Form 10-Q June 2006


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q


þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2006

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _____ to ______


Commission file number 1-32669

 
TRONOX INCORPORATED
(Exact Name of Registrant as Specified in its Charter)

Delaware
 
20-2868245
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification Number)

123 Robert S. Kerr Avenue, 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 and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): 

Large accelerated filer o Accelerated filer o Non-accelerated filer þ
 
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, 2006, 18,351,996 shares of the company’s Class A, $0.01 par value common stock and 22,889,431 shares of the company’s Class B, $0.01 par value common stock were outstanding.




TRONOX INCORPORATED

INDEX


 
     
Page
 
Part I
 
FINANCIAL INFORMATION
   
           
 
Item 1.
 
Financial Statements (Unaudited)
   
           
     
Condensed Consolidated and Combined Statement of Operations for the Three and Six Months Ended June 30, 2006 and 2005
 
1
           
     
Condensed Consolidated Balance Sheet at June 30, 2006 and December 31, 2005
 
2
           
     
Condensed Consolidated and Combined Statement of Cash Flows for the Six Months Ended June 30, 2006 and 2005
 
3
           
     
Notes to Condensed Consolidated and Combined Financial Statements
 
4
           
 
Item 2.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
36
           
 
Item 3.
 
Quantitative and Qualitative Disclosures About Market Risk
 
47
           
 
Item 4.
 
Controls and Procedures
 
47
           
 
Forward-Looking Statements
 
47
           
 
Part II
 
OTHER INFORMATION
   
           
 
Item 1.
 
Legal Proceedings
 
48
           
 
Item 4.
 
Submission of Matters to a Vote of Security Holders
 
49
           
 
Item 6.
 
Exhibits
 
49
           
 
SIGNATURES
 
50

 





PART I - FINANCIAL INFORMATION
 

 
Item 1. Financial Statements

 
TRONOX INCORPORATED
 
CONDENSED CONSOLIDATED AND COMBINED STATEMENT OF OPERATIONS
(UNAUDITED)

   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars, except per share data)
 
                   
Net sales
 
$
372.9
 
$
355.9
 
$
709.1
 
$
690.1
 
Cost of goods sold
   
341.9
   
291.6
   
617.9
   
563.9
 
Gross margin
   
31.0
   
64.3
   
91.2
   
126.2
 
                           
Selling, general and administrative expenses
   
25.5
   
29.3
   
61.2
   
57.5
 
Provision for environmental remediation and restoration, net of
    reimbursements
   
   
5.8
   
(20.5
)
 
16.7
 
     
5.5
   
29.2
   
50.5
   
52.0
 
Interest and debt expense - third parties
   
(12.3
)
 
   
(24.3
)
 
 
Other income (expense)
   
5.3
   
(10.2
)
 
9.7
   
(15.2
)
Income (Loss) from Continuing Operations before Income Taxes
   
(1.5
)
 
19.0
   
35.9
   
36.8
 
Income Tax Provision
   
(4.2
)
 
(10.7
)
 
(18.0
)
 
(16.1
)
Income (Loss) from Continuing Operations
   
(5.7
)
 
8.3
   
17.9
   
20.7
 
Loss from Discontinued Operations, net of income tax benefit of $5.1, $6.4, $6.9 and $10.9, respectively
   
(8.7
)
 
(11.9
)
 
(11.7
)
 
(20.3
)
Net Income (Loss)
 
$
(14.4
)
$
(3.6
)
$
6.2
 
$
0.4
 
                           
Income (Loss) per Common Share
                         
    Basic -
                         
            Continuing operations
 
$
(0.14
)
$
0.36
 
$
0.44
 
$
0.90
 
            Discontinued operations
   
(0.22
)
 
(0.52
)
 
(0.29
)
 
(0.88
)
                 Net income (loss)
 
$
(0.36
)
$
(0.16
)
$
0.15
 
$
0.02
 
                           
    Diluted -
                         
             Continuing operations
 
$
(0.14
)
$
0.36
 
$
0.44
 
$
0.90
 
             Discontinued operations
   
(0.22
)
 
(0.52
)
 
(0.29
)
 
(0.88
)
                  Net income (loss)
 
$
(0.36
)
$
(0.16
)
$
0.15
 
$
0.02
 
                           
Dividends Declared per Common Share
 
$
 
$
 
$
0.05
 
$
 
                           
Weighted Average Shares Outstanding (in thousands)
                         
    Basic
   
40,370
   
22,889
   
40,369
   
22,889
 
    Diluted
   
40,370
   
22,889
   
40,885
   
22,889
 
                           

The accompanying notes are an integral part of these statements.

1


 TRONOX INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)

   
June 30,
 
December 31,
 
   
2006
 
2005
 
   
(Millions of dollars)
 
ASSETS
         
Current Assets 
         
Cash and cash equivalents
 
$
25.9
 
$
69.0
 
Accounts receivable, net of allowance for doubtful accounts of
    $12.1 in 2006 and $11.3 in 2005
   
351.4
   
331.6
 
Inventories
   
333.3
   
312.3
 
Prepaid and other assets
   
25.7
   
28.5
 
Income tax receivable
   
6.6
   
2.4
 
Deferred income taxes
   
38.1
   
35.6
 
Total Current Assets
   
781.0
   
779.4
 
               
Property, Plant and Equipment — Net
   
859.2
   
839.7
 
Long-Term Receivables, Investments and Other Assets
   
199.5
   
78.8
 
Goodwill and Other Intangible Assets
   
63.0
   
60.4
 
Total Assets
 
$
1,902.7
 
$
1,758.3
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current Liabilities 
             
Accounts payable
 
$
193.8
 
$
195.3
 
Accrued liabilities
   
157.5
   
168.9
 
Long-term debt due within one year
   
2.0
   
2.0
 
Income taxes payable
   
7.5
   
8.8
 
Total Current Liabilities
   
360.8
   
375.0
 
               
Noncurrent Liabilities 
             
Deferred income taxes
   
86.2
   
79.0
 
Environmental remediation and/or restoration
   
140.0
   
145.9
 
Long-term debt
   
547.0
   
548.0
 
Other
   
245.6
   
121.4
 
Total Noncurrent Liabilities
   
1,018.8
   
894.3
 
               
Commitments and Contingencies (Notes 12 and 13)
             
               
Stockholders’ Equity 
             
Class A common stock, par value $0.01 - 100,000,000 shares authorized,
    18,358,133 and 17,886,640 shares issued and outstanding at June 30, 2006
    and December 31, 2005, respectively
   
0.2
   
0.2
 
Class B common stock, par value $0.01 - 100,000,000 shares authorized,
    22,889,431 shares issued and outstanding at June 30, 2006 and
    December 31, 2005
   
0.2
   
0.2
 
Capital in excess of par value
   
468.6
   
461.5
 
    Accumulated deficit
   
(0.1
)
 
(2.9
)
    Deferred compensation
   
   
(5.4
)
Accumulated other comprehensive income
   
54.4
   
35.4
 
        Treasury stock
   
(0.2
)
 
 
Total Stockholders’ Equity
   
523.1
   
489.0
 
Total Liabilities and Stockholders’ Equity
 
$
1,902.7
 
$
1,758.3
 

The accompanying notes are an integral part of these statements.

2



 

 
TRONOX INCORPORATED
 
CONDENSED CONSOLIDATED AND COMBINED STATEMENT OF CASH FLOWS
(UNAUDITED)

   
Six Months Ended June 30,
 
   
2006
 
2005
 
   
(Millions of dollars)
 
Cash Flows from Operating Activities 
         
Net income
 
$
6.2
 
$
0.4
 
Adjustments to reconcile net income to net cash provided by operating activities—
             
Depreciation and amortization
   
49.3
   
53.6
 
Deferred income taxes
   
5.6
   
(29.3
)
Asset write-downs and impairments
   
   
2.9
 
Provision for environmental remediation and restoration, net of reimbursements
   
(10.3
)
 
42.7
 
Allocations from Kerr-McGee
   
   
25.5
 
Other noncash items affecting net income
   
18.5
   
8.4
 
Changes in assets and liabilities
   
(55.9
)
 
(142.7
)
Net cash provided by (used in) operating activities
   
13.4
   
(38.5
)
Cash Flows from Investing Activities 
             
Capital expenditures
   
(43.3
)
 
(31.4
)
Collection on repurchased receivables
   
   
165.0
 
Other investing activities
   
0.5
   
0.9
 
Net cash provided by (used in) investing activities
   
(42.8
)
 
134.5
 
Cash Flows from Financing Activities 
             
Repayment of debt
   
(1.0
)
 
 
Debt issuance costs
   
(2.4
)
 
 
Dividends paid
   
(2.0
)
 
 
Net transfers with affiliates
   
   
(30.7
)
Net cash used in financing activities
   
(5.4
)
 
(30.7
)
Effects of Exchange Rate Changes on Cash and Cash Equivalents
   
(8.3
)
 
3.6
 
Net Increase (Decrease) in Cash and Cash Equivalents
   
(43.1
)
 
68.9
 
Cash and Cash Equivalents at Beginning of Period
   
69.0
   
23.8
 
Cash and Cash Equivalents at End of Period
 
$
25.9
 
$
92.7
 
               
Noncash Investing Activities
Receivables repurchased and contributed by Kerr-McGee
 
$
 
$
165.0
 
Noncash Financing Activities
Contribution of repurchased receivables by Kerr-McGee
   
   
(165.0
)
               

The accompanying notes are an integral part of these statements.

