SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2005 Commission file number 1-31763
--------------------- -------
KRONOS WORLDWIDE, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 76-0294959
- ------------------------------- --------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
---------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No
--- ---
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Number of shares of the Registrant's common stock outstanding on October 31,
2005: 48,949,549.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 2004; September 30, 2005 (Unaudited) 3
Consolidated Statements of Income -
Three months and nine months ended
September 30, 2004 and 2005 (Unaudited) 5
Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2004 and 2005 (Unaudited) 6
Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2005 (Unaudited) 7
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2004 and 2005 (Unaudited) 8
Notes to Consolidated Financial Statements (Unaudited) 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 4. Controls and Procedures 28
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 6. Exhibits 30
- 2 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2004 2005
------------- --------------
(Unaudited)
Current assets:
Cash and cash equivalents $ 60,790 $ 62,915
Restricted cash 1,529 915
Accounts and other receivables 190,319 199,304
Refundable income taxes 3,272 866
Receivable from affiliates 16 -
Inventories 233,858 251,445
Prepaid expenses and other 4,529 7,280
Deferred income taxes 1,205 4,299
----------- ----------
Total current assets 495,518 527,024
----------- ----------
Other assets:
Investment in TiO2 manufacturing joint venture 120,251 115,151
Deferred income taxes 238,284 178,553
Other 32,340 27,550
----------- ----------
Total other assets 390,875 321,254
----------- ----------
Property and equipment:
Land 35,511 32,140
Buildings 196,983 183,976
Equipment 857,714 787,043
Mining properties 71,980 66,607
Construction in progress 16,753 22,577
----------- ----------
1,178,941 1,092,343
Less accumulated depreciation and amortization 712,051 677,913
----------- ----------
Net property and equipment 466,890 414,430
----------- ----------
$ 1,353,283 $1,262,708
=========== ==========
- 3 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2004 2005
------------- --------------
(Unaudited)
Current liabilities:
Current maturities of long-term debt $ 13,792 $ 158
Accounts payable and accrued liabilities 170,009 168,711
Payable to affiliates 9,231 10,651
Income taxes 17,129 13,486
Deferred income taxes 2,722 906
----------- ----------
Total current liabilities 212,883 193,912
----------- ----------
Noncurrent liabilities:
Long-term debt 519,403 457,620
Deferred income taxes 60,081 58,335
Accrued pension costs 61,300 55,468
Accrued postretirement benefits costs 11,288 10,742
Other 17,407 13,425
----------- ----------
Total noncurrent liabilities 669,479 595,590
----------- ----------
Minority interest 76 73
----------- ----------
Stockholders' equity:
Common stock 489 489
Additional paid-in capital 1,060,643 1,061,540
Retained deficit (463,352) (437,846)
Accumulated other comprehensive loss:
Currency translation (88,181) (112,296)
Pension liabilities (38,754) (38,754)
----------- ----------
Total stockholders' equity 470,845 473,133
----------- ----------
$1,353,283 $1,262,708
=========== ==========
Commitments and contingencies (Notes 10 and 12)
See accompanying notes to consolidated financial statements.
- 4 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- ----------------------
2004 2005 2004 2005
---- ---- ---- ----
(Restated)
Net sales $ 286,058 $ 292,113 $ 845,114 $ 895,675
Cost of sales 219,382 216,193 649,118 640,918
--------- --------- --------- ---------
Gross margin 66,676 75,920 195,996 254,757
Selling, general and administrative expense 35,777 36,877 105,991 111,974
Other operating income (expense):
Currency transaction gains (losses), net (1,414) 228 (858) 3,551
Disposition of property and equipment (197) (287) (199) (441)
Other income 234 307 6,514 419
Corporate expense (589) (1,075) (1,868) (3,948)
--------- --------- --------- ---------
Income from operations 28,933 38,216 93,594 142,364
Other income (expense):
Trade interest income 287 247 699 467
Other interest income 284 160 657 780
Securities transaction gain - - - 5,439
Interest expense to affiliates (4,529) - (13,480) -
Interest expense (8,720) (10,630) (26,529) (34,027)
--------- --------- --------- ---------
Income before income taxes and
minority interest 16,255 27,993 54,941 115,023
Provision for income taxes (benefit) 6,189 20,039 (249,742) 52,796
Minority interest in after-tax earnings 18 2 38 9
--------- --------- --------- ---------
Net income $ 10,048 $ 7,952 $ 304,645 $ 62,218
========= ========= ========= =========
Cash dividend per share $ .25 $ .25 $ .75 $ .75
========= ========= ========= =========
Basic and diluted net income per share $ .21 $ .16 $ 6.22 $ 1.27
========= ========= ========= =========
Basic and diluted weighted-average shares used in
the calculation of net income per share 48,946 48,950 48,945 48,948
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
- 5 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Net income $ 304,645 $ 62,218
Other comprehensive income (loss) -
currency translation adjustment 2,476 (24,115)
--------- ---------
Comprehensive income $ 307,121 $ 38,103
========= =========
See accompanying notes to consolidated financial statements.
- 6 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2005
(In thousands)
(Unaudited)
Accumulated other
comprehensive loss
Additional ------------------------------ Total
Common paid-in Retained Currency Pension stockholders'
stock capital deficit translation liabilities equity
------- ---------- -------- ----------- ----------- -------------
Balance at December 31, 2004 $ 489 $1,060,643 $(463,352) $ (88,181) $(38,754) $470,845
Net income - - 62,218 - - 62,218
Dividends - - (36,712) - - (36,712)
Other comprehensive loss - - - (24,115) - (24,115)
Other - 897 - - - 897
------ ---------- --------- --------- -------- --------
Balance at September 30, 2005 $ 489 $1,061,540 $(437,846) $(112,296) $(38,754) $473,133
====== ========== ========= ========= ======== ========
See accompanying notes to consolidated financial statements.
- 7 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Cash flows from operating activities:
Net income $304,645 $ 62,218
Depreciation and amortization 32,588 32,711
Noncash interest expense 1,852 2,241
Deferred income taxes (261,228) 29,476
Minority interest 38 9
Net loss from disposition of property and equipment 199 441
Securities transaction gain - (5,439)
Distributions from TiO2 manufacturing joint venture, net 9,100 5,100
Pension cost, net 461 (3,251)
Other postretirement benefits, net (506) (658)
Other, net 1,942 (1,632)
Change in assets and liabilities:
Accounts and other receivables (49,582) (26,478)
Inventories 61,122 (36,107)
Prepaid expenses (4,729) (3,253)
Accounts payable and accrued liabilities (6,351) 13,672
Income taxes 33,290 1,438
Accounts with affiliates 1,297 3,528
Other, net (4,310) (4,723)
-------- --------
Net cash provided by operating activities 119,828 69,293
-------- --------
Cash flows from investing activities:
Capital expenditures (21,417) (20,868)
Change in restricted cash equivalents 409 592
Proceeds from disposal of interest in
Norwegian smelting operation - 3,542
Other, net 83 37
-------- --------
Net cash used in investing activities (20,925) (16,697)
-------- --------
Cash flows from financing activities:
Indebtedness:
Borrowings 99,968 8,600
Principal payments (100,030) (21,655)
Dividends paid (36,710) (36,712)
Other, net - 1,208
-------- --------
Net cash used in financing activities (36,772) (48,559)
-------- --------
- 8 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Cash and cash equivalents - net change from:
Operating, investing and financing activities $ 62,131 $ 4,037
Currency translation 497 (1,912)
Cash and cash equivalents at beginning of period 55,876 60,790
-------- --------
Cash and cash equivalents at end of period $118,504 $ 62,915
======== ========
Supplemental disclosures:
Cash paid (received) for:
Interest, net of amounts capitalized $ 30,369 $ 21,601
Income taxes, net (22,433) 20,724
Noncash investing activity - inventory
received as partial consideration for
disposal of interest in Norwegian
smelting operation $ - $ 1,897
See accompanying notes to consolidated financial statements.
