Earnings Call Transcript - TROX Q1 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the Tronox Holdings' Q1 2024 Earnings Conference Call. This call is being recorded on Thursday, May 2, 2024, and I would like to turn the conference over to Jennifer Guenther, Chief Sustainability Officer and Head of Investor Relations. Please go ahead.

Jennifer Guenther, Chief Sustainability Officer and Head of Investor Relations

Thank you, and welcome to our first quarter 2024 conference call and webcast. Turning to Slide 2, on our call today are John Romano, Chief Executive Officer, and John Srivisal, Senior Vice President, Chief Financial Officer. We will be using slides as we move through today's call. You can access the presentation on our website at investor.tronox.com. Moving to Slide 3, a friendly reminder that comments made on this call and the information provided in our presentation and on our website include certain statements that are forward-looking and subject to various risks and uncertainties including but not limited to the specific factors summarized in our SEC filing. This information represents our best judgment based on what we know today. However, actual results may vary based on these risks and uncertainties. The company undertakes no obligation to update or revise any forward-looking statements. During the conference call we will refer to certain non-U.S. GAAP financial terms that we use in the management of our business and believe are useful to investors in evaluating the company's performance. Reconciliations to their nearest U.S. GAAP terms are provided in our earnings release and in the appendix of the accompanying presentation. Additionally, please note that all financial comparisons made during the call are on a year-over-year basis unless otherwise noted. It is now my pleasure to turn the call over to John Romano. John?

John Romano, Chief Executive Officer

Thanks, Jennifer, and good morning, everyone. We'll begin this morning on Slide 5 with some key messages from the quarter. As mentioned in our preliminary results announcement, we delivered a stronger first quarter than anticipated. This was driven by our lower production costs through our global operations, destocking having largely run its course through the supply chain, paired with the demand trajectory outpacing normal seasonal levels and our ability to respond to that demand through the strength of our global footprint. Our revenue increased 13% compared to the prior quarter or 20% on TiO2 and zircon revenue alone, excluding other product sales which saw a decrease due to non-repeating sales of ilmenite and a portion of our rare earth tailings deposit in South Africa. The 18% increase in TiO2 volumes from the fourth quarter exceeded both our guidance of 12% to 16% and the growth that would be more typical for this time of year. However, this type of rebound is indicative of what we would expect to see on the front end of a recovery. Demand improved across all regions and outperformed even more so in Europe, the Middle East, Africa, and Latin America, where volumes declined more significantly over the past six quarters. Zircon continued to recover from the trough volume seen in July of 2023 driven by stronger underlying demand despite the market in China remaining relatively muted. Our volumes increased 54% versus Q4, which was well above our guidance of 15% to 30%. Pricing for TiO2 and zircon was in line with our expectations. On the operational side, we incurred significant costs in 2023 from running our assets at lower utilization rates due to softer underlying demand. As we saw the market beginning to turn late last year, we began increasing our operating rates, which had a positive impact on our manufacturing cost. As a result, our first quarter cost improved when compared to both the prior quarter and the prior year. This helped drive a better-than-anticipated EBITDA margin of almost 17% and adjusted EBITDA for the quarter totaling $131 million, which was above our guided range. As the high-cost inventory continues to move through our internal supply chain, efficiencies from investments made in the business to reduce costs will enable margins to return to levels realized prior to the downturn. The first quarter has been a true inflection point. We believe the trends both on the demand side and in reducing our costs will continue going forward. We're well on our way to delivering a step change in our earnings power, having already worked through much of the remaining high-cost inventory on the balance sheet. Our free cash flow for the quarter was a use of $105 million, but we will begin clawing back this use beginning in the second quarter and expect to generate positive free cash flow for the full year. I'll let John run through more of the first quarter numbers and the balance sheet, but we're comfortable with where we are from a liquidity and a debt position. We recently consolidated and repriced two tranches of our term loan, which will result in an estimated annual savings of approximately $5 million. I'm proud of how our team has continued to work to strengthen the business. And as we stand here today, we are well-positioned to continue to capitalize on the recovery that is underway. On the sustainability front, we're happy to confirm that we officially began receiving power from the 200-megawatt solar project in South Africa. This is not only a significant development on our journey to net zero by 2050, as we will realize an additional 13% CO2 emissions reductions from this project alone for a total of 18% relative to our total 2019 baseline. But it will also provide some cost avoidance benefit from increasing electricity costs in South Africa. We're already working on our next power purchase agreement in South Africa, this time on wind, as this is the highest cost contributor to carbon emissions, so it remains a high area of focus. We expect to publish our 2023 sustainability report this quarter that will outline these and other key initiatives across emissions and waste reduction, water management, social initiatives and more. We firmly believe that preserving our privilege to operate is critical for our strategy today and for our future. At the end of the day, our people and our planet enable us to carry out our work and as a result we have a responsibility to do so in a manner that is both safe and sustainable. I'll now turn the call over to John to review some of our financials from the quarter in more detail. John?

