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

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

 

Commission file number 1-32669

 

TRONOX INCORPORATED

(Exact Name of Registrant as Specified in its Charter)

 

 

One Leadership Square, Suite 300

211 N. Robinson Ave, Oklahoma City, Oklahoma 73102

(Address of principal executive offices)

 

Registrant’s telephone number, including area code: (405) 775-5000

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

No Securities are Registered Pursuant to Section 12(g) of the Act.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

The aggregate market values of the registrant’s Class A and Class B common stock held by non-affiliates of the registrant, computed by reference to the prices at which the classes of common stock were last sold on the New York Stock Exchange on June 29, 2007, were $269.4 million and $321.6 million, respectively.

 

As of February 18, 2008, 18,758,306 shares of the company’s Class A common stock and 22,889,431 shares of the company’s Class B common stock were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III incorporates certain information by reference from the registrant’s definitive proxy statement to be filed within 120 days of the year end with respect to its Annual Meeting of Shareholders to be held on May 14, 2008.

 

 

Tronox Incorporated

 

Form 10-K

 

Table of Contents

 

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

Statements in this report regarding Tronox Incorporated’s or management’s intentions, beliefs or expectations, or that otherwise speak to future events, are “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. These forward-looking statements include those statements preceded by, followed by or that otherwise include the words “believes,” “will,” “expects,” “anticipates,” “intends,” “estimates,” “projects,” “target,” “budget,” “goal,” “plans,” “objective,” “outlook,” “should” or similar words. Future results and developments discussed in these statements may be affected by numerous factors and risks, such as the accuracy of the assumptions that underlie the statements, the market value of Tronox Incorporated’s products, demand for consumer products for which Tronox Incorporated’s businesses supply raw materials, the financial resources of Tronox Incorporated and its competitors, changes in laws and regulations, the ability to respond to challenges in international markets, including changes in currency exchange rates, political or economic conditions in areas where Tronox Incorporated operates, trade and regulatory matters, general economic conditions, cost and availability of raw materials and transportation and other factors and risks identified in Tronox Incorporated’s U.S. Securities and Exchange Commission filings. Actual results and developments may differ materially from those expressed or implied in this Annual Report on Form 10-K. Tronox Incorporated does not undertake to update forward-looking statements to reflect the impact of circumstances or events that arise after the date the forward-looking statements were made. Investors are urged to consider closely the disclosures and risk factors in this Annual Report on Form 10-K.

TRONOX INCORPORATED

 

PART I

 

 

Company Background

 

Tronox Incorporated, a Delaware corporation, (NYSE: TRX, TRX.B) was formed on May 17, 2005, and upon an initial public offering (“IPO”), became a publicly traded company in November 2005. The terms “Tronox,” “the company,” “we,” “our” and similar terms are used interchangeably in this Annual Report to refer to Tronox Incorporated and its consolidated subsidiaries or to one or more of the companies that are part of the consolidated group. Prior to the IPO, we were a wholly owned subsidiary of Kerr-McGee Corporation (“Kerr-McGee”) comprising substantially all of its chemical business. Concurrent with the IPO, we, through our wholly owned subsidiaries, entered into borrowings of $550.0 million from senior unsecured notes and a senior secured credit facility. We distributed substantially all of the proceeds from the IPO and borrowings to Kerr-McGee. Following the IPO, Kerr-McGee retained 56.7% of our total outstanding stock which it distributed as dividends to Kerr-McGee shareholders on March 30, 2006, resulting in Kerr-McGee having no voting ownership interest in Tronox. Through our past affiliation with Kerr-McGee, we have more than 40 years of experience operating in the chemical industry. In 2006, Kerr-McGee was acquired by Anadarko Petroleum Corporation (“Anadarko”).

 

Our business has one reportable segment, pigment, and other businesses which include electrolytic and other chemical products. Our pigment segment is one of the leading global producers and marketers of titanium dioxide pigment (“TiO₂”), a white pigment used in a wide range of products. Our electrolytic and other chemical products businesses produce electrolytic manganese dioxide, sodium chlorate, boron-based and other specialty chemicals. See Note 20 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K for additional segment and geographic information.

 

In the past, we have operated or held businesses or properties, or currently hold properties, that do not relate to the current chemical business, including businesses involving the treatment of forest products, the refining and marketing of petroleum products, offshore contract drilling, coal mining and the mining, milling and processing of nuclear materials.

 

Based on the country of production, the geographic distribution of our net sales was as follows during the last three years:

 

 

Competitive Strengths

 

We benefit from a number of competitive strengths, including the following:

 

Leading Market Positions

 

We are the world’s third-largest producer and marketer of TiO₂ products based on reported industry capacity by the leading TiO₂ producers and the world’s second-largest producer and supplier of TiO₂ manufactured via proprietary chloride technology which we believe is preferred for many of the largest end-use applications. We estimate that we have a 13% share of the $6.3 billion global market for the use of TiO₂ in coatings, which industry sources consider the largest end-use market. We believe our leading market positions provide us with a competitive advantage in retaining existing customers and obtaining new business.

Global Presence

 

We are one of the few TiO₂ manufacturers with global operations. We have production facilities and a sales and marketing presence in the Americas, Europe and the Asia-Pacific regions. In 2007, sales into the Americas accounted for approximately 43% of our total TiO₂ net sales, followed by approximately 30% into Europe and approximately 27% into the Asia-Pacific region. Our global presence enables us to provide customers in approximately 100 countries with a reliable source of multiple grades of TiO₂. The diversity of the geographic markets we serve also mitigates some of our exposure to regional economic downturns.

 

Well-Established Relationships with a Diverse Customer Base

 

We sell our products to a diverse portfolio of customers with whom we have well-established relationships. Our customer base consists of approximately 1,100 customers in approximately 100 countries and includes market leaders in each of the major end-use markets for TiO₂. We have supplied each of our top ten customers with TiO₂ for more than ten years. We work closely with our customers to optimize their formulations, thereby enhancing the use of TiO₂ in their production processes. This has enabled us to develop and maintain strong relationships with our customers, resulting in a high customer retention rate.

 

Innovative, High-Performance Products

 

We offer innovative, high-performance products for nearly every major TiO₂ end-use application, including seven grades of TiO₂ for specialty applications such as food, catalysts, electro-ceramics and pharmaceutical applications. We are dedicated to continually developing our TiO₂ products to better serve our customers and responding to the increasingly stringent demands of their end-use markets. We have new and improved products for nearly every major application, and these grades are in various stages of development and preliminary plant trials. In 2007, we introduced a high-performance product for plastics.

 

Proprietary Production Technology

 

We are one of a limited number of producers in the TiO₂ industry to hold the rights to a proprietary chloride process for the production of TiO₂. Approximately 83% of our gross production capacity uses this process technology, which is the subject of numerous patents worldwide. TiO₂ produced using chloride process technology is preferred for many of the largest end-use applications. The chloride production process generates less waste, uses less energy and is less labor intensive than the sulfate process. The complexity of developing and operating the chloride process technology makes it difficult for others to enter and successfully compete in the chloride process TiO₂ industry.

 

Experienced Management Team

 

Our management team has an average of 23 years of business experience. The diversity of their business experience provides a broad array of skills that contributes to the successful execution of our business strategy. Our operations team and plant managers, who have an average of 22 years of manufacturing experience, participate in the development and execution of strategies that have resulted in production volume growth, production efficiency improvements and cost reductions. The experience, stability and leadership of our sales organization have been instrumental in growing sales volumes and developing and maintaining customer relationships.

 

Business Strategy

 

We use specific and individualized operating measures throughout our organization to track and evaluate key metrics. This approach serves as a scorecard to ensure alignment with, and accountability for, the execution of our strategy, which includes the following components:

 

Strong Customer Focus

 

We target our key markets with innovative, high-performance products that provide enhanced value to our customers at competitive prices. A key component of our business strategy is to continually enhance our product portfolio with high-quality, market-driven product development. We design our TiO₂ products to satisfy our

customers’ specific requirements for their end-use applications and align our business to respond quickly and efficiently to changes in market demands. A new grade for polyolefin masterbatch was introduced in 2007. Additional new customer-focused products are scheduled for introduction in 2008 and 2009.

 

Technological Innovation

 

We employ customer and end-use market feedback, technological expertise and fundamental research to create next-generation products and processes. Our technology development efforts include building value-added properties into our TiO₂ to enhance its performance in our customers’ end-use applications. Our research and development teams support our future business strategies, and we manage those teams using disciplined project management tools and a team approach to technological development.

 

Cornerstone Performance Improvement Program

 

In mid-2006, we implemented Project Cornerstone to improve our financial performance. Formal teams and a structured project approach were utilized to execute agreed upon work plans and timelines over a five-year period. As of the end of 2007, we were ahead of our cumulative targets in Project Cornerstone operating and selling, general and administrative cost and working capital and capital expenditure reductions. We were behind on our objectives related to land sales. The program is designed to achieve targeted levels of performance in a number of key operational and financial areas such as:

 

 

Operational Excellence

 

In 2007, due to the continual focus on safety throughout the organization, we achieved our best safety performance on record. We also improved in the areas of energy efficiency, operating efficiencies and managing fixed cost and continued to use a broad spectrum of TiO₂ ores, while maintaining the TiO₂ yield through more tightly controlled plant operations.

 

Maximize Asset Efficiency

 

We optimize our production plan through strategic use of our global facilities to save on transportation, tariffs and warehousing costs. Our production process is designed with multiple production lines. As a result, we can remedy issues with an individual line without shutting down other lines and idling an entire facility. We also actively manage production capability across all facilities. For instance, if one plant’s finishing lines are already at full capacity, that plant’s unfinished TiO₂ can be transferred to another plant for finishing.

 

Supply Chain Optimization

 

We improve our supply chain efficiency by focusing on reducing both operating costs and working capital needs. Our supply chain efforts to lower operating costs consist of reducing procurement spending, lowering transportation and warehouse costs and optimizing production scheduling.

 

Organizational Alignment

 

Aligning the efforts of our employees with our business strategies is critical to our success. To achieve that alignment, we evaluate the performance of our employees using a balanced scorecard approach. We also invest in training initiatives that link our employees’ activities directly to our business strategies. For instance, we continue to

utilize Six Sigma and lean manufacturing methodology training to support our operational excellence and asset efficiency strategic objectives.

 

Pigment Segment

 

Background

 

TiO₂ is used in a wide range of products for its exceptional ability to impart whiteness, brightness and opacity. TiO₂ is a critical component of everyday applications, such as coatings, plastics and paper, as well as many specialty products such as inks, food and cosmetics. TiO₂ is widely considered to be superior to alternative white pigments in large part due to its hiding power, which is the ability to cover or mask other materials effectively and efficiently. For example, TiO₂’s hiding power helps prevent show-through on printed paper materials (making the materials easier to read) and a high concentration of TiO₂ within paints reduces the number of coats needed to cover a surface effectively. TiO₂ is designed, marketed and sold based on specific end-use applications.

 

The global TiO₂ market is characterized by a small number of large global producers. In addition to our company, there are four other major producers: E.I. du Pont de Nemours and Company, National Titanium Dioxide Company Ltd. (“Cristal”), Huntsman Corporation and Kronos Worldwide, Inc. These five major producers accounted for approximately 68% of the global market in 2007, according to reports by these producers.

 

Based on reported industry sales by the leading TiO₂ producers, we estimate that global sales of TiO₂ in 2007 exceeded 4.9 million tonnes, generating approximately $11 billion in industry-wide revenues. Because TiO₂ is a “quality of life” product, its consumption growth is closely tied to a given region’s economic health and correlates over time to the growth in its average gross domestic product (“GDP”). According to industry estimates, TiO₂ consumption has been growing at a compounded annual growth rate of approximately 2.8% over the past decade.

 

Although there are other white pigments on the market, we believe that TiO₂ has no effective substitute because no other white pigment has the physical properties for achieving comparable opacity and brightness or can be incorporated in as cost-effective a manner. In an effort to optimize TiO₂’s cost-to-performance ratio in certain applications, some customers also use pigment “extenders,” such as synthetic pigments, kaolin clays and calcium carbonate. We estimate that the impact on our total sales from the use of such extenders is minimal.

 

We market TiO₂ under the brand name TRONOX^®, and our pigment segment represented approximately 93% of our net sales in 2007. Our world-class, high-performance pigment products are critical components of everyday consumer applications, such as coatings, plastics and paper, as well as specialty products, such as inks, foods and cosmetics.

 

Globally, including all of the production capacity of the facility operated under our Tiwest Joint Venture (discussed below), we have 535,000 and 107,000 tonnes of aggregate annual chloride and sulfate TiO₂ production capacity, respectively. We hold more than 200 patents worldwide, as well as other intellectual property and a highly skilled and technologically sophisticated work force.

 

The following are developments during 2007 that enable execution of Tronox’s overall strategic plan to increase profitability, optimize our asset base and grow sales in key regions and customers.

 

 

 

 

 

Facilities

 

We have two facilities located in the U.S., and we have one facility in each of Australia, Germany and the Netherlands. We own our facilities in Germany and the Netherlands, and the land under these facilities is held pursuant to long-term leases. We own our facilities in the U.S. and hold a 50% undivided interest in our Australian facility.

 

The following table summarizes our titanium dioxide production capacity (in gross tonnes per year) as of December 31, 2007, by location and process:

 

 

 

 

Including the TiO₂ produced by our Australian facility, we produced approximately 597,000 tonnes of TiO₂ in 2007. Our average production rates, as a percentage of capacity, were 93%, 95% and 94%, in 2007, 2006 and 2005, respectively. Excluding the Savannah sulfate facility we closed in September 2004, over the past five years, production at our current facilities increased by approximately 15%, primarily due to low-cost process improvements, improved uptime and debottlenecking. Our global manufacturing presence, coupled with our ability to increase capacity incrementally, makes us a stable supplier to many of the largest TiO₂ consumers.

 

Manufacturing Process

 

Production Process.  TiO₂ is produced using a combination of processes involving the manufacture of base pigment particles followed by surface treatment, drying and milling (collectively known as finishing). There are two commercial production processes in use: the chloride process and the sulfate process. The chloride process is a newer technology and has several advantages over the sulfate process: it generates less waste, uses less energy, is less labor intensive and permits the direct recycle of a major process chemical, chlorine, back into the production process. In addition, as described below under “Types of Titanium Dioxide,” TiO₂ produced using the chloride process is preferred for many of the largest end-use applications. As a result, the chloride process currently accounts for substantially all of the TiO₂ production capacity in North America and approximately 55% of worldwide capacity. Since the late 1980s, the vast majority of TiO₂ production capacity that has been built uses the chloride process.

In the chloride process, feedstock ores (titanium slag, synthetic rutile, natural rutile or ilmenite ores) are reacted with chlorine (the chlorination step) and carbon to form titanium tetrachloride (“TiCl₄”) in a continuous fluid bed reactor. Purification of TiCl₄ to remove other chlorinated products is accomplished using a distillation process. The purified TiCl₄ is then oxidized in a vapor phase form to produce base pigment particles and chlorine gas. The latter is recycled back to the chlorination step for reuse. Base pigment is then typically slurried with water and dispersants prior to entering the finishing step.

 

In the sulfate process, batch digestion of ilmenite ore or titanium slag is carried out with concentrated sulfuric acid to form soluble titanyl sulfate. After treatment to remove soluble and insoluble impurities and concentration of the titanyl sulfate, hydrolysis of the liquor forms an insoluble hydrous titanium oxide. This precipitate is filtered, bleached, washed and calcined to produce a base pigment that is then forwarded to the finishing step.

 

Types of Titanium Dioxide.  Commercial production of TiO₂ results in one of two different crystal forms, either rutile or anatase. Rutile TiO₂ is preferred over anatase TiO₂ for many of the largest end-use applications, such as coatings and plastics, because its higher refractive index imparts better hiding power at lower quantities than the anatase crystal form. Although rutile TiO₂ can be produced using either the chloride process or the sulfate process, customers often prefer rutile produced using the chloride process because it typically has a bluer undertone and greater durability.

 

Anatase TiO₂ can only be produced using the sulfate process and has applications in paper, rubber, fibers, ceramics, food and cosmetics. It is not recommended for outdoor applications because it is less durable than rutile TiO₂.