- 9 -
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Organization and basis of presentation:
Kronos Worldwide, Inc. ("Kronos") (NYSE: KRO) is a subsidiary of Valhi,
Inc. (NYSE: VHI). Kronos' sole business segment is associated with the
production and sale of titanium dioxide pigments ("TiO2"). At September 30,
2005, (i) Valhi held approximately 57% of Kronos' outstanding common stock and
NL Industries, Inc. (NYSE:NL) held an additional 36% of Kronos' common stock,
(ii) Valhi owned approximately 83% of NL's outstanding common stock and (iii)
Contran Corporation and its subsidiaries held approximately 92% of Valhi's
outstanding common stock. Substantially all of Contran's outstanding voting
stock is held by trusts established for the benefit of certain children and
grandchildren of Harold C. Simmons, of which Mr. Simmons is sole trustee, or is
held by Mr. Simmons or persons or other entities related to Mr. Simmons.
Consequently, Mr. Simmons may be deemed to control each of such companies.
The consolidated balance sheet of Kronos at December 31, 2004 has been
condensed from the Company's audited consolidated financial statements at that
date. The consolidated balance sheet at September 30, 2005, and the consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for the interim periods ended September 30, 2004 and 2005, have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). In the opinion of management,
all adjustments, consisting only of normal recurring adjustments, necessary to
state fairly the consolidated financial position, results of operations and cash
flows have been made.
The results of operations for the interim periods are not necessarily
indicative of the operating results for a full year or of future operations.
Certain information normally included in financial statements prepared in
accordance with GAAP has been condensed or omitted. The accompanying
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31, 2004 (the
"2004 Annual Report").
During the fourth quarter of 2004, Kronos determined that it should have
recognized an additional $17.3 million, or $.35 per diluted share, net deferred
income tax benefit during the second quarter of 2004, primarily related to the
amount of the valuation allowance related to Kronos' German operations which
should have been reversed. While the additional tax benefit is not material to
the Company's second quarter 2004 results, the Company's year-to-date results of
operations for the nine months ended September 30, 2004, as presented herein,
reflects this additional income tax benefit.
The Company has not issued any stock options to purchase Kronos common
stock. However, certain employees of the Company have been granted options by NL
to purchase NL common stock. As disclosed in the 2004 Annual Report, the Company
accounts for stock-based employee compensation in accordance with Accounting
Principles Board Opinion ("APBO") No. 25, "Accounting for Stock Issued to
Employees," and its various interpretations. See Note 13. Under APBO No. 25, no
compensation cost is generally recognized for fixed stock options in which the
exercise price is greater than or equal to the market price on the grant date.
Prior to 2004, and following the cash settlement of certain stock options held
by employees of NL and the Company, the Company commenced accounting for its
stock options using the variable accounting method of APBO No. 25 because Kronos
- 10 -
could not overcome the presumption that it would not similarly cash settle the
remaining stock options. Under the variable accounting method, the intrinsic
value of all unexercised stock options (including stock options with an exercise
price at least equal to the market price on the date of grant) is accrued as an
expense, with subsequent increases (decreases) in the Company's market price
resulting in the recognition of additional compensation expense (income).
Aggregate compensation expense related to NL stock options held by employees of
the Company was approximately $1 million and $1.9 million in the third quarter
and first nine months of 2004, respectively and aggregate compensation expense
(income) was approximately $500,000 and ($400,000) in the third quarter and
first nine months of 2005, respectively.
The following table presents what the Company's consolidated net income,
and related per share amounts, would have been in the 2004 and 2005 periods
presented if the Company and its subsidiaries had each elected to account for
their respective stock-based employee compensation related to stock options in
accordance with the fair value-based recognition provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based
Compensation," for all awards granted subsequent to January 1, 1995.
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2004 2005 2004 2005
---- ---- ---- ----
(In millions, except per share amounts)
Net income as reported $ 10.0 $ 8.0 $304.6 $62.2
Adjustments, net of applicable income
tax effects and minority interest:
Stock-based employee compensation
expense determined under APBO No. 25 .6 .3 1.2 (.3)
Stock-based employee compensation
expense determined under SFAS No. 123 - - - -
------ ----- ------ -----
Pro forma net income $ 10.6 $ 8.3 $305.8 $61.9
====== ===== ====== =====
Basic and diluted earnings per share:
As reported $ .21 $ .16 $ 6.22 $1.27
Pro forma .22 .17 6.25 1.26
Note 2 - Accounts and other receivables:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Trade receivables $176,332 $187,676
Insurance claims 32 21
Recoverable VAT and other receivables 16,332 14,124
Allowance for doubtful accounts (2,377) (2,517)
-------- --------
$190,319 $199,304
======== ========
- 11 -
Note 3 - Inventories:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Raw materials $ 45,962 $ 43,934
Work in process 16,612 19,480
Finished products 130,385 148,977
Supplies 40,899 39,054
-------- --------
$233,858 $251,445
======== ========
Note 4 - Other noncurrent assets:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Deferred financing costs, net $ 10,921 $ 8,886
Restricted marketable debt securities 2,877 2,682
Unrecognized net pension obligations 13,518 12,994
Other 5,024 2,988
-------- --------
$ 32,340 $ 27,550
======== ========
Note 5 - Accounts payable and accrued liabilities:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Accounts payable $ 91,713 $ 71,935
Employee benefits 36,861 34,625
Interest 152 10,244
Other 41,283 51,907
-------- --------
$170,009 $168,711
======== ========
Note 6 - Long-term debt:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Kronos International, Inc. and subsidiaries:
8.875% Senior Secured Notes $519,225 $457,572
European bank credit facility 13,622 -
Other 348 206
-------- --------
533,195 457,778
Less current maturities 13,792 158
-------- --------
$519,403 $457,620
======== ========
- 12 -
As previously reported in the 2004 Annual Report, Kronos International has
pledged 65% of the common stock or other ownership interests of certain of its
first-tier operating subsidiaries as collateral for its Senior Secured Notes.
Such operating subsidiaries are Kronos Titan GmbH, Kronos Denmark ApS, Kronos
Limited and Societe Industrielle Du Titane, S.A.
During the first nine months of 2005, the Company repaid an aggregate of
euro 10 million ($12.9 million when repaid) under its European Credit Facility.
During the second quarter of 2005, the Company extended the respective maturity
dates of its European and U.S. Credit Facilities each by three years to June
2008 and September 2008, respectively.
Note 7 - Other noncurrent liabilities:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Employee benefits $ 5,107 $ 4,615
Insurance claims and expenses 1,927 1,424
Asset retirement obligations 958 941
Other 9,415 6,445
-------- --------
$ 17,407 $ 13,425
======== ========
Note 8 - Stockholders' equity:
During the first nine months of 2005, Valhi purchased certain shares of the
Company's common stock in market transactions. Within six months of such
purchases, NL had sold certain shares of the Company's common stock in market
transactions. In settlement of any alleged short-swing profits derived from
these transactions as calculated pursuant to Section 16(b) of the Securities
Exchange Act of 1934, as amended, Valhi remitted approximately $1.1 million
which amount, net of income taxes, has been recorded by the Company as a capital
contribution, increasing additional paid-in capital.