3


TRONOX INCORPORATED
NOTES TO CONDENSED CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
JUNE 30, 2006


1. The Company, Basis of Presentation and Accounting Policies

Tronox Incorporated is an inorganic chemical company with worldwide operations. Our business has two reportable segments: pigment and electrolytic and other chemical products. Our pigment segment primarily produces and markets titanium dioxide pigment, TiO2, a white pigment used in a wide range of products for its exceptional ability to impart whiteness, brightness and opacity. The pigment segment has production facilities in the United States, Germany and the Netherlands, mining and production facilities in Australia, and a European marketing subsidiary in Switzerland. The electrolytic and other chemical products segment produces chemicals for both rechargeable and non-rechargeable batteries, sodium chlorate for pulp bleaching used in the paper industry and boron-based specialty chemicals used in pharmaceuticals, high-performance fibers and other specialty products. Also, 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 and combined financial statements to refer to the consolidated group or to one or more of the companies that are part of the consolidated group.

Tronox Incorporated was formed in May 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 Contribution and an initial public offering (“IPO”) were completed during November 2005 resulting in approximately 43.3% of the total outstanding common stock of Tronox being held by the general public and 56.7% being held by Kerr-McGee. A Master Separation Agreement (“MSA”), dated November 28, 2005, among Kerr-McGee, Kerr-McGee Worldwide Corporation and the company governs the relationship between the company and the Kerr-McGee group of companies throughout a transition period. On March 30, 2006, the company’s shares owned by Kerr-McGee were distributed as a dividend to its shareholders (the “Distribution”). As a result, Kerr-McGee no longer has any ownership or voting interest in the company.

Effective with the Distribution, the company established certain employee benefit plans to replace benefits previously sponsored by Kerr-McGee and issued stock-based compensation awards resulting from the conversion of certain Kerr-McGee stock-based awards held by company employees. See Notes 10 and 11 for further discussion of these events. In connection with the Distribution, Tronox consummated several noncash transactions with Kerr-McGee during the six months ended June 30, 2006, primarily related to the employee benefit plan transfers, contribution of assets, insurance and income taxes that are reflected as adjustments to the contribution from Kerr-McGee. These items resulted in a net increase in capital in excess of par value of $10.3 million.

Basis of Presentation

The accompanying unaudited condensed consolidated and combined financial statements have been prepared by the company, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, include all adjustments, consisting only of adjustments that are normal and recurring in nature, necessary to a fair statement of the results for the interim periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. Although the company believes that the disclosures are adequate to make the information presented not misleading, these condensed consolidated and combined financial statements should be read in conjunction with the annual consolidated and combined financial statements and the notes thereto included in the company’s latest annual report on Form 10-K.
 

4


Accounting Policies

Employee Stock-Based Compensation - Prior to the IPO, certain of the company’s employees participated in Kerr-McGee’s long-term incentive plans. Under these plans, employees received various stock-based compensation awards, including stock options, restricted stock, stock opportunity grants and performance units. In the fourth quarter of 2005, the company established its own long-term incentive plan and awarded stock options and/or restricted stock under the plan to its employees and non-employee directors.

Fair-Value Method. In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (revised 2004), “Share-Based Payment” (“FAS No. 123R”), which replaces the previously issued Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS No. 123”), and supersedes Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees.” FAS No. 123R requires all share-based payments to employees to be recognized in the financial statements based on their fair values. The company adopted FAS No. 123R effective January 1, 2006, using the modified prospective method. Under this method, stock-based compensation cost recognized in income from continuing operations for the three and six months ended June 30, 2006, includes: 1) compensation cost for all stock option and stock awards that were unvested as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of FAS No. 123 and 2) compensation cost for all stock options and nonvested stock awards granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of FAS No. 123R. Stock-based compensation expense recognized in the Condensed Consolidated Statement of Operations will be higher in the future (compared with periods prior to 2006), reflecting a change in the measurement basis of stock options from intrinsic to fair value. The magnitude of the increase will depend upon the number of options granted and other factors affecting fair value.

Pro Forma Fair-Value Method. Prior to January 1, 2006, the company accounted for its stock-based awards under the intrinsic-value method permitted by APB No. 25 and disclosed compensation expense under the Pro Forma Fair-Value Method in accordance with provisions of FAS No. 123. Following this method, compensation expense for stock-based awards was measured based on the estimated grant-date fair value. If compensation expense for stock-based awards had been determined using the fair value-based method, net income for the three-month and six-month periods ending June 30, 2005, would have been lower, as presented in the following table. Pro forma stock-based compensation expense presented below may not be representative of future compensation expense using the fair-value method of accounting as prescribed by FAS No. 123R.
 
   
Three Months
Ended
 
Six Months
 Ended
 
   
June 30, 2005
 
   
(Millions of dollars, except per share)
 
           
Net income (loss), as reported
 
$
(3.6
)
$
0.4
 
Add: stock-based employee compensation expense included in reported net income (loss), net of taxes
   
0.3
   
0.9
 
Deduct: stock-based employee compensation expense determined using a fair-value method, net of taxes
   
(0.5
)
 
(1.5
)
Pro forma net loss
 
$
(3.8
)
$
(0.2
)
               
Basic and diluted net income (loss) per common share:
             
As reported
 
$
(0.16
)
$
0.02
 
Pro forma
   
(0.17
)
 
(0.01
)

Earnings Per Share - Basic earnings per share includes no dilution and is computed by dividing net income or loss available to common stockholders by the weighted average number of common shares outstanding for the period. The weighted average number of common shares outstanding for the three and six months ended June 30, 2005, includes 22,889,431 shares of Class B common stock issued to Kerr-McGee in connection with the Contribution, retroactively adjusted for the recapitalization. For the three and six months ended June 30, 2005, there is no difference between basic and diluted earnings per share since there were no dilutive securities during that period. At the Distribution, forfeiture of Kerr-McGee stock-based awards resulted in the issuance of Tronox stock-based awards (see Note 10), which were included in the earnings per share calculation as if they were outstanding as of January 1, 2006, in accordance with the provisions of FAS No. 128.

5

Goodwill and Other Intangible Assets - Goodwill is initially measured as the excess of the purchase price of an acquired entity over the fair value of individual assets acquired and liabilities assumed. Goodwill and other indefinite-lived intangibles are not amortized but are reviewed annually for impairment, or more frequently if impairment indicators arise. The annual impairment assessment for goodwill and other indefinite-lived intangible assets was completed at June 30, 2006, and no impairment was indicated.

New/Revised Accounting Standards

Deferred Stripping Costs. On January 1, 2006, the company adopted Emerging Issues Task Force ("EITF") Issue No. 04-6, "Accounting for Stripping Costs Incurred during Production in the Mining Industry" in relation to the mining activities conducted by the company and its partner under our joint venture arrangement in Australia. EITF Issue No. 04-6 addresses the accounting for stripping costs incurred during the production phase of a mine and requires treatment of these costs as variable production costs that should be included as a component of inventory to be recognized in costs applicable to sales in the same period as the revenue from the sale of inventory. As a result, capitalization of post-production stripping costs is appropriate only to the extent product inventory exists at the end of a reporting period. The guidance allows 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. The cumulative effect adjustment reduced opening retained earnings by $1.4 million (net of taxes) and eliminated the $2.2 million net deferred stripping asset from the balance sheet. Adoption of EITF Issue No. 04-6 will not have an impact on the company’s cash position or net cash from operations.
 
    FASB Exposure Draft. The FASB has recently issued an exposure draft titled “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of FASB Statements No. 87, 88, 106, and 132(R))” and is expected to issue the resulting new accounting standard later in 2006, to be effective with the 2006 annual reporting period. Assuming the provisions of the new standard are consistent with decisions reached by the FASB to date, the standard will require recognition on the balance sheet of the unrecognized portion of projected benefit obligations, with an offsetting change in accumulated other comprehensive income in equity. This initial stage of the FASB project is not expected to affect the measurement of the net periodic cost. The result of such an accounting policy will be the recognition on the balance sheet of the over or under funded status of the plans (or the difference between the benefit obligation and the fair value of plan assets, if any). Based on preliminary estimates received from the company’s actuary, it is estimated that the company will recognize a reduction of approximately $120 million ($80 million after tax) in stockholders’ equity, which represents currently unrecognized obligations.

