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, 2006 Commission file number 1-31763
--------------------- -------
KRONOS WORLDWIDE, INC.
- --------------------------------------------------------------------------------
(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
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
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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 a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934). Large accelerated filer Accelerated filer
X Non-accelerated filer ---
- --- ---
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
--- ---
Number of shares of the Registrant's common stock outstanding on October 31,
2006: 48,953,049.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
December 31, 2005; September 30, 2006 (unaudited) 3
Condensed Consolidated Statements of Income - Three and nine
months ended September 30, 2005 and 2006 (unaudited) 5
Condensed Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2005 and 2006 (unaudited) 6
Condensed Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2006 (unaudited) 7
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2005 and 2006 (unaudited) 8
Notes to Condensed Consolidated Financial Statements
(unaudited) 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 3. Quantitative and Qualitative Disclosure About Market Risk 28
Item 4. Controls and Procedures 28
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 29
Item 1A. Risk Factors 29
Item 6. Exhibits 29
Items 2, 3, 4 and 5 of Part II are omitted because there is no information to
report
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2005 2006
-------------- --------------
(unaudited)
Current assets:
Cash and cash equivalents $ 72,029 $ 88,750
Restricted cash 1,355 933
Accounts and other receivables, net 184,584 241,156
Receivables from affiliate 2 355
Refundable income taxes 1,053 44
Inventories, net 259,844 247,048
Prepaid expenses and other 4,290 7,452
Deferred income taxes 2,187 844
----------- -----------
Total current assets 525,344 586,582
----------- -----------
Other assets:
Investment in TiO2 manufacturing joint venture 115,308 114,808
Deferred income taxes 213,722 227,481
Other 25,638 25,467
----------- -----------
Total other assets 354,668 367,756
----------- -----------
Property and equipment:
Land 31,678 34,156
Buildings 184,800 198,411
Equipment 786,953 847,683
Mining properties 68,165 70,456
Construction in progress 13,457 20,706
----------- -----------
1,085,053 1,171,412
Less accumulated depreciation and amortization 666,133 733,972
----------- -----------
Net property and equipment 418,920 437,440
----------- -----------
Total assets $ 1,298,932 $ 1,391,778
=========== ===========
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2005 2006
-------------- --------------
Current liabilities:
Current maturities of long-term debt $ 958 $ 933
Accounts payable and accrued liabilities 165,545 179,508
Payable to affiliates 10,382 10,807
Income taxes 24,014 19,334
Deferred income taxes 4,211 1,097
---------- ----------
Total current liabilities 205,110 211,679
---------- ----------
Noncurrent liabilities:
Long-term debt 464,365 528,266
Deferred income taxes 53,383 51,556
Accrued pension costs 139,786 139,363
Accrued postretirement benefits costs 10,174 9,997
Other 16,055 15,167
---------- ----------
Total noncurrent liabilities 683,763 744,349
---------- ----------
Minority interest 75 41
---------- ----------
Stockholders' equity:
Common stock 489 489
Additional paid-in capital 1,061,539 1,061,644
Retained deficit (441,295) (437,806)
Accumulated other comprehensive loss:
Currency translation (114,930) (92,799)
Pension liabilities (95,819) (95,819)
---------- ----------
Total stockholders' equity 409,984 435,709
---------- ----------
Total liabilities, minority interest and
stockholders' equity $1,298,932 $1,391,778
========== ==========
Commitments and contingencies (Notes 7 and 11)
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
---------------------- -----------------------
2005 2006 2005 2006
---- ---- ---- ----
(unaudited)
Net sales $ 292,113 $ 331,653 $ 895,675 $ 981,032
Cost of sales 216,193 256,225 640,918 748,827
--------- ---------- --------- ----------
Gross margin 75,920 75,428 254,757 232,205
Selling, general and administrative expense 36,877 39,389 111,974 118,506
Other operating income (expense):
Currency transaction gains (losses), net 228 (37) 3,551 (2,907)
Disposition of property and equipment (287) (602) (441) (1,709)
Other income 307 204 419 261
Corporate expense (1,075) (1,343) (3,948) (3,945)
--------- ---------- --------- ----------
Income from operations 38,216 34,261 142,364 105,399