 

Raw Materials.  The primary raw materials that we use to produce TiO₂ are various types of titanium-bearing ores, including ilmenite, natural rutile, synthetic rutile, titanium-bearing slag and leucoxene. We generally purchase ores under multi-year agreements from a variety of suppliers in Australia, Canada, India, Norway, South Africa, Ukraine and the U.S. We purchase approximately 33% of the titanium-bearing ores we require from two suppliers under long-term supply contracts that expire in 2008 through 2010. Approximately 81% of the synthetic and natural rutile used by our facilities are obtained from the operations under the Tiwest joint venture arrangement (discussed below). We do not anticipate difficulties obtaining long-term extensions to our existing supply contracts prior to their expiration. Other significant raw materials include chlorine and petroleum coke for the chloride process, which we obtain from many suppliers worldwide, and sulfuric acid for the sulfate process, which we produce ourselves.

 

The Tiwest Joint Venture

 

Our subsidiary, Tronox Western Australia Pty. Ltd. (“TWA”), has a 50% undivided interest in all of the assets that comprise the operations conducted in Australia under the Tiwest Joint Venture (“TJV”) arrangement and is severally liable for 50% of associated liabilities. The remaining 50% undivided interest is held by a subsidiary of our joint venture partner, Exxaro Australia Sands Pty Ltd (“Exxaro”), which is a subsidiary of Exxaro Resources Limited. The joint venture partners operate a chloride process TiO₂ plant located in Kwinana, Western Australia (the “Kwinana Facility”), a mining venture in Cooljarloo, Western Australia, a mineral separation plant and a synthetic rutile processing facility, both in Chandala, Western Australia. Under separate marketing agreements, we have the right to market our partner’s share of the TiO₂ produced by the Kwinana Facility.

 

Management.  The operations associated with the Tiwest joint venture arrangement are governed by two committees: a management committee and an operating committee. The operating committee meets at least monthly and supervises the joint venture’s routine operations, and the management committee meets at least quarterly and has the authority to make fundamental corporate decisions and to overrule the operating committee’s decisions. The committees’ decisions are made by simple majority approval. If there are an equal number of votes cast for and against a matter at an operating committee meeting, the matter is referred to a subsequent meeting. If at the subsequent meeting, the matter still receives an equal number of votes cast on each side, the matter is referred to the management committee. TWA and Exxaro each have the right to appoint half of each committee’s members.

 

Heavy Minerals.  The joint venture partners mine heavy minerals from 29,161 acres under long-term mineral leases from the State of Western Australia. Our 50% undivided interest in the properties’ remaining in-place proven and probable reserves is 4.9 million tonnes of heavy minerals contained in 135 million tonnes of sand averaging

3.5% heavy minerals. The valuable heavy minerals are composed on average of 59% ilmenite, 11% zircon, 5% natural rutile and 3% leucoxene, with the remaining 22% of heavy minerals having no significant value. Ongoing evaluation of these mining leases, including leases acquired in 2006, is expected to result in an increase in our reserves.

 

Heavy-mineral concentrate from the mine is processed at a 750,000-tonne per year dry separation plant. Some of the recovered ilmenite is upgraded at the nearby synthetic rutile facility in Chandala, which has a capacity of 235,000 tonnes per year. Synthetic rutile is a high-grade TiO₂ feedstock. All of the synthetic rutile feedstock for the TiO₂ plant located at Kwinana is provided by the Chandala processing facility. Production of feedstock in excess of the plant’s requirements is sold to our other facilities with any remainder sold to third parties.

 

The following table summarizes our heavy mineral reserves and production for each of the years indicated. Mineral reserves in this table represent the estimated quantities of proven and probable ore that, under anticipated conditions, may be profitably recovered and processed for the extraction of their mineral content. Future production of these resources depends on many factors, including market conditions and government regulations. See “Risk Factors — Fluctuations in costs of our raw materials or our access to supplies of our raw materials could have an adverse effect on our results of operations.”

 

 

End-Use Markets and Applications

 

The major end-use markets for TiO₂ products, which we sell in the Americas, Europe and the Asia-Pacific region, are coatings, plastics and paper and specialty products. The tables below summarize our 2007 net sales by geography and our 2007 sales volume by end-use market:

 

 

Coatings End-Use Market.  The coatings end-use market represents the largest end-use market for TiO₂ products and accounts for approximately 60% of overall industry demand, based on reported industry sales volumes. Customers in the coatings end-use market demand exceptionally high quality standards for TiO₂, especially with regard to opacity, durability, tinting strength and brightness. We recognize four sub-markets within the coatings end- use market based on application, each of which requires different TiO₂ formulations. The table below summarizes the sub-markets within coatings, as well as their applications and primary growth factors:

 

 

Plastics End-Use Market.  The plastics end-use market accounts for approximately 24% of overall industry demand for TiO₂, based on reported industry sales volumes. Plastics producers focus on TiO₂’s opacity, durability, color stability and thermal stability. We recognize four sub-markets within the plastics market based on application,

each of which requires different TiO₂ formulations. The table below summarizes the sub-markets within plastics, as well as their applications and primary growth factors:

 

 

Paper and Specialty End-Use Market.  The paper and specialty end-use market accounts for approximately 16% of overall industry demand for TiO₂, based on reported industry sales volumes. We recognize four sub-markets within paper and specialty end-use market based on application, each of which requires different TiO₂ formulations. The table below summarizes the sub-markets within paper and specialty, as well as their applications and primary growth factors:

 

 

Sales and Marketing

 

We supply TiO₂ to a diverse customer base that includes market leaders in each of the major end-use markets for TiO₂. In 2007, our ten largest customers represented approximately 35% of our total sales volume; however, no single customer accounted for more than 10% of our total sales volume.

 

In addition to price and product quality, we compete on the basis of technical support and customer service. Our direct sales and technical service organizations carry out our sales and marketing strategy and work together to provide quality customer service. Our direct sales staff is trained in all of our products and applications. Due to the technical requirements of TiO₂ applications, our technical service organization and direct sales offices are supported by a regional customer service staff located in each of our major geographic markets.

 

Our sales and marketing strategy focuses on effective customer management through the development of strong relationships throughout our company with our customers. We develop customer relationships and manage customer contact through our sales team, technical service organization, research and development team, customer service team, plant operations personnel, supply chain specialists and senior management. We believe that multiple points of customer contact facilitate efficient problem-solving, supply chain support, formula optimization and product co-development. By developing close relationships with our customers and providing well-designed products and services, we believe we are a value-added business partner.

Competitive Conditions

 

The global market in which our TiO₂ business operates is highly competitive. Worldwide, we believe that we and the four other major producers are the only companies that use proprietary chloride process technology for production of TiO₂. We estimate that, based on gross sales volumes, these companies accounted for approximately 68% of the global market share in 2007. We believe that cost efficiency and product quality, as well as technical and customer service, are key competitive factors for TiO₂ producers.

 

TiO₂ produced using chloride process technology is preferred for many of the largest TiO₂ end-use applications; however, TiO₂ produced using sulfate process technology is preferred for certain specialty applications. The following table summarizes the estimated market share and production process mix for the five leading TiO₂ producers for fiscal year 2007:

 

 

As of December 31, 2007, including the total production capacity of TJV, we had global production capacity of 642,000 tonnes per year and an approximate 12% global market share. In addition to the major competitors discussed above, we compete with numerous smaller, regional producers, as well as producers in China that have expanded their sulfate production capacity during the previous five years.

 

The year 2007 was challenging for the TiO₂ industry due to increasing input costs and decreasing TiO₂ prices. During the year, the industry saw continued increasing costs for major TiO₂ inputs such as chlorine, coke, caustic soda and energy. Due to the competitive environment for TiO₂ sales and decreasing demand for TiO₂ in the U.S. as a result of a downturn in the housing sector and increasing energy costs, we were not able to pass these cost increases through in the terms of TiO₂ pricing. This margin squeeze has continued to be an area of priority for us as we continue to seek revenue enhancement initiatives as well as cost reduction strategies. At the end of 2007, we were ahead of target on our Project Cornerstone initiatives to reduce operating and selling, general and administrative costs and enhance revenues with a cumulative reduction of $70 million in cash cost reductions since the project inception in April of 2006. Project Cornerstone will remain a focus area for us with additional 2008 targeted cash cost savings of $22 million.

 

Titanium Dioxide Outlook

 

The world economy has experienced a prolonged period of GDP growth over the past several years and throughout 2007. In Europe, we observed continued strength in the TiO₂ demand with some moderation compared to 2006. Asia continued to be the strongest growth region, in line with developing economies’ needs. The Americas continued to be a challenging region of the world due primarily to the U.S. economy’s continued struggles with the housing market; however, this was offset with very strong growth in Latin American countries. Due to the slowdown in the housing sector and its effects, the U.S. economy is expected to remain soft for the first half of 2008 but may begin to turn around in the second half of the year. While growth in the lower margin Asia Pacific region is expected to remain close to last year, the growth in this area is not expected to totally compensate for the impact of weak U.S. growth on the global economy. Outlook for emerging economies remains positive overall, but some moderation in growth is also expected.

 

Following the moderation in growth in 2008, the long-term outlook for TiO₂ remains positive with increasing demands in the rapidly growing Asia-Pacific region. This, coupled with the fact that the industry is not expecting significant increases in capacity due to new plant construction until at least 2011, should contribute to strong supply and demand fundamentals.

Electrolytic and Other Chemical Products

 

Background

 

The electrolytic and other chemical products businesses are primarily focused on three end-use markets: advanced battery materials, sodium chlorate for pulp and paper manufacture and specialty boron products serving the semi-conductor, pharmaceutical and igniter industries.

 

Battery Materials.  The battery industry is comprised of two application areas: primary (non-rechargeable) and secondary (rechargeable) with the former representing the majority of battery shipments. The primary battery market is dominated by alkaline battery technologies which are designed to address the various power delivery requirements of a multitude of consumer and industrial battery-powered devices. Alkaline batteries are higher performing and more costly than batteries using the older zinc carbon technology, and represent approximately 81% of primary battery market demand in the U.S.

 

Electrolytic manganese dioxide (“EMD”) is the active cathode material for alkaline batteries. We are a leading supplier of EMD for the alkaline battery industry. EMD quality requirements for alkaline technology are much more demanding than for zinc carbon technology and, as a result, alkaline-grade EMD commands a higher price than zinc carbon-grade EMD. The older zinc carbon technology remains in developing countries such as China and India. As the economies of China and India continue to mature, and the need for more efficient energy sources develops, we anticipate that the demand for alkaline-grade EMD will increase. Demand for alkaline-grade EMD will be further fueled by the continued growth of consumer electronics devices partly offset by the trend toward smaller battery sizes.

 

The market application for rechargeable lithium batteries includes consumer electronics such as cell phones, computers, digital cameras, and increasingly for high-power applications that include power tools, hybrid electric vehicles (“HEVs”/“EVs”), and interruptible power supplies. A combination of improved power delivery performance and lighter weight has allowed rechargeable lithium technology to displace older lead acid and nickel cadmium technologies. The performance advantage is particularly significant in second generation higher-power lithium applications, such as power tools and HEVs, contributing to double digit growth in this segment. There are several competing cathode materials for this fast growing lithium battery segment, with lithium manganese dioxide (“LMO”) being one of the leading technologies. We believe we are the market leader in the production of LMO primarily for power tool applications.

 

The main raw material that we use to produce battery materials is manganese ore, which is purchased under both multi-year agreements and spot contracts.

 

Sodium Chlorate.  The pulp and paper industry accounts for more than 95% of the market demand for sodium chlorate, which uses it to bleach pulp. Although there are other methods for bleaching pulp, the chlorine dioxide process is preferred for environmental reasons. Approximately 62% of North American sodium chlorate production capacity is located in Canada due to the availability of lower cost hydroelectric power, which reduces manufacturing costs and ultimately, product prices. However, we believe that the proximity of domestic sodium chlorate producers to the major domestic pulp and paper producers helps offset the lower-cost power advantage enjoyed by Canadian sodium chlorate producers, through lower transportation costs.

 

The primary raw material that we use to produce sodium chlorate is sodium chloride, which we purchase under multi-year agreements and spot contracts.

 

Boron.  We produce two types of boron specialty chemicals: boron trichloride and elemental boron. Boron trichloride is a specialty chemical gas that is used in many products, including pharmaceuticals, semiconductors, high-performance fibers, specialty ceramics and epoxies. Elemental boron is a specialty chemical that is used in igniter formulations for the defense, pyrotechnic and automotive air bag industries.

Facilities

 

We produce electrolytic and other chemical products at three domestic facilities, each of which we own. The following table summarizes our production capacity (in gross tonnes per year) as of December 31, 2007, by location and product.

 

 

End-Use Markets and Applications

 

The various markets and growth factors for the electrolytic and other chemical products are as follows:

 

 

Competitive Conditions and Outlook

 

Battery Materials.  The U.S. primary battery market is the largest in the world, accounting for over one-third of global demand for EMD, and is based on alkaline grade EMD. We are the leading supplier of EMD to the U.S. market with an estimated 41% of U.S. capacity. Other significant producers and their estimated global capacity shares include Erachem, Delta, Tosoh, Xiangtan and Mitsui. The remainder of global capacity is represented by various Chinese producers.

 

The global EMD market is challenged by excess supply that has resulted in antidumping investigations in Europe, Japan and the United States. In the United States, the antidumping investigation concerns EMD imports from China and Australia. The U.S. Commerce Department’s notice of initiation estimated that EMD from Australia is being sold into the U.S. market at a price that is 52.9% below fair value, and EMD from China is being sold at a price that is 133.8% below fair value. The preliminary determination, setting forth company-specific antidumping rates, is expected in March 2008, after which time U.S. importers will need to post antidumping bonds or duty deposits at the specified rates. Final determinations from the Commerce Department and the International Trade Commission are expected by the fall of 2008. If these determinations are favorable, the issuance of antidumping orders should result in improved profitability for the U.S. EMD industry.

 

For rechargeable batteries, LMO along with lithium ion phosphate are increasingly the leading cathode materials for power-tools, HEVs and other high-power applications. We believe we are the market leader in LMO followed by Mitsui, Nippon Denko, SudChemie and several new Chinese entrants. While the market is becoming

increasingly competitive, we believe strong market fundamentals, especially as LMO-based HEVs enter the market, will continue to support a positive environment for the LMO market.

 

Sodium Chlorate.  We continue to enjoy a strong market position with an estimated 10% share of North American sodium chlorate capacity. Our significant competitors are ERCO, Eka Chemicals, Canexus and Kemira-Finnish Chemicals. We expect the U.S. market will remain strong.

 

Boron Products.  We believe that we have the majority of the installed global capacity for boron trichloride followed by Aviabor, Sigma Aldrich, and captive Japanese based manufacturers. We anticipate the market for boron trichloride will remain positive underpinned by the semiconductor market with new liquid crystal display (“LCD”) plants coming online in Asia, continued growth of new pharmaceutical drug deliveries and U.S. export growth. We believe we own a similar leading capacity share in elemental boron.

 

Research and Development

 

Research and development is an integral component of our business strategy. Enhancing our product portfolio with high-quality, market-focused product development is key in driving our business from the customer perspective.

 

Within the organization, we have approximately 78 scientists, chemists, engineers and skilled technicians involved in the development and implementation of technology (products and processes) for our business. Our product development personnel have a high level of expertise in the plastics industry and polymer additives, the coatings industry and formulations, surface chemistry, material science, analytical chemistry and particle physics. Among the process technology development group’s highly developed skills are computational fluid dynamics, process modeling, particle growth physics, extractive metallurgy, corrosion engineering and thermodynamics. The majority of scientists supporting our research and development efforts are located in Oklahoma City, Oklahoma. Our expenditures for research and development were approximately $7.7 million in 2007, $9.4 million in 2006 and $8.4 million in 2005.

 

New process developments are focused on increased through-put, control of particle physical properties and general processing equipment-related issues. Ongoing development of process technology contributes to cost reduction, enhanced production flexibility, increased capacity and improved consistency of product quality.

 

In 2007, we commercialized a new pigment grade for polyolefin masterbatch and are working closely with customers for market implementation of this grade. Additionally, several existing products were enhanced either in performance, manufacturing capability or cost reduction. New products for coatings, plastic, paper laminate and specialty applications are scheduled for introduction in 2008.