    Uncertain Tax Positions. In July 2006, the FASB issued Interpretation No. 48 (“FIN No. 48”), “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes” (“FAS No. 109”). FIN No. 48 is effective for fiscal years beginning after December 15, 2006, and clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements. FAS No. 109 does not prescribe a recognition threshold or measurement attribute for the financial statement recognition and measurement of a tax position taken in a tax return. FIN No. 48 clarifies the application of FAS No. 109 by defining criteria that an uncertain tax position must meet in order to be recognized in an enterprise's financial statements. The interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The company is currently assessing the financial statement impact of adopting this interpretation.

6



2. Other Comprehensive Income (Loss)

Comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 was as follows:

   
Three Months Ended
    June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
                   
Net income (loss)
 
$
(14.4
)
$
(3.6
)
$
6.2
 
$
0.4
 
After tax changes in:
                         
   Foreign currency translation adjustments
   
15.4
   
(23.4
)
 
21.4
   
(37.3
)
   Deferred gain (loss) on cash flow hedges
   
(1.1
)
 
(0.6
)
 
(2.4
)
 
5.3
 
   Reclassification of realized loss on cash flow hedges to
        net income
   
0.1
   
   
1.1
   
 
   Minimum pension liability adjustments
   
   
   
(1.1
)
 
0.2
 
Comprehensive income (loss)
 
$
 
$
(27.6
)
$
25.2
 
$
(31.4
)
 
3. Inventories

Major categories of inventories at June 30, 2006 and December 31, 2005 were:

   
June 30,
2006
 
December 31,
2005
 
   
(Millions of dollars)
 
           
Raw materials
 
$
85.0
 
$
77.1
 
Work-in-progress
   
13.5
   
15.2
 
Finished goods
   
163.6
   
154.7
 
Materials and supplies
   
71.2
   
65.3
 
Total
 
$
333.3
 
$
312.3
 

4. Long-Term Receivables, Investments and Other Assets

Long-term receivables, investments, and other assets at June 30, 2006 and December 31, 2005 were as follows:

   
June 30,
2006
 
December 31,
2005
 
   
(Millions of dollars)
 
           
Prepaid pension cost
 
$
131.0
 
$
11.7
 
Receivables from insurers (Note 13)
   
23.4
   
23.5
 
Investments in equity method investees
   
21.9
   
17.5
 
Debt issuance costs
   
12.1
   
12.7
 
Receivable from the U.S. Department of Energy (Note 13)
   
5.8
   
12.5
 
Other
   
5.3
   
0.9
 
Total
 
$
199.5
 
$
78.8
 
 

7



5. Noncurrent Liabilities - Other

Noncurrent liabilities - other consisted of the following at June 30, 2006 and December 31, 2005:

   
June 30,
2006
 
December 31,
2005
 
   
(Millions of dollars)
 
           
Pension and postretirement obligations
 
$
124.6
 
$
12.6
 
Reserve for income taxes payable
   
39.5
   
37.2
 
Asset retirement obligations
   
31.1
   
27.7
 
Reserve for workers’ compensation and general liability claims
   
20.2
   
18.5
 
Other
   
30.2
   
25.4
 
Total
 
$
245.6
 
$
121.4
 

6. Discontinued Operations, Restructuring and Exit Activities

Restructuring and Exit Activities - The following table presents a reconciliation of the beginning and ending balances of reserves for restructuring and exit activities for the six months ended June 30, 2006. No significant changes in the status of such activities occurred during these periods.
   
Personnel
Costs
 
Dismantlement
and Closure
 
 
Contract Termination
 
Total(1)(2)
 
   
(Millions of dollars)
 
                   
Beginning balance
 
$
3.1
 
$
4.9
 
$
1.0
 
$
9.0
 
Payments
   
(0.2
)
 
(0.8
)
 
(0.3
)
 
(1.3
)
Adjustments
   
0.2
   
0.1
   
(0.2
)
 
0.1
 
Ending balance
 
$
3.1
 
$
4.2
 
$
0.5
 
$
7.8
 
_________________
(1)    Amounts exclude asset retirement obligations.
 
(2)
Amounts include obligations of the discontinued forest products operations that have been retained by the company.

In April 2005, in connection with the separation of the company from Kerr-McGee discussed in Note 1, the company initiated an employee compensation program designed to provide an incentive to certain employees to remain with the company over a one-year period. Costs associated with this program have been split based upon the periods in which participating employees met the service requirements, with Kerr-McGee bearing the costs for the period they benefited from this arrangement up to the IPO date and the company incurring costs after the IPO date. During the six-month period ending June 30, 2006, the company incurred costs of $1.7 million. Incentives were paid to employees during the quarter ended June 30, 2006, and Kerr-McGee reimbursed the company for its proportionate share of the incentives paid.

The company has been working on the development of a raw materials feed project to improve efficiencies and reduce costs at its Savannah, Georgia, pigment facility. The initial trials of the project indicated that modifications would be required to achieve a satisfactory economic benefit. During the second quarter of 2006, additional studies were performed to determine the technical requirements needed to achieve operations and the additional cost to complete the project. The company is evaluating the results of the study and expects to determine later in 2006 if the project will be completed. If it is decided that this is not a viable project, the assets will be written down approximately $4.0 million to their net realizable value.

Discontinued Operations - In 2004, the company’s forest products operations met the criteria for reporting as discontinued operations. Pretax loss applicable to discontinued forest products operations for the three months ended June 30, 2006 and 2005 was $1.9 million and $12.9 million, respectively. Pretax loss applicable to discontinued forest products operations for the six months ended June 30, 2006 and 2005 was $5.7 million and $14.5 million, respectively.

8

In addition to the company’s forest products operations, losses from discontinued operations for all periods presented include adjustments to amounts previously reported as discontinued operations upon disposition of the company’s thorium compounds manufacturing, uranium and refining operations. These adjustments resulted from legal expenses and changes in the estimated cost of environmental remediation and restoration activities directly related to the disposed operations. Disposals of the company’s uranium and refining operations were completed in 1989 and 1995, respectively. The company ceased operations at its West Chicago thorium processing facility in 1973. The company retained certain environmental remediation obligations and continues remediation activities directly related to these former operations, as more fully discussed in Note 13.

7. Other Income (Expense)

Components of other income (expense) for the three and six months ended June 30, 2006 and 2005 were as follows:

   
Three Months Ended
   June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
                   
Net foreign currency transaction gain (loss)
 
$
3.8
 
$
(3.7
)
$
8.1
 
$
(2.2
)
Equity in net earnings of equity method investees
   
4.7
   
   
4.7
   
0.2
 
Provision for litigation settlements
   
(3.7
)
 
   
(3.7
)
 
 
Net interest expense on borrowings with affiliates and interest income
   
0.6
   
(4.5
)
 
1.3
   
(7.6
)
Loss on accounts receivables sales
   
   
(1.2
)
 
   
(4.0
)
Other expense
   
(0.1
)
 
(0.8
)
 
(0.7
)
 
(1.6
)
Total
 
 
$
5.3
 
$
(10.2
)
$
9.7
 
$
(15.2
)


8. Summarized Income Statement Information of Affiliates

The company has investments in companies, located near its facility in Henderson, Nevada, which are accounted for under the equity method. These investees provide services to the Henderson facility and also market and develop land in the area. The company recognized $4.7 million of equity in net earnings of equity method investees for the three and six months ended June 30, 2006 (see Note 7). Unaudited summarized income statement information of the significant investees is as follows:

   
Three Months Ended
    June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
                   
Gross revenues
 
$
25.9
 
$
16.0
 
$
27.3
 
$
17.3
 
Gross profit
   
22.0
   
12.9
   
22.6
   
13.5
 
Income before income taxes
   
20.2
   
11.1
   
19.0
   
9.7
 
Net income
   
16.7
   
9.1
   
15.9
   
8.1
 

9


9. Income Taxes

In the following table the U.S. Federal income tax rate is reconciled to the company's effective tax rates for income (loss) from continuing operations as reflected in the Condensed Consolidated and Combined Statement of Operations for the three and six months ended June 30, 2006 and 2005.


   
Three Months Ended
    June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
                   
U.S. statutory tax rate - provision (benefit)
   
(35.0
)%
 
35.0
%
 
35.0
%
 
35.0
%
Increases (decreases) resulting from -
                         
  Taxation of foreign operations
   
294.0
   
15.9
   
13.8
   
5.4
 
  State income taxes
   
3.2
   
1.5
   
1.2
   
1.3
 
  Permanent adjustments
   
(21.1
)
 
2.8
   
(1.1
)
 
1.3
 
  Interest on foreign tax contingency
   
14.0
   
   
1.2
   
 
  Other-net    
24.9
   
1.1
   
   
0.8
 
Total
   
280.0
%
 
56.3
%
 
50.1
%
 
43.8
%

 
The effective tax rate was higher in the second quarter of 2006 compared to the first quarter of 2006 due primarily to the taxation of foreign operations, in particular, non-deductible permanent differences and forecasted losses in certain foreign jurisdictions in which the actual tax rate is below the statutory rate. The impact of these items was greater in the second quarter than the first as a result of a change in the proportion of income between the U.S. and foreign jurisdictions.