Other income (expense):
Trade interest income 247 603 467 1,483
Other interest income 160 181 780 1,212
Securities transaction gain - - 5,439 -
Loss on prepayment of debt - - - (22,311)
Interest expense (10,630) (9,690) (34,027) (33,494)
--------- ---------- --------- ----------
Income before income taxes and
minority interest 27,993 25,355 115,023 52,289
Provision for income taxes 20,039 13,751 52,796 12,079
Minority interest in after-tax earnings 2 2 9 7
--------- ---------- --------- ----------
Net income $ 7,952 $ 11,602 $ 62,218 $ 40,203
========= ========== ========= ==========
Basic and diluted net income per share $ .16 $ .24 $ 1.27 $ .82
========= ========== ========= ==========
Cash dividends per share $ .25 $ .25 $ .75 $ .75
========= ========== ========= ==========
Basic and diluted weighted-average
shares used in the calculation
of net income per share 48,950 48,953 48,948 48,951
========= ========== ========= ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Net income $ 62,218 $ 40,203
Other comprehensive income (loss), net of tax - currency
translation adjustment (24,115) 22,131
--------- ---------
Comprehensive income $ 38,103 $ 62,334
========= =========
See accompanying Notes to Condensed Consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2006
(In thousands)
Accumulated other
comprehensive loss
Additional ------------------------------ Total
Common paid-in Retained Currency Pension stockholders'
stock capital deficit translation liabilities equity
------ --------- -------- ------------ ----------- -------------
(unaudited)
Balance at December 31, 2005 $ 489 $1,061,539 $(441,295) $(114,930) $(95,819) $409,984
Net income - - 40,203 - - 40,203
Other comprehensive income - - - 22,131 - 22,131
Dividends - - (36,714) - - (36,714)
Issuance of common stock - 105 - - - 105
------ ---------- --------- --------- -------- --------
Balance at September 30, 2006 $ 489 $1,061,644 $(437,806) $ (92,799) $(95,819) $435,709
====== ========== ========= ========= ======== ========
See accompanying Notes to Condensed Consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from operating activities:
Net income $ 62,218 $ 40,203
Depreciation and amortization 32,711 32,862
Loss on prepayment of debt - 22,311
Call premium paid - (20,898)
Noncash interest expense 2,241 1,568
Deferred income taxes 29,476 (7,650)
Minority interest 9 7
Net loss from disposition of property and equipment 441 1,709
Distributions from (contributions to) TiO2 manufacturing
joint venture, net 5,100 500
Securities transaction gain (5,439) -
Benefit plan expense greater (less) than cash funding:
Defined benefit pension plans (3,251) 594
Other postretirement benefits (658) (370)
Other, net (1,026) (894)
Change in assets and liabilities:
Accounts and other receivables, net (26,478) (44,927)
Inventories, net (36,713) 28,293
Prepaid expenses and other (3,253) (2,805)
Accounts payable and accrued liabilities 13,672 6,675
Income taxes 1,438 (5,487)
Accounts with affiliates 3,528 (72)
Other, net (4,723) (1,286)
-------- --------
Net cash provided by operating activities 69,293 50,333
-------- --------
Cash flows from investing activities:
Capital expenditures (20,868) (26,794)
Change in restricted cash equivalents 592 487
Proceeds from disposal of interest in Norwegian
smelting operation 3,542 -
Other, net 37 40
-------- --------
Net cash used in investing activities (16,697) (26,267)
-------- --------
Cash flows from financing activities:
Indebtedness:
Borrowings 8,600 722,200
Principal payments (21,655) (686,621)
Deferred financing costs paid - (8,863)
Dividends paid (36,712) (36,714)
Other, net 1,208 105
-------- --------
Net cash used in financing activities (48,559) (9,893)
-------- --------
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash and cash equivalents - net change from:
Operating, investing and financing activities $ 4,037 $ 14,173
Currency translation (1,912) 2,548
Cash and cash equivalents at beginning of period 60,790 72,029
-------- --------
Cash and cash equivalents at end of period $ 62,915 $ 88,750
======== ========
Supplemental disclosures:
Cash paid for:
Interest $ 21,601 $ 16,107
Income taxes, net 20,724 25,622
Noncash investing activity - inventory received as
partial consideration for disposal of interest in
Norwegian smelting operation $ 1,897 $ -
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Note 1 - Organization and basis of presentation:
Organization - We are a majority-owned subsidiary of Valhi, Inc. (NYSE:
VHI). At September 30, 2006, Valhi held approximately 59% of our outstanding
common stock and NL Industries, Inc. (NYSE: NL) held an additional 36% of our
common stock. Valhi owns approximately 83% of NL's outstanding common stock.