Note 9 - Other income:
Nine months ended
September 30,
------------------------
2004 2005
---- ----
(In thousands)
Contract dispute settlement $6,289 $ -
Other income 225 419
------ ------
$6,514 $ 419
====== ======
Securities transaction gain in the nine months ended September 30, 2005,
classified as nonoperating income, relates to the sale of the Company's passive
interest in a Norwegian smelting operation, which had a nominal carrying value
for financial reporting purposes, for aggregate consideration of approximately
$5.4 million consisting of cash of $3.5 million and inventory with a value of
$1.9 million.
- 13 -
Note 10 - Provision for income taxes (benefit):
Nine months ended
September 30,
------------------------
2004 2005
---- ----
(In millions)
Expected tax expense $ 19.2 $ 40.3
Incremental U.S. tax and rate differences on .8
equity in earnings of non-tax group companies (.1)
Non-U.S. tax rates (.3) .3
Loss of German tax attribute - 17.5
State income taxes, net - 3.9
Tax contingency reserve adjustments - (12.5)
Change in deferred income tax valuation allowance, net (277.3) -
Refund of prior year income taxes (3.1) -
Nondeductible expenses 2.3 2.7
Other, net 9.6 (.2)
------ -----
($249.7) $ 52.8
====== ======
Certain of the Company's U.S. and non-U.S. tax returns are being examined
and tax authorities have or may propose tax deficiencies, including penalties
and interest. For example:
o Kronos received a preliminary tax assessment related to 1993 from the
Belgian tax authorities proposing tax deficiencies, including related
interest, of approximately euro 6 million ($7 million at September 30,
2005). Kronos filed a protest to this assessment, and believed that a
significant portion of the assessment was without merit. The Belgian tax
authorities have filed a lien on the fixed assets of Kronos' Belgian TiO2
operations in connection with this assessment. In April 2003, Kronos
received a notification from the Belgian tax authorities of their intent to
assess a tax deficiency related to 1999 that, including interest, would
have aggregated approximately euro 9 million ($11 million). Kronos filed a
written response to the assessment, and in September 2005 the Belgian tax
authorities withdrew the assessment.
o The Norwegian tax authorities have notified Kronos of their intent to
assess tax deficiencies of approximately kroner 12 million ($2 million)
relating to the years 1998 through 2000. Kronos has objected to this
proposed assessment.
o Kronos has received a tax assessment from the Canadian tax authorities
related to the years 1998 and 1999 proposing tax deficiencies, including
interest, of approximately Cdn. $5 million ($4 million). Kronos filed a
protest and in October 2005, the Canadian tax authorities agreed to reduce
the assessment and settle all issues, including interest, for approximately
Cdn. $2 million ($1.7 million).
During the third quarter of 2005, Kronos reached an agreement in principle
with the German tax authorities regarding such tax authorities' objection to the
value assigned to certain intellectual property rights held by Kronos' operating
subsidiary in Germany. Under the agreement in principle, the value assigned to
such intellectual property for German income tax purposes will be reduced
retroactively, resulting in a reduction in the amount of Kronos' net operating
loss carryforward in Germany as well as a future reduction in the amount of
amortization expense attributable to such intellectual property. As a result,
- 14 -
Kronos recognized a $17.5 million non-cash deferred income tax expense in the
third quarter of 2005 related to such agreement. The $12.5 million tax
contingency adjustment income tax benefit in the first nine months of 2005
relates primarily to the withdrawal of the Belgium tax authorities' assessment
related to 1999 and the Canadian tax authorities' reduction of one of its
assessments, as discussed above.
No assurance can be given that these tax matters will be resolved in the
Company's favor in view of the inherent uncertainties involved in settlement
initiatives and court and tax proceedings. The Company believes that it has
provided adequate accruals for additional taxes and related interest expense
which may ultimately result from all such examinations and believes that the
ultimate disposition of such examinations should not have a material adverse
effect on its consolidated financial position, results of operations or
liquidity.
In October 2004, the American Jobs Creation Act of 2004 was enacted into
law. The new law provided for a special 85% deduction for certain dividends
received from a controlled foreign corporation in 2005. In the third quarter of
2005, the Company completed its evaluation of this new provision and determined
that it would not benefit from such special dividends received deduction. As
disclosed in the 2004 Annual Report, the Company does not provide U.S. deferred
income taxes or foreign withholding taxes with respect to undistributed earnings
of foreign subsidiaries that the Company intends to permanently reinvest for the
foreseeable future.
Note 11 - Employee benefit plans:
The components of net periodic defined benefit pension cost are presented
in the table below.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Service cost $ 1,772 $ 1,974 $ 4,829 $ 5,875
Interest cost 4,267 4,311 12,882 13,345
Expected return on plan assets (3,776) (3,884) (11,396) (12,002)
Amortization of prior service cost 140 145 421 449
Amortization of net transition obligations 159 - 482 310
Recognized actuarial losses 739 900 2,227 2,778
------- ------- ------- -------
$ 3,301 $ 3,446 $ 9,445 $10,755
======= ======= ======= =======
The components of net periodic postretirement benefits other than pensions
("OPEB") cost are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Service cost $ 57 $ 56 $ 170 $ 165
Interest cost 180 146 540 435
Amortization of prior service credit (182) (159) (548) (479)
Recognized actuarial losses 38 18 116 53
------- ------- ------- -------
$ 93 $ 61 $ 278 $ 174
======= ======= ======= =======
- 15 -
Note 12 - Commitments and contingencies:
As noted in the 2004 Annual Report, the Company's principal German
operating subsidiary, Kronos Titan GmbH, leases the land under its Leverkusen
TiO2 production facility pursuant to a lease with Bayer AG that expires in 2050.
The Leverkusen facility itself, which is owned by the Company and which
represents approximately one-third of the Company's current TiO2 production
capacity, is located within Bayer's extensive manufacturing complex. Rent for
the land lease associated with the Leverkusen facility is periodically
established by agreement with Bayer for periods of at least two years at a time.
The lease agreement provides for no formula, index or other mechanism to
determine changes in the rent for such land lease; rather, any change in the
rent is subject solely to periodic negotiation between Bayer and the Company.
Any change in the rent based on such negotiations is recognized as part of lease
expense starting from the time such change is agreed upon by both parties, as
any such change in the rent is deemed "contingent rentals" under GAAP.
The Company and its affiliates are from time to time involved in various
environmental, contractual, product liability, patent (or intellectual
property), employment and other claims and disputes incidental to its past and
current operations. In certain cases, the Company has insurance coverage for
such items. The Company currently believes that the disposition of all claims
and disputes, individually or in the aggregate, should not have a material
adverse effect on its consolidated financial position, results of operations or
liquidity.
Reference is made to the 2004 Annual Report for a discussion of certain
other legal proceedings to which the Company is a party.