During the second quarter of 2006, the Mississippi State Tax Commission began an income and franchise tax audit of Kerr-McGee Worldwide Corporation covering tax years 2002 through 2004. Although no formal assessment has been received at this time, the auditors informally conveyed that an assessment for additional taxes may be forthcoming. Under the tax sharing agreement with Kerr-McGee dated November 28, 2005, Tronox is the controlling party for any Mississippi audit being conducted of Kerr-McGee Worldwide Corporation and would be potentially liable for the entire assessment, if one is made. However, Tronox believes that appropriate tax filings were made during the years under audit and is unable to determine any potential liability until a formal assessment is made. Accordingly, no reserve has been established related to this matter.

As of August 14, 2006, the company had received two preliminary written reports from the local tax authority in Germany taking exception to the deductibility of certain costs and expenses for income tax purposes and discussing the treatment of certain transactions for value added tax purposes with respect to the periods under audit of 1998 through 2001. Although the company has not fully analyzed this correspondence nor responded to such communication, the company believes that appropriate tax filings were made during the years under audit and that it has adequately provided for amounts that may be adjusted as a result of any audit settlement. However, the ultimate outcome is not presently known and, accordingly, additional provisions may be necessary and/or reclassifications of noncurrent tax liabilities to current may occur in the future related to this matter.

Contingent tax liabilities of $39.5 million and $37.2 million, at June 30, 2006 and December 31, 2005, respectively, have been included in noncurrent liabilities separate and apart from deferred income taxes. It is not expected that these contingent amounts will be paid prior to the close of calendar year 2006. These contingencies relate primarily to certain deductions associated with plant shutdown activities, deductions related to the effects of foreign currency translation and other tax-related matters. The company believes that it has made adequate provision for income taxes that may be payable with respect to years open for examination.


10


10. Employee Stock-Based Compensation

Overview - The company's Long-Term Incentive Plan (the “Plan”) authorizes the issuance of shares of the company’s Class A common stock to certain employees and non-employee directors any time prior to November 16, 2015, in the form of fixed-price stock options, restricted stock, stock appreciation rights or performance awards. A total of 6,060,000 shares of the company’s Class A common stock are authorized to be issued under the Plan, of which a maximum of 1.5 million shares of Class A common stock is authorized for issuance in connection with awards of restricted stock and performance awards to employees. The Plan also includes certain limitations on the size of awards to an individual employee and to non-employee directors as a group. Subject to these limits, a committee of the Board of Directors administering the Plan (the “Committee”) determines the size and types of awards to be issued.

The maximum period for exercise of an option granted under the Plan may not be more than ten years from the date the grant is authorized by the Committee and the exercise price may not be less than the fair market value of the Class A common stock on the date the option is granted. The Committee will determine the nature and extent of the restrictions on grants of restricted stock, the duration of such restrictions, and any circumstances under which restricted shares will be forfeited.

Stock-based awards granted by the company to its employees and non-employee directors (including awards issued as a result of the conversion of Kerr-McGee stock-based awards discussed below) generally have the following terms:

   
Vesting
 
Cash- or
 
 
Contractual
Period
Vesting
Stock-
Vesting and Other
 
Life (Years)
(Years)
Term
Settled
Conditions
         
Stock options
10
3
Graded (1)
Stock
Employee service
Restricted stock
Not applicable
3
Cliff (2)
Stock
Employee service
_________________
(1)            
An employee vests in one-third of the award at the end of each year of service. Employees terminating their employment due to retirement fully vest in their award upon retirement.
 
(2)            
An employee vests in the entire award at the end of the three-year service period. Employees terminating their employment due to retirement fully vest in their award upon retirement.
 
    Effect of Tronox Separation from Kerr-McGee - As provided in the Employee Benefits Agreement between Kerr-McGee and Tronox, except for vested stock options, vested performance unit awards, and awards held by retirement-eligible employees, Kerr-McGee stock-based awards held by Tronox employees at the date of the Distribution were forfeited and replaced with stock-based awards of comparable value issued by Tronox. Retirement-eligible Tronox employees fully vested in their Kerr-McGee stock options, restricted stock and stock opportunity grants on the Distribution date. The company evaluated this forfeiture and replacement of stock-based awards as a modification of awards (as defined by FAS No. 123R). Under the provisions of FAS No. 123R, if the fair value of the modified awards is less than their fair value immediately prior to the modification, then the initial grant-date fair value of the originally issued awards should be recognized in earnings. Refer to Note 1 for additional information on the change in the accounting policy for stock-based awards.

    The following weighted average assumptions were used with the Black-Scholes option-pricing model to evaluate the fair value of the Tronox stock option awards exchanged immediately after the modification:
   
March 30, 2006
 
Risk-free interest rate
   
4.6
%
Expected dividend yield
   
1.5
%
Expected volatility
   
34.5
%
Expected term (years)
   
6.3
 
Weighted-average estimated fair value of options converted
 
$
9.61
 
Stock fair value on the date of modification
 
$
17.47
 
Estimated fair value of the options as a % of the stock fair value on the date of modification
   
55.0
%

11

Based on the analysis and assumptions above, the company determined that the modifications did not increase the fair value of the converted stock options. Therefore, there was no incremental effect on compensation cost recognized in the first quarter of 2006, and no incremental effect is expected on cost recognition in future periods. The analysis for the other equity awards was based on the company’s Class A common stock fair value on the date of modification listed above and the number of units resulting from the conversion. This analysis also revealed that the modification did not increase the fair value of the converted equity awards, thus, there was no incremental effect on compensation cost recognized in the first quarter of 2006. The conversion of Kerr-McGee performance units to Tronox equity awards represented a liability-to-equity award modification and resulted in an insignificant amount of incremental compensation expense in the first quarter of 2006 in accordance with the newly adopted accounting standard.

Compensation Expense - The following summarizes total stock-based compensation expense recognized in income from continuing operations for the three and six months ended June 30, 2006 and 2005. Stock-based compensation expense recognized in 2006 is based on the fair value of the awards, while in 2005 it reflected the intrinsic value of the awards, if any, according to the provisions of APB No. 25.

   
Three Months Ended
     June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
Expense resulting from awards issued originally by Tronox:
                 
Stock options
 
$
0.2
 
$
 
$
0.3
 
$
 
Restricted stock
   
0.3
   
   
0.7
   
 
Expense resulting from awards issued originally by Kerr-McGee:
                         
Stock options
   
0.3
   
   
1.5
   
 
Restricted stock and stock opportunity grants
   
0.7
   
0.4
   
3.0
   
1.3
 
Total stock-based compensation expense, pretax
   
1.5
   
0.4
   
5.5
   
1.3
 
Income tax benefit
   
(0.5
)
 
(0.1
)
 
(1.4
)
 
(0.4
)
Total stock-based compensation expense, net of taxes
 
$
1.0
 
$
0.3
 
$
4.1
 
$
0.9
 

Primarily as a result of implementing FAS No. 123R for the conversion of Kerr-McGee awards, the company's income before income taxes and net income for the six months ended June 30, 2006, were $3.1 million and $2.5 million lower, respectively, than if the company had continued to account for stock-based compensation under APB No. 25. Accordingly, the respective basic and diluted per share amounts were $0.08 and $0.06 lower. Compensation expense related to Tronox stock-based awards was not significantly impacted by the adoption of the new standard.
 
The following table presents unamortized compensation cost associated with awards outstanding at June 30, 2006, and the weighted average period over which it is expected to be recognized (before considering the associated income tax benefit). Compensation cost ultimately recognized may differ from amounts presented below due to new awards, if any, and changes in the estimate of forfeitures.
   
Unamortized Cost (Pretax)
 
Remaining period
 
   
(Millions of dollars)
 
(Years)
 
           
Stock options issued by Tronox Incorporated
 
$
1.2
   
2.4
 
Restricted stock issued by Tronox Incorporated
   
3.4
   
2.4
 
Stock options converted from Kerr-McGee awards
   
2.0
   
1.4
 
Restricted stock and stock opportunity grants converted from Kerr-McGee awards
   
2.9
   
1.3
 
   
$
9.5
       

12


Stock Options - The following table presents a summary of activity for Tronox options for the six months ended June 30, 2006:
               
Intrinsic
 
   
Number of
     
Contractual
 
Value
 
   
Options
 
Price (1)
 
Life (years) (1)
 
(Millions) (2)
 
                   
Options outstanding at December 31, 2005
   
345,700
 
$
14.00
             
Options awarded (including those converted from Kerr-McGee awards)
   
923,766
   
9.63
             
Options forfeited
   
(24,711
)
 
10.71
             
Options outstanding at June 30, 2006
   
1,244,755
 
$
10.83
   
8.6
 
$
2.6
 
Options expected to vest
   
1,215,184
 
$
10.79
   
8.6
 
$
2.6
 
Options exercisable at June 30, 2006
   
350
                   
_________________
(1)            
Represents weighted average exercise price and weighted average remaining contractual life, as applicable.
 