John Srivisal, Chief Financial Officer

Thank you, John. Turning to Slide 6. We generated revenue of $774 million, an increase of 9% compared to the prior year or 13% sequentially, driven by higher revenue from both TiO2 and zircon. Income from operations was $41 million in the quarter and we reported a net loss of $9 million. While our profit before tax was $2 million, our tax expense was $11 million in the quarter. This was due to the fact that we generated higher-than-expected earnings in jurisdictions where we pay taxes, driven mainly by higher zircon sales. As a result, our adjusted diluted earnings per share was a loss of $0.05. As John previously mentioned, our adjusted EBITDA in the quarter was $131 million, and our adjusted EBITDA margin was approximately 17%. Free cash flow was a use of $105 million, of which $76 million was from capital expenditures. Now let's move to Slide 7 for a view of our commercial performance. As John mentioned, the recovery outpaced our expectations and drove TiO2 and zircon volume growth versus the prior quarter and prior year. Pricing was largely in line with our expectations and consistent with our margin stability program. TiO2 revenues increased 8% versus a year-ago quarter and 17% versus the prior quarter as sales volumes improved 18% in both comparisons. The volume increase was driven by both organic demand and restocking, which we saw across all regions with a higher recovery rate in Europe, Middle East, Africa, and Latin America where volumes declined more notably in the past six quarters. As expected, TiO pricing including mix saw a 1% decrease quarter-over-quarter. Zircon volumes increased 54% sequentially. We've continued to see recovery from the trough levels of July 2023 with stronger underlying demand in Q1. Zircon pricing was level with the prior quarter. Revenue from other products decreased 26% compared to the prior quarter, driven by an opportunistic sale of ilmenite and a portion of our rare earth tailings deposit in South Africa in the fourth quarter that, as we had communicated last quarter, would not repeat. Turning to Slide 8, I will now review our operating performance for the quarter. Our adjusted EBITDA of $131 million represented a 10% decline year-on-year, driven by lower average selling prices and mix and higher SG&A. This is partially offset by improved sales volumes, exchange rate tailwinds and favorable reductions in input cost from materials such as chlorine, coke, and caustic soda. Additionally, we saw favorable fixed cost absorption and freight costs as compared to Q1 2023. Sequentially, adjusted EBITDA improved 39%. As we mentioned last quarter, we expected to see improvements in costs as we increased our operating rates beginning late last year and continuing into this year. Compared to Q4, production costs improved $57 million. This was comprised of $32 million relating to favorable absorption and lower cost of market charges from the higher production, $15 million from the Q4 Botlek idle facility charge due to the supplier outage that did not repeat in Q1 and $10 million for lower mining costs primarily from Atlas. By the end of the year we expect to recover approximately $15 million from insurance claims relating to the downtime at Botlek due to the supplier outage. The TiO2 and zircon volume benefit to EBITDA was partially offset by the non-repeating opportunistic sale of ilmenite and a portion of our rare earth tailings deposit in Q4. Other headwinds versus the prior quarter, as expected, were price mix, FX, freight costs from the Red Sea impact and higher SG&A. Turning to Slide 9, I will now review our balance sheet and cash position. We ended the quarter with total debt of $2.8 billion and net debt of $2.7 billion. Our net leverage at the end of March was 5.2x on a trailing 12-month basis. Our balance sheet remains strong with ample liquidity ahead of anticipated critical vertically integrated capital expenditures. As John mentioned, we successfully completed a repricing transaction on two of our existing term loan tranches, which will result in approximately $5 million of annualized interest expense savings. We also extended the maturity of one of these tranches to 2029. Our nearest-term significant maturity remains 2028 and we have no financial covenants on our term loans or bonds. Our weighted average interest rate in Q1 was 6.5%. We maintained interest rate swaps such that approximately 73% of our interest rates are fixed through 2024 and approximately 64% are fixed from 2024 through 2028, aligning with the maturity of our earliest tranche of our term loan. Total available liquidity as of March 31st was $629 million, including $152 million in cash and cash equivalents that are well-distributed across the globe. Capital expenditures totaled $76 million in the quarter. Roughly 44% of this was for maintenance and safety and 56% was for strategic growth projects. Working capital was a use of $127 million in the quarter. The vast majority of this related to higher revenue driving an increase in accounts receivable. For inventory, we would normally expect to see an increase in the first quarter in preparation for the spring coating season. While we did plan for the upturn by running at the higher production rates, the increased demand across our business resulted in inventorying being a source of cash for the quarter. Accounts payable was a decrease, which is typical of our Q1 profile. We declared a dividend of $0.50 per share on an annualized basis in the first quarter that was paid to shareholders in the second quarter. I will now turn the call back over to John Romano for some comments on the year ahead and our outlook. John?