 

In 2007, we also launched several new electrolytic and specialty products with the major focus on advanced battery materials. This included two new LMO grades specially engineered for HEV applications and for advanced laptop batteries. In addition, we also commercialized a non-battery EMD grade sold into pigment and catalyst markets as part of our business portfolio diversification program.

 

Patents and Other Intellectual Property

 

Patents held for our products and production processes are important to our long-term success. We seek patent protection for our technology where competitive advantage may be obtained by patenting, and file for broad geographic protection given the global nature of our business. Our proprietary TiO₂ technology is the subject of numerous patents worldwide, the substantial majority of which relate to our chloride products and production technology.

 

We also rely upon and have taken steps to secure our unpatented proprietary technology, know-how and other trade secrets. Our proprietary chloride production technology is an important part of our overall technology position. We are committed to pursuing technological innovations in order to maintain our competitive position.

Employees

 

As of December 31, 2007, we had 2,031 employees, with 1,148 in the U.S., 846 in Europe, 23 in Australia and 14 in other international locations. Approximately 16% of our employees in the United States are represented by collective bargaining agreements, and substantially all of our employees in Europe are represented by works’ councils. We consider relations with our employees to be good.

 

Government Regulations and Environmental Matters

 

General

 

We are subject to extensive regulation by federal, state, local and foreign governments. Governmental authorities regulate the generation and treatment of waste and air emissions at our operations and facilities. At many of our operations, we also comply with worldwide, voluntary standards such as International Organization for Standardization (“ISO”) 9002 for quality management and ISO 14001 for environmental management. ISO 9000 and 14000 are standards developed by the ISO, a nongovernmental organization that promotes the development of standards and serves as a bridging organization for quality and environmental standards.

 

Environmental Matters

 

A variety of laws and regulations relating to environmental protection affect almost all of our operations. Under these laws, we are or may be required to obtain or maintain permits or licenses in connection with our operations. In addition, these laws require us to remove or mitigate the effects on the environment of the disposal or release of chemical, petroleum, low-level radioactive and other substances at various sites. Operation of pollution-control equipment usually entails additional expense. Some expenditures to reduce the occurrence of releases into the environment may result in increased efficiency; however, most of these expenditures produce no significant increase in production capacity, efficiency or revenue.

 

The table below presents environmental related expenditures we incurred for the year ended December 31, 2007, and projections of expenditures for the next two years. While it is difficult to estimate the total direct and indirect costs of government environmental regulations, the table below includes our current estimate of expenditures for 2008 and 2009.

 

 

 

 

Recurring operating expenses are expenditures related to the maintenance and operation of environmental equipment such as incinerators, waste treatment systems and pollution control equipment, as well as the cost of materials, energy and outside services needed to neutralize, process, handle and dispose of current waste streams at our operating facilities. These operating and capital expenditures are necessary to ensure that ongoing operations are handled in an environmentally safe and effective manner.

 

We are party to a number of legal and administrative proceedings involving environmental matters or other matters pending in various courts or agencies. These include proceedings associated with businesses and facilities currently or previously owned, operated or used by our affiliates or their predecessors, and include claims for personal injuries, property damages, breach of contract, injury to the environment, including natural resource damages, and non-compliance with, or lack of properly updated or renewed, permits. Our current and former operations also involve management of regulated materials and are subject to various environmental laws and regulations. These laws and regulations obligate us to clean up various sites at which petroleum and other

hydrocarbons, chemicals, low-level radioactive substances or other materials have been contained, disposed of and/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”) and are listed on the National Priority List.

 

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

 

 

We believe that we have reserved adequately for the probable and reasonably estimable costs of known contingencies. However, additions to the reserves may be required as additional information is obtained that enables us to better estimate our liabilities, including any liabilities at sites now under review. We cannot reliably estimate the amount of future additions to the reserves at this time. In certain situations reserves are probable but not presently estimable. Additionally, there may be other sites where we have potential liability for environmental-related matters for which we do not have sufficient information to determine that the liability is probable and/or reasonably estimable. We have not established reserves for such sites. For additional discussion of environmental matters, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

Availability of Reports and Governance Documents

 

We make available at no cost on our website, www.tronox.com, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and, if applicable, any amendments to those reports as soon as reasonably practicable after we file or furnish such reports to the Securities and Exchange Commission (“SEC”). Interested parties should refer to the Investor Relations link on our website. In addition, our Code of Business Conduct and Ethics, Code of Ethics for The Chief Executive Officer and Principal Financial Officers and Corporate Governance Guidelines, all of which were adopted by our Board of Directors, can be found on our website under the Corporate Governance link. We will provide these governance documents in print to any stockholder who requests

them. Any amendment to, or waiver of, any provision of the Code of Ethics for the Chief Executive Officer and Principal Financial Officers and any waiver of the Code of Business Conduct and Ethics for directors or executive officers will be disclosed on our website under the Corporate Governance link.

 

We confirm, as required by NYSE Rule 303A.12, that we are filing the certifications required by Section 302 of the Sarbanes-Oxley Act of 2002 as exhibits to this Annual Report on Form 10-K. Our Chief Executive Officer has also certified to the NYSE that he is not aware of any violation by us of any NYSE corporate governance listing standards.

 

 

We are subject to significant liabilities and claims that are in addition to those associated with our primary business. These liabilities and claims are adversely affecting our financial condition and results of operations and we could suffer losses as a result of these liabilities and claims even if our primary business performs well.

 

We currently operate our chemical business through our subsidiary, Tronox Worldwide LLC, and its subsidiaries. Tronox Worldwide LLC, its subsidiaries and their predecessors have operated a number of businesses in addition to the current chemical business, including businesses involving the treatment of forest products, the production of ammonium perchlorate and other chemicals, the refining and marketing of petroleum products, offshore contract drilling, coal mining and the mining, milling and processing of nuclear materials. As a result, we are subject to significant liabilities and claims that are in addition to those associated with our primary business, including legal, regulatory and environmental liabilities and claims. For example, we have liabilities and claims relating to the remediation of various sites at which chemicals such as creosote, perchlorate, low-level radioactive substances, asbestos and other materials have been used or disposed. Our financial condition and results of operations are adversely affected by these liabilities and claims. We also could suffer losses as a result of these liabilities and claims even if our primary business performs well. See Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K for a discussion of contingencies.

 

The costs of compliance with the extensive environmental, health and safety laws and regulations to which we are subject or the inability to obtain, update or renew permits required for the operation of our business could reduce our profitability or otherwise adversely affect us.

 

Our current and former operations involve the generation and management of regulated materials that are subject to various environmental laws and regulations and are dependent on the periodic renewal of permits from various governmental agencies. The inability to obtain, update or renew permits related to the operation of our businesses, or the costs required in order to comply with permit standards, could have a material adverse affect on us. For example, we are currently updating potential permit modification language with the EPA related to air emissions for our facility in Savannah, Georgia, and with the Clark County Department of Air Quality Management for our facility in Henderson, Nevada. Although we do not anticipate any significant difficulties in obtaining such modifications, the failure to obtain updated permit language could have a material adverse effect on our ability to produce our products and on our results of operations.

 

In addition, changes in the laws and regulations to which we are subject, or their interpretation, or the enactment of new laws and regulations, could result in materially increased and unanticipated capital expenditures and compliance costs. For example, the Registration, Evaluation and Authorization of Chemicals (“REACH”) regulatory scheme in the European Union (“EU”), will affect our European operations by imposing on us a testing, evaluation and registration program for some of the chemicals that we use or produce. At the present time, we are not able to predict the ultimate cost of compliance with these requirements or their effect on our business.

 

Environmental laws and regulations obligate us to remediate various sites at which chemicals such as creosote, perchlorate, low-level radioactive substances, asbestos and other materials have been disposed of or released. Some of these sites have been designated Superfund sites by EPA under the CERCLA. See Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K for a discussion of these matters. The discovery of contamination arising from historical industrial operations at some of our properties

has exposed us, and in the future may continue to expose us to significant remediation obligations and other damages.

 

The actual costs of environmental remediation and restoration could exceed estimates.

 

As of December 31, 2007, we had reserves in the amount of $188.8 million for environmental remediation and restoration. We reserve for costs related to environmental remediation and restoration only when a loss is probable and the amount is reasonably estimable. In estimating our environmental liabilities, including the cost of investigation and remediation at a particular site, we consider a variety of matters, including, but not limited to, the stage of the investigation at the site, the stage of remedial design for the site, the availability of existing remediation technologies, presently-enacted laws and regulations and the state of any related legal or administrative investigation or proceedings. For example, at certain sites we are in the preliminary stages of our environmental investigation and therefore have reserved for such sites amounts equal only to the cost of our environmental investigation. The findings of these site investigations could result in an increase in our reserves for environmental remediation. While we believe we have established appropriate reserves for environmental remediation based on the information we currently know, additions to the reserves may be required as we obtain additional information that enables us to better estimate our liabilities.

 

Our estimates of environmental liabilities at a particular site could increase significantly as a result of, among other things, changes in laws and regulations or relevant clean-up levels, revisions to the site’s remedial design, unanticipated construction problems, identification of additional areas or volumes of contamination, increases in labor, equipment and technology costs, changes in the financial condition of other potentially responsible parties, new information that allows us to estimate previously indeterminable obligations, and the outcome of any related legal and administrative proceedings or alternative dispute resolution proceedings (including mediation) to which we are or may become a party. For example, in 2007, the Nuclear Regulatory Commission (“NRC”) indicated that they would require additional flood protection structures for a closed tailings pile located in Ambrosia Lake, New Mexico. As a result of this new requirement, we increased reserves for environmental remediation for the Ambrosia Lake site by $5.7 million. We increased our reserves for environmental remediation in 2007, 2006 and 2005 by $15.1 million, $56.4 million and $69.0 million, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Environmental Matters — Environmental Costs” in Item 7 and Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

In addition to the sites for which we have established reserves, there may be other sites where we have potential liability for environmental matters but for which we do not have sufficient information to determine that a liability is probable and reasonably estimable. As we obtain additional information about those sites, we may determine that reserves for such sites can be reasonably estimated and should be established. New environmental claims also may arise as a result of changes in environmental laws and regulations or standards or for other reasons. If new claims arise and losses associated with those claims become probable and reasonably estimable, we will need to increase our reserves to reflect those new claims.

 

As a result of the factors described above, it is not possible for us to reliably estimate the amount and timing of all future expenditures related to environmental or other contingent matters, and our actual costs related to such matters could exceed our current reserves at December 31, 2007. See “Business — Government Regulations and Environmental Matters” and “Legal Proceedings” in Item 3.

 

Interruptions of operations at our facilities may result in liabilities or lower operating results.

 

Due to the nature of our business, we are exposed to the hazards associated with chemical manufacturing and the related storage and transportation of raw materials, products and wastes. These hazards could lead to an interruption or suspension of operations and due to the interdependence of these facilities, could have an adverse effect on the productivity and profitability of a particular manufacturing facility or on us as a whole. Potential hazards include the following:

 

 

 

There is also a risk that one or more of our key raw materials or one or more of our products may be found to have currently unrecognized toxicological or health-related impact on the environment or on our customers or employees. Such hazards may cause personal injury and loss of life, damage to property and contamination of the environment, which could lead to government fines or work stoppage injunctions and lawsuits by injured persons. If such actions are determined to be adverse to us, we may have inadequate insurance to cover such claims, or we may have insufficient cash flow to pay for such claims. Such outcomes could adversely affect our financial condition and results of operations.

 

We maintain property, business interruption, casualty and terrorism insurance that we believe is in accordance with customary industry practices, but we are not fully insured against all potential hazards incident to our businesses, including losses resulting from natural disasters or terrorist acts. Changes in insurance market conditions have in the past caused, and may in the future cause, premiums and deductibles for certain insurance policies to increase substantially and, in some instances, for certain insurance to become unavailable or available only for reduced amounts of coverage. If we were to incur a significant liability for which we were not fully insured, we might not be able to finance the amount of the uninsured liability on terms acceptable to us or at all, and might be obligated to divert a significant portion of our cash flow from normal business operations.

 

Violations or noncompliance with the extensive environmental, health and safety laws and regulations to which we are subject could result in unanticipated loss or liability.

 

Our operations and production facilities are subject to extensive environmental and health and safety laws and regulations at national, international and local levels in numerous jurisdictions relating to pollution, protection of the environment, transporting and storing raw materials and finished products and storing and disposing of hazardous wastes. We may incur substantial costs, including fines, damages, criminal or civil sanctions and remediation costs, or experience interruptions in our operations, for violations arising under these laws and regulations. In the event of a catastrophic incident involving any of the raw materials we use or chemicals we produce, we could incur material costs as a result of addressing the consequences of such event.

 

We are party to a number of legal and administrative proceedings involving environmental and other matters pending in various courts and before various agencies. These include proceedings associated with facilities currently or previously owned, operated or used by us or our predecessors, and include claims for personal injuries, property damages, injury to the environment, including natural resource damages and non-compliance with permits. Any determination that one or more of our key raw materials or products, or the materials or products associated with facilities previously owned, operated or used by us or our predecessors, has, or is characterized as having, a toxicological or health-related impact on our environment, customers or employees could subject us to additional legal claims. These proceedings and any such additional claims may be costly and may require a substantial amount of management attention, which may have an adverse affect on our financial condition and results of operations. See “Business — Government Regulations and Environmental Matters” and “Legal Proceedings” in Item 3.

 

The amount of our debt could adversely affect our financial condition, limit our ability to pursue business opportunities, reduce our operating flexibility or put us at a competitive disadvantage.

 

As of December 31, 2007, we had $475.6 million of long-term debt and $429.6 million of stockholders’ equity. Our debt could have important consequences for us. For instance, it could:

 

 

 

The senior secured credit facility and the indenture governing the unsecured notes limit, but do not prohibit, us from incurring additional debt, and we may incur additional debt in the future. If we incur additional debt, our ability to satisfy our debt obligations may become more limited.

 

The terms of our senior secured credit facility and our indenture governing the unsecured notes contain a number of restrictive and financial covenants that could limit our ability to pay dividends or to operate effectively in the future. If we are unable to comply with these covenants, our lenders could accelerate the repayment of our indebtedness.

 

The terms of our senior secured credit facility and our indenture governing the unsecured notes subject us to a number of covenants that impose significant operating restrictions on us, including our ability to incur indebtedness and liens, make loans and investments, make capital expenditures, sell assets, engage in mergers, consolidations and acquisitions, enter into transactions with affiliates, enter into sale and leaseback transactions, make optional payments or modifications of the unsecured notes or other material debt, change our lines of business and pay dividends on our common stock. We are also required by the terms of the senior secured credit facility to comply with financial covenant ratios. These restrictions could limit our ability to plan for or react to market conditions or meet capital needs.

 

A breach of any of the covenants imposed on us by the terms of our indebtedness, including the financial covenants in the senior secured credit facility, could result in a default under such indebtedness. In the event of a default, the lenders under the revolving credit facility could terminate their commitments to us, and they and the lenders of our other indebtedness could accelerate the repayment of all of our indebtedness. In such case, we may not have sufficient funds to pay the total amount of accelerated obligations, and our lenders under the senior secured credit facility could proceed against the collateral securing the facility. Any acceleration in the repayment of our indebtedness or related foreclosure could adversely affect our business.

 

We may need additional capital in the future and may not be able to obtain it on favorable terms, if at all.

 

Our industry is highly capital intensive and our success depends to a significant degree on our ability to develop and market innovative products and to update our facilities and process technology. We may require additional capital in the future to finance our future growth and development, implement further marketing and sales activities, fund our ongoing research and development activities and meet our general working capital needs. Our capital requirements will depend on many factors, including acceptance of and demand for our products, the extent to which we invest in new technology and research and development projects, and the status and timing of competitive developments. Additional financing may not be available when needed on terms favorable to us or at all. Further, the terms of the senior secured credit facility and the indenture governing the unsecured notes may limit our ability to incur additional indebtedness or issue additional shares of our common stock. If we are unable to obtain adequate funds on acceptable terms, we may be unable to develop or enhance our products, take advantage of future opportunities or respond to competitive pressures, which could harm our business.

 

As of February 29, 2008, we had total consolidated debt of $527.9 million and cash and cash equivalents of approximately $19.0 million. The total consolidated debt balance as of February 29, 2008, includes $53.0 million outstanding on the revolving credit facility and outstanding letters of credit issued under the credit facility in the amount of $67.2 million resulting in unused capacity under the revolving credit facility of $129.8 million.

