Kronos Worldwide, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited financial statements. Kronos is a global producer and marketer of titanium dioxide (TiO₂) pigments, with production facilities in Europe and North America; approximately half of nine-month sales volumes went to European markets.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $410.3m | $464.5m | $1,312.5m | $1,275.7m |
| Gross margin | $119.1m (29%) | $155.0m (33%) | $465.7m (35%) | $393.4m (31%) |
| Income from operations | $58.1m (14% of sales) | $96.1m (21%) | $285.5m (22%) | $226.8m (18%) |
| Net income | $32.6m | $73.8m | $181.0m | $307.1m |
| Diluted earnings per share | $0.28 | $0.64 | $1.56 | $2.65 |
- Cash flow: Nine-month operating cash flow was $199.0m, versus $218.3m. Investing used $21.8m, including $35.4m of capital expenditures; financing used $59.6m, including $59.1m of dividends. Cash, cash equivalents and restricted cash ended at $433.4m, up from $323.7m at year-end 2017.
- Liquidity and debt: September 30 cash and cash equivalents were $432.3m (plus $1.1m restricted cash). Total debt was $465.9m, including €400m of 3.75% Senior Secured Notes due 2025. Available revolver capacity was approximately $106.2m in North America and $105.7m in Europe. The company reported compliance with debt covenants.
- Balance sheet: Current assets were $1,238.4m and current liabilities $249.6m. Inventory rose to $446.2m from $382.3m at December 31, 2017; total stockholders’ equity increased to $873.4m from $754.3m.
Material changes and drivers
- Q3 sales fell 12% year over year: average TiO₂ selling prices were 9% higher, but sales volumes were 19% lower. Lower European and export shipments reflected customer inventory normalization after record 2017 volumes.
- Q3 operating income declined 40%, as higher prices were outweighed by lower sales and production volumes, higher raw-material and other production costs, and increased SG&A. Q3 production utilization was 92%, versus 100% a year earlier; maintenance affected output.
- For the nine-month period, sales rose 3% as an 18% increase in average prices and favorable currency effects more than offset a 15% volume decline. Operating income increased 26%; higher prices outweighed lower volumes and higher costs. Currency changes added an estimated $26m to operating income and $53m to sales.
- SG&A increased $6.0m in Q3 and $26.1m year to date, partly due to implementation of a new accounting and manufacturing system and higher sales-support costs. System implementation and product availability contributed to lower nine-month sales volumes.
- Q3 2018 net income was also affected by a $4.3m loss on marketable equity securities. Under a new accounting standard, fair-value changes on these securities are now recorded in earnings; the nine-month loss was $6.7m.
Outlook, risks and unusual items
- Management expected 2018 sales and operating income to be comparable to 2017: higher average selling prices were expected to offset lower sales and production volumes and higher costs, principally feedstock ore. Management expected 2018 net income to be lower, in part because 2017 included a $136.5m aggregate net income tax benefit.
- Management anticipated lower full-year 2018 production and sales volumes than the 2017 records, moderately higher cost per metric ton, and possible Q4 price decreases as customer inventories continued to decline. It described worldwide demand as solid and customer inventory changes as short term, while noting these outcomes depend on market conditions.
- Estimated 2018 capital expenditures were approximately $65m, including $35.4m spent through September. Expected 2018 pension and postretirement contributions were approximately $17m. The company said it expected sufficient liquidity for short- and long-term obligations, subject to actual developments.
- The unpaid U.S. tax-law Transition Tax balance was $63.8m at September 30, 2018, payable in installments; $58.1m was classified as noncurrent and $5.7m current. The amount remained provisional pending further guidance and completion of the measurement period. Management reported no material GILTI or BEAT tax impact identified to date.
- Key risks include TiO₂ supply, demand and pricing cycles; customer inventories; competition and capacity additions; feedstock, energy and other costs; foreign exchange; operating interruptions; liquidity and refinancing; tax matters; environmental regulation; and litigation. Management said risk factors were not materially changed from the 2017 annual report.
- A class antitrust matter was settled for an immaterial amount in January 2018 without admission of fault; court approval became final in August. The filing also describes ongoing general legal and environmental claims and contingencies.
- 2017 comparisons include a major noncash tax benefit from reversal of German and Belgian deferred-tax valuation allowances and an $11.3m tax benefit associated with a Canada-Germany tax agreement. A $7.1m debt-prepayment loss was recorded in Q3 2017. These items make reported net-income comparisons less indicative of operating trends.
Important facts for investors to verify
- Whether Q4 customer inventory normalization and any selling-price declines developed as management anticipated.
- Whether volume recovery, production utilization and raw-material costs supported the full-year sales and operating-income outlook.
- How working-capital pressure develops: days sales outstanding rose to 74 days and inventory days to 77 days at September 30, 2018.
- Final Transition Tax and other tax-law measurements, including the timing and classification of the remaining $63.8m liability.
- Whether cash generation, revolver availability, dividend payments and covenant compliance remain adequate under weaker TiO₂ market conditions.
- Costs, implementation progress and any control implications of the new enterprise resource planning system; management reported disclosure controls effective and no other material quarterly change in internal control.