John Romano, Chief Executive Officer

Thanks, John. So with the first quarter behind us, we can confidently reaffirm what we stated in the last quarter. 2024 has already demonstrated a reversal of several trends from the last 18 months and we anticipate the recovery to continue. On the market, we've already begun to see an uptick in TiO2 demand that is indicative of what we would see on the front end of a recovery. On pricing, we expect TiO2 pricing to reverse its downward trend and improve as we move through the remainder of 2024. Regarding zircon, volumes continue to improve from the trough levels realized in July of 2023, and there was a significant improvement in the first quarter. Further recovery will be somewhat reliant on China, given its significant share of the overall zircon market. Nevertheless, demand has rebounded even in the absence of a major shift in China. On the operational side, we incurred significant costs in 2023 in the range of $25 million to $35 million per quarter from running our assets at lower utilization rates due to soft market demand. At the end of 2023, we began increasing our operating rates in line with the demand improvements we were beginning to see in the market, which has and will continue to have a positive impact on our manufacturing costs. Although we still have some high-cost inventory to move through the business, with sales outpacing our previous guidance, our EBITDA margins will now be in the range of 20% this quarter. We will continue to deploy technology at our sites to reduce costs and improve efficiencies, which will also benefit our cost position as we ramp up. And we're investing in key capital projects to sustain our vertical integration. From a growth perspective, our R&D efforts remain focused on product and process innovations to enhance profitability. Additionally, we're continuing to explore opportunities in the rare earth space. Moving to Slide 11, I'll now review two key capital projects in more detail. As a reminder, this year we're investing approximately $130 million in two key mining projects in South Africa to replace our existing mines reaching end of life. These projects are critical to continuing our vertical integration strategy and are important to pursue now to ensure a smooth transition to replace existing mines reaching end of life. These investments will maintain our more than $300 per ton advantage relative to market pricing for feedstock, and our very high return projects with internal rates of return in excess of 30%. Turning to Slide 12, I'll review our outlook for the quarter and year ahead in more detail. For Q2, we expect TiO2 volumes to increase between 7% and 10% and zircon volumes to remain relatively flat, both compared to the first quarter. And we expect TiO2 pricing to increase slightly versus the first quarter. As a result, we're expecting Q2 2024 adjusted EBITDA to be $160 million to $180 million and adjusted EBITDA margins to be in the range of 20%. Our expectations for 2024 cash uses are as follows. Our capital expenditures are expected to be approximately $395 million. Our net cash taxes are expected to be less than $10 million as the significant capital expenditures in South Africa are deductible. Our net cash interest expense is expected to be $140 million, and we're expecting working capital to be a tailwind. The magnitude of the cash flow will depend on how significant the market recovery is as we move through the year. Our capital allocation strategy remains largely unchanged. We are prioritizing investments in the business that are critical to furthering our strategy and driving value from our vertically integrated portfolio. And even at this investment level, we expect to generate positive free cash flow for the full year. We will also be focused on bolstering our liquidity. And as the market recovers, we'll look to resume debt paydown. We will continue to prioritize our dividend. And finally, we will continue to evaluate strategic high-growth opportunities as they arise. Currently, we're focusing on the rare earth space. And we will keep the market updated on any key developments as they arise. That concludes our prepared comments. We'll now move to the Q&A portion of our call, so I'll hand the call back over to the operator to facilitate.

Operator, Operator

One moment for your first question. It will be from David Begleiter at Deutsche Bank.

David Begleiter, Analyst

John, Chinese exports were at an elevated level in March. What are the things driving that? Is it sustainable? And how much of a concern is it to your forecast for higher prices in the back half of the year?

John Romano, Chief Executive Officer

Yes, thanks, David. The March numbers were significant. When comparing February and March, February saw a decline that wasn't really consistent with our volumes during February for Chinese New Year. However, there was a notable increase from Q4 to Q1. There's ongoing discussion regarding antidumping, and I suspect part of what's happening is some repositioning of inventory. It's important to note that we're observing exports out of China rather than imports into Europe. Additionally, the increase from February to March, with March being significantly higher, likely relates to shipping delays. There's no doubt that volumes are increasing. Normally, we expect a bump in the first quarter, and the first quarter's volume of around 500,000 tons was indeed higher than last year. However, some of that may also relate to repositioning in anticipation of potential developments later in the year, likely in the third quarter regarding dumping.