Note 13 - Accounting principles not yet implemented:
Inventory costs. The Company will adopt SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," for inventory costs incurred on or after
January 1, 2006. SFAS No. 151 requires that the allocation of fixed production
overhead costs to inventory shall be based on normal capacity. Normal capacity
is not defined as a fixed amount; rather, normal capacity refers to a range of
production levels expected to be achieved over a number of periods under normal
circumstances, taking into account the loss of capacity resulting from planned
maintenance shutdowns. The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of idle plant or production levels
below the low end of normal capacity, but instead a portion of fixed overhead
costs is charged to expense as incurred. Alternatively, in periods of production
above the high end of normal capacity, the amount of fixed overhead costs
allocated to each unit of production is decreased so that inventories are not
measured above cost. SFAS No. 151 also clarifies existing GAAP to require that
abnormal freight and wasted materials (spoilage) are to be expensed as incurred.
The Company believes its production cost accounting already complies with the
requirements of SFAS No. 151, and the Company does not expect adoption of SFAS
No. 151 will have a material effect on its consolidated financial statements.
Stock options. As permitted by regulations of the Securities and Exchange
Commission ("SEC"), the Company will adopt SFAS No. 123R, "Share-Based Payment,"
as of January 1, 2006. SFAS No. 123R, among other things, eliminates the
alternative in existing GAAP to use the intrinsic value method of accounting for
stock-based employee compensation under APBO No. 25. Upon adoption of SFAS No.
123R, the Company will generally be required to recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award, with the cost recognized over the period
during which an employee is required to provide services in exchange for the
- 16 -
award (generally, the vesting period of the award). No compensation cost will be
recognized in the aggregate for equity instruments for which the employee does
not render the requisite service (generally, if the instrument is forfeited
before it has vested). The grant-date fair value will be estimated using
option-pricing models (e.g. Black-Scholes or a lattice model). Under the
transition alternatives permitted under SFAS No. 123R, the Company will apply
the new standard to all new awards granted on or after January 1, 2006, and to
all awards existing as of December 31, 2005 which are subsequently modified,
repurchased or cancelled. Additionally, as of January 1, 2006, the Company will
be required to recognize compensation cost for the portion of any non-vested
award existing as of December 31, 2005 over the remaining vesting period.
Because the number of non-vested awards as of December 31, 2005 with respect to
options granted by NL to employees of the Company is not expected to be
material, and because the Company has not granted any options and does not
expect to grant any options prior to January 1, 2006, the effect of adopting
SFAS No. 123R is not expected to be significant in so far as it relates to
existing stock options. Should the Company or its subsidiaries and affiliates,
however, either grant a significant number of options to employees of the
Company or modify, repurchase or cancel existing options in the future, the
effect on the Company's consolidated financial statements could be material.
- 17 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Executive summary
Relative changes in the Company's TiO2 sales and income from operations
during the 2004 and 2005 periods presented are primarily due to the net effects
of (i) higher average TiO2 selling prices, (ii) lower TiO2 selling volumes and
(iii) relative changes in foreign currency exchange rates. Selling prices for
TiO2 (in billing currencies) were generally decreasing during the first half of
2004, increasing during the last half of 2004 and the first six months of 2005
and decreasing during the third quarter of 2005.
The Company reported net income of $8.0 million, or $.16 per diluted share,
in the third quarter of 2005 as compared to net income of $10.0 million, or $.21
per diluted share, in the third quarter of 2004. The Company reported net income
of $62.2 million, or $1.27 per diluted share, in the first nine months of 2005
as compared to net income of $304.6 million, or $6.22 per diluted share, in the
first nine months of 2004. The Company reported lower net income in the third
quarter of 2005 as the favorable effect of higher income from operations in 2005
was more than offset by the effects of higher income taxes in 2005 related to
the Company's European operations. Net income in the first nine months of 2005
includes (i) a net third quarter non-cash income tax charge of $.10 per diluted
share for recent developments with respect to ongoing non-U.S. income tax audits
primarily in Germany, Belgium and Canada and (ii) a securities transaction gain
of $.07 per diluted share related to the sale of the Company's passive interest
in a Norwegian smelting operation. Net income in the first nine months of 2004
includes (i) a second quarter non-cash income tax benefit related to the
reversal of Kronos' deferred income tax asset valuation allowance in Germany of
$5.49 per diluted share and (ii) income related to Kronos' contract dispute
settlement of $.08 per diluted share. Each of these items is more fully
discussed below and/or in the notes to the Consolidated Financial Statements.
Forward-looking information
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that the statements in this
Quarterly Report on Form 10-Q relating to matters that are not historical facts
are forward-looking statements that represent management's beliefs and
assumptions based on currently available information. Forward-looking statements
can be identified by the use of words such as "believes," "intends," "may,"
"should," "could," "anticipates," "expected" or comparable terminology, or by
discussions of strategies or trends. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
cannot give any assurances that these expectations will prove to be correct.
Such statements by their nature involve substantial risks and uncertainties that
could significantly impact expected results, and actual future results could
differ materially from those described in such forward-looking statements. While
it is not possible to identify all factors, the Company continues to face many
risks and uncertainties. Factors that could cause actual future results to
differ materially from those described herein are the risks and uncertainties
discussed in this Quarterly Report and those described from time to time in the
Company's other filings with the SEC include, but are not limited to, the
following:
o Future supply and demand for the Company's products,
- 18 -
o The extent of the dependence of certain of the Company's businesses on
certain market sectors,
o The cyclicality of the Company's business,
o Customer inventory levels (such as the extent to which the Company's
customers may, from time to time, accelerate purchases of TiO2 in advance
of anticipated price increases or defer purchases of TiO2 in advance of
anticipated price decreases),
o Changes in raw material and other operating costs (such as energy costs),
o The possibility of labor disruptions,
o General global economic and political conditions (such as changes in the
level of gross domestic product in various regions of the world and the
impact of such changes on demand for TiO2),
o Competitive products and substitute products,
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o Competitive technology positions,
o The introduction of trade barriers,
o Fluctuations in currency exchange rates (such as changes in the exchange
rate between the U.S. dollar and each of the euro, the Norwegian kroner and
the Canadian dollar),
o Operating interruptions (including, but not limited to, labor disputes,
leaks, fires, explosions, unscheduled or unplanned downtime and
transportation interruptions),
o The timing and amounts of insurance recoveries,
o The ability of the Company to renew or refinance credit facilities,
o The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of which
has been recognized under the "more-likely-than-not" recognition criteria,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
o Government laws and regulations and possible changes therein,
o The ultimate resolution of pending litigation, and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecasted or expected. The
Company disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of changes in information, future
events or otherwise.
- 19 -
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------------
2004 2005 % Change 2004 2005 % Change
---- ---- -------- ---- ---- --------
(In millions, except percentages and volumes)
Net sales $286.1 $292.1 +2% $845.1 $895.7 +6%
Cost of sales 219.4 216.2 -1% 649.1 640.9 -1%
------ ------ ------ ------
Gross margin 66.7 75.9 +14% 196.0 254.8 +30%
Selling, general and
administrative expense (35.8) (36.9) +3% (106.0) (112.0) +6%
Currency transaction gains
(losses), net (1.4) .2 (.8) 3.5
Contract dispute settlement - - 6.3 -
Corporate expense (.6) (1.0) (1.9) (3.9)
------ ------ ------ ------
Income from operations $ 28.9 $ 38.2 +32% $ 93.6 $142.4 +52%
====== ====== ====== ======
TiO2 operating statistics:
Percent change in average
selling prices:
Using actual foreign
currency exchange rates +8% +12%
Impact of changes in foreign
currency exchange rates -1% -3%
---- ----
In billing currencies +7% +9%
==== ====
Sales volumes* 128 119 -7% 383 356 -7%
Production volumes* 123 122 -1% 363 371 +2%
________________________________
* Thousands of metric tons
Kronos' sales increased $6.0 million (2%) in the third quarter of 2005
compared to the third quarter of 2004 and increased $50.6 million (6%) in the
first nine months of 2005 as compared to the same period in 2004 due primarily
to the net effects of higher average TiO2 selling prices, lower TiO2 selling
volumes and the favorable effect of fluctuations in foreign currency exchange
rates, which increased sales by approximately $2 million and $24 million in the
quarter and year-to-date periods, respectively, as further discussed below.
