Kronos Worldwide, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results. Kronos produces and markets titanium dioxide (TiO₂) pigment. Figures below are in millions of dollars, except per-share data and where noted.
Financial performance
| Metric | Q2 2017 | Q2 2018 | Six months 2017 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $441.4 | $471.8 | $811.2 | $902.2 |
| Gross margin | $132.4 | $171.8 | $238.4 | $346.6 |
| Gross margin rate | 30% | 36% | 29% | 38% |
| Income from operations | $74.3 | $119.9 | $130.7 | $227.4 |
| Operating margin | 17% | 25% | 16% | 25% |
| Income tax expense (benefit) | $(131.1) | $32.4 | $(120.1) | $61.4 |
| Net income | $196.5 | $77.7 | $233.3 | $148.4 |
| Diluted EPS | $1.70 | $0.67 | $2.01 | $1.28 |
- Q2 sales rose 7%; first-half sales rose 11%. Management attributed the increases primarily to higher TiO₂ selling prices, partly offset by lower shipment volumes.
- Average selling prices increased 20% in Q2 and 23% in the first half year over year. TiO₂ sales volumes declined 12% and 13%, respectively; production volumes declined 4% and 6%.
- Higher prices lifted gross and operating margins despite lower volumes and higher raw-material and other production costs. Feedstock ore costs were a principal cost pressure. Foreign-exchange movements also benefited reported results.
- Reported net income fell year over year notwithstanding stronger operating income, mainly because 2017 included a noncash deferred-tax benefit from reversing German and Belgian deferred-tax valuation allowances: $157.6 million in Q2 and $162.6 million in the first half.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $169.7 million, versus $101.6 million in 2017. Capital expenditures were $24.8 million; investing cash flow was $(11.2) million and financing cash flow was $(39.7) million, including $39.4 million of dividends.
- Cash, cash equivalents and restricted cash totaled $433.2 million at June 30, 2018, including $173.4 million held by non-U.S. subsidiaries. Cash and cash equivalents alone were $431.9 million.
- Total debt was $461.6 million, including €400 million principal of 3.75% Senior Secured Notes due 2025 (carrying value $458.6 million) and approximately $3.0 million of other debt. The company reported compliance with debt covenants.
- Available borrowing capacity was approximately $118.1 million under the North American revolver and $104.7 million under the European revolver. Management expects liquidity to be sufficient for near- and long-term obligations, subject to business conditions.
- Current assets were $1,230.5 million and current liabilities $265.4 million. Receivables were $372.3 million and inventories $412.0 million, up from $346.5 million and $382.3 million, respectively, at year-end 2017. Days sales outstanding rose to 70 and days sales in inventory to 68.
- Stockholders’ equity increased to $853.6 million from $754.3 million at December 31, 2017. The company paid dividends of $0.34 per share in the first half.
Material changes and management commentary
- Management said Q2 volume weakness reflected product-availability issues and customer inventory levels returning toward normal, particularly in Europe and export markets. First-half volume declines also reflected a controlled ERP-system rollout and lower production early in the year, including scheduled maintenance and a Belgian facility improvement project.
- Higher feedstock ore costs and other production costs increased costs by an estimated $23 million in Q2 and $35 million in the first half, though lower sales and production volumes and currency effects also affected cost of sales.
- SG&A increased by $7.0 million in Q2 and $20.1 million in the first half, partly due to ERP implementation and higher sales-support costs.
- The company adopted new revenue-recognition guidance in January 2018; management reported no material financial-statement impact. A new accounting standard moved unrealized marketable-equity-security gains and losses into earnings; the first-half 2018 loss was $2.4 million.
Outlook, risks and contingencies
- For full-year 2018, management expects production and sales volumes to be somewhat lower than record 2017 levels, but expects sales and operating income to be higher, principally from higher average selling prices. It expects full-year net income to be lower because 2017 included a substantial tax benefit. Management said first-half volume declines are not representative of its full-year expectation and expects inventory changes to be short term, not continuing past Q3.
- Management expects 2018 cost of sales per metric ton to be moderately higher than in 2017, principally due to feedstock ore costs. It expects 2018 interest expense to be comparable to 2017 and plans approximately $67 million of capital expenditures for the year, including $24.8 million spent through June 30.
- The company estimated approximately $17 million of 2018 pension and other postretirement plan contributions. It also expects to complete accounting for provisional Tax Act amounts and its GILTI policy election within the measurement period ending December 22, 2018. The remaining estimated transition-tax payable at June 30 was $67.0 million: $64.0 million noncurrent and $3.0 million current, payable over the remaining eight-year period.
- Key risks include TiO₂ industry cyclicality and pricing, demand and customer inventories, competitor capacity additions, raw-material availability and costs, currency movements, operational interruptions, ERP implementation, liquidity and refinancing, taxes, environmental matters and litigation. Management cited uncertain implementation of announced Chinese capacity expansions.
- The company settled two TiO₂ antitrust matters for immaterial amounts without admitting wrongdoing; final approval of the class settlement was expected in the second half of 2018. Other claims are described as incidental to the business. Management said disclosure controls were effective and reported no material change in internal control over financial reporting; it implemented a new ERP system in January.
Important facts for investors to verify
- Whether pricing gains persist and customer inventory normalization or product-availability constraints continue to affect volumes after Q3.
- Actual feedstock ore costs, production levels, and whether full-year sales and operating-income expectations are achieved.
- Cash conversion and working-capital trends, particularly the rise in receivables and inventory and days sales outstanding/inventory.
- Availability of revolver capacity, continued covenant compliance, and the timing and amount of transition-tax payments or any Tax Act measurement-period adjustments.
- Final approval of the antitrust class settlement and any material developments in other legal, environmental or tax matters.
- The cost and execution of the ERP rollout, planned capital spending, and the expected 2019 lease-accounting adoption, for which the company anticipated a material right-of-use asset and lease liability.