David Begleiter, Analyst

And just on the antidumping case, do you expect provisional duties to be enacted? And if so, is it Q3 or earlier? And is there any change yet that you're seeing in customer buying behavior in Europe due to these antidumping investigations?

John Romano, Chief Executive Officer

Yes. So look, I'd say I'm not going to presuppose what's going to happen, but I think there's clearly an indication that if duties go into place, provisional duties should happen sometime at the end of June, maybe latest early July. So there's an assumption that that is going to happen. And in addition to the EU investigation in the last three weeks, there have been two other formal investigations launched, one in India and one in Brazil. So there's lots of moving parts on dumping. When we think of our forecast, as I mentioned in the last call, because we don't expect a lot of dumping actual duties to be imposed or provisional duties to be imposed before the end of the second quarter, there's not a lot of volume moving in our numbers with regards to that. Could there be some positioning? It's possible. It's hard to really tell at this stage. And we ought to get some better visibility in that as we kind of move through the balance of this quarter.

David Begleiter, Analyst

Next question will be from John McNulty at BMO Capital Markets.

John McNulty, Analyst

So, in terms of the asset utilization rates, obviously a lot stronger. I think you had $32 million, I think you cited as a reduction in fixed cost absorption. I guess how should we be thinking about that as we progress through the year? And I guess, can you give us some relative assumptions for kind of maybe what utilization rates are at or the change that you've seen? It might just give us some ability to calibrate how much more there may be ahead in terms of improvement there.

John Romano, Chief Executive Officer

Yes. From our perspective, we were clear last year about our capacity utilization across our nine pigment plants, which averaged around 70% over the past 12 months. In some cases, it was even lower. However, we're now seeing that figure creep up to over 80%. This indicates a recovery, especially considering we started from a low baseline. We had a strong quarter in terms of volume, which I believe signals the beginning of this recovery. We noticed some signs of improvement towards the end of last year, prompting us to increase production. We expected that high-cost inventory would take until the end of the second quarter to manage, but the volumes are moving faster than anticipated, allowing us to address that inventory more quickly. We're currently running our assets at a more consistent rate, which is a change from the challenges we faced operating at 70% on average. With the current rate of operation, we believe it's much more reliable, and we don't expect to encounter the same downtime we faced previously. There is still potential for improvement as the market evolves, and as that happens, we will continue to adjust our production according to our integrated business planning process, which also considers how we handle our ore blends. John, do you have any comments?

John Srivisal, Chief Financial Officer

Yes, as John mentioned earlier, we began to increase our efforts in the fourth quarter of last year. Due to our vertically integrated chain, it typically takes three to six months for these efforts to materialize. Therefore, a significant portion was reflected in the first quarter. We anticipate that the higher-cost inventory will be worked through by the second quarter. While we might not see the same level as in the first quarter, it will still be substantial and close to that amount.

John McNulty, Analyst

Got it. That's really helpful information. As a follow-up, it seems that the volumes are coming in better than the usual seasonal increase in both the first and second quarters. How do you view the typical seasonal patterns for TiO2 demand as we approach the second half of the year? Should we expect it to return to a more normal level, or could it possibly be slightly less down as we move into the latter part of the year?

John Romano, Chief Executive Officer

We have projected a 7% to 10% increase in Q2. However, this varies by year, especially given the fluctuations we've experienced in the last three years due to COVID and its aftermath. This range may be on the higher side, and it's still early to predict what will occur in the third quarter, although we are starting to see our order book taking shape. In some cases, a third quarter could be slightly lower depending on the year and the economic cycle. Usually, in a standard market, you'd see inventory being built in the first quarter, used in Q2 and Q3, and then replenished in Q4. Therefore, I expect a pattern similar to this, and we are not currently anticipating a significant increase in third quarter volumes. However, it is still too early to make definitive statements. Additionally, I am not making any forecasts regarding antidumping measures, but if duties are imposed, that could influence the situation.

Operator, Operator

And your next question will be from Duffy Fischer at Goldman Sachs.

Duffy Fischer, Analyst

Can you walk through the major geographies? When you look at your Q2 guide, both on price and volume, can you give us some color on how that will vary between Europe, the U.S. and Asia?