Excluding the effect of fluctuations in the value of the U.S. dollar relative to
other currencies, Kronos' average TiO2 selling prices in billing currencies in
the third quarter and first nine months of 2005 were 7% and 9% higher as
compared to the third quarter and first nine months of 2004, respectively. When
translated from billing currencies to U.S. dollars using actual foreign currency
exchange rates prevailing during the respective periods, Kronos' average TiO2
selling prices in the third quarter of 2005 increased 8% compared to the third
quarter of 2004 and increased 12% for the first nine months of 2005 compared to
the first nine months of 2004. Kronos' average TiO2 selling prices in billing
currencies in the third quarter of 2005 decreased 1% compared to the second
quarter of 2005.
Kronos' sales are denominated in various currencies, including the U.S.
dollar, the euro, other major European currencies and the Canadian dollar. The
disclosure of the percentage change in Kronos' average TiO2 selling prices in
billing currencies (which excludes the effects of fluctuations in the value of
- 20 -
the U.S. dollar relative to other currencies) is considered a "non-GAAP"
financial measure under regulations of the SEC. The disclosure of the percentage
change in Kronos' average TiO2 selling prices using actual foreign currency
exchange rates prevailing during the respective periods is considered the most
directly comparable financial measure presented in accordance with GAAP ("GAAP
measure"). Kronos discloses percentage changes in its average TiO2 prices in
billing currencies because Kronos believes such disclosure provides useful
information to investors to allow them to analyze such changes without the
impact of changes in foreign currency exchange rates, thereby facilitating
period-to-period comparisons of the relative changes in average selling prices
in the actual various billing currencies. Generally, when the U.S. dollar either
strengthens or weakens against other currencies, the percentage change in
average selling prices in billing currencies will be higher or lower,
respectively, than such percentage changes would be using actual exchange rates
prevailing during the respective periods. The difference between the 8% and 12%
increases in Kronos' average TiO2 selling prices during the third quarter and
first nine months of 2005 as compared to the third quarter and first nine months
of 2004 using actual foreign currency exchange rates prevailing during the
respective periods (the GAAP measure), and the 7% and 9% increases in Kronos'
average TiO2 selling prices in billing currencies (the non-GAAP measure) during
each of such periods is due to the effect of changes in foreign currency
exchange rates. The above table presents in a tabular format (i) the percentage
change in Kronos' average TiO2 selling prices using actual foreign currency
exchange rates prevailing during the respective periods (the GAAP measure), (ii)
the percentage change in Kronos' average TiO2 selling prices in billing
currencies (the non-GAAP measure) and (iii) the percentage change due to changes
in foreign currency exchange rates (or the reconciling item between the non-GAAP
measure and the GAAP measure).
Kronos' TiO2 sales volumes in both the third quarter and first nine months
of 2005 decreased 7% compared to the corresponding periods in 2004, with volumes
lower in all regions of the world. Kronos' production levels, decreased 1% in
the third quarter of 2005 and increased 2% during the first nine months of 2005
as compared to the same periods in 2004. Kronos' operating rates were near full
capacity in those periods, and Kronos' production volumes were a new record for
Kronos for a first nine-month period.
The Company's cost of sales decreased $3.2 million (1%) in the third
quarter of 2005 compared to the third quarter of 2004, and decreased $8.2
million (1%) in the year-to-date period largely due to lower sales volumes. As a
result of the higher average TiO2 selling prices in billing currencies, the
Company's cost of sales, as a percentage of net sales, decreased from 77% in
each of the third quarter and first nine months of 2004 to 74% and 72% in the
third quarter and first nine months of 2005, respectively.
The Company's gross margins for the third quarter of 2005 increased $9.2
million (14%) from the third quarter of 2004 and increased $58.8 million (30%)
in the first nine months of 2005 as compared to the first nine months of 2004
due to the aforementioned increases in net sales.
Selling, general and administrative expenses increased $1.1 million (3%)
and $6.0 million (6%), respectively, in the third quarter and first nine months
of 2005 as compared to the corresponding periods in 2004. These increases are
largely attributable to the impact of translating foreign currencies (primarily
the euro) into U.S. dollars. Corporate expense increased $400,000 and $2.0
million, respectively, in the third quarter and first nine months of 2005 as
compared to the corresponding periods of 2004 due primarily to higher
professional fees and other costs associated with Kronos being a public company.
- 21 -
Income from operations in the nine months ended September 30, 2004 includes
income of $6.3 million ($4.1 million, or $.08 per diluted share, net of income
taxes) related to settlement of a contract dispute with a customer.
The Company has substantial operations and assets located outside the
United States (particularly in Germany, Belgium, Norway and Canada). A
significant amount of the Company's sales generated from its non-U.S. operations
are denominated in currencies other than the U.S. dollar, principally the euro,
other major European currencies and the Canadian dollar. A portion of the
Company's sales generated from its non-U.S. operations are denominated in the
U.S. dollar. Certain raw materials, primarily titanium-containing feedstocks,
are purchased in U.S. dollars, while labor and other production costs are
denominated primarily in local currencies. Consequently, the translated U.S.
dollar value of the Company's foreign sales and operating results are subject to
currency exchange rate fluctuations which may favorably or adversely impact
reported earnings and may affect the comparability of period-to-period operating
results. Overall, fluctuations in the value of the U.S. dollar relative to other
currencies, primarily the euro, increased TiO2 sales by approximately a net $2
million in the third quarter of 2005 as compared to the same period in 2004 and
increased TiO2 sales in the first nine months of 2005 by approximately $24
million compared to the same period in 2004. Fluctuations in the value of the
U.S. dollar relative to other currencies similarly impacted the Company's
foreign currency-denominated operating expenses. The Company's operating costs
that are not denominated in the U.S. dollar, when translated into U.S. dollars,
were higher in the third quarter and first nine months of 2005 as compared to
the third quarter and first nine months of 2004. Overall, the net impact of
currency exchange rate fluctuations on the Company's operating income
comparisons resulted in approximately a net $2 million increase in the Company's
income from operations in the first nine months of 2005 as compared to the
corresponding period in 2004 (currency exchange rate fluctuations did not have a
significant effect on the quarter-to-quarter comparisons).
Outlook
Kronos expects its income from operations in 2005 will be significantly
higher than 2004, due primarily to higher overall average selling prices on a
year-to-year comparison basis. While the Company expects its income from
operations in calendar 2005 will be higher than calendar 2004, Kronos expects
its income from operations in the fourth quarter of 2005 will be consistent with
the third quarter of 2005, exclusive of the effect of any insurance recoveries
which might be recognized as a result of Hurricane Rita (as discussed below).
