Kronos Worldwide, Inc. — Q3 2013 Form 10-Q
Business context and reporting period
Kronos produces and markets titanium dioxide (TiO₂) pigments for coatings, plastics, paper and other industrial uses. This unaudited filing covers the quarter and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Figures are in U.S. dollars; financial amounts are in millions except per-share data. Kronos is majority-owned by Valhi and NL Industries.
Financial performance and liquidity
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $419.1 | $472.9 | $1,363.8 | $1,579.5 |
| Gross margin | $47.2 (11%) | $86.0 (18%) | $60.7 (4%) | $510.8 (32%) |
| Operating income (loss) | $(37.0) ((9)%) | $38.5 (8%) | $(131.6) ((10)%) | $358.5 (23%) |
| Net income (loss) | $(29.9) | $35.2 | $(104.9) | $236.6 |
| Basic and diluted EPS | $(0.26) | $0.30 | $(0.91) | $2.04 |
- Sales volumes rose 4% in Q3 and 8% year to date; production volumes rose 15% in Q3 and 1% year to date. Average TiO₂ selling prices fell 18% in Q3 and 21% year to date.
- For the first nine months, cost of sales increased $234.4 million to $1,303.1 million, while sales declined. Management attributed the deterioration chiefly to lower selling prices and higher raw-material costs, especially feedstock ore. Feedstock-cost moderation began to benefit cost of sales more meaningfully in Q3.
- Operating cash flow was $60.8 million for the first nine months, versus $57.5 million a year earlier. Capital expenditures were $49.9 million. Cash and cash equivalents declined to $59.8 million from $282.7 million at year-end 2012; cash, cash equivalents and restricted cash totaled $68.9 million.
- At September 30, total debt was $224.0 million, including $20.7 million of current maturities, compared with $400.1 million at year-end 2012. Debt included a $175.0 million note payable to Contran and $46.2 million drawn on the North American revolver. Kronos reported $56.6 million available under that revolver.
- The European facility was undrawn, but its financial-ratio covenant limits effective available borrowing to approximately $32.4 million; Kronos was discussing a covenant amendment with the lender. The company said it was in compliance with its debt covenants and expected sufficient liquidity for its stated short- and long-term needs.
- The company paid $52.2 million in dividends in the first nine months ($0.45 per share). Interest expense was $16.6 million year to date, down from $20.0 million.
Material changes versus the prior comparable period
- Q3 net sales fell 11% and nine-month sales fell 14%, principally from lower TiO₂ prices, partly offset by higher sales volumes and favorable currency effects on sales.
- Nine-month gross margin fell to $60.7 million from $510.8 million, and operating results shifted from profit to loss. The first-half 2013 cost of sales reflected higher-cost ore purchased in 2012, unlike the lower-cost ore used in much of the comparable 2012 sales.
- Q3 included a $35 million charge for settlement of a direct-purchaser antitrust class action. Nine-month results also included $8.9 million of non-cash pre-tax charges for writing off financing costs following voluntary term-loan prepayments. These charges contributed to the reported losses.
- Kronos prepaid $390 million of term-loan principal during 2013, funding the prepayments with cash, a new Contran note and revolver borrowings. The term loan was fully repaid by July.
- Inventories declined to $393.4 million from $638.3 million at year-end 2012, contributing to operating cash flow. Receivables increased to $336.9 million from $285.8 million.
Outlook, commentary and risks
- Management expected 2013 sales volumes to exceed 2012 levels if global economic conditions did not deteriorate, and anticipated lower cost of sales per metric ton in Q4 year over year. It expected full-year 2013 operating income to be significantly below 2012, but Q4 operating income to improve from quarterly levels in the first nine months.
- After roughly a year of industry price declines, management said selling prices had generally stabilized. It cited price increases initiated from June 2013 and further increases announced for October, low customer inventories and longer delivery lead times. Achieving additional increases depended on market conditions; the filing provides no specific earnings or revenue guidance.
- Unionized employees at the Canadian facility, about 19% of worldwide capacity, remained locked out after the collective bargaining agreement expired in June. The plant was operating at about 15% capacity with non-union management employees. Kronos said it had been meeting customer orders with inventory and output from other facilities, but warned that no agreement was assured and its terms could affect results.
- The $35 million direct-purchaser antitrust settlement was reached without admission of wrongdoing and was payable in two installments expected by mid-2014, subject to court approval and related process. A separate indirect-purchaser antitrust class action was proceeding; Kronos denied the allegations and intended to defend itself.
- Other stated risks include cyclical TiO₂ demand and pricing, raw-material and energy costs and availability, competition and capacity changes, foreign-exchange movements, production interruptions, liquidity and refinancing, tax examinations, environmental regulation, and litigation. Canadian tax reassessments could result in approximately $15.7 million of cash tax liability if fully assessed; Kronos disputed them and had posted Cdn. $7.5 million of letters of credit.
- Kronos estimated 2013 pension and other postretirement contributions of approximately $28 million and full-year capital expenditures of approximately $65 million. It reported disclosure controls effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether announced TiO₂ price increases were implemented and sustained, and whether sales volumes and customer demand continued to improve.
- Whether lower feedstock costs flowed through to reported costs and margins, particularly in Q4, and whether operating results improved as management expected.
- Progress and terms of the Canadian labor negotiations, and any resulting production, customer-service or cost effects.
- Court approval, payment timing and final cost of the direct-purchaser settlement, as well as developments in the indirect-purchaser case.
- Amendment status and practical availability of the European credit facility, covenant headroom, cash levels and ability to meet debt service and benefit-plan funding requirements.
- Outcomes of tax examinations and Canadian reassessments, and any change in the recognized value of German tax-loss carryforwards.