(2)            
Reflects aggregate intrinsic value based on the difference between the market price of Tronox stock at June 30, 2006, and the options' exercise price.

        Valuation and cost attribution methods. Options’ fair value is determined on the date of grant using the Black-Scholes option-pricing model and is recognized in earnings (net of expected forfeitures) on a straight-line basis over the employee service period necessary to earn the awards, which is generally the vesting period. However, compensation cost associated with employees whose retention of the options is not contingent on providing future service is recognized immediately upon grant.
 
Tronox Stock Option valuation. The fair value of the Tronox options granted in 2005 was estimated as of the date of the grant using the Black-Scholes option-pricing model with the following assumptions:
 
   
2005
 
Risk-free interest rate
   
4.6
%
Expected dividend yield
   
1.5
%
Expected volatility
   
34.5
%
Expected term (years)
   
6.3
 
Per-unit fair value of options granted
 
$
5.01
 

    Expected Volatility - In setting the volatility assumption, the company considers both the implied volatility of the traded options of peer group companies and historical volatility of peer group company stock prices over the same contractual term as the options.

Expected Term - The expected term represents a weighted average of the expected terms of three groups of plan participants: 1) participants eligible to retire at the measurement date, 2) participants eligible to retire one year after the measurement date, and 3) participants not eligible to retire one year after the measurement date.

Kerr-McGee Stock Option valuation. The following table presents inputs and assumptions used by Kerr-McGee to estimate the fair value of stock options granted to Tronox employees in 2005 and 2004. Prior to January 1, 2006, Kerr-McGee utilized the Black-Scholes option-pricing model to estimate fair value of stock option awards.

   
2005
 
2004
 
Risk-free interest rate
   
3.9
%
 
3.5
%
Expected dividend yield
   
3.5
%
 
3.6
%
Expected volatility
   
26.4
%
 
22.6
%
Expected term (years)
   
6.0
   
5.8
 
Weighted-average estimate of fair value of options converted
 
$
20.96
 
$
8.63
 


13


Restricted Stock and Stock Opportunity Grants - The following table summarizes information about restricted stock and stock opportunity grant activity during the first six months of 2006:
           
   
Number of
 
Fair
 
   
Shares
 
Value (1)
 
           
Balance at December 31, 2005
   
321,790
 
$
13.77
 
Awards issued (including those converted from Kerr-McGee awards)
   
636,205
   
12.98
 
Awards forfeited
   
(16,339
)
 
13.70
 
Awards lapsed (due to retirements)
   
(3,236
)
 
11.74
 
Balance at June 30, 2006
   
938,420
 
$
13.24
 
Awards expected to vest
   
912,168
 
$
13.23
 
Vested at June 30, 2006
   
       
_________________
(1)            
Represents the weighted-average grant-date fair value.
 
    Valuation and cost attribution method. Grant-date fair value of restricted stock and stock opportunity grants is determined by reference to market quotes for the company’s common stock. Compensation cost is recognized in earnings (net of expected forfeitures) on a straight-line basis over the employee service period necessary to earn the awards, which is generally the vesting period. However, compensation cost associated with employees whose retention of stock awards is not contingent on providing future service is recognized immediately upon grant. 

11. Employee Benefit Plans

Overview - The company has noncontributory defined-benefit retirement plans in the U.S. and Germany, a contributory defined-benefit retirement plan in the Netherlands and company-sponsored contributory postretirement plans for health care and life insurance in the U.S. Most employees are covered under the company’s retirement plans, and substantially all U.S. employees may become eligible for postretirement benefits if they reach retirement age while working for the company. As discussed below, the company’s U.S. plans were established at the Distribution date, according to the employee benefits agreement between Kerr-McGee and Tronox.

Establishment of U.S. Plans - Effective with the Distribution at March 30, 2006, the company established a U.S. qualified defined-benefit plan (funded), a U.S. supplemental nonqualified benefit plan (unfunded) and a U.S. postretirement plan (unfunded). Benefits under the qualified plan are generally based on years of service and final average pay. The supplemental nonqualified benefit plan is designed to maintain benefits for all employees at the plan formula level.

The establishment of the U.S. plans resulted in a transfer of certain assets to the company and an assumption of obligations associated with current and former employees participating in such newly established plans. According to the employee benefits agreement between Kerr-McGee and Tronox, $450.3 million in qualified plan assets was transferred to Tronox’s newly established trust. Although not considered plan assets, certain nonqualified benefit payments will be paid from a newly established Grantor Trust. Assets in the amount of $4.4 million were transferred, in the second quarter of 2006, from the Kerr-McGee Grantor Trust account to the Tronox Grantor Trust account.


14


The following table presents U.S. obligations and assets assumed by Tronox effective March 30, 2006, based on actuarial analyses, as well as the funded status, unrecognized items and the resulting prepaid or accrued benefit cost.

   
Effective March 30, 2006
 
   
U.S. Retirement Plans
 
U.S. Postretirement Plans
 
   
(Millions of dollars)
 
           
Accumulated benefit obligation
 
$
(381.8
)
$
(144.2
)
               
Projected benefit obligation
 
$
(410.9
)
$
(144.2
)
Fair value of plan assets
   
450.3
   
 
Funded status - over (under)
   
39.4
   
(144.2
)
Unrecognized prior service cost (credit)
   
16.9
   
(5.7
)
Unrecognized actuarial loss
   
59.2
   
35.0
 
Prepaid/(accrued) benefit cost
 
$
115.5
 
$
(114.9
)

The actuarial present values of the benefit obligations presented above are based on a discount rate assumption and a rate of compensation increases assumption developed by management. The company selected a discount rate of 6% for its U.S. plans based on the results of a cash flow matching analysis which used the March 31, 2006 Citigroup Pension Discount Curve and an assumption rate of compensation increases of 3.5% based on the company’s long-term plans for compensation increases and expected economic conditions, including the effects of merit increases, promotions and general inflation. The company also selected an estimated long-term rate of return assumption as of March 31, 2006, of 8% to be used in the determination of net periodic cost for the period from April 1, 2006, through December 31, 2006. This rate was developed after reviewing both a capital asset pricing model using historical data and a forecasted earnings model.

Retirement Expense - Prior to the Distribution and the establishment of the company’s U.S. plans, Kerr-McGee allocated costs associated with employees covered by its U.S. plans based on salary for defined-benefit pension plans and based on active headcount for health and welfare postretirement plans. The tables below present this allocated cost, as well as net periodic (benefit) cost associated with the U.S. and foreign retirement plans sponsored by the company for the three-month and six-month periods ending June 30, 2006 and 2005:

   
Retirement Plans
 
Postretirement Plans
 
   
Three Months Ended June 30,
 
   
2006
 
2005 (1)
 
2006
 
2005 (1)
 
   
(Millions of dollars)
 
                   
Net periodic cost -
                 
Service cost
 
$
2.5
 
$
0.4
 
$
0.4
 
$
 
Interest cost
   
6.8
   
0.8
   
2.1
   
 
Expected return on plan assets
   
(9.6
)
 
(0.6
)
 
   
 
Net amortization -
                         
Prior service cost
   
0.7
   
(0.1
)
 
(0.3
)
 
 
Net actuarial (gain) loss
   
0.4
   
0.2
   
0.4
   
 
Sub-total net periodic cost
   
0.8
   
0.7
   
2.6
   
 
Allocated benefit plan expense (credit) from Kerr-McGee
   
   
(0.1
)
 
   
1.7
 
Total retirement expense
 
$
0.8
 
$
0.6
 
$
2.6
 
$
1.7
 
_________________
(1) 
Includes costs associated with active and inactive employees of the company’s domestic chemical business and does not include costs associated with Kerr-McGee corporate employees that became employees of Tronox after the IPO.

15



   
Retirement Plans
 
Postretirement Plans
 
   
Six Months Ended June 30,
 
   
2006
 
2005 (1)
 
2006
 
2005 (1)
 
   
(Millions of dollars)
 
                   
Net periodic cost -
                 
Service cost
 
$
3.1
 
$
0.9
 
$
0.4
 
$
 
Interest cost
   
7.6
   
1.6
   
2.1
   
 
Expected return on plan assets
   
(10.4
)
 
(1.3
)
 
   
 
Net amortization -
                         
Prior service cost
   
0.7
   
(0.1
)
 
(0.3
)
 
 
Net actuarial (gain) loss
   
0.6
   
0.4
   
0.4
   
 
Sub-total net periodic cost
   
1.6
   
1.5
   
2.6
   
 
Allocated benefit plan expense (credit) from Kerr-McGee
   
0.7
   
(0.2
)
 
2.6
   
3.4
 
Total retirement expense
 
$
2.3
 
$
1.3
 
$
5.2
 
$
3.4
 
_________________
     
 (1)
 
Includes costs associated with active and inactive employees of the company’s domestic chemical business and does not include costs associated with Kerr-McGee corporate employees that became employees of Tronox after the IPO.