Kronos' expectations as to the future prospects of Kronos and the TiO2 industry
are based upon a number of factors beyond Kronos' control, including worldwide
growth of gross domestic product, competition in the marketplace, unexpected or
earlier-than-expected capacity additions and technological advances. If actual
developments differ from Kronos' expectations, Kronos' results of operations
could be unfavorably affected.
On September 22, 2005, the chloride-process TiO2 facility operated by the
Company's 50%-owned joint venture, Louisiana Pigment Company ("LPC"),
temporarily halted production due to Hurricane Rita. Although storm damage to
core processing facilities was not extensive, a variety of factors, including
loss of utilities, limited access and availability of employees and raw
materials, prevented the resumption of partial operations until October 9, 2005.
Operations are expected to be restored in early November 2005. The joint venture
expects the majority of its property damage and unabsorbed fixed costs for
periods in which normal production levels were not achieved are covered by
insurance, and the Company believes insurance will cover its business
interruption losses (subject to applicable deductibles) resulting from its share
of the lost production from LPC. The Company's results of operations in the
- 22 -
third quarter of 2005 include approximately $1 million of costs related to
hurricane Rita (primarily the Company's share of LPC's unabsorbed fixed costs)
for which no insurance recovery has yet been recognized as the amounts are not
presently determinable. The effect on the Company's financial results will
depend on the timing and amount of insurance recoveries. The Company-owned
warehouse and slurry facilities located near to LPC's facility were also
temporarily closed due to the storm, but property damage to these facilities was
not significant.
The Company's efforts to debottleneck its production facilities to meet
long-term demand continue to prove successful. Such debottlenecking efforts
included, among other things, the addition of finishing capacity in the German
facility and equipment upgrades and enhancements in several locations to allow
for reduced downtime for maintenance activities. The Company's production
capacity has increased by approximately 30% over the past ten years due to
debottlenecking programs, with only moderate capital expenditures. The Company
believes its annual attainable production capacity for 2005 (absent the effect
of the Hurricane discussed above) is approximately 500,000 metric tons, with
approximately 10,000 metric tons additional capacity expected to be available in
2006 through its continued debottlenecking efforts.
Other income (expense)
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------------
2004 2005 Difference 2004 2005 Difference
---- ---- ---------- ---- ---- ----------
(In millions, except percentages and volumes)
Trade interest income $ .3 $ .3 $ - $ .7 $ .5 $ (.2)
Other interest income .3 .1 (.2) .6 .7 .1
Securities transaction gain - - - - 5.4 5.4
Interest expense to affiliates (4.5) - 4.5 (13.5) - 13.5
Other interest expense (8.7) (10.6) (1.9) (26.5) (34.0) (7.5)
------ ------ ------ ------ ------ ------
$(12.6) $(10.2) $ 2.4 $(38.7) $(27.4) $ 11.3
====== ====== ====== ====== ====== ======
Securities transaction gain in the second quarter of 2005 relates to the
sale of the Company's passive interest in a Norwegian smelting operation, which
had a nominal carrying value for financial reporting purposes, for aggregate
consideration of approximately $5.4 million consisting of cash of $3.5 million
and inventory with a value of $1.9 million. See Note 9 to the Consolidated
Financial Statements.
Interest expense to affiliates in 2004 relates to the Company's $200
million long-term notes payable to affiliates, which were prepaid in the fourth
quarter of 2004.
Kronos has a significant amount of outstanding indebtedness denominated in
the euro, including Kronos International, Inc.'s ("KII") euro 375 million Senior
Secured Notes. Accordingly, the reported amount of interest expense will vary
depending on relative changes in foreign currency exchange rates. Other interest
expense in the third quarter and first nine months of 2005 was $10.6 million and
$34.0 million, respectively, or $1.9 million and $7.5 million higher than the
respective periods of 2004. The increases were due primarily to higher levels of
outstanding indebtedness resulting from the issuance of an additional euro 90
million principal amount of KII's Senior Secured Notes in November 2004. In
addition, the increases in interest expense were due to relative changes in
foreign currency exchange rates, which increased the U.S. dollar equivalent of
- 23 -
interest expense on the euro 285 million KII Senior Secured Notes outstanding
during both periods by approximately $100,000 in the third quarter of 2005 and
$1.0 million in the first nine months of 2005 as compared to the third quarter
and first nine months of 2004. Assuming no significant change in interest rates
or foreign currency exchange rates, other interest expense for the full-year
2005 is expected to be higher than amounts for the same periods in 2004 due
primarily to the effect of the additional euro 90 million Senior Secured Notes
issued in November 2004.
Provision for income taxes
The principal reasons for the difference between the Company's effective
income tax rates and the U.S. federal statutory income tax rates are explained
in Note 10 to the Consolidated Financial Statements.
At September 30, 2005, Kronos has the equivalent of $564 million and $146
million of income tax loss carryforwards for German corporate and trade tax
purposes, respectively, all of which have no expiration date. As more fully
described in the 2004 Annual Report, during 2004 Kronos concluded the benefit of
such income tax loss carryforwards met the "more-likely-than-not" recognition
criteria of GAAP, and accordingly in 2004 Kronos reversed the deferred income
tax asset valuation allowance related to such German carryforwards and other net
deductible temporary differences related to Germany. Prior to the complete
utilization of such carryforwards, it is possible that the Company might
conclude in the future that the benefit of such carryforwards would no longer
meet the "more-likely-than-not" recognition criteria, at which point the Company
would be required to recognize a valuation allowance against the then-remaining
tax benefit associated with the carryforwards. The Company's income tax benefit
in the first nine months of 2004 includes a $277.3 million tax benefit ($5.67
per diluted share) related to reversal of the German deferred income tax asset
valuation allowance (including the $268.6 million tax benefit recognized in the
second quarter of 2004).
Accounting principles not yet implemented
See Note 13 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES:
Consolidated cash flows
The Company's consolidated cash flows from operating, investing and
financing activities for the nine months ended September 30, 2004 and 2005 are
presented below:
Nine months ended
September 30,
----------------------------
2004 2005
---- ----
(In millions)
Net cash provided (used) by:
Operating activities $119.8 $ 69.3
Investing activities (20.9) (16.7)
Financing activities (36.8) (48.6)
------ ------
Net cash provided by operating,
investing and financing activities $ 62.1 $ 4.0
====== ======
- 24 -
Summary
The Company's primary source of liquidity on an ongoing short-term and
long-term basis is its cash flows from operating activities, which is generally
used to (i) fund capital expenditures, (ii) repay any short-term indebtedness
incurred primarily for working capital purposes and (iii) provide for the
payment of dividends. In addition, from time-to-time the Company will incur
indebtedness, generally to (i) fund short-term working capital needs, (ii)
refinance existing indebtedness or (iii) fund major capital expenditures or the
acquisition of other assets outside the ordinary course of business. Also, the
Company will from time-to-time sell assets outside the ordinary course of
business, the proceeds of which are generally used to (i) repay existing
indebtedness (including indebtedness which may have been collateralized by the
assets sold), (ii) make investments in marketable and other securities, (iii)
fund major capital expenditures or the acquisition of other assets outside the
ordinary course of business or (iv) pay dividends.
Operating activities
The TiO2 industry is cyclical and changes in economic conditions within the
industry significantly impact the earnings and operating cash flows of the
Company. Cash flow from operations is considered the primary source of liquidity
for the Company. Changes in TiO2 pricing, production volume and customer demand,
among other things, could significantly affect the liquidity of the Company.