 

Market conditions and cyclical factors that adversely affect the demand for the end-use products that contain our titanium dioxide could adversely affect our results.

 

Historically, regional and world events that negatively affect discretionary spending or economic conditions generally, such as terrorist attacks, the incidence or spread of contagious diseases or other economic, political, or public health or safety conditions, have adversely affected demand for the finished products that contain TiO₂ and from which we derive substantially all of our revenue. Events such as these are likely to contribute to a general

reluctance by the public to purchase “quality of life” products, which could cause a decrease in demand for our chemicals and, as a result, may have an adverse effect on our results of operations and financial condition.

 

Additionally, the demand for TiO₂ during a given year is subject to seasonal fluctuations. TiO₂ sales are generally higher in the second and third quarters of the year than in the other quarters due in part to the increase in paint production in the spring to meet demand resulting from the spring and summer painting season in North America and Europe. We may be adversely affected by existing or future cyclical changes, and such conditions may be sustained or further aggravated by anticipated or unanticipated changes in regional weather conditions. For example, poor weather conditions in a region can lead to an abbreviated painting season, which can depress consumer sales of paint products that use TiO₂.

 

Our business, financial condition and results of operations could be adversely affected by global and regional economic downturns and other conditions.

 

We have significant production, sales and marketing operations throughout the U.S., Europe and the Asia-Pacific region, with approximately 1,100 customers in approximately 100 countries. We also purchase many of the raw materials used in the production of our products in foreign jurisdictions. In 2007, approximately 47% of our total revenues were generated from production outside of the U.S. Due to these factors, our performance, particularly the performance of our pigment segment, is cyclical and tied closely to general economic conditions, including global GDP. As a result, our business, financial condition and results of operations are vulnerable to political and economic conditions affecting global gross domestic product and the countries in which we operate. For example, from 2000 through 2003, our business was affected when the TiO₂ industry experienced a period of unusually weak business conditions as a result of a variety of factors, including the global economic recession and exceptionally rainy weather conditions in Europe and the Americas, and the outbreak of SARS in Asia. Based on these factors, global and regional economic downturns and other conditions, such as downturns in the housing or construction industries, may have an adverse effect on our financial condition and results of operations.

 

Our results of operations may be adversely affected by fluctuations in currency exchange rates.

 

The financial condition and results of operations of our operating entities in the European Union, among other jurisdictions, are reported in various foreign currencies and then translated into U.S. dollars at the applicable exchange rate for inclusion in the financial statements. As a result, any appreciation of the U.S. dollar against these foreign currencies will have a negative impact on our reported sales and operating margin. In addition, our operating entities often need to convert currencies they receive for our products into currencies in which they purchase raw materials or pay for services, which could result in a gain or loss depending on fluctuations in exchange rates. Because we have significant operations in Europe and Australia, we are exposed primarily to fluctuations in the euro and the Australian dollar. For instance, our operating costs in Australia were adversely affected by the 8.5% decline in the U.S. dollar relative to the Australian dollar in the fourth quarter of 2007 compared to the first nine months of the year.

 

In the past, we have sought to minimize our foreign currency translation risk by engaging in hedging transactions. We may be unable to effectively manage our foreign currency translation risk, and any volatility in foreign currency exchange rates may have an adverse effect on our financial condition or results of operations. For a further discussion of how we manage our foreign currency risk, see “Quantitative and Qualitative Disclosure about Market Risk — Foreign Currency Exchange Rate Risk” in Item 7A.

 

Our industry and the end-use markets in which we compete are highly competitive. This competition may adversely affect our results of operations and operating cash flows.

 

Each of the markets in which we compete is highly competitive. Competition is based on a number of factors such as price, product quality and service. We face significant competition from major international producers, including the four other major producers, as well as smaller regional competitors. Our most significant competitors include major chemicals and materials manufacturers and diversified companies, a number of which have substantially larger financial resources, staffs and facilities than we do. The additional resources and larger staffs and facilities of such competitors may give them a competitive advantage when responding to market conditions

and capitalizing on operating efficiencies. Increased competition could result in reduced sales, which could adversely affect our profitability and operating cash flows. See “Business — Pigment Segment — Competitive Conditions.”

 

In addition, within the end-use markets in which we compete, competition between products is intense. We face substantial risk that certain events, such as new product development by our competitors, changing customer needs, production advances for competing products or price changes in raw materials, could cause our customers to switch to our competitor’s products. If we are unable to develop and produce or market our products to compete effectively against our competitors following such events, our results of operations and operating cash flows may suffer.

 

Fluctuations in costs of our raw materials or our access to supplies of our raw materials could have an adverse effect on our results of operations.

 

In 2007, raw materials used in the production of TiO₂ constituted approximately 28% of our operating expenses. Costs of many of the raw materials we use may fluctuate widely for a variety of reasons, including changes in availability, major capacity additions or reductions or significant facility operating problems. These fluctuations could negatively affect our operating margins and our profitability. As these costs rise, our operating expenses likely will increase and could adversely affect our business, especially if we are unable to pass price increases in raw materials through to our customers.

 

Should our vendors not be able to meet their contractual obligations or should we be otherwise unable to obtain necessary raw materials, we may incur higher costs for raw materials or may be required to reduce production levels, which may have an adverse effect on our financial position, results of operations or liquidity. For a further discussion, see “Business — Pigment Segment — Manufacturing Process — Raw Materials.”

 

The labor and employment laws in many jurisdictions in which we operate are more restrictive than in the U.S. Our relationship with our employees could deteriorate, which could adversely affect our operations.

 

In the U.S., approximately 188 employees at our Savannah, Georgia, facility are members of a union and are subject to a collective bargaining arrangement that is scheduled to expire in April 2008. Approximately 43% of our employees are employed outside the U.S. In certain of those countries, such as Australia and the member states of the European Union, labor and employment laws are more restrictive than in the U.S. and, in many cases, grant significant job protection to employees, including rights on termination of employment. For example, in Germany and the Netherlands, by law some of our employees are represented by a works’ council, which subjects us to employment arrangements very similar to collective bargaining agreements.

 

We are required to consult with and seek the consent or advice of the unions or works’ councils that represent our employees for certain of our activities. This requirement could have a significant impact on our flexibility in managing costs and responding to market changes. Furthermore, there can be no assurance that we will be able to negotiate labor agreements with our unionized employees in the future on satisfactory terms. If those employees were to engage in a strike, work stoppage or other slowdown, or if any of our other employees were to become unionized, we could experience a significant disruption of our operations or higher ongoing labor costs, which could adversely affect our financial condition and results of operations.

 

Third parties may develop new intellectual property rights for new processes and/or products that we would want to use, but would be unable to do so; or, third parties may claim that the products we make or the processes we use infringe their intellectual property rights, which may cause us to pay unexpected litigation costs or damages or prevent us from making, using or selling the products we make or require us to alter the processes we use.

 

Although currently there are no pending or threatened proceedings or claims relating to alleged infringement, misappropriation, or violation of the intellectual property rights of others, we may be subject to legal proceedings and claims in the future in which third parties allege that their patents or other intellectual property rights are infringed, misappropriated or otherwise violated by us or by our products or processes. In the event that any such

infringement, misappropriation or violation of the intellectual property rights of others is found, we may need to obtain licenses from those parties or substantially re-engineer our products or processes in order to avoid such infringement, misappropriation or violation. We might not be able to obtain the necessary licenses on acceptable terms or be able to re-engineer our products or processes successfully. Moreover, if we are found by a court of law to infringe, misappropriate or otherwise violate the intellectual property rights of others, we could be required to pay substantial damages or be enjoined from making, using or selling the infringing products or technology. We also could be enjoined from making, using or selling the allegedly infringing products or technology pending the final outcome of the suit. Any of the foregoing could adversely affect our financial condition and results of operations.

 

Results of our operations may also be negatively impacted if a competitor develops or has the right to use intellectual property rights for new processes or products and we cannot obtain similar rights on favorable terms and are unable to independently develop non-infringing competitive alternatives.

 

If we are not able to continue our technological innovation and successful commercial introduction of new products, our profitability could be adversely affected.

 

Our industries and the end-use markets into which we sell our products experience periodic technological change and product improvement. Our future growth will depend on our ability to gauge the direction of commercial and technological progress in key end-use markets and on our ability to fund and successfully develop, manufacture and market products in such changing end-use markets. We must continue to identify, develop and market innovative products or enhance existing products on a timely basis in order to maintain our profit margins and our competitive position. We may not be able to develop new products or technology, either alone or with third parties, or license intellectual property rights from third parties on a commercially competitive basis. If we fail to keep pace with the evolving technological innovations in our end-use markets on a competitive basis, our financial condition and results of operations could be adversely affected.

 

If our intellectual property were compromised or copied by competitors, or if competitors were to develop similar intellectual property independently, our results of operations could be negatively affected.

 

Our success depends to a significant degree upon our ability to protect and preserve our intellectual property rights. Although we own and have applied for numerous patents and trademarks throughout the world, we may have to rely on judicial enforcement of our patents and other proprietary rights. Our patents and other intellectual property rights may be challenged, invalidated, circumvented, rendered unenforceable or otherwise compromised. A failure to protect, defend or enforce our intellectual property could have an adverse effect on our financial condition and results of operations.

 

We also rely upon unpatented proprietary technology, know-how and other trade secrets to maintain our competitive position. While it is our policy to enter into confidentiality agreements with our employees and third parties to protect our proprietary expertise and other trade secrets, these agreements may not be enforceable or, even if legally enforceable, we may not have adequate remedies for breaches of such agreements. We also may not be able to readily detect breaches of such agreements. The failure of our patents or confidentiality agreements to protect our proprietary technology, know-how or trade secrets could result in significantly lower revenues, reduced profit margins or loss of market share.

 

We may be unable to determine when third parties are using our intellectual property rights without our authorization. We also have licensed certain of our intellectual property rights to third parties, and we cannot be certain that our licensees are using our intellectual property only as authorized by the applicable license agreement. The undetected or unremedied, unauthorized use of our intellectual property rights or the legitimate development or acquisition of intellectual property related to our industry by third parties could reduce or eliminate any competitive advantage we have as a result of our intellectual property, adversely affecting our financial condition and results of operations. If we must take legal action to protect, defend or enforce our intellectual property rights, any suits or proceedings could result in significant costs and diversion of our resources and our management’s attention, and we may not prevail in any such suits or proceedings. A failure to protect, defend or enforce our intellectual property rights could have an adverse effect on our financial condition and results of operations.

Shared control of our joint venture may delay decisions or actions important for operations.

 

A portion of our operations currently are conducted through a joint venture. We share control of this joint venture with Exxaro.

 

Our forecasts and plans with respect to this joint venture assume that our joint venture partner will observe their joint venture obligations. In the event that our joint venture partner does not observe their joint venture obligations, it is possible that the joint venture would not be able to operate in accordance with its business plans or that we would be required to increase our level of commitment in order to give effect to such plans.

 

As with any joint venture arrangement, differences in views among the joint venture participants may result in delayed decisions or in failures to agree on major matters, potentially adversely affecting the business and operations of the joint venture and in turn our business and operations.

 

 

None.

 

 

Our properties consist of the physical assets necessary and appropriate to produce, distribute and supply our TiO_2, electrolytic manganese dioxide, sodium chlorate, boron-based and other specialty chemicals and consist mainly of manufacturing and distribution facilities and mining tenements. We believe our properties are in good operating condition and are well maintained. Pursuant to separate financing agreements, substantially all of the U.S. properties and our mining tenements are pledged or encumbered to support or otherwise provide the security for our indebtedness. In addition, we currently hold properties that do not relate to the current chemical business, including businesses involving the treatment of forest products, the production of ammonium perchlorate, the refining and marketing of petroleum products, offshore contract drilling, coal mining and the mining, milling and processing of nuclear materials.

 

For additional information regarding our properties, see “Item 1. Business” and Note 20 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

 

Savannah Plant

 

On September 8, 2003, the Environmental Protection Division of the Georgia Department of Natural Resources (“EPD”) issued a unilateral Administrative Order to our subsidiary, Tronox Pigments (Savannah) Inc., claiming that the Savannah plant exceeded emission allowances provided for in the facility’s Title V air permit. On September 19, 2005, the EPD rescinded the Administrative Order and filed a Withdrawal of Petition for Hearing on Civil Penalties. Accordingly, the proceeding on administrative penalties has been dismissed, without prejudice. After dismissal of the Administrative Order, representatives of EPD, the EPA and Tronox continued with their discussions regarding a resolution of the alleged violations, with EPA taking the lead role in these discussions. On December 6, 2006, the EPA informed Tronox Pigments (Savannah) Inc. that it had submitted a civil referral to the U.S. Department of Justice (“DOJ”) with respect to the air quality bypass issue and for matters stemming from the EPA led Resource Conservation and Recovery Act (“RCRA”) Compliance Evaluation Inspection (“CEI”) that occurred in January 2006. Prior to the filing of any formal action, DOJ had agreed to a series of settlement negotiations to determine if the matter could be resolved. After discussions with the EPA and the DOJ, the company tendered an offer of settlement and compromise to the government on June 22, 2007, to settle all outstanding issues in the amount of $600,000 as a cash penalty payable over an eight-month period and approximately $2.4 million in supplemental environmental projects. On November 27, 2007, the parties entered into an agreement to toll the statute of limitations, which will expire on March 21, 2008, unless further extended by the parties. Discussions regarding the offer of settlement are ongoing.

Hamilton Plant

 

The EPA and the Mississippi Department of Environmental Quality (“MDEQ”) conducted a CEI at the Hamilton facility during April 2006, which focused on compliance with the RCRA. In November 2006, the EPA transmitted to the facility a copy of its RCRA CEI Report and Sampling Report, which identified a number of “alleged violations” of the RCRA, as incorporated by the Mississippi Hazardous Waste Management Regulations. In March 2007, the facility sent a response to the alleged violations. In November 2007, the DOJ informed Tronox that the EPA, Region 4, had referred the alleged violations to the DOJ for civil enforcement. Prior to any enforcement being instituted, Tronox has requested a meeting with the DOJ and the EPA to discuss the alleged violations. Discussions with the DOJ and EPA are ongoing.

 

New Jersey Wood-Treatment Site

 

Tronox LLC was named in 1999 as a potential responsible party (“PRP”) under CERCLA at a former wood-treatment site in New Jersey at which the EPA is conducting a cleanup. On April 15, 2005, Tronox LLC received a letter from the EPA asserting it is liable under CERCLA as a former owner or operator of the site and demanding reimbursement of costs expended by the EPA at the site. The letter made demand for payment of past costs in the amount of approximately $179 million, plus interest, though the EPA has informed Tronox LLC that as of December 5, 2006, project costs are approximately $244 million, plus other future costs and interest and would consider resolving the matter for $239 million. Tronox LLC did not operate the site, which had been sold to a third party before Tronox LLC succeeded to the interests of a predecessor in the 1960s. The predecessor also did not operate the site, which had been closed 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 any liabilities for the site. In addition, although it appears there may be other PRPs to whom notice has been given, the company does not know whether the other PRPs have any valid defenses to liability for the site or whether the other PRPs have the financial resources necessary to meet their obligations, if proven. Tronox LLC, Tronox Worldwide LLC, Tronox Incorporated, Kerr-McGee Worldwide Corporation and the EPA entered into an agreement to toll the statute of limitations (“tolling agreement”) on March 28, 2006, and Tronox LLC and the EPA have submitted the matter to nonbinding mediation that could lead to a settlement or resolution of the EPA’s demand.

 

On June 25, 2007, the New Jersey Department of Environmental Protection (“NJ DEP”) and the Administrator of the New Jersey Spill Compensation Fund sued Tronox LLC and unnamed others in Superior Court, Law Division, Somerset County, New Jersey. The plaintiffs allege defendants are responsible for releases from the Federal Creosote Superfund Site that damaged the state’s groundwater and seek natural resource damages and reimbursement of costs that the state expended at the site and other similar relief. Tronox LLC has filed an answer in the matter. The state court has ordered that the case be stayed and referred the matter to the ongoing mediation with the EPA regarding the site.