Approximately 92% of Valhi's outstanding common stock is held by Contran
Corporation and its subsidiaries. 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 these companies.
Basis of presentation - The unaudited Condensed Consolidated Financial
Statements contained in this Quarterly Report have been prepared on the same
basis as the audited Consolidated Financial Statements in our Annual Report on
Form 10-K for the year ended December 31, 2005 that we filed with the Securities
and Exchange Commission ("SEC") on March 16, 2006 (the "2005 Annual Report"). In
our opinion, we have made all necessary adjustments (which include only normal
recurring adjustments) in order to state fairly, in all material respects, our
consolidated financial position, results of operations and cash flows as of the
dates and for the periods presented. We have condensed the Consolidated Balance
Sheet at December 31, 2005 contained in this Quarterly Report as compared to our
audited Consolidated Financial Statements at that date, and we have omitted
certain information and footnote disclosures (including those related to the
Consolidated Balance Sheet at December 31, 2005) normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). Our results of operations for the
interim periods ended September 30, 2006 may not be indicative of our operating
results for the full year. The Condensed Consolidated Financial Statements
contained in this Quarterly Report should be read in conjunction with our 2005
Consolidated Financial Statements contained in our 2005 Annual Report.
Unless otherwise indicated, references in this report to "we", "us" or
"our" refer to Kronos Worldwide, Inc. and its subsidiaries (NYSE: KRO) taken as
a whole.
Note 2 - Accounts and other receivables, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Trade receivables $170,619 $219,160
Recoverable VAT and other receivables 15,930 24,003
Allowance for doubtful accounts (1,965) (2,007)
-------- --------
Total $184,584 $241,156
======== ========
Note 3 - Inventories, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Raw materials $ 52,343 $ 47,865
Work in process 17,959 22,178
Finished products 149,900 131,907
Supplies 39,642 45,098
-------- --------
Total $259,844 $247,048
======== ========
Note 4 - Other noncurrent assets:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Unrecognized net pension obligations $ 11,916 $ 12,539
Deferred financing costs 8,150 9,186
Restricted marketable debt securities 2,572 2,692
Other 3,000 1,050
-------- --------
Total $ 25,638 $ 25,467
======== ========
Note 5 - Accounts payable and accrued liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Accounts payable $ 91,397 $ 78,725
Employee benefits 35,610 35,760
Interest 191 15,728
Other 38,347 49,295
-------- --------
Total $165,545 $179,508
======== ========
Note 6 - Long-term debt:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Kronos International, Inc.:
8.875% Senior Secured Notes $449,298 $ -
6.5% Senior Secured Notes - 505,241
Revolving credit facilities:
Kronos U.S. subsidiaries 11,500 14,850
Kronos Canada - 4,495
Other 4,525 4,613
-------- --------
Total debt 465,323 529,199
Less current maturities 958 933
-------- --------
Total long-term debt $464,365 $528,266
======== ========
Senior Secured Notes - On April 11, 2006, our wholly-owned subsidiary,
Kronos International, Inc. ("KII") issued an aggregate of euro 400 million
principal amount of new 6.5% Senior Secured Notes due April 2013, at 99.306% of
their principal amount ($498.5 million when issued). These Senior Secured Notes
were issued pursuant to an indenture that contains covenants, restrictions and
collateral substantially identical to the covenants, restrictions and collateral
of our 8.875% Senior Secured Notes. On May 11, 2006, we redeemed all of our
8.875% Senior Secured Notes at 104.437% of the aggregate principal amount of
euro 375 million for an aggregate of $491.4 million, including the $20.9 million
call premium. We used the proceeds from the 6.5% Senior Secured Notes issued in
April 2006 to fund the redemption. We recognized a $22.3 million pre-tax
interest charge in the second quarter of 2006 related to the prepayment of the
8.875% Senior Secured Notes, consisting of the call premium on the notes and the
write-off of deferred financing costs and unamortized premium related to the
notes.