John Romano, Chief Executive Officer

Yes, Duffy. So look, when we think about the first quarter, as I mentioned in the call, we saw growth in every region. And we saw, I'd say, disproportional growth in the areas where we had further reductions over the last six quarters. So Europe, Middle East, Africa, and Asia Pacific was a bit higher on the growth side. Moving into Q2, we're starting to see what we would normally project in the first quarter for our coating season build. So the Americas is starting to pick up. We're seeing some green shoots in Brazil. But we're seeing pretty consistent growth. But I'd say the difference between Q1 and Q2 is that we're starting to see a little bit more growth in North America. Not to say we didn't see growth in the first quarter, but we're seeing what's more indicative of a northern hemisphere coating season with volumes picking up in North America and still getting increases in Europe, Middle East, Africa and Asia Pacific as well. But I'd say that we're getting a bit more of a push in North America as well in the second quarter.

Duffy Fischer, Analyst

Okay. And then if you look at your debt ratio, you've talked about obviously wanting to get that better. How should we think about how much of that repair comes from just EBITDA moving higher versus how much you actually want to pay down net debt or pay down gross debt from here?

John Romano, Chief Executive Officer

So maybe I'll start with what our goal is, and it's still to get to between $2.7 billion and $2.8 billion depending upon gross or net debt. We still have a goal to get to $2 billion. And I'll let John talk about it.

John Srivisal, Chief Financial Officer

Yes. The leverage relates to net debt, which involves either reducing debt or generating cash. As John mentioned, we aim to enhance liquidity through the end of this year while managing the market and reducing debt. We do expect positive free cash flow for the year, with Q1 being a significant outflow. We anticipate a considerable amount of free cash flow in the last three quarters, which will improve that metric. Additionally, our guidance of $160 million to $180 million indicates that we will start seeing much better year-over-year EBITDA, potentially as early as Q2, depending on our results. The second half of 2023 presents a manageable target that we are confident we can surpass. Thus, we anticipate a significant decrease in our net leverage ratio over the remainder of this year and beyond.

Duffy Fischer, Analyst

But I guess that was kind of my question. What's the baseline EBITDA you want to use when you look at that ratio? Would you want to use kind of the trough of the LTM as we sit today? Or is it just going to be the LTM floating as we go through time, which will have a higher EBITDA number behind it?

John Srivisal, Chief Financial Officer

Yes, definitely the higher level.

John Romano, Chief Executive Officer

Yes, the latter.

Operator, Operator

Next question will be from John Spector at UBS.

Joshua Spector, Analyst

I wanted to ask if you think your volumes benefited in the first quarter from competitor outages or not. And to the extent that they did or didn't, is any of that a permanent shift in your view and share gains for Tronox that maybe you've locked down the contracts or do you view any of that as more transitory?

John Romano, Chief Executive Officer

Hey, Josh. When I mentioned that we increased our assets anticipating signs of improvement in demand in the fourth quarter, it was because we noticed demand starting to rise and were able to respond effectively. I attribute this to the strength of our global presence, having assets on six continents, which places us closer to our customers. We navigated some challenges related to the Red Sea and the Panama Canal, and our positioning allowed us to respond to the volume. While I'm not sure I would label that as gaining market share, it reflects our ability to react to the early signs of an increase in demand. Looking ahead, I noted that we see continued growth into the second quarter. Various factors influenced our demand, including an increase in our volumes and the supply chain effectively working through inventory. Customers are returning to a normal ordering pattern, and a portion of our volume stems from our global positioning, enabling us to meet demand across all regions we supply. As I mentioned, we experienced an uptick in every region in the first quarter.

Patrick Fischer, Analyst

Okay. Appreciate that. And I wanted to ask on the cost side. So I mean, John, you mentioned earlier, I think, pretty clearly on the sequential improvements that you guys expect. But I guess if I look back a year ago, the operating cost impact, it was minus $100 million plus, and it was negative the year before. So just trying to take a little bit longer term can you recover any of that as we look over the next couple of years? Is that higher operating rates? Or is that related with some of the CapEx projects around the mine? Just helping frame how that layers in over the next couple of years would be helpful.

John Srivisal, Chief Financial Officer

Yes. We anticipate higher production rates, which should be evident by the end of Q2. Over the past few years, we've seen a significant increase in raw material costs, with an increase of over $400 million from 2020 to 2022 when adjusted for constant volumes and currency. In 2023, we haven't experienced a substantial decrease in costs, reflecting about a 4% reduction. For 2024, we expect high single-digit improvements, but even at those projected levels, the current costs are not sustainable. Therefore, while we expect some changes, significant improvements are likely not to materialize in 2024.

