Kronos Worldwide, Inc. — Q1 2017 Form 10-Q
Business and period: Global producer and marketer of titanium dioxide (TiO₂) pigments used in paints, plastics, paper and other products. This unaudited report covers the three months ended March 31, 2017; comparisons are with Q1 2016 unless stated otherwise. Figures are in millions of dollars, except per-share data and operating statistics.
Financial performance
| Metric | Q1 2016 | Q1 2017 |
|---|---|---|
| Net sales | $318.4 | $369.8 |
| Gross margin | $40.4; 13% of sales | $103.4; 28% of sales |
| Operating income (loss) | $(0.3) | $52.3; 14% of sales |
| Net income (loss) | $(3.8) | $36.8 |
| Diluted EPS | $(0.03) | $0.32 |
| Operating cash flow | $(15.3) | $41.6 |
| Capital expenditures | $14.3 | $11.9 |
- Sales rose 16%: average TiO₂ selling prices increased 17% and sales volumes increased 3%; product mix and currency each reduced sales by an estimated 2%.
- Cost of sales fell 4% to $266.4 despite higher volumes. Lower raw-material and other production costs, especially third-party feedstock ore, and higher production volumes supported gross-margin expansion.
- Interest expense was $4.7, down from $5.1. Income tax expense was $11.0 versus a $1.4 benefit in Q1 2016. Q1 2017 included a $5.0 non-cash tax benefit from reducing German and Belgian deferred-tax valuation allowances.
- Cash and cash equivalents were $89.8 at March 31, up from $50.7 at year-end; restricted cash was $1.1. Cash, cash equivalents and restricted cash totaled $90.9. Working capital included receivables of $273.9 and inventories of $360.7.
- Total debt was $364.5, comprising a term loan, $26.0 outstanding on the North American revolver and approximately $3.1 of other debt. The term loan’s carrying amount was $335.4; current maturities were $3.6. The company reported compliance with all debt covenants.
Material changes and management commentary
- Operating income improved by $52.6 year over year, driven mainly by higher selling prices, lower production costs and higher sales and production volumes. Sales volumes were a first-quarter record; capacity utilization was 100%, versus approximately 97% a year earlier.
- Currency movements reduced Q1 2017 sales by an estimated $7 and operating income by approximately $8 versus Q1 2016. The prior-year quarter included a $2.0 pre-tax business-interruption insurance settlement gain; no further material recovery was expected.
- Operating cash flow improved by $56.9 year over year, primarily reflecting higher operating income. The company paid $17.4 in dividends, or $0.15 per share, and borrowed a net $26.0 under its North American revolver.
- At March 31, available borrowing was approximately $74.9 under the North American revolver and $88.3 under the European facility, subject to facility terms. Management expected liquidity to cover short- and long-term obligations. The European revolver matured in September 2017, and management expected to obtain an extension. The North American facility’s then-current maturity was November 2019.
Outlook, risks and other notable items
- Management expected 2017 operating income to exceed 2016, mainly due to higher average selling prices and, to a lesser extent, higher production volumes. It expected full-year sales volumes comparable to 2016, assuming global economic conditions did not deteriorate, and production volumes slightly higher.
- Management expected 2017 cost of sales per metric ton to be comparable to slightly higher than 2016. Feedstock ore procured in Q1 was comparable to slightly more expensive than in Q4 2016; higher-cost material was expected to affect results beginning in Q2. Further price increases depended on market conditions.
- Management estimated approximately $65 of 2017 capital expenditures, including $11.9 spent through Q1. It expected interest expense for 2017 to be comparable to 2016.
- German and Belgian tax valuation allowances remained significant. Management said a material non-cash tax benefit could arise if sustained German earnings support reversal of its allowance; timing and amount were uncertain. Belgian operations continued to have cumulative losses over the most recent 12 quarters.
- Key risks include TiO₂ pricing, demand and cyclicality; competition and capacity changes; raw-material, energy and currency fluctuations; operating disruptions; refinancing and liquidity; tax audits; environmental matters; and litigation. The company was defending two U.S. TiO₂ antitrust cases and stated it had not accrued material losses, assessing a material loss as not reasonably possible in the described matters.
- The company implemented part of a new enterprise resource planning system in January 2017; remaining sales, procurement, manufacturing and plant-maintenance implementation was not expected before January 2018. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Investor verification points
- Check whether TiO₂ price increases and strong demand persist, and how customer inventories, competitor capacity and market conditions affect realized prices and volumes.
- Track feedstock ore and other production costs, currency effects, and whether the expected margin improvement is sustained.
- Monitor cash conversion and working capital, planned capital spending, dividend payments, and borrowing under revolving facilities.
- Verify the European revolver extension and continued covenant compliance, alongside debt maturities and refinancing needs.
- Follow German and Belgian profitability, tax valuation allowances and pending tax matters for potential effects on reported earnings, cash taxes and liquidity.
- Review developments in the antitrust litigation and the timing and risks of the remaining ERP implementation.