 

As a follow-up to a July 2007 mediation session, another meeting was held on November 28, 2007, with the mediator, the EPA, the DOJ, the New Jersey Attorney General’s office and the NJ DEP to discuss the remedy utilized by the government to clean up the site. Following this meeting, the DOJ and the EPA discussed the next steps with the mediator and it was agreed that the EPA and DOJ would continue to focus on their evaluation of other PRPs and would submit a response (either in writing or in another meeting) to the issues we raised in the November mediation session. On January 16, 2008, the EPA served information requests on Tronox LLC seeking additional information related to the transaction by Kerr-McGee that resulted in the ultimate spin off of Tronox. A similar request was also served on Anadarko Petroleum Corporation on or about the same date.

 

On November 14, 2007, two members of the U.S. Senate requested the U.S. Government Accountability Office (“GAO”) investigate EPA’s cleanup of the site. On November 28, 2007, the GAO accepted the request and indicated it would begin its investigation around February 1, 2008.

 

The tolling agreement has been extended until the end of July 2008, in order to work through the various issues. If the mediation is unsuccessful, we intend to vigorously defend against the EPA’s claim.

Forest Products

 

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

 

At Columbus, Mississippi, the Maranatha Faith Center filed a state court property damage lawsuit in 2000. The church filed bankruptcy in 2003 but continues to prosecute its lawsuit. Tronox LLC moved for change of venue due to adverse publicity in the Columbus community stemming from prior litigation and settlements. In September 2006, the judge agreed with Tronox LLC and ordered the transfer of venue. On February 6, 2008, the judge reassigned the case to another judge and transferred the trial from Columbus to Starkville, Mississippi. Trial is set for October 27, 2008. Also pending in Mississippi state courts are two cases with two local businesses alleging property damage. Pending in Mississippi federal court are 238 cases filed from 2002 to 2005 that have been consolidated for pretrial and discovery purposes. While many plaintiffs have been dismissed on motions filed by Tronox LLC, over 2,000 plaintiffs remain in the consolidated action. In January 2007, the judge granted the Tronox LLC severance motion, requiring each individual plaintiff’s case to be tried separately. However, the judge excepted from his severance order two plaintiffs (one with personal injuries and the other with property damage) who were set to be tried jointly later in 2007. These cases were subsequently stricken from the court’s trial docket so that the parties could pursue mediation. On October 3, 2007, the judge entered an order dismissing the consolidated litigation without prejudice, limiting future litigation to individual cases that are not settled through mediation. In December 2007, negotiations on the terms of a mediation agreement concluded with the execution of a mediation agreement. The first mediation hearing in this matter is expected to begin in the first half of 2008.

 

At Avoca, Pennsylvania, 35 state court lawsuits were filed in 2005 by over 4,000 plaintiffs. The plaintiffs have classified their claims into various alleged disease categories. In September 2005, the judge ordered that discovery and the first trial will focus on plaintiffs who allege precancerous skin lesions. The first trial was scheduled for August 2007, but in May 2007 the parties agreed on arbitration as an alternative to this litigation. The trial judge approved arbitration and placed the lawsuits on an inactive docket. The first arbitration, to address plaintiffs who claim pre-cancerous skin lesions, was conducted from October 1-10, 2007, with a single arbitrator to decide whether plaintiffs’ claims should be compensated. In November 2007, both sides submitted post-arbitration briefs, findings of fact and conclusions of law for the arbitrator’s consideration. On January 4, 2008, counsel for the parties made closing arguments to the arbitrator, and the parties are awaiting a decision by the arbitrator.

 

At Texarkana, Texas, three federal lawsuits were filed from 2004 to 2006. The five plaintiffs in May v. Tronox concluded settlement negotiations with the insurer for Tronox in April 2007, and the case was dismissed in June 2007. Similarly, in Avance v. Tronox, 27 plaintiffs reached settlements with the insurer in July, and the case was dismissed on October 12, 2007. In Jeans v. Tronox, six plaintiffs and the insurer reached an agreement in principle to settle in January 2008. When the agreement is finalized, this case will be dismissed. It is expected that the settlement will be fully funded by the insurer.

 

For a discussion of other legal proceedings and contingencies, including proceedings related to our environmental liabilities, see Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

 

None.

 

 

Our common stock is traded on the New York Stock Exchange (“NYSE”). As of February 18, 2008, we had 15 holders of record of our Class A (NYSE: TRX) common stock and 12,833 holders of record for our Class B (NYSE: TRX.B) common stock.

 

We declared four dividends in both 2007 and 2006 of five cents per share for Class A and Class B common stock.

 

The following graph presents the cumulative total return for our Class A common stock since initial trading started on November 22, 2005, compared with the cumulative total return to shareholders of the S&P 500 Stock Index and the S&P Chemicals Index.

 

COMPARISON OF 13 MONTH CUMULATIVE TOTAL RETURN*
Among Tronox Incorporated, The S & P 500 Index
And The S & P Chemicals Index

 

 

 

 

 

The following table sets forth selected financial data as of the dates and for the periods indicated. The statement of operations and balance sheet data have been derived from our audited consolidated and combined financial statements. Certain prior-year amounts relating to net sales, cost of goods sold, gross margin, and selling, general and administrative expenses have been reclassified to conform to the current-year presentation. These changes had no impact on income (loss) from continuing operations or net income (loss). A description of these changes is available in Note 1 to the Consolidated and Combined Financial\ Statements included in Item 15(a) of this Annual Report on Form 10-K. The information should be read in conjunction with our Consolidated and Combined Financial Statements (including the notes thereto) and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report.

 

 

 

The following table reconciles net income (loss) to EBITDA and Adjusted EBITDA for the periods presented:

 

 

 

 

 

 

The following discussion should be read in conjunction with the selected financial data and the consolidated and combined financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.

 

General

 

Our business has one reportable segment, pigment, and other businesses which include electrolytic and other chemical products. Our pigment segment is one of the leading global producers and marketers of titanium dioxide pigment (“TiO₂”), a white pigment used in a wide range of products. Our other businesses include electrolytic and other chemical products which produce electrolytic manganese dioxide (“EMD”), sodium chlorate, boron-based and other specialty chemicals. We operate eight production facilities (five pigment and three other chemical products) and have direct sales and technical service organizations in the United States (“U.S.”), Europe and the Asia-Pacific region.

 

Segment Evaluation.  Our management evaluates the pigment segment performance separately based on segment operating profit (loss), which represents the results of segment operations before unallocated costs, such as general corporate expenses not identified to a specific segment and environmental provisions related to sites no longer in operation, income tax expense or benefit and other income (expense). Total operating profit (loss) of our segment and other businesses is a financial measure of our performance which is not determined in accordance with generally accepted accounting principles (“GAAP”), as it excludes general expenses and environmental provisions related to sites no longer in operation which are a component of income (loss) from continuing operations, the most comparable GAAP measure.

 

Our management considers total operating profit (loss) of our segment and other businesses to be an important supplemental measure of our operating performance by presenting trends in our core businesses and facilities currently in operation. This measure is used by us for planning and budgeting purposes and to facilitate period-to-period comparisons in operating performance. It is also useful to investors because it provides a means to evaluate the operating performance of our segment and our company on an ongoing basis using criteria that are used by our internal decision makers. Additionally, it highlights operating trends and aids analytical comparisons. However, total operating profit (loss) of our segment and other businesses has limitations and should not be used as an alternative to income (loss) from continuing operations, a performance measure determined in accordance with GAAP, as it excludes certain costs that may affect our operating performance in future periods.

 

Overview

 

General Factors Affecting the Results of Continuing Operations

 

The year 2007 was challenging for the TiO₂ industry due to increasing input costs and decreasing TiO₂ prices. During the year, the industry saw continued increasing costs for major TiO₂ inputs such as chlorine, coke, caustic soda and energy. Due to the competitive environment for TiO₂ sales and decreasing demand for TiO₂ in the U.S. as a result of a downturn in the housing sector, we were not able to pass these cost increases through in the terms of TiO₂ pricing. This margin squeeze has continued to be an area of priority for us as we continue to seek revenue enhancement initiatives as well as cost reduction strategies.

 

In February 2007, we announced a global TiO₂ production strategy that focuses on capturing opportunities presented by our chloride technology expertise, strong customer base and the rapid growth of the Asia-Pacific market. Consistent with this strategy, we have made the following recent announcements:

 

 

 

 

 

We had been working on the development of a raw materials feed project to improve efficiencies and reduce costs at our Savannah, Georgia, pigment facility. Due to reductions in capital spending, it is doubtful that this project will be completed, and therefore, it does not meet the criteria for treatment as assets. Accordingly, we recorded a charge of $3.8 million reflected in cost of goods sold in the Consolidated and Combined Statement of Operations for the year ended December 31, 2007, to write off this project. Additionally, other assets at the plant with a total net book value of $1.1 million were not currently in use and were written off to cost of goods sold in 2007.

 

Due to the nature of our current and former operations, we have significant environmental remediation obligations and are subject to legal and regulatory liabilities. Former operations include, among others, operations involving the treatment of forest products, the refining and marketing of petroleum products, offshore contract drilling, coal mining and the mining, milling and processing of nuclear materials. For example, we have liabilities relating to the remediation of various sites at which chemicals such as creosote, perchlorate, low-level radioactive substances, asbestos and other materials have been used or disposed. As of December 31, 2007, we had reserves in the amount of $188.8 million for environmental matters and receivables for reimbursement for such matters of $67.6 million. For the year ended December 31, 2007, we provided a net provision of $2.4 million for environmental remediation and restoration costs as part of continuing operations and a net remediation reimbursement of $0.8 million for environmental remediation and restoration costs related to discontinued operations. We had $50.2 million of expenditures associated with our environmental remediation projects, and received $17.3 million in third-party reimbursements in 2007.

 

Pursuant to the Master Separation Agreement dated November 28, 2005, among Kerr-McGee Corporation (“Kerr-McGee”), Kerr-McGee Worldwide Corporation and us (the “MSA”), Kerr-McGee has agreed to reimburse us for a portion of the environmental remediation costs we incur and pay during the seven-year period following our initial public offering (“IPO”). The reimbursement obligation extends to costs incurred at any site associated with any of our former businesses or operations. With respect to any site for which a reserve has been established as of the effective date of the MSA, 50% of the remediation costs we incur and pay 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 our reasonable and good faith estimate, that will be recovered from third parties. With respect to any site for which a reserve has not been established as of the effective date of the MSA, 50% of the amount of the

remediation costs we incur and pay (after meeting a $200,000 minimum threshold amount) will be reimbursable by Kerr-McGee, net of any amounts recovered or, in our reasonable and good faith estimate, that will be recovered from third parties. Kerr-McGee is only required to reimburse us for costs we actually incur and pay during the seven-year period following the IPO, up to a maximum aggregate amount of $100 million. Kerr-McGee’s reimbursement obligation is subject to various other limitations and restrictions.

 

Basis of Presentation

 

Consolidated and Combined Financial Statements

 

Our combined financial statements prior to the contribution and transfer by Kerr-McGee Corporation of certain entities, including those comprising substantially all of its chemical business (the “Contribution” on November 28, 2005) were derived from the accounting records of Kerr-McGee, principally representing the Chemical — Pigment and Chemical — Other segments of Kerr-McGee, using the historical results of operations, and historical basis of assets and liabilities of the subsidiaries that the company did not own but currently owns and the chemical business the company operates.

 

Our Consolidated and Combined Statement of Operations included in Item 15(a) of this Annual Report on Form 10-K includes allocations of costs for corporate functions historically provided to us by Kerr-McGee prior to the IPO (November 28, 2005), including:

 

General Corporate Expenses.  Represents costs related to corporate functions such as accounting, tax, treasury, human resources, legal and information management and technology. These costs were historically allocated primarily based on estimated use of services as compared to Kerr-McGee’s other businesses. These costs are included in selling, general and administrative expenses in the Consolidated and Combined Statement of Operations. This allocation ceased at the IPO date and any services rendered subsequent to that date and the resulting costs were billed under the terms of the transition services agreement.

 

Employee Benefits and Incentives.  Represents fringe benefit costs and other incentives, including group health and welfare benefits, U.S. pension plans, U.S. postretirement health and life plans and employee stock-based compensation plans. These costs were historically allocated on an active headcount basis for health and welfare benefits, including U.S. postretirement plans, on the basis of salary for U.S. pension plans and on a specific identification basis for employee stock-based employee compensation plans. These costs are included in costs of goods sold, selling, general and administrative expenses, restructuring charges and loss from discontinued operations in the Consolidated and Combined Statements of Operations.

 

Interest Expense.  Prior to the IPO, Kerr-McGee provided financing to us through cash flows from its other operations and debt incurred. Although the incurred debt was not allocated to us, a portion of the interest expense was allocated based on specifically-identified borrowings at Kerr-McGee’s average borrowing rates. These costs are included in other income (expense) in the Consolidated and Combined Statement of Operations, net of interest income that was allocated to Kerr-McGee on certain monies we loaned to Kerr-McGee. This allocation ceased at the IPO date because Kerr-McGee no longer provided financing to us.

 

Prior to the IPO, Kerr-McGee allocated certain expenses that were considered to be reasonable reflections of the historical utilization levels of various corporate services. Expense allocations from Kerr-McGee reflected in our consolidated and combined financial statements for the year ended December 31, 2005, were $24.3 million for general corporate expenses, $24.0 million for employee benefits and incentives, and $14.6 million in net interest expense.

 

Subsequent to the IPO, the expense allocations for certain corporate services previously provided by Kerr-McGee ceased, and we began purchasing such services from Kerr-McGee under the terms of the transition services agreement. Under the terms of this agreement, which ended in November 2006, we also received compensation for services provided to Kerr-McGee. The net expense charged to us in 2006 was $3.0 million for the period prior to the expiration of the transition services agreement. Under the provisions of the employee benefits agreement between Kerr-McGee and us, our qualifying current and former U.S. employees continued to participate in certain benefit plans sponsored by Kerr-McGee through the Distribution. As such, in the first quarter of 2006, Kerr-McGee billed us $8.3 million in costs related to these benefits.

We believe the assumptions underlying our consolidated and combined financial statements are reasonable. However, the consolidated and combined financial statements may not necessarily reflect our future results of operations, financial position and cash flows or what our results of operations, financial position and cash flows would have been had we been a stand-alone company during the periods presented.

 

Results of Operations

 

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

 

Total net sales were $1,426.3 million during the year ended December 31, 2007, an increase of 0.3% from the prior year period. The following table presents net sales for the periods indicated:

 

 

Pigment segment net sales were essentially flat at $1,320.6 million during the year ended December 31, 2007, from $1,320.3 million during the prior-year period. Sales were unfavorably affected by lower prices resulting primarily from the slowdown in North America’s housing market which resulted in additional volumes being sold to regions with lower selling prices. Changes in the euro exchange rate offset the lower prices. While the foreign exchange impact was an increase to sales of approximately $38.6 million, lower prices resulted in a decrease to sales of approximately $38.2 million. Volume was essentially flat compared to the prior-year period.

 

Electrolytic and other chemical products businesses net sales increased $4.2 million, or 4.1%, to $105.7 million during the year ended December 31, 2007, from $101.5 million during the prior-year period. The increase was primarily attributable to higher selling prices and volumes of sodium chlorate, partially offset by lower sales prices and volumes of manganese dioxide.

 

Gross margin decreased $59.4 million, or 33.8%, to $116.1 million during the year ended December 31, 2007, from $175.5 million during the prior-year period. Gross margin percentage decreased to 8.1%, from 12.3%, primarily due to lower pricing, higher production and shipping and handling costs and changes in foreign exchange rates. Included in production costs for 2007 were write-offs of $4.9 million on certain capital projects at our Savannah, Georgia, facility. Pricing, volumes, production, shipping and handling costs reduced gross margin by $49.0 million and the weaker U.S dollar reduced gross margin by $10.4 million.

 

Selling, general and administrative expenses decreased $8.8 million, or 6.9%, to $118.5 million during the year ended December 31, 2007, from $127.3 million during the prior-year period. The decrease was mainly due to reductions in payroll and employee benefits, totaling $6.5 million, and lower franchise taxes of $3.3 million related to a prior-year Mississippi franchise tax assessment during 2006. Partially offsetting these decreases was the write-off of an information technology project related to our financial and operational systems.

