbon contamination in soils is expected to take about four more years. The long-term scope, duration and cost of groundwater remediation are uncertain and, therefore, additional costs beyond those accrued may be incurred in the future.

 

In 1993, Triple S received a decommissioning license from the NRC, the successor to the AEC’s licensing authority, to perform certain cleanup of uranium and thorium residuals. All known radiological contamination has been removed from the site and shipped to a licensed disposal facility, substantially completing the license requirements.

 

At the company’s request, the NRC terminated the site license in 2006, thereby allowing the company to avoid costs that would otherwise be incurred in association with continued license maintenance.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $10.1 million for the costs of the ongoing remediation and decommissioning work described above. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Jacksonville, Florida

 

In 1970, Tronox LLC purchased a facility in Jacksonville, Florida, that manufactured and processed fertilizers, pesticides and herbicides. Tronox LLC closed the facility in 1978. In 1988, all structures were removed, and Tronox LLC began site characterization studies. In 2000, Tronox LLC entered into a consent order with the EPA to conduct a remedial investigation and a feasibility study. The remedial investigation was completed and submitted to the EPA in August 2005. A feasibility study was submitted to the EPA in October 2006. The study recommended site soil

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

remediation and excavation, site capping and limited groundwater remediation. The EPA has requested additional sediment data be collected to support the site recommendation. A work plan is currently being prepared to respond to the EPA’s request.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $5.2 million to conduct the clean-up and remediation activities recommended in the feasibility study submitted to the EPA. Although actual costs may differ from the current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Columbus, Mississippi

 

The Columbus, Mississippi, wood-treating plant ceased operation in July 2003. At that time, the process facilities were decommissioned, although groundwater remediation continues. In 2006, the City of Columbus started a drainage improvement program in nearby Probst Park. During excavation of the drainage ditch, certain amounts of creosote-like materials were discovered by the City of Columbus, Mississippi, and disposed of by the company. The City of Columbus’ drainage project continues in 2007 and additional contaminated soil has been identified, which the company expects to remediate.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $3.0 million related to conducting groundwater treatment and disposal of contaminated soils. Although actual costs may differ from the current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

 

Other Sites

 

In addition to the sites described above, the company is responsible for environmental costs related to certain other sites. These sites relate primarily to wood treating, chemical production, landfills, mining, and oil and gas refining, distribution and marketing. As of June 30, 2007, the company had reserves of $35.5 million for the environmental costs in connection with these other sites. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time. One such site is a mining site in South Dakota, which the company refers to as Riley Pass, which has a reserve of $1.3 million at June 30, 2007, as a result of a consent order requiring a predesign and vegetation study. Once the study is complete, additional costs may be required to remediate adjacent areas within the site, but such costs cannot be reasonably estimated at this time.

 

Master Separation Agreement

 

Pursuant to the MSA (which recites that it binds successors), Kerr-McGee will reimburse the company for a portion of the environmental remediation costs it incurs and pays (net of any cost reimbursements it recovers or expects to recover from insurers, governmental authorities or other parties). The reimbursement obligation extends to costs incurred at any site associated with any of the company’s former businesses or operations.

 

With respect to any site for which the company has established a reserve as of the effective date of the MSA, 50% of the remediation costs the company incurs in excess of the reserve amount (after meeting a $200,000 minimum threshold amount) will be reimbursable by Kerr-McGee, net of any amounts recovered or, in the company’s reasonable and good faith estimate, that will be recovered from third parties. With respect to any site for which the company has not established a reserve as of the effective date of the MSA, 50% of the amount of the remediation costs the company incurs and pays (after meeting a $200,000 minimum threshold amount) will be reimbursable by Kerr-McGee, net of any amounts recovered or, in the company’s reasonable and good faith estimate, that will be recovered from third parties. At June 30, 2007, the company had a receivable of $18.0 million, primarily representing 50% of the settlement offer the company made related to the New Jersey wood-treatment site as described above that Anadarko Petroleum Corporation, on behalf of Kerr-McGee, has consented to contribute at or before the time the settlement, if accepted, becomes payable.

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Kerr-McGee’s aggregate reimbursement obligation to the company cannot exceed $100 million and is subject to various other limitations and restrictions. For example, Kerr-McGee is not obligated to reimburse the company for amounts it pays to third parties in connection with tort claims or personal injury lawsuits, or for administrative fines or civil penalties that the company is required to pay. Kerr-McGee’s reimbursement obligation also is limited to costs that the company actually incurs and pays within seven years following the completion of the IPO.