Trends in cash flows from operating activities (excluding the impact of
significant asset dispositions and relative changes in assets and liabilities)
are generally similar to trends in the Company's earnings. However, certain
items included in the determination of net income are non-cash, and therefore
such items have no impact on cash flows from operating activities. Non-cash
items included in the determination of net income include depreciation and
amortization expense, deferred income taxes and non-cash interest expense.
Non-cash interest expense consists of amortization of original issue discount or
premium on certain indebtedness and amortization of deferred financing costs.
Certain other items included in the determination of net income may have an
impact on cash flows from operating activities, but the impact of such items on
cash flows from operating activities will differ from their impact on net
income. For example, the amount of periodic defined benefit pension plan expense
and periodic OPEB expense depends upon a number of factors, including certain
actuarial assumptions, and changes in such actuarial assumptions will result in
a change in the reported expense. In addition, the amount of such periodic
expense generally differs from the outflows of cash required to be currently
paid for such benefits.
Relative changes in assets and liabilities generally result from the timing
of production, sales, purchases and income tax payments. Such relative changes
can significantly impact the comparability of cash flow from operations from
period to period, as the income statement impact of such items may occur in a
different period from when the underlying cash transaction occurs. For example,
raw materials may be purchased in one period, but the payment for such raw
materials may occur in a subsequent period. Similarly, inventory may be sold in
one period, but the cash collection of the receivable may occur in a subsequent
period.
Cash flows from operating activities decreased from $119.8 million provided
by operating activities in the first nine months of 2004 to $69.3 million of
cash provided by operating activities in the first nine months of 2005. This
$50.5 million decrease was due primarily to the net effects of (i) lower net
income of $242.4 million, (ii) higher deferred income taxes of $290.7 million,
(iii) lower net distributions from the TiO2 manufacturing joint venture of $4.0
- 25 -
million, (iv) a higher amount of net cash used from relative changes in the
Company's inventories, receivables, payables and accruals of $51.9 million in
the first nine months of 2005 as compared to the first nine months of 2004 and
(v) higher cash paid for income taxes of $43.2 million, due in large part to an
aggregate $34.7 million of tax refunds received during the first nine months of
2004. Relative changes in accounts receivable are affected by, among other
things, the timing of sales and the collection of the resulting receivables.
Relative changes in inventories and accounts payable and accrued liabilities are
affected by, among other things, the timing of raw material purchases and the
payment for such purchases and the relative difference between production
volumes and sales volumes. The Company's average days sales outstanding ("DSO")
increased from 60 days at December 31, 2004 to 61 days at September 30, 2005,
due to the timing of collection on the slightly higher accounts receivable
balance at the end of September. At September 30, 2005, the average number of
days in inventory ("DII") increased to 105 days from 97 days at December 31,
2004 due to the effects of higher production volume and lower sales volume.
Investing and financing activities
The Company's capital expenditures were $21.4 million and $20.9 million in
the first nine months of 2004 and 2005, respectively. During the second quarter
of 2005, the Company received $3.5 million from the sale of its passive interest
in a Norwegian smelting operation.
During the first nine months of 2005, the Company repaid euro 10 million
($12.9 million when repaid) under its European Credit Facility. The Company also
borrowed and repaid $8.6 million under its U.S. credit facility during the first
nine months of 2005. In each of the first, second and third quarters of 2005,
the Company paid a regular quarterly dividend to stockholders of $.25 per share,
aggregating $36.7 million.
At September 30, 2005, unused credit available under Kronos' existing
credit facilities approximated $147 million, which was comprised of: $96 million
under its European revolving credit facility, $11 million under its Canadian
credit facility, $36 million under its U.S. credit facility and $4 million under
other non-US facilities. At September 30, 2005, KII had approximately $89
million allowed for payment of dividends and other restrictive payments as
permitted by the provisions of the Senior Secured Notes indenture. Based upon
Kronos' expectation for the TiO2 industry and anticipated demands on Kronos'
cash resources as discussed herein, Kronos expects to have sufficient liquidity
to meet its future obligations including operations, capital expenditures, debt
service and current dividend policy. To the extent that actual developments
differ from Kronos' expectations, Kronos' liquidity could be adversely affected.
Provisions contained in certain of Kronos' credit agreements could result
in the acceleration of the applicable indebtedness prior to its stated maturity
for reasons other than defaults from failing to comply with typical financial
covenants. For example, certain credit agreements allow the lender to accelerate
the maturity of the indebtedness upon a change of control (as defined) of the
borrower. In addition, certain credit agreements could result in the
acceleration of all or a portion of the indebtedness following a sale of assets
outside the ordinary course of business. Other than operating leases discussed
in the 2004 Annual Report, neither Kronos nor any of its subsidiaries or
affiliates are parties to any off-balance sheet financing arrangements.
- 26 -
Other
At September 30, 2005, the Company and its subsidiaries had (i) current
cash and cash equivalents aggregating $62.9 million ($59.9 million held by
non-U.S. subsidiaries), (ii) current restricted cash of $1.0 million and (iii)
noncurrent restricted marketable debt securities of $2.7 million.
At September 30, 2005, Kronos' outstanding debt was comprised of (i) $457.6
million related to KII's Senior Secured Notes and (ii) approximately $200,000 of
other indebtedness. During the second quarter of 2005, the Company extended the
respective maturity dates of its European and U.S. Credit Facilities each by
three years to June 2008 and September 2008, respectively.
KII's assets consist primarily of investments in its operating
subsidiaries, and its ability to service its parent level obligations, including
the Senior Secured Notes, depends in large part upon the distribution of
earnings of its subsidiaries, whether in the form of dividends, advances or
payments on account of intercompany obligation, or otherwise. None of KII's
subsidiaries have guaranteed the Senior Secured Notes, although KII has pledged
65% of the common stock or other ownership interest of certain of KII's
first-tier operating subsidiaries as collateral of such Senior Secured Notes.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact Kronos' earnings and operating cash
flows. Cash flows from operations is considered the primary source of liquidity
for Kronos. Changes in TiO2 pricing, production volumes and customer demand,
among other things, could significantly affect the liquidity of Kronos.
Based upon Kronos' expectations for the TiO2 industry and anticipated
demand for Kronos' cash resources as discussed herein, Kronos expects to have
sufficient short-term (defined as the twelve-month period ending September 30,
2006) and long-term (defined as the five-year period ending December 31, 2009,
the time period for which the Company generally does long-term budgeting)
liquidity to meet its obligations including operations, capital expenditures,
debt service and dividends. To the extent that actual developments differ from
Kronos' expectations, Kronos' liquidity could be adversely affected.
See Note 10 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of Kronos' income tax
returns in various non-U.S. jurisdictions, and see Note 12 to the Consolidated
Financial Statements for discussion of certain legal proceedings with respect to
Kronos.
