Kronos Worldwide, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; unaudited. Kronos is a global producer and marketer of titanium dioxide (TiO₂) pigments, with production facilities in Europe and North America. About half of year-to-date sales volume went to European markets. Figures are in U.S. dollars unless noted.
Financial performance
- Third quarter: Net sales were $548.0 million, up 46% from $376.6 million. Net income was $85.9 million ($0.74 per diluted share), versus $32.1 million ($0.33 per share). Operating income increased to $156.6 million from $57.0 million.
- First nine months: Net sales were $1,505.9 million, up 40%; net income was $235.2 million ($2.03 per diluted share), versus $94.1 million ($0.96 per share). Operating income rose to $403.2 million from $117.5 million.
- Margins: Gross margin was 38% in Q3 versus 25% a year earlier, and 37% for the nine months versus 22%. Operating margin was 28% in Q3 versus 15%, and 27% year to date versus 11%.
- Sales drivers: Average TiO₂ selling prices rose 41% in Q3 and 37% year to date. Sales volumes were down 1% in both comparisons; year-to-date production volume increased 4%. Currency translation added an estimated $38 million to Q3 sales and $66 million to nine-month sales.
- Cash flow: Operating cash flow was $243.4 million for the nine months, versus $67.7 million in 2010. Capital expenditures were $38.7 million. Investing cash outflow was $173.5 million and financing cash outflow was $263.3 million. Cash and equivalents ended at $112.1 million, down from $304.7 million at year-end 2010.
- Liquidity and debt: At September 30, cash, cash equivalents and restricted cash totaled $113.6 million; current marketable securities added $44.5 million. Approximately $109 million remained available under the European revolving credit facility, with no borrowings outstanding. Total debt was $402.9 million, down from $539.6 million at year-end; it included $397.6 million of 6.5% Senior Secured Notes due 2013. The company reported compliance with debt covenants.
- Shareholder returns: Dividends paid in the first nine months totaled $107.2 million, including a $57.9 million special dividend. The company implemented a 2-for-1 stock split in May 2011; per-share figures are adjusted for it.
Material changes and notable items
- Profit growth principally reflected higher TiO₂ selling prices, which more than offset higher raw-material, maintenance and other manufacturing costs. Year-to-date production reached a company record for a first nine-month period.
- Cost of sales rose 20% in Q3 and 14% year to date. Management cited higher feedstock ore and petroleum coke costs, maintenance expense and currency effects.
- Year-to-date income tax expense was $143.1 million, compared with a $5.7 million tax benefit in 2010. The prior-year period included a $35.2 million non-cash German tax benefit; 2011 included $13.2 million of U.S. incremental tax on German earnings repatriated to fund some debt repurchases.
- The company redeemed €80 million of notes in March and repurchased notes in the third quarter. It also repurchased an additional €10.5 million principal amount in October, after quarter-end.
- At September 30, Kronos held $103.3 million in a note receivable from parent Valhi. The amended revolving demand note is payable on demand, but not before December 31, 2013. Kronos is controlled through related-company ownership: Valhi held about 50% and NL Industries about 30% of Kronos common stock.
Outlook, risks and contingencies
- Management expected to operate facilities near full practical capacity through the rest of 2011. It anticipated no significant increase in 2011 production or sales volumes compared with 2010, as debottlenecking projects were expected to add only nominal capacity.
- Management expected average selling prices to continue rising in Q4 2011 and operating income to remain significantly above comparable 2010 periods, assuming strong demand and the anticipated price increases. This was management’s outlook, not quantified earnings guidance.
- Management estimated 2011 cost per metric ton of TiO₂ would rise approximately 10%–15% from 2010, driven by ore, petroleum coke, energy and freight costs; it expected price increases to recover these higher costs. Outcomes depend on industry supply and demand, competition, economic conditions, costs and currency rates.
- Management expected sufficient liquidity for near- and long-term obligations and forecast approximately $80 million of 2011 capital expenditures. These expectations could be affected by weaker demand, lower prices, cost inflation or other operating and financial developments.
- Canadian tax authorities reassessed tax years 2002–2004. Kronos disputed the reassessment and planned to appeal; it expected to post a Cdn. $4.9 million letter of credit. The potential cash tax liability if the full adjustment were upheld was estimated at $11.9 million. The company said it had adequate accruals and did not expect tax examinations to materially harm its financial position, results or liquidity.
- Kronos considered the decline in its TIMET investment’s market value temporary at quarter-end; the investment had an unrealized loss of $10.3 million. A future conclusion that a decline is other-than-temporary could result in an income-statement impairment charge. Broader risks include TiO₂ cyclicality, raw-material availability and prices, currency fluctuations, operational interruptions, environmental regulation, taxes and litigation.
- Management reported disclosure controls effective at September 30, 2011 and no material change in internal control over financial reporting during the quarter. The filing said there were no material changes to previously disclosed risk factors.
Important facts for investors to verify
- Whether TiO₂ pricing and demand remained strong enough to offset the forecast 10%–15% increase in unit costs.
- Subsequent operating cash flow, working-capital needs, cash balance and availability under the European credit facility.
- Debt repurchases and remaining obligations under the 6.5% notes due 2013, including the October 2011 activity.
- Developments in the Canadian tax reassessment, related collateral requirement and any changes to tax accruals.
- Valuation and concentration risks in marketable securities, including related-party holdings and the Valhi receivable.
- Whether actual 2011 capital spending, production, sales volumes and pricing tracked management’s stated outlook.