Frank Mitsch, Analyst

Congrats on the beat and raise. I want to drill down a little bit more into the fixed cost absorption production level issues. You indicated that this was a negative of over $100 million in 2023. So, as we think about 2024 and given the start that you're off to, is it fair to assume that absent those costs, all else equal EBITDA should be up over $100 million in 2024?

John Srivisal, Chief Financial Officer

Yes, that's a fair statement.

John Romano, Chief Executive Officer

Suitable math.

Frank Mitsch, Analyst

Okay. Fantastic. I much appreciate it because obviously the Street is not there. But I suspect, as I said, given the beat and raise, the Street will get there. And then on the pricing side, you indicated that you anticipate a slight uptick here in 2Q versus 1Q. Can you comment at all with respect to the geographic expectations on that?

John Romano, Chief Executive Officer

Yes, Frank. So in some of the areas where we saw the biggest decline in volumes, so over the last six quarters, Europe, Middle East, Africa, Latin America, Asia Pacific, that's where we're starting to see the market recover the strongest, and that's where we're starting to see some, I'd say, progress on pricing. There's a lot of announcements out there on pricing. And I think it's probably worth spending a little bit of time talking about. It takes a little bit of time for price. So any time the market rebounds, and that's what we saw in the first quarter, you wouldn't normally see that kind of a pickup in the first quarter. So again, what we saw was indicative of the startings that we're recovering. It takes a little bit of time for pricing to actually roll through. So when people make announcements, takes time for those announcements to get implemented. Typically, capacity utilization needs to get to a certain point before and inventories need to get to a certain place before pricing actually starts to move through. So we're making progress. Again, Latin America, Asia Pacific, Europe, Middle East and Africa. And as we move into the second half of the year, we'll start to make progress in other regions. But those are the areas where we're starting to get some progress. And like I said, it typically takes a little bit of time to get that pricing traction once the volume comes along. It doesn't happen overnight. And we got a lot of questions about why our price was down in the first quarter. That wasn't down. 1% was in line with what we thought, and that's largely just mix. So we have a good feel for where we are on the second quarter because we've already negotiated those increases. That's why we made that reference to a slight increase. But as we get into the second half and we kind of evaluate how the market is continuing to evolve, we'll continue to make those progress on pricing.

Next question will be from Mike Leithead at Barclays., Analyst

I just have one question maybe for John or CFO John, on inventory. Dollar inventory decreased maybe 1% sequentially and your sales volumes improved something like 20% sequentially. And you mentioned you recently burned through a lot of the high-cost inventory. So I would have thought inventories would have declined more. So can you help explain that?

John Srivisal, Chief Financial Officer

Yes, that's a great question. We did see a decrease in inventory, which is unusual for this quarter, as typically we would expect an increase due to normal seasonality. It's important to consider this when comparing overall balances. Additionally, as a vertically integrated supplier, our inventory isn't limited to pigments or zircon; it also includes our mining operations. While some costs have decreased, we still have significant expenses related to an increase of $400 million over the last couple of years, which is contributing to the current situation. However, we anticipate recovering a good portion of that increase over time. When input costs go down, we expect to see that recovery. Furthermore, if the commercial side strengthens in the second half of the year, similar to what we experienced in 2021, we will convert that inventory into cash. For reference, we generated $468 million in free cash flow in 2021, indicating the earnings and cash flow potential of our business.

John Romano, Chief Executive Officer

We previously mentioned that we reduced our TiO2 inventory. Now we are increasing production at Atlas. To clarify, we don't solely have TiO2 inventory; we also hold pig iron, ilmenite, slag, and natural rutile inventories, creating a diverse portfolio. As costs decrease, the value of this inventory will also decline. It's important to understand that there are both days of inventory and its valuation, and we anticipate this value to continue decreasing for the remainder of the year.

John Srivisal, Chief Financial Officer

And the other thing to note is, obviously we do have a contract with Jazan. So we are buying feedstock and that is building our inventory of feedstock.

Operator, Operator

Next question will be from Hassan Ahmed at Alembic Global.

Hassan Ahmed, Analyst

Question on the guidance. You guys reported $130 million in EBITDA in Q1. And obviously $160 million to $180 million is the guidance range for Q2. So I mean, taking the midpoint of Q2 guidance, you're roughly sort of guiding to around $300 million in the first half of the year. And it seems from all your commentary that earnings momentum is developing, right? So the back half should look far better than the first half. And yet, I take a look at consensus numbers, and they are slightly shy of $600 million. So which to me seems highly beatable. I mean is that the fair way of thinking about 2024?