12. Commitments and Contractual Agreements

At June 30, 2006, the company had outstanding letters of credit of approximately $65.3 million. These letters of credit have been granted to us by financial institutions to support our environmental cleanup costs and miscellaneous operational and severance requirements in international locations.

Tronox Western Australia Pty Ltd, a wholly-owned subsidiary of the company, entered into an agreement to purchase a 50% undivided interest in mining tenements and related mining assets. The agreement was nonbinding at June 30, 2006, pending governmental approval. The final approval was received on July 12, 2006. The tenements provide additional heavy mineral resources to be processed by our joint venture, Tiwest Joint Venture, and provide feedstock for our pigment operations. The company will record noncash capital additions during the third quarter of 2006 of approximately $9.4 million and debt of $9.4 million. The debt requires scheduled payments through 2014, including $1.1 million in 2006, with an early payment option commencing at the end of 2007.

13. Contingencies

The following table summarizes the contingency reserve balances, provisions, payments and settlements for the six months ended June 30, 2006, as well as balances, accruals and receipts of reimbursements of environmental costs from other parties.

   
Reserves for
Litigation
 
Reserves for
Environmental
Remediation(1)
 
Reimbursements
Receivable(1)
 
   
(Millions of dollars)
 
               
Balance at December 31, 2005
 
$
9.2
 
$
223.7
 
$
56.7
 
Provisions / Accruals
   
3.7
   
15.0
   
25.3
 
Payments / Settlements
   
(1.5
)
 
(17.7
)
 
(35.1
)
Balance at June 30, 2006
 
$
11.4
 
$
221.0
 
$
46.9
 
_________________
(1)
Provisions for environmental remediation and restoration include $14.3 million related to the company’s former forest products operations, thorium compounds manufacturing, uranium and refining operations. Accrual of reimbursements receivable includes $4.2 million related to the company’s former thorium compounds manufacturing. These amounts are reflected in the Condensed Consolidated and Combined Statement of Operations as a component of loss from discontinued operations (net of tax).


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Management believes, after consultation with its internal legal counsel, that the company is currently 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 each environmental site are based 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:

·  
Some sites are in the early stages of investigation, and other sites may be identified in the future.
·  
Remediation activities vary significantly in duration, scope and cost from site to site depending on the mix of unique site characteristics, applicable technologies and regulatory agencies involved.
·  
Remediation requirements are difficult to predict at sites where remedial investigations have not been completed or final decisions have not been made regarding remediation requirements, technologies or other factors that bear on remediation costs.
·  
Environmental laws frequently impose joint and several liability on all potentially responsible parties, and it can be difficult to determine the number and financial condition of other potentially responsible parties and their respective shares of responsibility for cleanup costs.
·  
Environmental laws and regulations, as well as enforcement policies, are continually changing, and the outcome of court proceedings and discussions with regulatory agencies are inherently uncertain.
·  
Unanticipated construction problems and weather conditions can hinder the completion of environmental remediation.
·  
Some legal matters are in the early stages of investigation or proceeding or their outcomes otherwise may be difficult to predict, and other legal matters may be identified in the future.
·  
The inability to implement a planned engineering design or use planned technologies and excavation methods may require revisions to the design of remediation measures, which delay remediation and increase costs.
·  
The identification of additional areas or volumes of contamination and changes in costs of labor, equipment and technology generate corresponding changes in environmental remediation costs.

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 (“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 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.

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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 (“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 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 and is expected to be completed within the next 12 months. 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 (“CalEPA”), has set a public health goal for perchlorate, and the federal EPA has established a reference dose for perchlorate, which are preliminary steps to setting drinking water standards. The establishment of 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, 2006, reserves for environmental remediation at Henderson totaled $34.2 million. 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 - 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 only after Tronox LLC exhausts a self-insured retention of approximately $61.3 million and covers only those costs incurred to achieve a cleanup level specified in the policy. As noted above, federal and state agencies have not established a drinking water standard and, therefore, it is possible that Tronox LLC may be required to achieve a cleanup level more stringent than that covered by the policy. If so, the amount recoverable under the policy may be less than the ultimate cleanup cost.


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At June 30, 2006, the company had received $7.8 million of cost reimbursement under the insurance policy, and expects additional estimated aggregate cleanup cost of $91.1 million less the $61.3 million self-insured retention to be covered by the policy (for a net amount of $29.8 million in additional reimbursement). The company believes that additional reimbursement of approximately $29.8 million is probable, and, accordingly, the company has recorded a receivable in the financial statements for that amount.

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 (“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 remediation discussed below. Groundwater monitoring and remediation is expected to continue for approximately ten years.

Vicinity Areas - EPA has listed four areas in the vicinity of the closed West Chicago facility on the NPL and has designated Tronox LLC as a Potentially Responsible Party (“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). The other NPL site, known as Kress Creek, is contiguous and involves low levels of insoluble thorium residues, principally in streambanks and streambed sediments, virtually all within a floodway. 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 cleanup work, which began in the third quarter of 2005, is expected to take about four to five years to complete, 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, 2006, the company had reserves of $93.7 million for costs related to the West Chicago facility and vicinity properties. During the quarter ended June 30, 2006, the company recorded an increase of $12.0 million to the reserve for Kress Creek due to a cost increase implemented by the commercially licensed disposal facility. The increase is effective at the end of the current contract which expires December 2007. 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”) (discussed below).

Government Reimbursement - Pursuant to Title X, the U.S. Department of Energy (“DOE”) is obligated to reimburse the company for certain decommissioning and cleanup 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 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 cleanup costs. Through June 30, 2006, the company had been reimbursed approximately $292.7 million under Title X.

Reimbursements under Title X are provided by congressional appropriations. Historically, congressional appropriations have lagged the company’s cleanup expenditures. As of June 30, 2006, the government’s share of costs incurred by the company but not yet reimbursed by the DOE totaled approximately $16.8 million, which includes $3.4 million accrued in 2006. The company received $12.0 million from the government in April 2006 and believes that receipt of the remaining $16.8 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.

19

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 (“AEC”), now the Nuclear Regulatory Commission (“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 NRC. Mill tailings, certain impacted surface soils and selected pond sediments have been consolidated in an onsite containment unit, and groundwater treatment has been ongoing. 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 remaining impacted soil was submitted by Rio Algom to the NRC in January 2005 and is currently under review. If approved, the soil decommissioning plan would take about one to two years to complete. The state of New Mexico had raised issues about certain non-radiological constituents in the groundwater at the site. A request to cease groundwater treatment, that included the non-radiological constituents, was approved by the NRC in February 2006. Discussions regarding these issues are ongoing, and resolution of them 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, 2006, the company had reserves of $10.9 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. The company has not provided a reserve for this lawsuit because at this time it cannot reasonably determine the probability of a loss, and the amount of loss, if any, cannot be reasonably estimated. Though the company and Rio Algom tentatively agreed to submit the matter to arbitration, an arbitration agreement was not reached and the suit is now in the discovery stage. The company currently believes that the ultimate resolution of the litigation is not likely to have a material adverse affect on the company.

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 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, Cimarron submitted to the NRC and the Oklahoma Department of Environmental Quality (“ODEQ”) a draft remediation work plan addressing the groundwater contamination. In 2005, the company began evaluating available technologies to address remaining groundwater issues. It is anticipated that the company will submit a plan to the NRC and the ODEQ later in 2006 for the remediation of the remaining groundwater issues following completion of the evaluation. The results of the evaluation may result in additional remediation efforts required, the costs of which, if any, are not currently included in the financial reserves discussed below.

Financial Reserves - As of June 30, 2006, the company had reserves of $5.8 million for the costs of 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.


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Lakeview, Oregon

A predecessor of Tronox Worldwide LLC operated two uranium mines near Lakeview, Oregon, from 1958 to 1960. The mines are currently designated as a Superfund site. In 2001, EPA issued a Record of Decision (“ROD”) requiring consolidation and capping of contaminated soils and continued neutralization of acidic waters in one of the two mines. It is anticipated that required work, which began in the second quarter of 2005, will take about one to two more years to complete.

Litigation - In April 2005, Tronox Worldwide LLC and two other parties reached an agreement with the federal government to settle a lawsuit filed by the government with respect to the remediation of contaminated materials at the site and to settle related claims by the parties. The suit sought reimbursement of Forest Service response costs, an injunction requiring compliance with a Unilateral Administrative Order issued to the private parties regarding cleanup of the site, and civil penalties for alleged noncompliance with the administrative order. The court approved the agreement in January 2006. As a result of the settlement, the parties have resolved their respective claims and agreed to apportion responsibility for the cleanup.

Financial Reserves - As of June 30, 2006, the company had reserves of $3.4 million for its share of 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.

Soda Springs, Idaho

From 1963 to 2000, Tronox LLC owned and operated a vanadium processing facility near Soda Springs, Idaho. In 1989, EPA designated this site as a Superfund site under CERCLA, listed the site on the NPL and named Tronox LLC as a PRP. In 2000, EPA amended a ROD previously issued by it, requiring Tronox LLC to address the presence of calcine tailings, a byproduct of vanadium processing. The amended ROD required the capping of the calcine tailings in place, the closure of certain impoundments and groundwater monitoring.

