Kronos Worldwide, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Kronos produces and markets titanium dioxide (TiO₂) pigments. All dollar figures below are in millions, except per-share data and where noted.
Financial performance
| Metric | Q3 2016 | Q3 2017 | 9M 2016 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $356.1 | $464.5 | $1,030.6 | $1,275.7 |
| Gross margin | $75.5 | $152.2 | $171.4 | $385.4 |
| Gross margin % | 21% | 33% | 17% | 30% |
| Income from operations | $28.0 | $91.6 | $38.2 | $214.0 |
| Net income | $22.2 | $73.8 | $20.1 | $307.1 |
| Diluted EPS | $0.19 | $0.64 | $0.17 | $2.65 |
- Q3 sales rose 30%, mainly from 23% higher average selling prices and 5% higher sales volumes; currency translation added an estimated $13 to sales. Q3 operating margin improved to 20% from 8%.
- For the first nine months, sales increased 24%, reflecting 20% higher average prices and 5% higher volumes. Operating margin increased to 17% from 4%.
- Q3 cost of sales rose 11%, including approximately $9 of higher raw-material and other production costs, principally feedstock ore. For the nine-month period, such costs were approximately $5 lower year over year, alongside production efficiencies.
- Q3 interest expense was $5.0; nine-month interest expense was $14.5. Q3 included a $7.1 debt-prepayment loss.
Cash flow, balance sheet and liquidity
- Nine-month operating cash flow was $218.3, versus $68.7 in 2016. Capital expenditures were $40.7; dividends paid were $52.2. Cash, cash equivalents and restricted cash increased to $318.0 from $52.3 at year-end 2016.
- At September 30, 2017, total assets were $1,710.4, current assets $1,021.2, current liabilities $240.0 and stockholders’ equity $710.7. Cash and cash equivalents were $316.7, with $1.3 of restricted cash.
- Total debt was $467.6, including $464.2 carrying value of euro-denominated senior notes and $3.4 of other debt. Cash and restricted cash exceeded reported debt by approximately $149.6.
- Available borrowing capacity was approximately $100.0 under the North American revolver and $106.1 under the European revolver. The company reported compliance with debt covenants and expected sufficient liquidity for its stated short- and long-term planning periods.
Material changes and unusual items
- In September, subsidiary Kronos International issued €400 of 3.75% senior secured notes due 2025. Proceeds were used principally to repay the term loan and North American revolver borrowings. The notes carry a $464.2 balance-sheet carrying value; the filing reports $471.6 equivalent principal exposure before issuance costs for market-risk purposes.
- The refinancing eliminated variable-rate term-loan exposure and terminated the related interest-rate swap, with a $3.3 termination payment included in the $7.1 prepayment loss. The euro-denominated notes introduce foreign-exchange exposure: a hypothetical 10% adverse exchange-rate move would increase their U.S.-dollar equivalent by about $47.
- Nine-month net income included a $170.4 non-cash tax benefit from releasing German and Belgian deferred-tax-asset valuation allowances, plus an $11.3 tax benefit related to a Canada-Germany advance pricing agreement. The remaining $11.7 valuation allowance was expected to be reversed in Q4. These tax items materially elevated reported year-to-date earnings.
- Q3 pension cost was $7.5, compared with $5.5 a year earlier; nine-month pension cost was $21.4, compared with $16.6.
Outlook, risks and contingencies
- Management expected 2017 production to exceed 2016, sales volumes to be slightly higher assuming economic conditions continued, and operating income to increase, primarily on higher selling prices and anticipated higher volumes. It expected full-year cost of sales per metric ton to be comparable to 2016 and estimated 2017 capital expenditures of approximately $65.
- Management cited strong demand, low producer and customer inventories, and full practical capacity utilization in the first nine months. It noted long-term TiO₂ demand growth expectations of 2%–3% annually; this is not a formal earnings forecast.
- Key risks include TiO₂ pricing and industry cyclicality, demand and capacity changes, feedstock and energy costs, foreign-exchange movements, operational interruptions, liquidity and refinancing, tax outcomes, environmental regulation and litigation.
- The company is defending two U.S. antitrust cases alleging TiO₂ price-fixing. It said it believes the claims are without merit and had not accrued material amounts, concluding a material loss was not reasonably possible for the matters described.
- The company expected adoption of the revenue recognition standard in Q1 2018 to have minimal revenue impact. It expected the new lease standard, effective in 2019, to result in a material right-of-use asset and lease liability.
Most important facts for investors to verify
- How much of reported earnings growth is supported by ongoing TiO₂ pricing, volume and operating-margin trends versus non-cash tax benefits.
- Whether selling-price gains and demand persist as feedstock costs rise, and whether management’s 2017 volume and operating-income expectations are met.
- The company’s euro-denominated debt exposure, refinancing terms, available revolver capacity and covenant headroom.
- Progress on the expected Q4 reversal of the remaining tax valuation allowance and any changes in tax audits, litigation or other contingencies.
- Capital spending, working-capital cash conversion and the effects of the ERP rollout and upcoming accounting-standard changes.