John Romano, Chief Executive Officer

Yes, that's another interesting way to ask the question Frank raised. I believe your comments are justified. If you double 300, you still fall short of the figure we just confirmed with Frank. So we do see some potential for growth as we progress. I'm not meant to discuss consensus because Jennifer guides me on that. I have mentioned your point, but I think your remarks are accurate.

Hassan Ahmed, Analyst

Fantastic, fantastic. And again, just sort of digging a little deeper into that. You guys talked about fixed cost absorption being a $25 million to $35 million penalty last year, right? So as your operating rates sort of move up and you were talking about sort of operating rates being sort of above 80% now, how much of that penalty was an offset in Q1? How much of it is going to be an offset in Q2? And what does the back half look like?

John Romano, Chief Executive Officer

So we're not going to provide the back half yet. But I would expect if we continue running at this rate. So I'll let John kind of work through the numbers because we gave you that. It was about $25 million to $30 million in the first quarter. But you have to think about how those numbers worked through last year, right? We said $25 million to $35 million a quarter, but there were quarters where that number was higher. So John, you might.

John Srivisal, Chief Financial Officer

I mean we said in Q1 versus Q4, production costs were about $57 million, $32 million was favorable absorption and lower cost of market changes, $15 million from the Botlek idle and then $10 million from higher mining. So if you take a look at that $32 million or so, and then we did answer on the Q&A recently, we do expect a similar amount, not quite the amount, but a similar amount in Q2. So if you take a look at that, it's additional to this $32 million that we've quoted. So you're already seeing a good amount of it, and that will continue through Q3 and Q4. So that's why we said that we expect that to recover the $25 million to $35 million from running at lower through Q2.

John Romano, Chief Executive Officer

We are not operating at full capacity yet, as we are still in the early stages of recovery. There is room to respond to increased demand as the recovery progresses. We have mentioned that the fourth quarter of 2022 was the low point, and since then, there has been slow improvement in 2023. Recently, we have observed positive signs indicating the start of a real recovery. As we move through the rest of the year, we will continue to assess the situation. The situation in China remains uncertain, and if it recovers, we will likely see effects not only on TiO2 but also on zircon.

Operator, Operator

Next question will be from Jeffrey Zekauskas at JPMorgan.

Jeffrey Zekauskas, Analyst

When you take a step back and you look at the coatings markets in the United States, they didn't grow in the first quarter, and maybe they shrank a little bit. And the coatings markets in Europe, maybe they're flat. And when you listen to the commentary of PPG or Sherwin-Williams, what they say is that they have plenty of TiO2. So when you look at your volume growth, where did it come from? And why isn't it simply just a restocking of lower inventories with volume to fall off because the TiO2 growth rate is so much higher than the end market coatings growth rate? How do you assess those different pulls and pushes?

John Romano, Chief Executive Officer

Thanks, Jeff. I think you got to go back to the last 24 months, right? So let's wind the clock back to the '22 and '23, where volumes dropped 15% each year. So over that 24-month period we lost 27% of our volume. That's not sustainable either. And you didn't hear that kind of a reduction from all of those coatings companies. So there is an element of a tremendous amount of inventory that was in the supply chain that we talked about the destocking effect. So part of it was destocking, and now we're just getting back to normal buying patterns. We're not back to where we were in '19 yet. To get to '21 levels, 2021 was a boom year for a lot of reasons for the TiO2 industry because people were staying at home, they weren't going out to and they were using products that our products are in. So we're not suggesting we're going to get back to '21 volumes. But what we saw over the last 2 years wasn't sustainable either. Now we're getting back to what we would refer to as just more normal buying patterns. There has been no significant replacement for TiO2, where 15% of the demand can just drop away on an annualized basis. So when you think about our growth, a lot of that growth is just getting back to normal buying patterns and feeding through that supply chain, which has been bloated with inventory and has been now depleted and we're starting to see upticks in demand. And I'm not going to speak to what or who you're speaking to with regards to the customers, but we're supplying all of them.

Operator, Operator

Next question will be from Vincent Andrews at Morgan Stanley.

Turner Hinrichs, Analyst

This is Turner Hinrichs on for Vincent. I'm wondering if you could provide some additional color on industry operating rates and how the supply and demand balance has trended by region?

John Romano, Chief Executive Officer

We won't provide specific comments on industry operating rates or what others are doing. We have shared our position, and as the market improves, we anticipate that companies will start evaluating their operating rates in response to the recovering demand. Regarding your second question, could you clarify if you were referring to regional demand?