Revolving credit facilities - For the nine months ended September 30, 2006,
we borrowed an aggregate of Cdn. $5.0 million ($4.5 million when borrowed) under
our Canadian revolving credit facility and a net $3.4 million under our U.S.
bank credit facility. The average interest rates on the outstanding borrowings
under these facilities at September 30, 2006 were 6.75% and 8.25%, respectively.
Note 7 - Income taxes:
Nine months ended
September 30,
------------------------
2005 2006
---- ----
(In millions)
Expected tax expense $40.3 $18.3
Incremental U.S. tax and rate differences on
equity in earnings of non-tax group companies .8 .7
Non-U.S. tax rates .3 (1.1)
Loss of German tax attribute 17.5 -
Nondeductible expenses 2.7 2.6
U.S. state income taxes, net 3.9 .7
Contingency reserve adjustment, net (12.5) (8.1)
Canadian tax rate change - (1.1)
Other, net (.2) .1
----- -----
Total $52.8 $12.1
===== =====
In June 2006, Canada enacted a 2% reduction in the Canadian federal income
tax rate and the elimination of the federal surtax. The 2% reduction will be
phased in from 2008 to 2010, and the federal surtax will be eliminated in 2008.
As a result, during the first nine months of 2006 we recognized a $1.1 million
income tax benefit related to the effect of such reduction on our
previously-recorded net deferred income tax liability.
Due to the favorable resolution of certain income tax audits related to our
German and Belgian operations during the first six months of 2006, we recognized
a $2.0 million income tax benefit related to adjustments of prior year income
taxes. Due to an unfavorable resolution of certain income tax audit issues
related to our German operations during the third quarter of 2006, we recognized
a $2.0 million provision for income taxes related to prior year income taxes,
which offset the $2.0 million benefit recognized in the first six months of the
year.
Tax authorities are examining certain of our non-U.S. tax returns and have
or may propose tax deficiencies, including penalties and interest. For example:
o We previously received a preliminary tax assessment related to 1993 from
the Belgian tax authorities proposing tax deficiencies, including related
interest, of approximately euro 6 million. The Belgian tax authorities
filed a lien on the fixed assets of our Belgian TiO2 operations in
connection with their assessment. This lien did not interfere with on-going
operations at the facility. We filed a protest to this assessment, and in
July 2006 the Belgian tax authorities withdrew the assessment. The lien was
subsequently released.
o The Norwegian tax authorities previously notified us of their intent to
assess tax deficiencies of approximately kroner 12 million relating to the
years 1998 through 2000. We objected to this proposed assessment, and in
May 2006 the Norwegian tax authorities withdrew the assessment.