 

Litigation and Claims

 

Birmingham, Alabama

 

Until 1995, Triple S operated a petroleum terminal in Birmingham, Alabama. In late 2005, a local church, which is located on property adjacent to the site, demanded payment for damages of approximately $25 million in connection with a release of petroleum alleged to have occurred at the terminal and threatened litigation. In March 2006, the company filed a lawsuit in federal court seeking a declaration of the parties’ rights and injunctive relief. The defendant has moved to dismiss the company’s suit and has also filed a countersuit in the circuit court for Jefferson County, Alabama, against the company and third parties seeking property damages, injunctive relief and costs. The company has responded to the motion. In January 2007, the judge in the federal lawsuit issued an order abstaining from exercising jurisdiction over the matter, leaving the case before the Jefferson County circuit court. The company has filed an appeal of the order with the U.S. Court of Appeals in the Eleventh Circuit. The company has not provided a reserve for the litigation because at this time it cannot reasonably determine the probability of a loss, and the amount of loss, if any, cannot be reasonably estimated. The company currently believes that the ultimate resolution of the litigation is not likely to have a material adverse effect on the company.

 

Forest Products Litigation

 

The company is defending a number of lawsuits related to three former wood-treatment plants in Columbus, Mississippi; Avoca, Pennsylvania; and Texarkana, Texas. All of these lawsuits seek recoveries under a variety of common law and statutory legal theories for personal injuries and/or property damages allegedly caused by exposure to and/or release of chemicals used in the wood-treatment process, primarily creosote. The company currently believes that claims asserted in these lawsuits are without substantial merit and is vigorously defending them.

 

At Columbus, Mississippi, the consolidated federal case has been set for the initial trial of two plaintiffs in November 2007.

 

At Avoca, Pennsylvania, 35 state court lawsuits were filed in 2005 by over 4,000 plaintiffs. The plaintiffs have classified their claims into various alleged disease categories. In September 2005, the judge ordered that discovery and the first trial will focus on plaintiffs who allege pre-cancerous skin lesions. The first trial was scheduled for August 2007, but in May 2007 the parties agreed on arbitration as an alternative to this litigation. The judge approved arbitration and placed the lawsuits on an inactive docket. The first arbitration hearing is set for October 2007.

 

At Texarkana, Texas, the five plaintiffs in the May vs. Tronox case concluded settlement negotiations with the insurer for Tronox LLC in April 2007, with the case being dismissed in June 2007. Similarly, in a separate case (the Avance case), plaintiffs reached settlements with the insurer in July and dismissals are expected to follow soon.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $11.0 million related to certain forest products litigation. Although actual costs may differ from the current reserves, the amount of any revisions in litigation costs cannot be reasonably estimated at this time. The company currently believes that the ultimate resolution of this forest products litigation is not likely to have a material adverse effect on the company.

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Savannah Plant

 

On September 8, 2003, the Environmental Protection Division of the Georgia Department of Natural Resources (the “EPD”) issued a unilateral Administrative Order to our subsidiary, Tronox Pigments (Savannah) Inc., claiming that the Savannah plant exceeded emission allowances provided for in the facility’s Title V air permit. On September 19, 2005, the EPD rescinded the Administrative Order and filed a Withdrawal of Petition for Hearing on Civil Penalties. Accordingly, the proceeding on administrative penalties has been dismissed, without prejudice. After dismissal of the Administrative Order, representatives of the EPD, the EPA and Tronox continued with their discussions regarding a resolution of the alleged violations, with the EPA taking the lead role in these discussions. On December 6, 2006, the EPA informed Tronox Pigments (Savannah) Inc. that it had submitted a civil referral to the U.S. Department of Justice (the “DOJ”) with respect to the air quality bypass issue and for matters stemming from the EPA led Resource Conservation and Recovery Act (“RCRA”) Compliance Evaluation Inspection (“CEI”) that occurred in January 2006. Prior to the filing of any formal action, the DOJ has agreed to a series of settlement negotiations to determine if the matter can be resolved. After discussions with the EPA and the DOJ, Tronox Pigments (Savannah) Inc. tendered an offer of settlement and compromise to the government to settle all outstanding issues in the amount of $600,000 as a penalty to be paid over an eight month period and approximately $2.4 million in “Supplemental Environmental Projects.” The EPA is evaluating terms of the proposed settlement.

