Tronox Limited — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Amounts are in U.S. dollars; financial figures are in millions unless stated otherwise.
Business context and comparability
Tronox produces titanium dioxide (TiO2) pigment and mineral sands products, including titanium feedstock and zircon. On June 15, 2012, it combined its existing business with Exxaro’s mineral sands operations: 74% of specified South African operations and Exxaro’s 50% interest in the Tiwest joint venture. Tronox consequently began reporting minerals and pigment as separate segments and owns 100% of Tiwest.
Comparisons require care: the 2012 results include the acquired business only from June 15, while the 2011 periods reflect the predecessor/successor accounting divide. Q3 2012 includes a full quarter of the acquired business, unlike Q3 2011. Nine-month 2012 earnings also include a substantial, nonrecurring bargain-purchase gain.
Key financial results
| Metric | Q3 2012 | Comparable period |
|---|---|---|
| Net sales | $487.3 | $465.4, Q3 2011 |
| Gross margin / margin rate | $21.5 / 4.4% | $143.0 / 30.7%, Q3 2011 |
| Operating income (loss) | $(38.1) | $99.2, Q3 2011 |
| Net income (loss) | $(18.0); $(16.7) attributable to Tronox Limited | $98.9, Q3 2011 |
| Diluted earnings (loss) per share | $(0.14) | $1.25, Q3 2011 |
| Adjusted EBITDA | $131.1 | $140.9, Q3 2011 |
Q3 sales increased 5%, primarily reflecting acquired-business revenue and higher prices, partly offset by lower volumes and unfavorable currency effects. The sharp fall in gross margin and operating results reflected weaker volumes, lower capacity utilization, higher ore and other input costs, and $85.2 million of noncash purchase-accounting amortization for inventory step-up and unfavorable ore contracts.
For the nine months, net sales were $1,349.8 and operating income was $95.4. Net income attributable to Tronox was $1,225.5, including a $1,045.6 bargain-purchase gain; this reported profit should not be treated as recurring operating performance. Nine-month comparisons are also affected by the differing reporting periods and the acquisition.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $68.0; investing cash flow was $23.6, including $114.8 cash received in the acquisition and $91.2 of capital expenditures. Financing cash flow was $522.6, and cash increased $620.4 to $774.4.
- Working capital was $1,787.2. Reported total liquidity was $1,124.1: $774.4 cash, $270.6 available under the UBS revolver and $79.1 available under the ABSA revolver.
- Long-term debt was $1,618.7, plus $30.4 of short-term debt and $11.0 due within one year. Major financing included $900.0 of 6.375% senior notes due 2020 and a $700.0 term facility due 2018. Q3 interest and debt expense was $18.1, up from $8.0 a year earlier.
- Tronox reported compliance with its financial covenants at September 30, 2012. Capital expenditures for the remainder of 2012 were expected to be $40–$50.
Material changes and management outlook
- Minerals segment Q3 sales were $271.7 and operating income was $19.4. Feedstock volumes and prices remained strong, while zircon demand was soft. Acquired operations recorded an operating loss, affected by lower utilization at the Hillendale mine, product mix and purchase accounting.
- Pigment segment Q3 sales were $279.8, down 30% year over year; operating loss was $13.2 versus operating income of $111.6. TiO2 sales volumes fell 32% year over year. Average TiO2 selling prices were about 6% lower than Q2 2012.
- Management expected Q4 pigment market conditions to be similar to Q3, with modest further declines in average global pigment prices. It anticipated mineral sands volumes would remain steady except for zircon, and expected mineral sands prices in the second half of 2012 to exceed 2011 levels. Management saw potential for pigment market recovery and more normalized supply and demand by mid-2013; this was an expectation, not a guarantee.
- On August 20, Tronox issued $900.0 of senior notes; approximately $326.2 of proceeds funded a share repurchase. The company repurchased about 12.6 million Class A shares for $326.2 and completed the program in September. A 5-for-1 share split was effected in July. A $0.25-per-share dividend was declared in November for payment in December.
Risks, contingencies and unusual items
- Demand weakness and customer destocking in Europe, Asia and North America, lower utilization, higher feedstock and input costs, and currency movements pressured results. Management cited an approximately A$10 million annual impact from Australia’s carbon tax.
- The KZN Fairbreeze mine project received approval for selected early construction activities, but a conservation group sought an injunction to halt construction; Tronox opposed it. The filing does not report the outcome.
- Western Australia’s revenue office had made a preliminary determination that the company was “land rich” in connection with a 2002 share transfer, potentially exposing it to stamp duty and penalties. No assessment had been made; Tronox had accrued $3.2 million and disputed the position.
- Environmental, legal and regulatory proceedings could adversely affect the company; management said reserves covered known probable and estimable matters but could not reliably estimate all future environmental expenditures. South African political or labor unrest could disrupt operations.
- The $1,045.6 bargain-purchase gain and related purchase accounting were preliminary; pending appraisals could result in material adjustments. Purchase-accounting charges included $108.8 of inventory-step-up and unfavorable-contract amortization in the nine months.
Important facts for investors to verify
- How much of reported nine-month earnings and segment performance is attributable to the acquisition, purchase-accounting charges and the nonrecurring bargain-purchase gain.
- Whether pigment volumes, pricing and capacity utilization stabilize, and whether management’s mid-2013 recovery outlook is borne out.
- Cash generation and working-capital trends, particularly the inventory build, against debt service, capital spending and shareholder distributions.
- Final acquisition valuations and any material revisions to the bargain-purchase gain or acquired asset and liability values.
- Developments in the Fairbreeze injunction, stamp-duty review, environmental exposures and compliance with debt covenants.