Certain of Kronos' sales generated by its non-U.S. operations are
denominated in U.S. dollars. Kronos periodically uses currency forward contracts
to manage a nominal portion of its foreign exchange rate risk associated with
receivables denominated in a currency other than the holder's functional
currency or similar exchange rate risk associated with future sales. Kronos has
not entered into these contracts for trading or speculative purposes in the
past, nor does Kronos currently anticipate entering into such contracts for
trading or speculative purposes in the future. Derivatives used to hedge
forecasted transactions and specific cash flows associated with foreign currency
denominated financial assets and liabilities which meet the criteria for hedge
accounting are designated as cash flow hedges. Consequently, the effective
portion of gains and losses is deferred as a component of accumulated other
comprehensive income and is recognized in earnings at the time the hedged item
affects earnings. Contracts that do not meet the criteria for hedge accounting
are marked-to-market at each balance sheet date with any resulting gain or loss
recognized in income currently as part of net currency transactions. For the
- 27 -
periods ended September 30, 2004 and 2005 the Company has not used hedge
accounting for any of its contracts. To manage such exchange rate risk, at
September 30, 2005, Kronos held a series of contracts, which mature at various
dates through December 2005, to exchange an aggregate of U.S. $10.0 million for
an equivalent amount of Canadian dollars at exchange rates of Cdn. $1.25 per
U.S. dollar to Cdn. $1.26 per U.S. dollar. At September 30, 2005, the actual
exchange rate was Cdn. $1.18 per U.S. dollar. The estimated fair value of such
foreign currency forward contracts at September 30, 2005 was not material.
Kronos periodically evaluates its liquidity requirements, alternative uses
of capital, capital needs and availability of resources in view of, among other
things, its dividend policy, its debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, Kronos has in the past and may in the future seek to reduce, refinance,
repurchase or restructure indebtedness, raise additional capital, repurchase
shares of its common stock, modify its dividend policy, restructure ownership
interests, sell interests in subsidiaries or other assets, or take a combination
of such steps or other steps to manage its liquidity and capital resources. In
the normal course of its business, Kronos may review opportunities for
acquisitions, divestitures, joint ventures or other business combinations in the
chemicals or other industries, as well as the acquisition of interests in, and
loans to, related entities. In the event of any such transaction, Kronos may
consider using its available cash, issuing its equity securities or increasing
its indebtedness to the extent permitted by the agreements governing Kronos'
existing debt.
Kronos has substantial operations located outside the United States for
which the functional currency is not the U.S. dollar. As a result, the reported
amounts of Kronos' assets and liabilities related to its non-U.S. operations,
and therefore Kronos' consolidated net assets, will fluctuate based upon changes
in currency exchange rates.
Non-GAAP financial measures
In an effort to provide investors with additional information regarding the
Company's results of operations as determined by GAAP, the Company has disclosed
certain non-GAAP information which the Company believes provides useful
information to investors.
o The Company discloses percentage changes in its average TiO2 selling prices
in billing currencies, which excludes the effects of foreign currency
translation. The Company believes disclosure of such percentage changes
allows investors to analyze such changes without the impact of changes in
foreign currency exchange rates, thereby facilitating period-to-period
comparisons of the relative changes in average selling prices in the actual
various billing currencies. Generally, when the U.S. dollar either
strengthens or weakens against other currencies, the percentage change in
average selling prices in billing currencies will be higher or lower,
respectively, than such percentage changes would be using actual exchange
rates prevailing during the respective periods. See page 20.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company maintains a
system of disclosure controls and procedures. The term "disclosure controls and
procedures," as defined by regulations of the SEC, means controls and other
procedures that are designed to ensure that information required to be disclosed
in the reports that the Company files or submits to the SEC under the Securities
Exchange Act of 1934, as amended (the "Act"), is recorded, processed, summarized
- 28 -
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits to the SEC under the Act is
accumulated and communicated to the Company's management, including its
principal executive officer and its principal financial officer, or persons
performing similar functions, as appropriate to allow timely decisions to be
made regarding required disclosure. Each of Harold C. Simmons, the Company's
Chief Executive Officer, and Gregory M. Swalwell, the Company's Vice President,
Finance and Chief Financial Officer, has evaluated the Company's disclosure
controls and procedures as of September 30, 2005. Based upon their evaluation,
these executive officers have concluded that the Company's disclosure controls
and procedures are effective as of the date of such evaluation.
Internal Control Over Financial Reporting. The Company also maintains
internal control over financial reporting. The term "internal control over
financial reporting," as defined by regulations of the SEC, means a process
designed by, or under the supervision of, the Company's principal executive and
principal financial officers, or persons performing similar functions, and
effected by the Company's board of directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with GAAP, and includes those policies and procedures that:
o Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the assets of the
Company,
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and
that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company,
and
o Provide reasonable assurance regarding prevention or timely detection of an
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the Company's Consolidated Financial
Statements.
As permitted by the SEC, the Company's assessment of internal control over
financial reporting excludes (i) internal control over financial reporting of
its equity method investees and (ii) internal control over the preparation of
the Company's financial statement schedules required by Article 12 of Regulation
S-X. However, the Company's assessment of internal control over financial
reporting with respect to the Company's equity method investees did include the
Company's controls over the recording of amounts related to the Company's
investments that are recorded in the Company's consolidated financial
statements, including controls over the selection of accounting methods for the
Company's investments, the recognition of equity method earnings and losses and
the determination, valuation and recording of the Company's investment account
balances.
There has been no change to the Company's internal control over financial
reporting during the quarter ended September 30, 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
- 29 -
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 12 of the Consolidated Financial Statements and
to the 2004 Annual Report for descriptions of certain legal proceedings.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
The Company has retained a signed original of any of the above exhibits
that contains signatures, and the Company will provide such exhibit to the
Commission or its staff upon request. Kronos will also furnish, without charge,
a copy of its Code of Business Conduct and Ethics, its Audit Committee Charter
and its Corporate Governance Guidelines, each as adopted by the Company's board
of directors, upon request. Such requests should be directed to the attention of
Kronos's Corporate Secretary at Kronos's corporate offices located at 5430 LBJ
Freeway, Suite 1700, Dallas, Texas 75240.
- 30 -
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Kronos Worldwide, Inc.
---------------------------
(Registrant)
Date November 3, 2005 By /s/ Gregory M. Swalwell
----------------------------------
Gregory M. Swalwell
Vice President, Finance and Chief
Financial Officer (Principal
Financial Officer)
Date November 3, 2005 By /s/ James W. Brown
----------------------------------
James W. Brown
Vice President and Controller
(Principal Accounting Officer)
- 31 -
EXHIBIT 31.1
CERTIFICATION
I, Harold C. Simmons, the Chief Executive Officer of Kronos Worldwide, Inc.,
certify that:
1) I have reviewed this quarterly report on Form 10-Q of Kronos Worldwide,
Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 3, 2005
/s/ Harold C. Simmons
- ------------------------------
Harold C. Simmons
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Gregory M. Swalwell, the Chief Financial Officer of Kronos Worldwide, Inc.,
certify that:
1) I have reviewed this quarterly report on Form 10-Q of Kronos Worldwide,
Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: November 3, 2005
/s/ Gregory M. Swalwell
- ------------------------------
Gregory M. Swalwell
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Kronos Worldwide, Inc. (the Company)
on Form 10-Q for the quarter ended September 30, 2005 as filed with the
Securities and Exchange Commission on the date hereof (the Report), I, Harold C.
Simmons, Chief Executive Officer of the Company, and I, Gregory M. Swalwell,
Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002,
that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Harold C. Simmons
- --------------------------
Harold C. Simmons
Chief Executive Officer
/s/ Gregory M. Swalwell
- --------------------------
Gregory M. Swalwell
Chief Financial Officer
November 3, 2005
Note: The certification the registrant furnishes in this exhibit is not deemed
"filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liabilities of that Section. Registration
Statements or other documents filed with the Securities and Exchange Commission
shall not incorporate this exhibit by reference, except as otherwise expressly
stated in such filing.
