Kronos Worldwide, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Kronos is a global producer and marketer of titanium dioxide (TiO₂) pigments, with about half of nine-month sales in Europe. Financial amounts are in U.S. dollars; dollar figures are in millions except per-share data.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $356.1 | $336.5 | $1,030.6 | $1,061.8 |
| Gross margin | $75.5 | $43.2 | $171.4 | $167.1 |
| Gross margin percentage | 21% | 13% | 17% | 16% |
| Operating income (loss) | $28.0 | $(3.2) | $38.2 | $18.6 |
| Net income (loss) | $22.2 | $(11.8) | $20.1 | $(153.2) |
| Diluted earnings (loss) per share | $0.19 | $(0.10) | $0.17 | $(1.32) |
| Operating cash flow | Not separately provided | Not separately provided | $68.7 | $50.1 |
Q3 sales rose 6% year over year, reflecting 6% higher sales volume and 2% higher average selling prices. For the first nine months, sales fell 3%: volume increased 6%, but average selling prices declined 7%; currency reduced sales by approximately $8 million. Operating income improved in both comparison periods, supported by lower feedstock and other production costs, higher volumes, workforce-reduction savings and, in Q3, higher prices. EBITDA is not clearly reported as a value in the filing text.
Financial position and liquidity
- At September 30, 2016, cash and cash equivalents were $92.1; cash, cash equivalents and restricted cash totaled $93.3. Total assets were $1,241.5 and stockholders’ equity was $454.9.
- Total debt was approximately $358.0: term loan carrying amount $336.4, North American revolving facility borrowings $18.5 and other debt $3.1. Current maturities were $22.0. The term loan’s aggregate principal was $341.3 and is due in February 2020.
- Available borrowing was approximately $57.4 under the North American facility and $29.6 under the European facility. The company reported compliance with debt covenants at quarter-end.
- Operating cash flow of $68.7 less capital expenditures of $34.3 implies approximately $34.4 of operating cash flow after capital expenditures. Dividends paid during the first nine months were $52.2, or $0.45 per share.
- Capital expenditures were $34.3 through September; management estimated approximately $63 million for full-year 2016. The North American and European revolving facilities mature in June and September 2017, respectively; management expected to obtain extensions in the normal course.
Material changes and unusual items
- Q3 2016 included a $5.6 current income tax benefit from finalizing a U.S.-Canada Advance Pricing Agreement (APA). The agreement covers tax years 2005–2015; a Canadian tax payment of approximately $2.3 was accrued and had not been paid at quarter-end.
- Nine-month 2016 results included a $3.4 insurance settlement gain relating to a 2014 business interruption claim and a $2.1 non-cash deferred tax valuation allowance for German and Belgian operations.
- The prior-year nine-month loss included a $152.6 non-cash tax valuation allowance, largely recognized in Q2 2015, and a $12.0 pre-tax impairment charge on a marketable security. 2015 also included $21.5 of workforce-reduction charges; management cited approximately $19 million of expected annual savings from the reductions.
- Debt increased from $341.0 at December 31, 2015 to $358.0 at September 30, 2016, while cash declined from $92.5 to $92.1. Inventory declined from $387.2 to $317.1; receivables increased from $220.8 to $267.8.
Outlook, risks and contingencies
Management expected 2016 production and sales volumes to exceed 2015 levels, assuming global economic conditions did not deteriorate, and expected full-year operating income to be higher than in 2015. It cited lower feedstock costs, workforce and other cost savings, higher volumes and implemented price increases. Selling prices rose during Q2 and Q3; end-Q3 average prices were 8% above end-2015 but remained below the beginning of 2015. Management described long-term TiO₂ demand growth expectations of 2%–3% annually, not as a near-term forecast.
- Results are exposed to cyclical TiO₂ supply and demand, selling-price and customer-inventory changes, competition, raw-material and energy costs, foreign exchange, economic conditions, and unplanned operating interruptions.
- German and Belgian deferred tax assets remain subject to a valuation allowance. Management said full reversal depends on sufficient positive evidence, including sustained profitability; it did not expect a full reversal in 2016. A Canada-Germany APA was expected to be finalized within 12 months, with no material adverse effect expected based on existing accruals.
- Kronos faces TiO₂ price-fixing claims, including the Los Gatos matter and a Home Depot complaint filed in September 2016. The company denies wrongdoing, intends to defend the cases, and reported no accrual because it determined a material loss was not reasonably possible.
- Management expected sufficient liquidity for its stated short- and long-term obligations, but noted that actual results, industry conditions and the ability to extend or refinance credit facilities could affect liquidity.
Important facts for investors to verify
- Whether price increases and stronger demand persist, and whether selling prices recover further from levels still below early 2015.
- Progress on refinancing or extending the two revolving facilities due in 2017, and continuing covenant compliance and borrowing availability.
- Cash conversion and working-capital trends, particularly the increase in receivables and lower inventory, alongside the dividend and planned capital spending.
- Evidence supporting recovery of German and Belgian tax assets, and outcomes or cash requirements from the Canada-Germany APA and tax examinations.
- Developments in the TiO₂ antitrust litigation and any change to the company’s assessment of potential loss.