 

Total operating loss for the year ended December 31, 2007, was $14.7 million, compared to total operating profit of $84.6 million during the prior-year period. The following table presents operating profit (loss), with a

reconciliation to consolidated income (loss) from continuing operations before income taxes, for the periods indicated:

 

 

Pigment segment operating profit decreased $65.7 million, or 84.3%, to $12.2 million during the year ended December 31, 2007, from $77.9 million during the prior-year period. The decrease was due to lower sales prices, increased shipping costs, our current year restructuring charge, asset write-offs at our Savannah, Georgia, facility, and the weaker U.S. dollar, compounded by the effects of a prior-year arbitration award, and a prior-year restructuring credit that resulted from updating estimated projections of closure costs for the former Mobile, Alabama, synthetic rutile facility and Savannah, Georgia, sulfate facility. Partially offsetting these decreases were lower manufacturing and selling, general and administrative (“SG&A”) costs.

 

Electrolytic and other chemical products businesses operating profit decreased $27.6 million, or 109.1%, to a loss of $2.3 million during the year ended December 31, 2007, from profit of $25.3 million during the prior-year period. The change was primarily due to the prior year recovery of $20.5 million for past environmental remediation costs related to ammonium perchlorate remediation at our Henderson, Nevada, facility from the U.S. in 2006. In addition, lower prices and volumes along with higher costs for EMD contributed to the decline in profit in 2007. Reduced volumes and higher costs were primarily attributable to the excess worldwide supply for EMD and the import of low price products into the U.S. from China and Australia. These imports prompted an antidumping investigation the result of which is expected to assist in making U.S. produced EMD more competitive and improve profitability within the U.S. EMD industry.

 

Corporate and non-operating sites had an operating loss of $24.6 million during the year ended December 31, 2007, an increased loss of $6.0 million from a loss of $18.6 million during the prior-year period. Additional losses in the current period were primarily due to a $3.5 million write-off of an information technology project related to our financial and operational systems begun prior to our spin-off and a $7.0 million restructuring charge related to our work force reduction partially offset by lower payroll and employee benefits.

 

Interest and debt expense decreased $0.3 million to $50.1 million during the year ended December 31, 2007, from $50.4 million during the prior-year period.

 

Other income decreased $11.2 million to $2.7 million during the year ended December 31, 2007, from $13.9 million during the prior-year period. The change was mainly due to lower foreign exchange gains in 2007 compared to the gains in 2006, lower income from equity affiliates and a loss on sale of accounts receivable related to the receivables securitization program.

 

The income tax provision was $43.0 million during the year ended December 31, 2007, compared to $23.1 million during the prior-year period. We recorded valuation allowances against certain deferred tax assets during the year ended December 31, 2007. A valuation allowance of $29.5 million was established in relation to certain deferred tax assets relating to the U.S. consolidated group. Of the $29.5 million valuation allowance, $20.1 million related to deferred tax assets recorded at December 31, 2006. The valuation allowance was established in accordance with SFAS No. 109 and does not affect our ability to benefit from the deferred tax assets in future periods.

In connection with the decision to retain the Uerdingen facility, we have begun a reorganization of our European operations and legal entities. The reorganization process is expected to be effectively completed in 2008. Due to the reorganization, we no longer expect to realize a benefit from certain deferred tax assets previously recorded related to our Swiss entity. As a result, we recorded a valuation allowance of $9.4 million, of which $4.4 million related to the net deferred tax asset recorded at December 31, 2006, while $5.0 million related to the benefit of the loss for the twelve-month period ended December 31, 2007.

 

Loss from discontinued operations decreased $23.9 million, or 94.8%, to $1.3 million during the year ended December 31, 2007, from $25.2 million during the prior-year period. Both periods include losses related to legal and environmental costs associated with our former forest products operations. The 2006 loss was primarily attributable to legal fees and environmental costs associated with our former forest products operations of $16.6 million, net of taxes, including $11.0 million, net of taxes, as a result of ongoing settlement discussions related to nonbinding mediation with the U.S. Environmental Protection Agency (“EPA”) regarding reimbursement for remediation of the former wood-treatment site in New Jersey. In addition, losses include environmental costs of $3.8 million, net of taxes, for the proposed groundwater remediation solution at a former nuclear fuels plant in Crescent, Oklahoma, and additional costs for erosion and vegetation studies of $0.8 million, net of taxes, related to former uranium mines at Riley Pass, South Dakota. These losses were partially offset by the recognition of amounts due from the Department of Energy (“DOE”) of $3.3 million, net of taxes, related to their share of costs at the former West Chicago site.

 

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

 

Total net sales were $1,421.8 million during the year ended December 31, 2006, an increase of 3.4% from the prior-year period. The following table presents net sales for the periods indicated:

 

 

Pigment segment net sales increased $42.1 million, or 3.3%, to $1,320.3 million during 2006 from $1,278.2 million during 2005. Approximately $28.2 million was due to an improved volume and mix of sales and approximately $13.9 million was due to increased average unit selling prices. Total volume increased slightly, primarily in the Asia-Pacific region due to the overall strength of that market in 2006 and the impact, in 2005, of a brief two-week shutdown of our Australian pigment plant in the fourth quarter of 2005. The unplanned shutdown was necessitated by a shutdown of our third-party process gas supplier. Volumes in Europe were relatively flat from year to year as the European economy started the year slowly and improved as the year progressed. Volumes in the U.S. were down from the prior year, in part due to 2005 volumes in the fourth quarter being unusually high as a result of the hurricanes and the shutdown of a competitor’s plant which followed. The increase in average unit selling price resulted from price increases in the early part of the year, following the hurricanes and plant shutdown. The overall average impact of foreign currency exchange rate changes was approximately $0.8 million when comparing the twelve-month periods ending December 31, 2006 and 2005, respectively.

 

Electrolytic and other chemical products businesses net sales increased $4.5 million, or 4.6%, to $101.5 million during 2006 from $97.0 million during 2005. The increase was primarily due to increased sales of sodium chlorate, partially offset by lower sales of manganese dioxide. Sodium chlorate sales volumes increased 10.6% in addition to an increase in sales price. During 2006, we aggressively sought additional market share and increased prices to offset higher costs. We were able to increase sales prices and volumes by utilizing latent capacity at a restructured competitive cost structure. Manganese dioxide sales declined primarily due to a decrease in volumes of 17.4%, which was the result of record volumes in 2005 brought about by hurricane Katrina.

Gross margin decreased $54.4 million, or 23.7%, to $175.5 million during 2006 from $229.9 million during 2005. Gross margin percentage decreased to 12.3% in 2006 from 16.7% in 2005 primarily due to higher costs of production offset slightly by the improved pricing mentioned above. Increased production costs in our U.S. and European operations were primarily due to higher energy and process chemical costs. In our Australian operations, difficult mining conditions and a temporary shutdown of the Chandala kiln increased costs and reduced production, both of which increased per unit costs. The kiln had to be shut down to perform maintenance that had been scheduled for 2007, but had to be accelerated due to deterioration in the kiln.

 

Selling, general and administrative expenses increased $2.4 million, or 1.9%, to $127.3 million during 2006 from $124.9 million during 2005. The increase was mainly due to increased compensation and benefit costs, including costs related to stock-based awards, certain retention award programs, and increased retirement and other postretirement benefits expense. Partially offsetting the increase was a decrease in variable cash compensation, primarily the result of lower overall profits.

 

Total operating profit for the year ended December 31, 2006, was $84.6 million, compared to total operating profit of $87.9 million during the prior-year period. The following table presents operating profit (loss), with a reconciliation to consolidated income (loss) from continuing operations before income taxes, for the periods indicated:

 

 

Pigment segment operating profit decreased $23.6 million, or 23.3%, to $77.9 million for the year ended December 31, 2006, from $101.5 million, in the same period of 2005. The decline in operating profit was primarily due to the higher costs of production, offset by the improved pricing, a reversal of previously recorded restructuring charges and the receipt of an arbitration award. Increased production costs in our U.S. and European operations were primarily due to higher raw material, process chemical and energy costs at our manufacturing facilities around the world. In our Australian operations, difficult mining conditions, and a temporary shutdown of the Chandala kiln increased costs and reduced production which increased per unit costs of sale. The kiln had to be shut down to perform maintenance that had been scheduled for 2007, but had to be accelerated due to increased deterioration in the kiln. The reversal of previously recorded restructuring charges resulted from updating our estimates of closure costs (including timing) related to our former Mobile, Alabama, synthetic rutile facility and Savannah, Georgia, sulfate facility. The arbitration award related to a claim in the London Court of International Arbitration (“LCIA”) against Kemira, alleging breach of representations and warranties related to the acquisition of the TiO₂ production facility in Savannah, Georgia. On November 15, 2006, we were notified that the LCIA awarded us approximately $8.9 million in damages and interest. Legal expenses of $2.7 million in 2006 and $1.1 million in 2005 related to this lawsuit are included in SG&A expenses.

 

These higher costs were partially offset by lower selling, general and administrative expenses which decreased $22.6 million primarily due to a decrease in employee incentive compensation related to cash bonuses as a result of lower overall company profits, partially offset by increased other compensation and benefit costs, including costs related to stock-based awards, certain retention award programs, and increased retirement and other postretirement benefits expense.

 

Electrolytic and other chemical products businesses operating profit increased $31.2 million to $25.3 million during the year ended December 31, 2006, from a loss of $5.9 million during the prior-year period. The change was

primarily due to the $20.5 million recovery of past environmental remediation costs from the U.S. in 2006, compared to a net environmental provision of $11.4 million in 2005 related to ammonium perchlorate remediation associated with our Henderson, Nevada, facility. For the year, increased manufacturing costs more than offset the sales gains discussed above, and lower selling, general and administrative expenses. Higher costs were primarily related to higher feedstock, maintenance and energy costs.

 

Corporate and nonoperating sites had an operating loss of $18.6 million during the year ended December 31, 2006, a decline of $10.9 million from a loss of $7.7 million during the prior-year period. The additional loss was primarily due to unallocated corporate expenses related to corporate functions absorbed by Tronox from Kerr-McGee after the IPO including board of directors costs, corporate overhead, retention awards and franchise tax charges. These costs were partially offset by a provision of $5.6 million in the prior year related to remediation of the Jacksonville, Florida, former agricultural chemical site, for soil removal and excavation.

 

Interest and debt expense increased $45.9 million to $50.4 million during 2006 from $4.5 million during 2005. The increase was due to interest on our unsecured notes and term loan facility that were entered into concurrent with the IPO in November 2005.

 

Other income (expense), net increased $29.1 million to income of $13.9 million during 2006 from expense of $15.2 million during 2005. The change is mainly due to a $4.3 million increase in income from equity affiliates, the elimination of $14.7 million of interest expense allocated from affiliates during 2005 and foreign exchange gains during 2006 of $8.8 million compared to losses during 2005 of $3.0 million. Partially offsetting these favorable effects was a provision for litigation settlements of $3.7 million in 2006.

 

The effective income tax rate was 48% for 2006 compared to 32% for 2005. The fiscal 2006 effective income tax rate was higher primarily due to the taxation of foreign operations, in particular, non-deductible differences and losses in certain foreign jurisdictions in which our actual tax rate is below the U.S. statutory rate. The foreign losses in relation to U.S. income are proportionately greater for 2006, contributing to the higher effective tax rate. The treatment of stock-based compensation as required under our Tax Sharing Agreement entered into in connection with our separation from Kerr-McGee also contributed to the higher effective rate.

 

Loss from discontinued operations decreased $2.4 million, or 8.7% to $25.2 million during 2006 from $27.6 million during 2005. In 2006, the loss from discontinued operations included $16.6 million, net of taxes, for legal fees and environmental costs associated with our former forest products operations, additional environmental costs of $3.8 million, net of taxes, for groundwater remediation at a former nuclear fuels plant in Crescent, Oklahoma, and additional costs of $0.8 million, net of taxes, for erosion and vegetation studies related to former uranium mines at Riley Pass, South Dakota. The 2005 loss includes $17.7 million loss, net of taxes, on our former forest products operations, including legal costs of $4.8 million, net of taxes, and an environmental provision of $7.2 million, net of taxes, for additional soil volumes related to the Sauget, Illinois, wood-treatment plant. The 2005 loss also includes a $5.2 million environmental provision, net of taxes, for pond closure, rock placement and surface water channels at the Ambrosia Lake, New Mexico, site associated with our formerly conducted uranium mining and milling operations (see Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K).

Financial Condition and Liquidity

 

The following table provides information for the analysis of our historical financial condition and liquidity:

 

 

 

 

Our primary cash needs are for working capital, capital expenditures, environmental cash expenditures, debt service under the senior secured credit facility (discussed below) and the unsecured notes. We believe that our cash flows from operations, together with available borrowings under our revolving credit facility, will be sufficient to meet these cash needs. However, our ability to generate cash is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If our cash flows from operations are less than we expect, we may need to raise additional capital. We may also require additional capital to finance our future growth and development, implement additional marketing and sales activities, and fund our ongoing research and development activities.

 

Additional debt or equity financing may not be available when needed on terms favorable to us or even available to us at all. We are restricted by the terms of the senior secured credit facility and the indenture governing the unsecured notes from incurring additional indebtedness. Under our tax sharing agreement with Kerr-McGee, if we enter into transactions during the two-year period following the Distribution which results in the issuance or acquisition of our shares, and the Internal Revenue Service subsequently determines that Section 355(e) of the Internal Revenue Code is applicable to the Distribution, we will be required to indemnify Kerr-McGee for any resulting tax liability.

 

We have an interest in The LandWell Company LP (“LandWell”), a limited partnership formed to market or develop land in the Henderson, Nevada, area. LandWell has commenced negotiations with a number of parties who have interest in the development of either part or all of approximately 2,200 contiguous acres of its land in Henderson for eventual use as a new, mixed-use master planned community. LandWell is also proceeding with remediation efforts on a portion of the 2,200 acres. LandWell’s efforts to secure zoning for the site were successful with final approval of the development standards and development agreement being received from the City of Henderson on October 2, 2007. This large parcel, in addition to other parcels available for sale by LandWell is in the vicinity of our Henderson facility. Cash flows resulting from the sale of the 2,200 contiguous acres of land in the Henderson, Nevada, area must be used to pay down outstanding debt under our senior secured credit facility.

 

We are in negotiations with interested parties for the sale of parcels of land which are 100% Tronox owned. During 2007, we executed a contract involving a 53-acre parcel of 100% Tronox owned land in the Henderson, Nevada, area. The “no further action letter” was obtained on this and other parcels next to this. In January 2008, the buyer of the contract cancelled the contract as they were unable to secure financing. Negotiations have commenced with other interested parties for this parcel of land but there can be no guarantee that a sale will be concluded during the next twelve months.

In connection with our separation from Kerr-McGee, the net amount due from us to Kerr-McGee as of the IPO date was contributed by Kerr-McGee, forming a part of our continuing equity. Such net amounts due to Kerr-McGee that were outstanding at the balance sheet dates prior to our separation have been reflected in our consolidated and combined financial statements as a component of owner’s net investment in equity. Amounts due to or from Kerr-McGee arising from transactions subsequent to our separation through the expiration of the transition services agreement with Kerr-McGee have been settled in cash.

 

Of cash and cash equivalents at December 31, 2007, $9.5 million was held in the U.S. and $11.5 million was held in other countries. In 2005, $131.0 million of unremitted foreign earnings in Australia were repatriated as extraordinary dividends, as defined in the American Jobs Creation Act of 2004, and subsequently transferred to Kerr-McGee as part of its centralized cash management system.

 

Cash Flows

 

Cash Flows from Operating Activities.  Cash flows from operating activities for 2007 were $95.3 million compared to $111.6 million for 2006. The $16.3 million decrease in cash flows from operating activities for 2007 was due primarily to increased net loss of $106.2 million compared to the prior year, partially offset by net proceeds from our receivables securitization program of $57.0 million and reduction of our working capital as a result of recent management initiatives.