Turner Hinrichs, Analyst

Supply and demand balance.

John Romano, Chief Executive Officer

Yes. TiO2 is a global market, and in a normal market, it flows quite freely in terms of supply and demand. However, over the past eight months, due to the geopolitical climate, shipping materials has become more challenging. This is why I mentioned that our global presence and the proximity of our assets to customers have positioned us well to take advantage of the early stages of recovery. Europe, Latin America, and the Middle East have experienced significant declines over the last six quarters, but we are beginning to see a rebound in those regions. China's demand has been a critical factor in growth over the past decade, particularly concerning capacity, as indicated by exports. Globally, there are various complexities in supply and demand across different regions. Nevertheless, we are starting to see signs of growth in demand overall, although China remains somewhat subdued. Regions that were more heavily affected in the past are showing stronger recovery from a lower base at this point. In North America, we are starting to notice the typical seasonal demand patterns, especially in the second quarter, which is beginning to positively affect us.

Turner Hinrichs, Analyst

Great. Great. Appreciate all the additional color. Just to confirm, it sounds like there's been some improvement of local-for-local selling this year, perhaps due to higher freight trends. And if you don't mind providing as well just an update of how global trade flows have been so far this quarter, that would also be of interest.

John Romano, Chief Executive Officer

Yes. So clearly, there has been a big bump in March on exports out of China. And again, that's exports. Those don't actually align with the imports going into Europe. So it's my opinion that some of that is probably prepositioned in bonded warehouses in anticipation for what might be happening on dumping. There has been an impact on a company's ability to move material and the time to move material from one country to another has been impacted, but based on what's going on in the Red Sea and the Panama Canal. So again, our global footprint allows us to take advantage of that because we have inventory positioned because of the location of our assets allows us to respond quicker to ups and downs in demand. And not being impacted as much. I'm not saying it's no impact to us because we do ship globally. But the impacts of the Red Sea and the Panama Canal probably have less impact on us than they do the balance of our competitors.

Operator, Operator

And your next question will be from Roger Spitz at Bank of America.

Roger Spitz, Analyst

It seems that many of the questions regarding EBITDA and cash flow are largely centered on the source of your working capital, specifically in relation to the excess costs and inventory from 2023. To clarify, am I correct in understanding that when you state that 2024 will see working capital inflow and that you expect both higher volumes and prices, this inflow will result from reducing the high-cost inventory and excess production costs from 2023? Additionally, could you provide insight into the exact figures involved? As of December 2023, your inventory was approximately 1,425, in 2022 it was 1,275, and in December 2021 it was 1,050. The figures for December 2019 and December 2020 were both around 1,125. Should we consider 1,125 as the normalized level once you have addressed the excess costs in your inventory?

John Romano, Chief Executive Officer

Let me make one comment. In 2021, consider our inventory from a days perspective, not just its value. We had inventory levels much lower than our comfort zone, especially since that was when things peaked. We moved through 100,000 tons of zircon inventory beyond what we produced. Our inventory levels on the TiO2 side were significantly lower than what we typically maintain. There are two aspects to this, and I will let John address them. One is what a normalized inventory looks like in terms of volume, and the other concerns normalization based on value.

John Srivisal, Chief Financial Officer

Yes, that's correct. In 2021, we sold nearly all that we could produce, resulting in low inventory levels. I wouldn’t consider 2021 as a normalized period. We had to rebuild our inventory and safety stock. Starting from 2021, we experienced significant cost increases over the next few years, exceeding $400 million. While we expect to recover a substantial portion of that, it's important to note that in 2021, we had some favorable contracts, so I wouldn’t anticipate the full $400 million comeback. In Q1, we did benefit from reducing our inventory by replacing higher-cost goods with lower-cost ones. Additionally, we experienced higher sales volumes than anticipated, which contributed significantly to the positive cash flow from an inventory standpoint in Q1.

John Romano, Chief Executive Officer

And we're not suggesting we're going to get that in 2024. It's going to be over a longer period of time, but we should be able to recover north of $100 million of that.

Operator, Operator

And at this time, Mr. Romano, we have no further questions. Please proceed, sir.

John Romano, Chief Executive Officer

Okay. Well, thank you, and thank you all for joining us today. Look, we're very confident that our vertical integration strategy, as we've talked about at length, will continue to provide a competitive advantage for Tronox. We're optimistic about the short, medium, and long-term potential for Tronox and the value that we continue to create through what we're kind of referring to as our leading sustainable mining and upgrading solutions. So with that, we appreciate your time, and thank you for your support and interest in Tronox. Have a great day.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.