Kronos Worldwide, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Kronos produces and markets titanium dioxide (TiO₂) pigments; approximately half of nine-month sales volumes were in Europe. Figures below are in U.S. dollars, millions except per-share data and volumes.
Financial performance
| Metric | Q3 2011 | Q3 2012 | Nine months 2011 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $548.0 | $472.9 | $1,505.9 | $1,579.5 |
| Gross margin | $210.9 (38%) | $86.0 (18%) | $554.3 (37%) | $510.8 (32%) |
| Income from operations | $156.6 | $38.5 | $403.2 | $358.5 |
| Net income | $85.9 | $35.2 | $235.2 | $236.6 |
| Diluted EPS | $0.74 | $0.30 | $2.03 | $2.04 |
| Operating cash flow | Not stated separately for the quarter | $243.4 | $57.5 |
- Q3 sales fell 14%; TiO₂ sales volume declined 15%, while average selling prices were 5% higher year over year. Currency movements reduced sales by an estimated $34 million.
- Q3 cost of sales rose 15%, including an estimated $85 million increase in raw-material costs. Lower production led to about $25 million of unabsorbed fixed costs charged to cost of sales. Production volume fell 27% year over year.
- For the nine months, sales rose 5%, principally reflecting a 20% increase in average selling prices, partly offset by a 9% drop in sales volume and an estimated $70 million adverse currency effect. Operating income declined 11%; net income was nearly unchanged, helped by lower income-tax expense.
- Q3 income-tax benefit was $1.4 million versus expense of $63.8 million a year earlier. The 2012 benefit included an $11.1 million benefit related to a decision not to remit certain non-U.S. dividends.
Cash, debt and liquidity
- Cash and cash equivalents were $110.9 million at September 30, 2012, versus $82.5 million at year-end 2011. Including restricted cash, the total was $120.4 million. Current assets were $1,054.6 million and current liabilities $305.5 million.
- Operating cash flow was $57.5 million for the first nine months, down from $243.4 million. Management attributed the decline to lower operating income, working-capital outflows (especially inventory and receivables), greater joint-venture funding and higher cash taxes. Inventory increased to $604.2 million from $444.2 million at year-end.
- Total debt was $437.6 million, including $21.5 million current maturities; long-term debt was $416.1 million. In June, Kronos borrowed under a new $400 million term loan and used proceeds to retire the remaining €279.2 million of 6.5% Senior Secured Notes. The term loan matures in June 2018; its September average interest rate was 5.75%.
- The amended European revolving facility had $45.2 million outstanding and approximately €85 million ($110 million) available. The $125 million North American revolver was undrawn and available. Kronos reported compliance with debt covenants and expected sufficient liquidity, while noting that results below expectations could affect covenant compliance or liquidity.
- Capital expenditures were $45.5 million through September; the company estimated approximately $70 million for 2012. Nine-month dividends paid were $52.2 million, or $0.45 per share.
Outlook, risks and notable items
- Management expected 2012 production at 80%–85% of attainable practical capacity of 550,000 metric tons; full-year sales volume was expected below 2011, with sales exceeding production.
- For Q4 2012, management expected average selling prices below Q4 2011 levels and operating income significantly lower year over year, reflecting weaker volumes and higher production costs. It expected 2012 production cost per metric ton to rise approximately 45%–55% versus 2011, driven mainly by feedstock ore costs and under-absorbed fixed costs.
- Industry conditions included customer inventory correction, global economic uncertainty and weaker demand, particularly in Europe. The company reduced operating rates to about 71% of practical capacity in Q3, after 86% in Q2.
- Key exposures include TiO₂ supply, demand and pricing; raw-material, energy and manufacturing costs; currency movements; economic conditions; production interruptions; refinancing and liquidity; and tax and environmental matters. Management cautioned that actual results could differ materially from forward-looking expectations.
- Tax authorities were examining returns. Canadian authorities had reassessed 2002–2004 tax years; Kronos disputed the matter and appealed. If the full proposed adjustment were assessed, the cash tax liability was estimated at approximately $15.9 million; $7.5 million of letters of credit were posted. Management believed accruals were adequate and the matter would not materially affect the company.
- A court granted class certification in the Haley Paint litigation in August 2012; trial was set for September 2013. Management said claims and disputes were not expected to have a material adverse effect beyond existing accruals.
- Kronos is majority-owned by Valhi and NL; related-party relationships include a $167.6 million note receivable from Valhi at September 30 and net lending of $31.5 million to Valhi during the nine-month period. The filing states that Harold C. Simmons may be deemed to control Kronos through related entities.
Important facts for investors to verify
- Whether demand, TiO₂ pricing and production volumes stabilized after the steep Q3 decline, and how actual results compared with management’s Q4 and full-year expectations.
- Whether raw-material costs and reduced utilization continued to pressure gross margins, including the forecast 45%–55% increase in production cost per metric ton.
- Cash conversion and working-capital trends, particularly inventory levels, operating cash flow and funding needs at the TiO₂ joint venture.
- Debt levels, interest expense, covenant headroom and actual availability under the European and North American revolving facilities.
- Developments in the Canadian tax reassessment, the Haley Paint litigation and any potential impairment of marketable securities or German tax-loss carryforwards.