Principally as a result of the withdrawal of the Belgian and Norwegian
assessments discussed above, we recognized a $9.5 million income tax benefit in
the first six months of 2006 related to the total reduction in our income tax
contingency reserve. Principally as a result of our ongoing income tax audits in
Germany, we recognized a $1.4 million increase in our income tax contingency
reserve in the third quarter of 2006. Other income tax examinations related to
our operations continue, and we cannot guarantee that these tax matters will be
resolved in our favor due to the inherent uncertainties involved in settlement
initiatives and court and tax proceedings. We believe we have adequate accruals
for additional taxes and related interest expense which could ultimately result
from tax examinations. We believe the ultimate disposition of tax examinations
should not have a material adverse effect on our consolidated financial
position, results of operations or liquidity.
Note 8 - Employee benefit plans:
Defined 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,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands) (In thousands)
Service cost $ 1,974 $ 1,982 $ 5,875 $ 5,817
Interest cost 4,311 4,825 13,345 14,145
Expected return on plan assets (3,884) (4,083) (12,002) (12,001)
Amortization of prior service cost 145 117 449 343
Amortization of net transition obligations - 145 310 428
Recognized actuarial losses 900 2,196 2,778 6,426
------- ------- ------- -------
Total $ 3,446 $ 5,182 $10,755 $15,158
======= ======= ======= =======
Postretirement benefits - The components of net periodic postretirement
benefit costs are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands) (In thousands)
Service cost $ 56 $ 73 $ 165 $ 215
Interest cost 146 158 435 471
Amortization of prior service credit (159) (50) (479) (150)
Recognized actuarial losses 18 29 53 86
------- ------ ------- ------
Total $ 61 $ 210 $ 174 $ 622
======= ====== ======= ======
Contributions - We expect our 2006 contributions for our pension and
postretirement benefit plans to be consistent with the amount we disclosed in
our 2005 Annual Report.
Note 9 - Other noncurrent liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Employee benefits $ 4,735 $ 6,371
Insurance claims and expenses 1,733 1,431
Asset retirement obligations 934 1,050
Other 8,653 6,315
-------- --------
Total $ 16,055 $ 15,167
======== ========
Note 10 - Accounts with affiliates:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Current receivables from affiliates:
Valhi - Income taxes, net $ - $ 355
Other 2 -
------- -------
Total $ 2 $ 355
======= =======
Current payables to affiliates:
Louisiana Pigment Company $ 9,803 $10,674
Valhi - Income taxes, net 434 -
NL 145 133
------- -------
Total $10,382 $10,807
======= =======
Note 11 - Commitments and contingencies:
Litigation matters - As reflected in our 2005 Annual Report, Kronos'
Belgian subsidiary and certain of its employees were the subject of civil and
criminal proceedings relating to an accident that resulted in two fatalities at
our Belgian facility in 2000. In June 2006, the appellate court upheld a finding
of civil responsibility against the subsidiary, reduced by approximately 50% the
fine that had been imposed against the subsidiary by the lower court, and
reversed the finding of responsibility as it related to the individual Kronos
employees. No appeal was taken of the appellate court's decision.
We and our affiliates are involved in various environmental, contractual,
product liability, patent (or intellectual property), employment and other
claims and disputes incidental to our present and former businesses. In certain
cases, we have insurance coverage for these items. We currently believe the
disposition of all claims and disputes, individually or in the aggregate, should
not have a material adverse effect on our consolidated financial position,
results of operations or liquidity beyond the accruals already provided for.
Please refer to our 2005 Annual Report for a discussion of certain other
legal proceedings to which we are a party.
Note 12 - Recent accounting pronouncements:
Inventory costs - Statement of Financial Accounting Standards ("SFAS") No.
151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, became effective
for us for inventory costs incurred on or after January 1, 2006. SFAS No. 151
requires that the allocation of fixed production overhead costs to inventory be
based on normal capacity of the production facilities, as defined by SFAS No.
151. SFAS No. 151 also clarifies the accounting for abnormal amounts of idle
facility expense, freight handling costs and wasted material, requiring those
items be recognized as current-period charges. Our existing production cost
policies complied with the requirements of SFAS No. 151, therefore the adoption
of SFAS No. 151 did not affect our Consolidated Financial Statements.