 

Cash flows from operating activities for 2006 were $111.6 million compared to $61.5 million for 2005. The $50.1 million increase in cash flows from operating activities for 2006, was due primarily to the impact of the termination of the accounts receivable monetization program in 2005 and a lower amount of net cash used from relative changes in our inventories in 2006 compared to 2005. This was partially offset by interest payments on long-term debt arrangements, timing of income tax payments, a decrease in environmental reimbursement receipts and cash bonus program payments in 2006. Termination of our accounts receivable monetization program resulted in an extension of the collection period for accounts receivable arising from pigment sales compared to the collection period of receivables prior to program termination. This had a one-time impact, in the 2005 period, of reducing our cash flows from operating activities related to the increase in our accounts receivable.

 

Cash Flows from Investing Activities.  Net cash used in investing activities for 2007, was $69.2 million, a decrease of $5.8 million compared to 2006. The decrease was primarily due to lower capital expenditures in 2007 compared to the prior year.

 

Capital expenditures in the 2007 period were $70.9 million compared to $79.5 million in 2006. Significant projects in 2007 included upgrades to waste treatment and to an oxidation line at the Botlek, Netherlands, facility, relining a kiln and maintenance improvements at the synthetic rutile facility at Chandala, Australia, and a selas floor replacement at the Hamilton, Mississippi, facility. Significant projects in 2006 and 2005 included changes to the Uerdingen, Germany, pigment facility to convert waste to a saleable product and reduce raw material costs, upgrading the oxidation line at the Botlek, Netherlands, facility and process improvements at the Hamilton, Mississippi, facility for the purpose of producing a new grade of pigment for use in architectural paints.

 

Capital expenditures during 2008 are expected to be in the range of $62.0 million to $65.0 million excluding the expansion of our Kwinana, Western Australia plant.

 

Cash Flows from Financing Activities.  Net cash used in financing activities in 2007 was $71.9 million compared to $19.6 million in 2006.

 

Cash used in 2007 included $64.9 million in long-term debt payments and $8.3 million in dividends. These were partially offset by proceeds from stock option exercises of $1.6 million. The increased payment on long-term debt was primarily funded by a portion of the proceeds from sales of the company’s U.S. accounts receivable through a securitization program. Under our credit agreement, we are required to remit 50% of the net cash proceeds from qualifying accounts receivable sales as a prepayment of principal. As a result, $30.3 million of the initial proceeds from the securitization program was utilized to make mandatory prepayment, while an additional $20.0 million was utilized to make an optional prepayment on long-term debt. During 2007, we were also required to make a mandatory prepayment of $11.1 million based on the 2006 excess cash flow calculation (as defined in the credit agreement). The remaining payments on long-term debt in 2007 of $3.5 million were mandatory.

The cash used in 2006 consisted primarily of principal payments related to our long-term debt of $11.1 million and the payment of $6.2 million in dividends. Of the total principal payment of $11.1 million, $8.0 million was paid under the optional prepayment provision of our credit agreement.

 

Net cash used in financing activities was $19.6 million in 2006 and $103.3 million in 2005. The decrease in use of funds primarily resulted from becoming a stand-alone and self-supported company.

 

In 2005, we completed our IPO by issuing 17.5 million shares of Class A common stock which provided proceeds, net of issuance costs, of $226.0 million. Concurrent with the IPO, we issued $350.0 million in aggregate principal amount of 91/2% senior unsecured notes and entered into a senior secured credit facility consisting of a $200.0 million six-year term loan facility. Proceeds from the unsecured notes and the term loan facility provided $539.1 million in cash flow from financing activities in 2005, net of debt issuance costs. The net proceeds from our Class A common stock offering, unsecured notes and term loan facility were distributed to Kerr-McGee in the amount of $761.8 million. Net transfers to Kerr-McGee were $106.6 million in 2005.

 

Capital Resources

 

Credit Agreement.  In November 2005, our wholly owned subsidiary, Tronox Worldwide LLC, entered into a senior secured credit facility. This facility consists of a $200 million six-year term loan facility and a five-year multicurrency revolving credit facility of $250 million. Interest on amounts borrowed under the senior secured credit facility is payable, at our election, at a base rate or a LIBOR rate, in each case as defined in the agreement. As of December 31, 2007, based on our credit ratings the margin applicable to LIBOR borrowings was 150 basis points.

 

The terms of the credit agreement provide for customary representations and warranties, affirmative and negative covenants, and events of default. Our primary financial covenants are a Total Leverage Ratio and an Interest Coverage ratio (both as defined in the credit agreement).

 

There can be no assurance that we will be in compliance with such covenants in the future. Future compliance with the covenants may be adversely affected by various economic, financial and industry factors. In the event of any future noncompliance with any covenants, we would seek to negotiate amendments to the applicable covenants or to obtain waivers from our lenders. If we were unable to obtain amendments or waivers, noncompliance with the covenants would constitute an event of default under the credit agreement, allowing the lenders to accelerate repayment of any outstanding borrowings and/or to terminate their commitments to the credit facility.

 

2007 Credit Agreement Covenant Amendment

 

In March 2007, we requested and obtained approval for an amendment to the financial covenants in the credit agreement. The amendment maintained the original Total Leverage Ratio and the Interest Coverage Ratio at 3.75:1 and 2:1, respectively, through December 31, 2007. We were in compliance with our financial covenants at December 31, 2007.

 

As of December 31, 2007, we had total consolidated debt of $484.8 million and cash and cash equivalents of $21.0 million. We had outstanding letters of credit issued under the credit facility in the amount of $66.9 million and no borrowings outstanding on the revolving credit facility resulting in unused capacity under the revolving credit facility of $183.1 million. Although we had unused capacity, the amount available is subject to our financial covenants. Based on the total leverage ratio of 3.75:1 and our Adjusted EBITDA of $141.2 million for the year ended December 31, 2007, the total consolidated debt we were permitted to incur as of December 31, 2007, was $529.5 million. As a result, of the unused capacity of $183.1 million, $44.7 million was available for borrowings.

 

2008 Credit Agreement Covenant Amendment

 

In February 2008, we proactively requested and obtained approval for an amendment to the 2008 and 2009 financial covenants. The table below presents the approved requirements by quarter. The limitations on capital expenditures have not been modified and are $130 million in 2008 and $100 million in 2009 and thereafter. We incurred an amendment fee of approximately $2.5 million in the first quarter of 2008 related to this and our margin

applicable to LIBOR borrowings is now 300 basis points. Our margin remains subject to increases or decreases depending on our credit rating.

 

 

The prospective relief under these ratios was necessary in order for us to continue to comply with these covenants on a quarterly basis over the next two years. We assessed our ability to meet the amended ratios based on an analysis of our 2008 and 2009 forecast and believe that we have adequate “cushion” under both ratios beginning with the first quarter of 2008 and ending with the fourth quarter of 2009.

 

The achievement of our forecasted results is subject to the risks discussed in Item 1A, “Risk Factors,” and is critical for us to be in compliance with the financial covenants. Assumptions key to achieving our forecasted results include meeting our Project Cornerstone cash cost reduction targets, the realization of some of the pricing increases announced for 2008, the effect that the outcome of the anti-dumping investigation will have on our electrolytic business and maintaining our market share during a period of expected 3% global TiO₂ demand growth. Further weakening of the U.S. economy and any resulting negative impact on the economic conditions in other regions could have a negative effect on our ability to achieve our forecasted results. In our analysis, we excluded land sales and the resultant debt repayment from land sales. As a result, the execution of land sales, and the resultant debt repayment, would increase the amount of cushion we are expecting. Management of our capital expenditures and legacy expenditures during this challenging period will also limit our cash requirements and create additional opportunities for cushion. Based on this, management anticipates that we will remain in compliance with these ratios during 2008 and 2009, with on-going compliance thereafter.

 

As of February 29, 2008, we had total consolidated debt of $527.9 million and cash and cash equivalents of approximately $19.0 million. The total consolidated debt balance as of February 29, 2008, includes $53.0 million outstanding on the revolving credit facility and outstanding letters of credit issued under the credit facility in the amount of $67.2 million resulting in unused capacity under the revolving credit facility of $129.8 million. As noted above, the amount available on the revolving credit is subject to our financial covenants.

 

We are required, under the terms of the credit agreement, to remit a certain percentage of excess cash flow (“ECF Percentage,” as defined in the credit agreement) as a prepayment of the principal. As a result, in addition to the normal quarterly installments, the first such mandatory payment, in the amount of $11.1 million, was paid in April 2007 based on the ECF Percentage for the fiscal year 2006. We are also required to remit 50% of the net cash proceeds from qualifying accounts receivable sales as a prepayment of principal. As a result of the securitization program we implemented in the third quarter of 2007, proceeds of $30.3 million were remitted in September 2007 as required, with an additional $20.0 million remitted in October 2007 as an optional prepayment.

 

Senior Unsecured Notes.  Also concurrently with the IPO, Tronox Worldwide LLC and Tronox Finance Corp. issued $350 million in aggregate principal amount of 91/2% senior unsecured notes due 2012 in a private offering. Interest on the notes is payable on June 1 and December 1 of each year. During the second quarter of 2006, we registered these notes with the Securities and Exchange Commission (the “SEC”) and subsequently completed an exchange of all notes and guarantees for publicly tradable notes and guarantees having substantially identical terms on July 14, 2006. These notes are guaranteed by our material direct and indirect wholly owned domestic subsidiaries.

Note Payable due July 2014.  In July 2006, Tronox Western Australia Pty Ltd, our wholly owned subsidiary, completed the purchase of a 50% undivided interest in additional mining tenements and related mining assets. We acquired the mine tenements by entering into an eight-year note payable agreement. As a result, we had additional debt totaling $8.8 million as of December 31, 2006. A required payment of $1.8 million in 2007 along with a $0.9 million revaluation of this Australian dollar denominated debt resulted in a balance of $7.9 million at December 31, 2007. Under the provisions of the note, the earliest opportunity to prepay the note was as of December 31, 2007. Due to the higher interest rate associated with the note, we elected to prepay the note in full in January 2008.

 

Receivables Securitization.  We executed a $100.0 million accounts receivable securitization program (the “Program”) in September 2007 with an initial term of one year. Financing under the program can be extended for an additional two years in the form of a securitization or a secured borrowing as determined by the sponsoring institution, ABN AMRO Bank N.V. (“ABN”). Under the Program, receivables owned by our U.S. subsidiaries are sold on a recurring basis to Tronox Funding LLC (“Funding”), a wholly owned special purpose subsidiary owned by us. Funding, in turn, sells to either Amsterdam Funding Corporation (“AFC”), an asset-backed commercial paper conduit sponsored by ABN, or sells to ABN directly (both AFC and ABN collectively referred to as “Amsterdam”) an undivided percentage ownership interest in the pool of receivables Funding acquires from the company (subject to a program limit in the aggregate of $100.0 million). We retain the servicing responsibility for the accounts receivable. At December 31, 2007, receivables sold by us to Funding totaled $97.3 million, of which $57.0 million was sold to Amsterdam in the form of the purchased participation interest, resulting in a subordinated retained interest held by us with a carrying amount of $39.5 million. The subordinated retained interest serves as over-collateralization on the purchased interest by Amsterdam and, thus, provides credit enhancement to the Program.

 

Until April 2005, we had an accounts receivable monetization program, which served as a source of liquidity up to a maximum of $165.0 million.

 

Off-Balance Sheet Arrangements

 

We have entered into agreements that require us to indemnify third parties for losses related to environmental matters, litigation and other claims. We have recorded no material obligations in connection with such indemnification obligations as none are currently evaluated as probable of loss. In addition, pursuant to the MSA, we will be required to indemnify Kerr-McGee for all costs and expenses incurred by it arising out of or due to our environmental and other liabilities other than such costs and expenses reimbursable by Kerr-McGee pursuant to the MSA. At December 31, 2007, we had outstanding letters of credit in the amount of $67.8 million, of which $66.9 million was issued under our credit agreement, resulting in unused capacity under the revolving credit facility of $183.1 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.

 

Outlook

 

At the end of 2007, we were ahead of target on our Project Cornerstone initiatives to reduce operating and selling, general and administrative costs and enhance revenues with a cumulative reduction of $70 million in cash cost reductions since the project’s inception in April of 2006. Project Cornerstone will remain a focus area for us with additional 2008 targeted cash cost savings of $22 million.

 

Due to the slowdown in the housing sector and its effects, the U.S. economy is expected to remain soft for the first half of 2008 but may begin to turn around in the second half of the year. While growth in the lower margin Asia-Pacific region is expected to remain close to last year, the growth in this area is not expected to totally compensate for the impact of weak U.S. growth on the global economy. Outlook for emerging economies remains positive overall, but some moderation in growth is also expected.

 

The global EMD market is challenged by excess supply that has resulted in antidumping investigations in Europe, Japan and the United States. In the United States, the antidumping investigation concerns EMD imports from China and Australia. The preliminary determination from the investigation, setting forth company-specific antidumping rates, is expected in March 2008. Final determinations from the Commerce Department and the

International Trade Commission are expected by the fall of 2008. If these determinations are favorable, the issuance of antidumping orders should result in improved profitability for the U.S. EMD industry.

 

Contractual Obligations and Commercial Commitments

 

In the normal course of business, we enter into operating leases, purchase obligations and borrowing arrangements. Operating leases primarily consist of the rental of railcars, office space and production equipment. Purchase obligations are agreements to purchase goods or services that are enforceable, legally binding and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions, and the approximate timing of the transaction. We are also obligated under an employee benefits agreement with Kerr-McGee to maintain the Material Features (as defined in the employee benefits agreement) of the U.S. postretirement plan without change for a period of three years following the effective date of the Distribution. Based on the actuarially determined obligations under that plan, we expect contributions to be approximately $9.0 million in 2008 and approximately $4.0 million in each of the following four years as our announced modifications to the plan take effect in April 2009.

 

The aggregate future payments under these borrowings, contracts and other arrangements (including all U.S. nonqualified and foreign pension and postretirement obligations) as of December 31, 2007, are summarized in the following table:

 

 

 

 

Environmental Matters

 

Current Businesses

 

We are subject to a broad array of international, federal, state and local laws and regulations relating to environmental protection. Under these laws, we are or may be required to obtain or maintain permits or licenses in connection with our operations. In addition, under these laws, we are or may be required to remove or mitigate the effects on the environment of the disposal or release of chemical, petroleum, low-level radioactive and other substances at various sites. Environmental laws and regulations are becoming increasingly stringent, and compliance costs are significant and will continue to be significant in the foreseeable future. There can be no assurance

that such laws and regulations or any environmental law or regulation enacted in the future is not likely to have a material effect on us.

 

Sites at which we have environmental responsibilities include sites that have been designated as Superfund sites by the U.S. EPA pursuant to the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (“CERCLA”) and that are included on the National Priority List (“NPL”). As of December 31, 2007, we had received notices that we had been named a potentially responsible party (“PRP”) with respect to 12 existing EPA Superfund sites on the NPL that require remediation.

 

Decommissioning and remediation obligations, and the attendant costs, vary substantially from site to site and depend on unique site characteristics, available technology and the regulatory requirements applicable to each site. Additionally, we may share liability at some sites with numerous other PRPs, and U.S. law currently imposes joint and several liability on all PRPs under CERCLA. We are also obligated to perform or have performed remediation or remedial investigations and feasibility studies at sites that have not been designated as Superfund sites by EPA. Such work frequently is undertaken pursuant to consent orders or other agreements.

 

Legacy Businesses

 

Historically, we have engaged in businesses unrelated to our current primary business, such as the treatment of forest products, the production of ammonium perchlorate, the refining and marketing of petroleum products, offshore contract drilling, coal mining and the mining, milling and processing of nuclear materials. Although we are no longer engaged in such businesses, residual obligations with respect to certain of these businesses still exist, including obligations related to compliance with environmental laws and regulations that include the Clean Water Act, the Clean Air Act, the Atomic Energy Act, CERCLA and the Resource Conservation and Recovery Act. These laws and regulations require us to undertake remedial measures at sites of current and former operations or at sites where waste was disposed. For example, we are required to conduct decommissioning and environmental remediation at certain refineries, production and distribution facilities and service stations previously owned or operated before exiting the refining and marketing business in 1995. We also are required to conduct decommissioning and remediation activities at sites where we were involved in the exploration, production, processing or sale of minerals, including uranium and thorium compounds and at sites where we were involved in the production and sale of ammonium perchlorate. Additionally, we are decommissioning and remediating our former wood-treatment facilities as part of our exit from the forest products business. For a description of the decommissioning and remediation activities in which we currently are engaged, see “Environmental Costs” below and Notes 5 and 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

Environmental Costs

 

Expenditures for environmental protection and cleanup for each of the last three years and for the three-year period ended December 31, 2007, are as follows:

 

 

Recurring operating expenses are expenditures related to the maintenance and operation of environmental equipment such as incinerators, waste treatment systems and pollution control equipment, as well as the cost of materials, energy and outside services needed to neutralize, process, handle and dispose of current waste streams at our operating facilities. These operating and capital expenditures are necessary to ensure that ongoing operations are handled in an environmentally safe and effective manner.

