Kronos Worldwide, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Kronos is a global producer and marketer of titanium dioxide (TiO2) pigment, with production facilities in Europe and North America. Figures below are in U.S. dollars; financial-statement amounts are in millions except per-share data.
Financial performance
| Metric | Q2 2010 | Q2 2011 | Six months 2010 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $380.1 | $537.5 | $699.8 | $957.9 |
| Gross margin | $85.2 (22%) | $197.0 (37%) | $145.7 (21%) | $343.4 (36%) |
| Income from operations | $38.8 (10%) | $144.2 (27%) | $60.5 (9%) | $246.6 (26%) |
| Net income | $19.3 | $89.0 | $62.1 | $149.3 |
| Diluted earnings per share | $0.20 | $0.77 | $0.63 | $1.29 |
| Operating cash flow | Not provided by quarter | $(3.4) | $80.2 |
- Q2 sales rose 41% year over year, chiefly from a 39% increase in average TiO2 selling prices. H1 sales rose 37%, with average prices up 36%. Currency added an estimated $33 million to Q2 sales and $28 million to H1 sales; product mix reduced sales by an estimated $23 million and $21 million, respectively.
- Q2 sales volume declined 1% while production volume rose 6%. H1 sales volume was up less than 1%, and production volume rose 7%. The company reported record Q2 production and record first-half sales and production volumes.
- Higher prices and production volumes more than offset higher manufacturing costs. Cost of sales rose 15% in Q2 and 11% in H1, including higher feedstock, petroleum coke and maintenance costs. Cost of sales fell to 63% of sales in Q2 and 64% in H1, from 78% and 79%, respectively.
- H1 income taxes were $79.3, versus a $21.7 tax benefit in H1 2010. The prior-year benefit included a one-time, noncash $35.2 German tax benefit. Q2 2011 tax expense was $48.4, versus $9.8 a year earlier.
Balance sheet, cash flow and liquidity
- At June 30, 2011, cash and cash equivalents were $72.2, restricted cash $1.8, current marketable securities $79.6, and current assets $829.7. Cash, cash equivalents, restricted cash and current marketable securities together totaled $153.6; $21.7 was held by non-U.S. subsidiaries.
- Total debt was $511.7, including $455.8 of 6.5% Senior Secured Notes, $49.9 borrowed under the European revolving facility and $6.0 of other debt. The notes mature in 2013; the credit facility matures in October 2013. Unused facility availability was approximately $64.2. The company reported compliance with its debt covenants.
- H1 operating cash flow was $80.2, compared with cash used of $3.4 in H1 2010. Investing activities used $159.1, including net purchases of marketable securities; financing activities used $156.1, including dividends and debt payments. Cash declined by $235.0 from the start of the period to $72.2.
- H1 capital expenditures were $24.6. The company estimated full-year 2011 capital expenditures of approximately $70.
- Receivables increased to $358.0 from $231.2 at year-end 2010, and inventories rose to $308.8 from $275.8. The company attributed higher days sales outstanding to price-driven sales increases; days sales in inventory declined from 52 to 49.
Material changes and unusual items
- In March 2011, Kronos redeemed €80 million of its €400 million 6.5% notes, funded by borrowing under its European credit facility. It recorded a $3.3 pretax charge for the call premium and write-off of financing costs and discount. €320 million of notes remained outstanding at June 30.
- The company paid $89.8 in dividends during H1, including a $57.9 special dividend. The reported H1 dividends were $0.775 per share, including the $0.50 special dividend; Q2 dividends were $0.15 per share. A 2-for-1 stock split was effected as a stock dividend in May 2011; per-share data is adjusted for the split.
- Kronos purchased related-party shares during H1 and held $106.4 of noncurrent marketable securities at June 30, including TIMET and Valhi stock. It also had a $69.0 note receivable from Valhi; in June, the $175 million revolving demand note’s maturity was amended so principal is due on demand but no earlier than December 31, 2013.
Outlook, risks and contingencies
- Management expected strong TiO2 demand and low industry inventories to persist through the rest of 2011, with facilities operating near practical capacity. It anticipated average selling prices would continue to rise significantly and operating income would be significantly higher than in comparable 2010 periods.
- Management forecast TiO2 production costs per metric ton to rise approximately 10%–15% in 2011, citing tight feedstock supplies and higher petroleum coke, energy and freight costs. It believed further price increases could recoup these costs. Capacity additions from debottlenecking were expected to be modest, and full-year sales volumes were not expected to increase significantly versus 2010.
- The company expected sufficient liquidity for its stated short- and long-term obligations, but results and liquidity remain sensitive to TiO2 prices, demand, volumes, raw-material and energy costs, exchange rates, operational interruptions and refinancing access. Management cautioned that industry and economic outcomes could differ from its assumptions.
- Tax authorities are examining certain non-U.S. returns. A Canadian proposed adjustment for 2002–2004 could have an estimated net impact of approximately $6.0 if fully assessed; Kronos disputed it and was in discussions with the authorities. The company believed tax accruals were adequate and expected no material adverse effect from tax examinations.
- Kronos reported that pending litigation and claims were not expected to have a material adverse effect beyond existing accruals. It identified no material changes to previously disclosed risk factors. Disclosure controls were assessed as effective as of June 30, 2011.
Important facts for investors to verify
- Whether TiO2 pricing and demand stayed strong enough to support management’s outlook and offset the forecast cost increases.
- Working-capital needs and cash conversion, particularly the growth in receivables and inventories and the substantial H1 cash decline.
- Debt maturities, facility availability, covenant compliance and the restrictions governing subsidiary distributions and the Valhi receivable.
- Exposure to related parties and marketable-security price changes; the filing estimated that a 10% change in security prices would affect June 30 market value by $18.6.
- Outcomes of tax examinations, including the Canadian proposal, and continued support for the valuation of German tax-loss carryforwards.