 

Financial Reserves — As of June 30, 2007, the company had reserves of $0.6 million related to Savannah plant emission litigation. Although actual costs may differ from the current reserves, the amount of any revisions in litigation costs cannot be reasonably estimated at this time.

 

Other Matters

 

The company is party to a number of legal and administrative proceedings involving environmental and/or other matters pending in various courts or agencies. These proceedings, individually and in the aggregate, are not expected to have a material adverse effect on the company. These proceedings are also associated with facilities currently or previously owned, operated or used by the company and/or its predecessors, some of which include claims for personal injuries, property damages, clean-up costs and other environmental matters. Current and former operations of the company also involve management of regulated materials and are subject to various environmental laws and regulations. These laws and regulations will obligate the company to clean up various sites at which petroleum and other hydrocarbons, chemicals, low-level radioactive substances and/or other materials have been contained, disposed of or released. Some of these sites have been designated Superfund sites by the EPA pursuant to CERCLA or state equivalents. Similar environmental laws and regulations and other requirements exist in foreign countries in which the company operates.

 

 

At June 30, 2007, the company had outstanding letters of credit in the amount of $68.1 million. These letters of credit have been granted by financial institutions to support our environmental clean-up costs and miscellaneous operational and severance requirements in international locations.

 

The company has entered into certain agreements that require it to indemnify third parties for losses related to environmental matters, litigation and other claims. No material obligations are presently known and, thus, no reserve has been recorded in connection with such indemnification agreements.

 

TRONOX INCORPORATED

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

The company has one reportable segment representing the company’s pigment business. The pigment segment primarily produces and markets TiO₂ and has production facilities in the United States, Australia, Germany and The Netherlands. The pigment segment also includes heavy minerals production operated through our joint venture. The heavy minerals production is integrated with our Australian pigment plant, but also has third-party sales of minerals not utilized by the company’s pigment operations. Electrolytic and other chemical products (which does not constitute a reportable segment) represents the company’s other operations which are comprised of electrolytic manufacturing and marketing operations, all of which are located in the United States. Segment performance is evaluated based on segment operating profit (loss), which represents results of segment operations before considering general expenses and environmental provisions related to sites no longer in operation; interest and debt expense; other income, net and income tax provision.

 

 

 

 

 

Tronox conducted transactions with Exxaro Australia Sands Pty Ltd (“Exxaro”), the company’s 50% partner in the Tiwest Joint Venture. The company purchased raw materials used in its production of TiO₂ and also purchased Exxaro’s share of TiO₂ produced by the Tiwest Joint Venture. The company also provided administrative services and product research and development activities which were reimbursed by Exxaro. The company made total net payments of $54.5 million and $63.3 million during the six months ended June 30, 2007 and 2006, respectively, for these activities and had a net payable to Exxaro totaling $39.2 million at June 30, 2007. Additionally, the company owes Exxaro $10.1 million for the outstanding note payable and accrued interest related to the mining tenements acquired in July 2006.

 

Asset Impairment.  We have been working on the development of a raw materials feed project to improve efficiencies and reduce costs at our Savannah, Georgia, pigment facility. The initial trials of the project indicated that modifications would be required to achieve a satisfactory economic benefit. During 2006, additional studies were performed to determine the technical requirements needed to achieve operations and the additional cost to complete the project. We are planning a trial to evaluate the effectiveness of the project. The trial will be scheduled when permitting and installation issues are confirmed, which are expected to occur by year end. If it is determined that this is not a viable project, the assets will be written down approximately $4.0 million to their net realizable value.

 

Results of Operations

 

Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006

 

Total net sales were $366.5 million during the three months ended June 30, 2007, a decrease of 2.5% from the 2006 period. The following table presents net sales for the periods indicated:

 

 

Pigment segment net sales decreased $11.8 million, or 3.4%, to $340.2 million during the three months ended June 30, 2007, from $352.0 million during the three months ended June 30, 2006. The decrease was primarily due to lower prices and volumes resulting primarily from the slowdown in North America’s housing industry. Changes in the Euro exchange rate partially offset the lower prices. While the foreign exchange impact was an increase to sales of approximately $7.0 million, lower prices and volumes resulted in a decrease to sales of approximately $18.8 million.