 

In addition to past expenditures, reserves have been established for the remediation and restoration of active and inactive sites where liability is probable and future costs to be incurred are reasonably estimable. For environmental sites, we consider a variety of matters when setting reserves, including the stage of investigation;

whether EPA or another relevant agency has ordered action or quantified cost; whether we have received an order to conduct work; whether we participate as a PRP in the Remedial Investigation/Feasibility Study (“RI/FS”) process and, if so, how far the RI/FS has progressed; the status of the record of decision by the relevant agency; the status of site characterization; the stage of the remedial design; evaluation of existing remediation technologies; the number and financial condition of other potentially responsible parties PRPs; and whether we can reasonably evaluate costs based on a remedial design or engineering plan.

 

After the remediation work has begun, additional accruals or adjustments to costs may be made based on any number of developments, including revisions to the remedial design; unanticipated construction problems; identification of additional areas or volumes of contamination; inability to implement a planned engineering design or to use planned technologies and excavation methods; changes in costs of labor, equipment or technology; any additional or updated engineering and other studies; and weather conditions. Additional reserves of $15.1 million, $56.4 million and $69.0 million were added in 2007, 2006 and 2005, respectively, for active and inactive sites.

 

As of December 31, 2007, our financial reserves for all active and inactive sites totaled $188.8 million. In the Consolidated Balance Sheet at December 31, 2007, included in Item 15(a) of this Annual Report on Form 10-K, $93.9 million of the total reserve is classified as noncurrent liabilities-environmental remediation and/or restoration, and the remaining $94.9 million is included in accrued liabilities. We believe we have reserved adequately for the reasonably estimable costs of known environmental contingencies. However, additional reserves may be required in the future due to the previously noted uncertainties.

 

Pursuant to the MSA, Kerr-McGee agreed to reimburse us for a portion of the environmental remediation costs we incur and pay after the IPO (net of any cost reimbursements we expect to recover from insurers, governmental authorities or other parties). The reimbursement obligation extends to costs incurred at any site associated with any of our former businesses or operations.

 

With respect to any site for which we have established a reserve as of the effective date of the MSA, 50% of the remediation costs we incur and pay 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 our reasonable and good faith estimate, that will be recovered from third parties. With respect to any site for which we have not established a reserve as of the effective date of the MSA, 50% of the amount of the remediation costs we incur and pay (after meeting a $200,000 minimum threshold amount) will be reimbursable by Kerr-McGee, net of any amounts recovered or, in our reasonable and good faith estimate, that will be recovered from third parties.

 

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

The following table reflects our portion of the known estimated costs of investigation, remediation or claims that are probable and estimable. The table summarizes EPA Superfund NPL sites where we have been notified we are a PRP under CERCLA and other sites for which we had financial reserves recorded at year-end 2007. In the table, aggregated information is presented for other sites (each of which has a remaining reserve balance of less than $3 million). Sites specifically identified in the table below are discussed in Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

 

West Chicago, Illinois (Vicinity Areas).  Remediation of thorium tailings at the Reed-Keppler Park and the Sewage Treatment Plant is substantially complete. Cleanup of thorium tailings at Kress Creek is ongoing. A review of remediation work done in certain Residential Areas is being conducted by the EPA, in order to determine the completeness of the remediation.

 

Amounts reported in the table for the West Chicago sites are not reduced for actual or expected reimbursement from the U.S. government under Title X of the Energy Policy Act of 1992 (“Title X”).

 

Manville, New Jersey.  EPA led remediation of the former impoundments and residential areas has been completed. The remediation of the former process area (currently a non-related commercial property) is ongoing with completion expected in 2008. We are engaged in mediation with the EPA and DOJ with respect to the government’s claim for response costs.

 

Amounts reported in the table for the Manville, New Jersey, site are not reduced for actual or expected reimbursement from Anadarko Petroleum Corporation, on behalf of Kerr-McGee, under the MSA.

 

Other Superfund Sites.  Sites where we have been named a PRP, including landfills, wood-treating sites, a mine site and an oil recycling refinery. These sites are in various stages of investigation/remediation.

 

West Chicago, Illinois (Former Manufacturing Facility).  Excavation, removal and disposal of contaminated soils at former thorium mill are substantially complete. The site will be used for moving material from the Kress

Creek remediation site. Surface restoration and groundwater remediation are expected to continue for approximately seven years. Groundwater monitoring may continue for approximately eleven years.

 

Amounts reported in the table for the West Chicago sites are not reduced for actual or expected reimbursement from the U.S. government under Title X.

 

Cushing, Oklahoma.  The site NRC license has been terminated allowing avoidance of future license maintenance costs. Investigation of and remediation addressing hydrocarbon contamination is continuing.

 

Henderson, Nevada.  Groundwater treatment to address ammonium perchlorate contamination is being conducted under consent order with Nevada Division of Environmental Protection (NDEP). An environmental conditions assessment of the Henderson site is being conducted under the terms of a consent agreement with NDEP.

 

Amounts reported in the table for the Henderson, Nevada, site are not reduced for actual or expected reimbursement from the U.S. government under a consent decree settlement nor for expected insurance policy recoveries.

 

Ambrosia Lake, New Mexico.  Uranium mill tailings and selected pond sediments have been consolidated and capped onsite. Decommissioning of impacted soils and the design of additional erosion controls are ongoing.

 

Crescent, Oklahoma.  Buildings and soil decommissioning is complete. A work plan to address limited on-site radionuclide contamination of groundwater is in negotiation with the NRC.

 

Sauget, Illinois.  Soil and sediment remediation of wood-treatment related contamination is ongoing. Final pond closure and groundwater investigation will follow.

 

Cleveland, Oklahoma.  Facility is dismantled and certain interim remedial measures to address air, soil, surface water and groundwater contamination are complete. Design for soil and waste remediation has been approved.

 

Jacksonville, Florida.  Remedial investigation of a former manufacturing and processing site for fertilizers, pesticides and herbicides completed. Feasibility study with recommended remediation activities is under review by the U.S. EPA.

 

Riley Pass, South Dakota.  Remedial assessment of a former uranium mining site has been completed. A work plan for remedial actions needed to address contaminated soils or to prevent soil erosion has been approved by the Forest Service. Final design plans for the cells and the procedures for excavating and transporting the material to the cells will be submitted to the Forest Service for approval in 2008. Additional plans and design details will continue to be evaluated in 2008 to identify any other work required at the site.

 

Other Sites.  Sites related to wood-treatment, chemical production, landfills, mining, and oil and gas refining, distribution and marketing. These sites are in various stages of investigation/remediation.

 

There may be other sites where we have potential liability for environmental-related matters but for which we do not have sufficient information to determine that the liability is probable or reasonably estimable. We have not established reserves for such sites.

 

Critical Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates and assumptions regarding matters that are inherently uncertain and that ultimately affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Generally, accounting rules do not involve a selection among alternatives, but involve a selection of the appropriate policies for applying the basic principles. The estimates and assumptions are based on management’s experience and understanding of current facts and circumstances. These estimates may differ from actual results. Certain of our accounting policies are considered critical as they are both important to reflect the company’s financial position and results of operations and require significant or complex judgment on the part of management. The following is a summary of certain accounting policies considered critical by the management of the company.

Long-Lived Assets

 

Key estimates related to long-lived assets include useful lives, recoverability of carrying values and existence of any retirement obligations. As a result of future decisions, such estimates could be significantly modified. The estimated useful lives of our property, plant and equipment range from three to 40 years and depreciation is recognized on the straight-line basis. Useful lives are estimated based upon our historical experience, engineering estimates and industry information. Our estimates include an assumption regarding periodic maintenance and an appropriate level of annual capital expenditures to maintain the assets.

 

Long-lived assets are evaluated for potential impairment whenever events or changes in circumstances indicate that carrying value may be greater than future net cash flows. Such evaluations involve a significant amount of judgment since the results are based on estimated future events, such as sales prices, costs to produce the products, the economic and regulatory climates and other factors. We evaluate impairment for our pigment segment based on a single global pigment asset group. Due to a recent downturn in the U.S. TiO₂ industry, impairment indicators warranted the preparation of an impairment analysis for the global pigment asset group as of December 31, 2007. Accordingly, we prepared a cash flow analysis comparing projected cash flows to the net carrying value of the global pigment asset group. The analysis indicated that no impairment was present as of December 31, 2007. We cannot predict when or if future impairment charges will be required for held-for-use assets.

 

Restructuring and Exit Activities

 

We have recorded charges in recent periods in connection with closing facilities and work force reduction programs. With the exception of asset retirement obligations, these charges are recorded when management commits to a plan and incurs a liability related to the plan. Estimates for plant closing include the write-down of inventory, write-down of property, plant and equipment, any necessary environmental or regulatory costs, contract termination and severance costs. Asset retirement obligations are recorded in accordance with SFAS No. 143, “Accounting for Asset Retirement Obligations.” Estimates for work force reductions are recorded based on estimates of the number of positions to be terminated, termination benefits to be provided, estimates of any enhanced benefits provided under pension and postretirement plans and the period over which future service will continue, if any. We evaluate the estimates on a quarterly basis and adjust the reserves when information indicates that the estimates are above or below the initial estimates. We cannot predict when or if future restructuring or exit reserves will be required. For additional information regarding work force reduction programs, exit activities and asset retirement obligations, see Notes 5 and 7 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

Environmental Remediation and Other Contingency Reserves

 

Our management makes judgments and estimates in accordance with applicable accounting rules when it establishes reserves for environmental remediation, litigation and other contingent matters. Provisions for such matters are charged to expense when it is probable that a liability has been incurred and reasonable estimates of the liability can be made. Estimates of environmental liabilities, which include the cost of investigation and remediation, are based on a variety of matters, including, but not limited to, the stage of investigation; the stage of the remedial design; the availability of existing remediation technologies; presently enacted laws and regulations; and the state of any related legal or administrative investigation or proceedings. We have been identified as a PRP at several sites for which an obligation is not currently probable and/or estimable and accordingly, have not recorded reserves for those sites. In future periods, a number of factors could significantly change our estimate of environmental remediation costs, such as changes in laws and regulations; relevant cleanup levels; revisions to the remedial design; unanticipated construction problems; identification of additional areas or volumes of contamination; increases in labor; equipment and technology costs; changes in the financial condition of other potentially responsible parties; and the outcome of any related legal and administrative proceedings or alternative dispute resolution proceedings (including mediation) to which we are or may become a party. Consequently, it is not possible for us to reliably estimate the amount and timing of all future expenditures related to environmental or other contingent matters and actual costs could exceed our current reserves.

Before considering reimbursements of our environmental costs discussed below, we provided $15.1 million, $56.4 million and $69.0 million pretax for environmental remediation and restoration costs in 2007, 2006 and 2005, respectively, including provisions of $11.6 million, $55.8 million and $29.9 million in 2007, 2006 and 2005, respectively, related to former businesses reflected as a component of loss from discontinued operations.

 

To the extent costs of investigation and remediation are recoverable from the U.S. government or Kerr-McGee, and have been incurred or are recoverable under certain insurance policies or from other parties and such recoveries are deemed probable, we record a receivable. In considering the probability of receipt, we evaluate our historical experience with receipts, as well as our claim submission experience. At December 31, 2007, estimated recoveries of environmental costs recorded in the Consolidated Balance Sheet totaled $67.6 million. Provisions for environmental remediation and restoration in the Consolidated and Combined Statements of Operations were reduced by $13.5 million, $53.1 million and $34.3 million in 2007, 2006 and 2005, respectively, for estimated recoveries, including recoveries of $12.4 million, $32.1 million and $12.3 million in 2007, 2006 and 2005, respectively, related to former businesses reflected as a component of loss from discontinued operations.

 

For additional information about contingencies, refer to “Environmental Matters” above and Note 17 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

 

Income Taxes

 

We have operations in several countries around the world and are subject to income and similar taxes in these countries. The estimation of the amounts of income tax to be recorded by the company involves the interpretation of complex tax laws and regulations and how foreign taxes affect domestic taxes, as well as the analysis of the realizability of deferred tax assets, tax audit findings and uncertain tax positions. Although we believe our tax accruals are adequate, differences may occur in the future, depending on the resolution of pending and new tax matters.

 

A valuation allowance is provided against a deferred tax asset when it is more likely than not that all or some portion of the deferred tax asset will not be realized. SFAS No. 109 requires that when a cumulative loss exists, unless there is overwhelming positive evidence to support the future use of net operating losses, a valuation allowance should be recorded. In 2007, we recorded a noncash valuation allowance on certain U.S. deferred tax assets of $29.9 million.

 

In connection with the decision to retain the Uerdingen facility, we have begun a reorganization of our European operations and legal entities. The reorganization process is expected to be effectively completed in 2008. Due to the reorganization, we no longer expect to realize a benefit from the net deferred tax asset previously recorded related to our Swiss entity. As a result, we recorded a valuation allowance of $9.4 million, of which $4.4 million related to the net deferred tax asset recorded at December 31, 2006, while $5.0 million related to the benefit of the loss for the twelve-month period ended December 31, 2007.

 

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

 

We also record assets and liabilities arising from uncertain tax positions meeting certain criteria in our financial statements. Refer to “New/Revised Accounting Standards” below for the definition and discussion of FIN No. 48.

 

Pension and Postretirement Accounting

 

We currently provide pension and postretirement benefits for qualifying employees worldwide. These plans are accounted for and disclosed in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 87, “Employers’ Accounting for Pensions,” SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” and SFAS No. 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits — An Amendment of FASB Statements No. 87, 88 and 106 (revised),” all of which were amended by SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” in 2006.

U.S. Plans

 

As of March 30, 2006, we separated from Kerr-McGee and established certain funded and unfunded U.S. benefit plans to cover our U.S. employees who previously participated in certain U.S. benefit plans sponsored by Kerr-McGee.

 

The following are considered significant assumptions related to our retirement and postretirement plans, with a brief description of the methodology used by management to develop the significant assumptions included below:

 

 

Discount Rate.  We selected a discount rate of 6.25% and 5.75% as of December 31, 2007 and 2006, respectively, for our U.S. plans based on the results of a cash flow matching analysis which projected the expected cash flows of the plans using the yield curves produced by the applicable Citigroup Pension Discount Curves.

 

Expected Long-term Rate of Return.  The estimated long-term rate of return assumption used in the determination of net periodic cost for the year ended December 31, 2007, was 8%. This rate was developed after reviewing both a capital asset pricing model using historical data and a forecasted earnings model. An expected return analysis is performed which incorporates the current portfolio allocation, historical asset-class returns and an assessment of expected future performance using asset-class risk factors. We selected 7.5% as of December 31, 2007, to be used in the determination of net periodic cost for the 2008 annual period.

 

Rate of Compensation Increases.  Our estimated rate of compensation increases was 3.5% at both December 31, 2007, and December 31, 2006, based on our long-term plans for compensation increases and expected economic conditions, including the effects of merit increases, promotions and general inflation.

 

The above assumptions are specific to us and our employee groups covered, and, therefore, are expected to be different from assumptions formed by Kerr-McGee for its plans. Application of such assumptions by us may result in different amounts of net periodic cost (benefit) recognized in our financial statements in future periods compared to the net periodic cost (benefit) historically allocated to us by Kerr-McGee. It is estimated that the company will record a total net periodic credit for the annual 2008 period of approximately $3.8 million related to its U.S. plans. See Note 15 to the Consolidated and Combined Financial Statements included in Item 15(a) of this Annual Report on Form 10-K.

The following table shows the impact of changes in the primary assumptions used in actuarial calculations associated with our pension and other postretirement benefits. The net periodic cost (benefit) amounts reflect the impact on net periodic cost for the year ended December 31, 2007. The projected benefit obligation (“PBO”) amounts reflect the impact on the projected benefit obligation as of December 31, 2007.