Since 2000, the vanadium processing facility plant and a fertilizer plant on the site have been closed, dismantled and removed from the site. All former impoundments included in the amended ROD have been closed. A ten-acre pond not covered by the ROD is scheduled for closure within the next two years. Tronox LLC anticipates constructing a landfill onsite as part of the closure. The duration of groundwater monitoring is not known.

Financial Reserves - As of June 30, 2006, the company had reserves of $2.7 million for the costs of the remediation required by the ROD, as well as closure of the above mentioned ten-acre pond. Although actual costs may differ from current estimates, the amount of any revisions in remediation costs cannot be reasonably estimated at this time.

Milwaukee, Wisconsin

In 1976, Tronox LLC closed a wood-treatment facility it had operated in Milwaukee, Wisconsin. Operations at the facility prior to its closure had resulted in the contamination of soil and groundwater at and around the site with creosote and other substances used in wood treating. In 1984, EPA designated the Milwaukee wood-treatment facility as a Superfund site under CERCLA, listed the site on the NPL and named Tronox LLC as a PRP. Tronox LLC executed a consent decree in 1991 that required it to perform soil and groundwater remediation at and below the former wood-treatment area and to address a tributary creek of the Little Menominee River that had become contaminated as a result of the wood-treatment operations. Actual remedial activities were deferred until after the decree was finally entered in 1996 by a federal court in Milwaukee.

Groundwater treatment was initiated in 1996 to remediate groundwater contamination below and in the vicinity of the former wood-treatment area. It is not possible to reliably predict how groundwater conditions will be affected by soil removal in the vicinity of the former wood-treatment area, which has been completed, and by ongoing groundwater treatment. It is unknown, therefore, how long groundwater treatment will continue. Soil cleanup of the former wood-treatment area began in 2000 and was completed in 2002. Also in 2002, remedial designs for the upper portion of the tributary creek were agreed to with EPA, after which Tronox LLC began the implementation of a remedy to reroute the creek and to remediate associated sediment and stream bank soils. Remediation of the upper portion of the creek is expected to take about three more years. Tronox LLC has not yet agreed with relevant regulatory authorities regarding remedial designs for the lower portion of the tributary creek.

 
21

Financial Reserves - As of June 30, 2006, the company had reserves of $4.0 million for the costs of the remediation 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. The costs associated with remediation, if any, of the lower portion of the tributary creek are not reasonably estimable at this time and, thus, no reserve has been recorded.

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 EPA is conducting a cleanup. On April 15, 2005, Tronox LLC and Tronox Worldwide LLC received a letter from EPA asserting they are liable under CERCLA as a former owner or operator of the site and demanding reimbursement of costs expended by EPA at the site. The letter made demand for payment of past costs in the amount of approximately $179 million, plus interest though EPA has informed Tronox LLC that it expects final project costs will be approximately $236 million, plus possible other costs and interest. 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 owner in the 1960s. The predecessor also did not operate the site, which had been closed down before it was acquired by the predecessor. Based on historical records, there are substantial uncertainties about whether or under what terms the predecessor assumed liabilities for the site. In addition, although it appears there may be other PRPs, the company does not know whether there are any defenses to liability available to the other PRPs or whether the other PRPs have the financial resources necessary to meet their obligations. Tronox LLC intends to vigorously defend against EPA’s demand. However, Tronox LLC and EPA have agreed to submit the matter to nonbinding mediation that could lead to a settlement or resolution of EPA’s demand. No reserve for reimbursement of cleanup costs at the site has been recorded because it is not possible to reliably estimate the liability, if any, the company may have for the site because of the aforementioned defenses and uncertainties.

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, 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 consent order requires Tronox LLC to perform an environmental investigation and remediation feasibility study, and this work is ongoing. Soil remediation and groundwater monitoring are being conducted, and further remediation options to address sediment and surface water are being evaluated. Duration of remedial activities currently cannot be estimated.

Financial Reserves - As of June 30, 2006, the company had reserves of approximately $8.1 million for the remediation activities, including those currently under evaluation, 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.

Hattiesburg, Mississippi

In January 2003, Tronox LLC entered into a consent order with the Mississippi Department of Environmental Quality to implement a remedy pursuant to an approved remediation work plan for a wood-treatment site in Hattiesburg, Mississippi. Components of the work plan included excavation of certain materials from the former processing areas and off-site sediments and containment of other on-site and off-site materials. Remediation of the former processing and certain off-site areas was completed in 2003. Some off-site remediation required by the work plan has not been completed where access by current leaseholders has been denied. Efforts to obtain necessary access are ongoing, and remedial activities are expected to take about one to two more years once access is obtained.

Financial Reserves - As of June 30, 2006, the company had reserves of approximately $2.6 million 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.

22

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, ODEQ approved the remedial design for soil and waste, which includes construction of an on-site disposal cell. A feasibility study of surface and groundwater remedial measures is under ODEQ review. Duration of remedial activities currently cannot be estimated.

Financial Reserves - As of June 30, 2006, the company had reserves of approximately $4.1 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 are 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 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. The NRC terminated the site license in May 2006.
 
Financial Reserves - As of June 30, 2006, the company had reserves of $11.1 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.

Calhoun, Louisiana

From 1973 until 1988, Triple S owned and operated a gas condensate stripping facility located near Calhoun, Louisiana. When the facility was sold in 1988, Triple S retained responsibility for environmental conditions existing prior to the date of closing. Operations at the facility prior to the sale had resulted in the contamination of soil and groundwater with petroleum hydrocarbons. Soil and groundwater remediation is ongoing under a Corrective Action Plan approved by the Louisiana Department of Environmental Quality. Remediation is estimated to take about three years pending results of a Risk Evaluation being conducted as part of the approved plan.

Financial Reserves - As of June 30, 2006, the company had reserves of $4.1 million for the costs of 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.
 
 
 

23


 
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 EPA to conduct a remedial investigation and a feasibility study. The remedial investigation was completed and submitted to EPA in August 2005. It is anticipated that the feasibility study will be submitted to EPA in late 2006 and that it will recommend soil remediation and excavation at the site as well as site capping.
 
 
Financial Reserves - As of June 30, 2006, the company had reserves of $5.6 million to complete the feasibility study and to conduct the cleanup and remediation activities the company expects to recommend to 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.
 
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, 2006, the company had reserves of $30.7 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.
 
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, 2006, the company had a receivable of $0.2 million from Kerr-McGee for remediation costs incurred in excess of established reserves.
 
 
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.
 

24


Litigation and Claims

Western Fertilizer Contract

In 1995, Tronox LLC executed an exclusive agreement with Western Fertilizer, Inc. (“Western Fertilizer”) for the storage and distribution of fertilizer produced by the company. In May 2000, the company terminated the agreement because the owner, operator and the key person of Western Fertilizer, had been sentenced to serve 17 years in prison for federal crimes involving activities unrelated to the company, thus rendering Western Fertilizer unable to perform its duties under the agreement. In June 2000, Western Fertilizer filed for bankruptcy, and its trustee alleged that the company did not have the right to terminate the agreement. In May 2003, Western Fertilizer’s bankruptcy claim against Tronox LLC was transferred to a litigation trust, and, in October 2004, the litigation trust filed an amended complaint in a pending federal lawsuit in the U.S. District Court in Idaho, seeking monetary damages of approximately $13.0 million for alleged breaches of contract. Discovery in the litigation was completed in February 2006. On March 1, 2006, both parties filed motions for summary judgment. On June 30, 2006, the Court ruled on the parties’ motions for summary judgment. It granted in part and denied in part the motion of each, ordered the parties to meet and confer regarding any remaining open issues and report back to the court. The company and plaintiff then undertook settlement discussions that resulted in an oral settlement agreement. The company currently expects a written settlement agreement will soon be entered.

Financial Reserves - As of June 30, 2006, the company had reserves of $3.7 million related to the plaintiff’s claims. Although costs associated with the resolution of the claims may ultimately differ, the amount of any difference is not expected to have a material adverse effect on the company.

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 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 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
 
Between December 31, 2002, and May 2, 2005, approximately 250 lawsuits (filed on behalf of approximately 5,100 claimants) were filed against Tronox LLC in connection with the former wood-treatment plant in Columbus, Mississippi. Substantially all of these lawsuits are pending in the U.S. District Court for the Northern District of Mississippi and have been consolidated for pretrial and discovery purposes. In June 2006, over 400 plaintiffs were involuntarily dismissed. In addition, a suit filed by the Maranatha Faith Center against Tronox LLC and Tronox Worldwide LLC on February 18, 2000, relates to the former wood-treatment plant in Columbus and is pending in the Circuit Court of Lowndes County, Mississippi. Between December 31, 2002, and June 25, 2004, three lawsuits (filed on behalf of approximately 3,300 claimants) were filed against Tronox LLC in connection with a former wood-treatment plant located in Hattiesburg, Mississippi. These lawsuits were removed to the U.S. District Court for the Southern District of Mississippi. Between September 9, 2004, and February 23, 2005, three lawsuits (filed on behalf of 64 claimants) were filed against Tronox LLC in connection with a former wood-treatment plant located in Texarkana, Texas. Two of the Texarkana lawsuits that were filed in Oklahoma (on behalf of 30 claimants) have been dismissed on jurisdictional grounds. However, in December 2005, five plaintiffs (two of whom were in the dismissed Oklahoma case) filed a new lawsuit in a Texas federal court, and in July 2006, five plaintiffs (three of whom were in the dismissed Oklahoma cases) filed a new suit in Texas. Between January 3, 2005, and July 26, 2005, 35 lawsuits (filed on behalf of approximately 4,600 claimants) were filed against Tronox LLC and Tronox Worldwide LLC in connection with the former wood-treatment plant in Avoca, Pennsylvania. All of these lawsuits seek recovery 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 creosote, a chemical used in the wood-treatment process.
 
 
25

In 2003, Tronox LLC entered into a settlement agreement that resolved approximately 1,490 of the Hattiesburg claims, which resulted in aggregate payments by Tronox LLC of approximately $0.6 million. In December 2005, Tronox LLC entered into settlement agreements to resolve up to 1,335 of the remaining Hattiesburg claims and up to 879 of the Columbus claims. The December 2005 settlement agreements required Tronox LLC to pay up to $2.5 million, of which $1.8 million was paid in December 2005. In addition, all of the remaining Hattiesburg claims have been dismissed without prejudice on the basis of failure to pay filing fees and failure to disclose information in compliance with court orders. The company currently believes that the unresolved claims relating to the Columbus, Hattiesburg, Texarkana and Avoca plants are without substantial merit and is vigorously defending against them.
 
 
Financial Reserves - As of June 30, 2006, the company had reserves of $7.2 million related to 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 the forest products litigation is not likely to have a material adverse effect on the company.
 
Kemira

In 2000, the company acquired its titanium dioxide production facility in Savannah, Georgia, from Kemira Pigments Oy, a Finnish company, and its parent, Kemira Oyj (together, “the Sellers”). After acquiring the facility, the company discovered that certain matters associated with environmental conditions and plant infrastructure were not consistent with representations made by the Sellers. The company sought recovery for breach of representations and warranties in a proceeding before the London Court of International Arbitration (“LCIA”). On May 9, 2005, the company received notice from the LCIA that the LCIA had found in favor of the company as to liability with respect to certain of the claims. The LCIA still must determine the amount of damages and a hearing related to this was held in late May 2006. A decision from the tribunal is expected in the second half of the year. The company currently cannot reasonably estimate the amount of damages that will be awarded. The company will recognize a receivable, if and when damages are awarded and all contingencies associated with any recovery are resolved.

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 also are 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, cleanup 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 EPA pursuant to CERCLA or state equivalents. Similar environmental laws and regulations and other requirements exist in foreign countries in which the company operates.


26


14. Business Segments

The company has two reportable segments: pigment and electrolytic and other chemical products. The pigment segment primarily produces and markets titanium dioxide pigment and has production facilities in the United States, Australia, Germany and the Netherlands. The pigment segment also includes heavy minerals production operated via our joint venture arrangement. The heavy minerals production is integrated with our Australian pigment plant, but also has sales to third parties. The electrolytic and other chemical products segment represents the company’s electrolytic manufacturing and marketing operations, all of which are located in the United States. Segment performance is evaluated based on operating profit, 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 (expense) and income taxes.

   
Three Months Ended
     June 30,
 
Six Months Ended
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
   
(Millions of dollars)
 
Net sales
                 
Pigment
 
$
349.0
 
$
331.4
 
$
658.0
 
$
642.2
 
Electrolytic and other chemical products
   
23.9
   
24.5
   
51.1
   
47.9
 
Total
 
$
372.9
 
$
355.9
 
$
709.1
 
$
690.1
 
Operating profit
                         
Pigment
 
$
10.2
 
$
33.5
 
$
35.9
 
$
65.2
 
Electrolytic and other chemical products(1)
   
1.3
   
1.9
   
23.1
   
(6.8
)
     
11.5
   
35.4
   
59.0
   
58.4
 
Corporate and nonoperating sites(2)
   
(6.0
)
 
(0.6
)
 
(8.5
)
 
(0.8
)
Provision for environmental remediation and restoration(3)
   
   
(5.6
)
 
   
(5.6
)
Total operating profit
   
5.5
   
29.2
   
50.5
   
52.0
 
Interest and debt expense - third parties
   
(12.3
)
 
   
(24.3
)
 
 
Other income (expense)
   
5.3
   
(10.2
)
 
9.7
   
(15.2
)
Income tax provision
   
(4.2
)
 
(10.7
)
 
(18.0
)
 
(16.1
)
Income (loss) from continuing operations
 
$
(5.7
)
$
8.3
 
$
17.9
 
$
20.7
 
_________________
(1)
Includes $0.1 million and nil for the three months ended June 30, 2006 and 2005 and $(20.4) million and $11.0 million for the six month ended June 30, 2006 and 2005, respectively, of environmental charges, net of reimbursements, related to ammonium perchlorate at the company’s Henderson facility.

(2)
Includes general corporate expenses not identified to a specific segment and general expenses related to various businesses in which the company’s affiliates are no longer engaged, but that have not met the criteria for reporting as discontinued operations.

(3)
Includes environmental provisions related to various businesses in which the company’s affiliates are no longer engaged, but that have not met the criteria for reporting as discontinued operations.



27


15. Condensed Consolidating and Combining Financial Information

The senior unsecured notes, issued jointly by Tronox Worldwide LLC and Tronox Finance Corp., with an aggregate principal amount of $350.0 million have been fully and unconditionally guaranteed by Tronox Incorporated and all of its material wholly-owned domestic subsidiaries. As a result of these guarantee arrangements, the company is required to present condensed consolidating and combining financial information.

The following tables for the periods ended June 30, 2006, and December 31, 2005, present condensed consolidating and combining financial information for (a) Tronox Incorporated, the parent company and also one of the guarantors, (b) the Issuers, Tronox Worldwide LLC and Tronox Finance Corp., (c) the guarantor subsidiaries and (d) the nonguarantor subsidiaries.

Tronox Incorporated and Tronox Finance Corp. were formed subsequent to June 30, 2005. Therefore, condensed consolidating and combining financial information for the period ended June 30, 2005, present condensed consolidating and combining financial information for (a) the Issuer, Tronox Worldwide LLC, (b) the guarantor subsidiaries and (c) the nonguarantor subsidiaries.
 
Other income (expense) in the Condensed Consolidating and Combining Statement of Operations for all periods presented includes equity interest in income (loss) of subsidiaries.

28


Condensed Consolidating Statement of Operations
Three Months Ended June 30, 2006

   
Tronox Incorporated
 
Issuers
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated
 
   
(Millions of dollars)
 
                           
Net sales
 
$
 
$
 
$
214.3
 
$
196.7
 
$
(38.1
)
$
372.9
 
Cost of goods sold
   
   
   
191.3
   
186.2
   
(35.6
)
 
341.9
 
Gross margin
   
   
   
23.0
   
10.5
   
(2.5
)
 
31.0
 
Selling, general and administrative expenses
   
0.8
   
0.1
   
14.7
   
10.9
   
(1.0
)
 
25.5
 
Provision for environmental remediation and restoration, net of reimbursements
   
   
   
   
   
   
 
     
(0.8
)
 
(0.1
)
 
8.3
   
(0.4
)
 
(1.5
)
 
5.5
 
Interest and debt expense - third parties
   
   
(13.0
)
 
0.4
   
0.3
   
   
(12.3
)
Other income (expense)
   
(13.7
)
 
(2.1
)
 
(2.1
)
 
2.1
   
21.1
   
5.3
 
Income (Loss) from Continuing Operations before Income Taxes
   
(14.5
)
 
(15.2
)
 
6.6
   
2.0
   
19.6
   
(1.5
)
Income Tax Benefit (Provision)
   
0.1
   
1.7
   
(1.1
)
 
(4.9
)
 
   
(4.2
)
Income (Loss) from Continuing Operations
   
(14.4
)
 
(13.5
)
 
5.5
   
(2.9
)
 
19.6
   
(5.7
)
Loss from Discontinued Operations, net of taxes
   
   
(0.2
)
 
(8.5
)
 
   
   
(8.7
)
Net Income (Loss)
 
$
(14.4
)
$
(13.7
)
$
(3.0
)
$
(2.9
)
$
19.6
 
$
(14.4
)

Condensed Combining Statement of Operations
Three Months Ended June 30, 2005

   
Issuer
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Combined
 
   
(Millions of dollars)
 
                       
Net sales
 
$
 
$
206.3
 
$
186.7
 
$
(37.1
)
$
355.9