 

Electrolytic and other chemical products businesses net sales increased $2.4 million, or 10.0%, to $26.3 million during the three months ended June 30, 2007, from $23.9 million during the three months ended June 30, 2006. Sales increased $3.5 million due to higher sales volumes of manganese dioxide and sodium chlorate.

 

Gross margin decreased $3.8 million, or 11.4%, to $29.4 million during the three months ended June 30, 2007, from $33.2 million during the three months ended June 30, 2006. Gross margin percentage decreased to 8.0% during the three months ended June 30, 2007, from 8.8% during the three months ended June 30, 2006, primarily due to lower pricing, higher shipping and handling costs and changes in foreign exchange rates. Lower pricing was primarily attributable to the slowdown in the North America housing industry. Production costs during the quarter were better than in the same period last year primarily due to improved operating conditions in our mining operations and lower input costs and better capacity utilization in the TiO₂ operations than in the prior year. While pricing, volumes and shipping and handling costs accounted for a $12.2 million decrease in gross margin, improved costs provided an offset of $10.1 million. The net foreign exchange impact reduced gross margin by $1.7 million.

 

Selling, general and administrative expenses increased $1.7 million, or 6.1%, to $29.4 million during the three months ended June 30, 2007, from $27.7 million during the three months ended June 30, 2006. The increase was mainly due to the prior-year reversal of variable compensation related costs and the effects of foreign exchange of approximately $4.2 million, partially offset by decreases in outside consulting, travel and other expenses of approximately $2.5 million.

Total operating loss for the three months ended June 30, 2007, was $1.5 million, a decrease of $7.0 million from the 2006 period. The following table presents operating profit (loss), with a reconciliation to consolidated loss from continuing operations before income taxes, for the periods indicated:

 

 

Pigment segment operating profit decreased $6.5 million, or 63.7%, to $3.7 million during the three months ended June 30, 2007, from $10.2 million during the three months ended June 30, 2006. The decrease was mainly due to lower selling prices of approximately $10.3 million, higher selling, general and administrative expenses of approximately $2.6 million and approximately $5.0 million for foreign exchange changes and shipping and handling costs, partially offset by lower production costs of approximately $11.2 million.

 

Electrolytic and other chemical products businesses operating profit decreased $2.1 million to a loss of $0.8 million during the three months ended June 30, 2007, from profit of $1.3 million during the three months ended June 30, 2006. During the second quarter of 2007, we recorded a $1.5 million provision (net of $1.2 million increased receivable for reimbursement) for an environmental assessment at our Henderson, Nevada, facility. In addition, higher manufacturing, shipping and handling costs and higher selling, general and administrative expenses reduced operating profit. Higher manufacturing costs were primarily related to lower capacity utilization to control inventories while also ramping up production of a new product line.

 

Interest and debt expense increased $0.1 million to $12.4 million during the three months ended June 30, 2007, from $12.3 million during the three months ended June 30, 2006.

 

Other income decreased $4.6 million to $0.7 million during the three months ended June 30, 2007, from $5.3 million during the three months ended June 30, 2006. The change was mainly due to foreign exchange losses in 2007 compared to gains in 2006 and lower income from equity affiliates partially offset by a provision for litigation settlements recorded in 2006.

 

We recorded a tax charge of $4.0 million in the second quarter of 2007 due to additional discussions with German tax authorities pertaining to the company’s ongoing income tax audit for the years 1998 through 2001. Additionally, we recorded tax expense on loss from continuing operations as a result of losses in jurisdictions with statutory tax rates generally lower than those jurisdictions where the company had income and due to interest on uncertain tax positions.

 

Loss from discontinued operations decreased $7.5 million, or 86.2%, to $1.2 million during the three months ended June 30, 2007, from $8.7 million during the three months ended June 30, 2006. The change was primarily attributable to provisions required in 2006 related to additional environmental costs for the former West Chicago site due primarily to a cost increase implemented by the licensed disposal facility used in remediation efforts.

Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006

 

Total net sales were $705.6 million during the six months ended June 30, 2007, a decrease of 1.3% from the 2006 period. The following table presents net sales for the periods indicated: