Kronos Worldwide, Inc. — Q2 2014 Form 10-Q
Business context and reporting period. Kronos is a global producer and marketer of titanium dioxide (TiO₂) pigments, used in coatings, plastics, paper and other products. This unaudited report covers the quarter and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods.
Financial results and liquidity
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | 2014: $443.5 million; 2013: $481.1 million | 2014: $863.6 million; 2013: $944.7 million |
| Gross margin | 2014: $93.8 million (21%); 2013: $9.6 million (2%) | 2014: $174.3 million (20%); 2013: $13.5 million (1%) |
| Operating income (loss) | 2014: $44.3 million; 2013: $(47.7) million | 2014: $70.3 million; 2013: $(94.6) million |
| Net income (loss) | 2014: $33.1 million ($0.29 per share); 2013: $(33.9) million ($(0.29) per share) | 2014: $47.4 million ($0.41 per share); 2013: $(75.0) million ($(0.65) per share) |
| Operating cash flow | Six months: $19.8 million provided in 2014 versus $15.1 million used in 2013 |
For the second quarter, sales volume fell 8% and average TiO₂ selling prices fell 4% year over year. For the first half, sales volume fell 8% and average prices fell 5%. Lower sales were partly offset by favorable currency effects. Production volume rose 9% in Q2 and 3% in the first half. Cost of sales declined 26% in both comparison periods, principally because of lower feedstock ore and other production costs. Currency changes added an estimated $12 million to Q2 operating income and $20 million to first-half operating income year over year.
Interest expense was $4.7 million in Q2 and $8.7 million for the first half, down from $5.7 million and $12.1 million, respectively, in 2013. The company paid $0.15 per share in Q2 dividends and $0.30 per share for the first half, or $34.8 million in total cash dividends.
At June 30, cash and cash equivalents were $177.9 million; cash, cash equivalents and restricted cash totaled $180.5 million. Total debt on the balance sheet was $349.7 million, including a $347.5 million term-loan carrying value and $2.2 million of other debt. The company reported $83 million available under its North American revolver and approximately $81.8 million (about 50% of the facility) available under its European facility. It stated it was in compliance with debt covenants and expected sufficient liquidity for short- and long-term obligations. First-half capital expenditures were $27.7 million; management estimated full-year 2014 capital expenditures of approximately $68 million.
Material changes and unusual items
- Profitability improved substantially despite lower sales, as reduced raw-material costs and higher production outweighed lower selling prices and sales volumes.
- Cash from operations improved by $34.9 million year over year. Working-capital movements were a significant offset to improved operating results.
- In February 2014, Kronos issued a $350 million term loan due February 2020, used $170 million of proceeds to repay its Contran note, and repaid its North American revolver balance. The new term loan bears interest at LIBOR (subject to a 1% floor) plus 3.75%, or a defined base rate plus 2.75%; the reported average rate through June 30 was 4.75%.
- Q2 2014 results included a $5.7 million non-cash income-tax benefit from reductions in uncertain-tax-position reserves. The first-half 2014 tax benefit from such reductions was reported as $5.5 million. A favorable Canadian tax appeal and completion of a U.S. tax audit contributed to the reserve releases.
- First-half 2013 results included a $6.6 million pre-tax non-cash charge related to prepayment of an earlier term loan.
- The company’s Valhi investment had an unrealized loss of $4.3 million at June 30. Management considered the decline temporary; an eventual conclusion that it is other-than-temporary would require an income-statement impairment charge.
Outlook, commentary and risks
Management expected 2014 operating income to exceed 2013, citing lower feedstock costs, higher production, and the absence of the 2013 litigation-settlement charge. It expected higher production volumes for 2014 but continued operation below capacity, reflecting the Canadian facility restart after a labor lockout and planned productivity projects and maintenance shutdowns. Management also expected second-half 2014 cost of sales per metric ton to be below the first half, reflecting the lag between feedstock purchases and product sales.
Management described demand as generally stable in major European and North American markets, with signs of improving demand in some primary markets. It noted low producer and customer inventories and longer delivery lead times, but said price increases during 2014 depended on market conditions. The company cited long-term TiO₂ demand growth expectations of 2%–3% annually, while warning that actual results depend on global economic conditions, supply and demand, pricing, raw-material and energy costs, currency rates, production interruptions, competition, credit availability, taxes, environmental regulation and litigation. The filing says interim results may not indicate full-year performance.
Other disclosed matters include ongoing tax examinations and ordinary-course legal and environmental claims. Management believed existing accruals were adequate and did not expect the disposition of claims to materially adversely affect the company, but outcomes remain uncertain. The company also disclosed that a European credit-facility financial-test waiver was set to cease after submission of its June compliance certificate, after which the facility’s Net Debt/EBITDA test would again apply. Management cautioned that weaker-than-expected results could impair covenant compliance or liquidity.
Important facts for investors to verify
- Whether selling prices and sales volumes stabilize or recover, particularly in export markets, and whether lower feedstock costs continue to improve margins.
- Whether the Canadian facility restart and planned capital and maintenance work support the production outlook without further disruption.
- Current borrowing availability and covenant compliance, especially under the European facility after the waiver ends; also monitor the term loan’s restrictions and refinancing exposure.
- Whether cash generation can support debt service, working-capital needs, planned capital spending and dividends through the TiO₂ cycle.
- Whether the Valhi securities decline remains temporary and whether tax examinations, litigation or other contingencies result in charges or cash outflows.