Stock options - We adopted the fair value provisions of SFAS No. 123R,
"Share-Based Payment," on January 1, 2006, using the modified prospective
application method. SFAS No. 123R, among other things, requires the cost of
employee compensation paid with equity instruments to be measured based on the
grant-date fair value. That cost is then recognized over the vesting period.
Using the modified prospective method, we will apply the provisions of the
standard to all new equity compensation granted after January 1, 2006 and any
existing awards vesting after January 1, 2006. We have not issued any stock
options to purchase Kronos common stock. However, certain of our employees have
been granted options by NL to purchase NL common stock. The number of non-vested
equity awards issued by NL as of December 31, 2005 is not material. Prior to the
adoption of SFAS No. 123R we accounted for equity compensation in accordance
with APBO No. 25, Accounting for Stock Issued to Employees. Our affiliate NL
accounted for their equity awards under the variable accounting method whereby
the equity awards were revalued based on the current trading price at each
balance sheet date. We now account for these awards using the liability method
under SFAS No. 123R, which is substantially identical to the variable accounting
method we previously used. We recorded compensation expense of approximately
$500,000 in the quarter ended September 30, 2005 for stock-based employee
compensation and no material income or compensation expense was recorded in the
quarter ended September 30, 2006. We recorded income for stock-based employee
compensation of approximately $400,000 in each of the nine month periods ended
September 30, 2005 and 2006. If we grant a significant number of equity awards
or modify, repurchase or cancel existing equity awards in the future, the amount
of equity compensation expense in our Consolidated Financial Statements could be
material.
Effective January 1, 2006, SFAS No. 123R requires the cash income tax
benefit resulting from the exercise of stock options in excess of the cumulative
income tax benefit previously recognized for GAAP financial reporting purposes
to be reflected as a component of cash flows from financing activities in our
Consolidated Financial Statements. Because we account for these options to
purchase NL common stock under the liability method of SFAS No. 123R, the cash
income tax benefit resulting from the exercise of such stock options will always
be equal to the cumulative income tax benefit we would have previously
recognized for GAAP financial reporting purposes. SFAS No. 123R also requires
certain expanded disclosures regarding equity compensation, and we provided
these expanded disclosures in our 2005 Annual Report.
Uncertain tax positions - In the second quarter of 2006 the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. ("FIN") 48,
Accounting for Uncertain Tax Positions, which will become effective for us on
January 1, 2007. FIN 48 clarifies when and how much of a benefit we can
recognize in our Consolidated Financial Statements for certain positions taken
in our income tax returns under SFAS No. 109, Accounting for Income Taxes, and
enhances the disclosure requirements for our income tax policies and reserves.
Among other things, FIN 48 will prohibit us from recognizing the benefits of a
tax position unless we believe it is more-likely-than-not our position will
prevail with the applicable tax authorities and limits the amount of the benefit
to the largest amount for which we believe the likelihood of realization is
greater than 50%. FIN 48 also requires companies to accrue penalties and
interest on the difference between tax positions taken on their tax returns and
the amount of benefit recognized for financial reporting purposes under the new
standard. Our current income tax accounting policies comply with this aspect of
the new standard. We will also be required to reclassify any reserves we have
for uncertain tax positions from deferred income tax liabilities, where they are
currently recognized, to a separate current or noncurrent liability, depending
on the nature of the tax position. We are currently evaluating the impact of FIN
48 on our Consolidated Financial Statements, we expect to complete our analysis
in the fourth quarter of 2006.
Planned Major Maintenance Activities - In September 2006 FASB issued FASB
Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major Maintenance
Activities, which will become effective for us on January 1, 2007 although early
adoption is permitted. Under FSP No. AUG AIR-1, accruing in advance for major
maintenance is no longer permitted. Companies that previously accrued in advance
for major maintenance activities will be required to restate retroactively their
financial statements to reflect a permitted method of expense for all periods
presented. In the past we accrued in advance for our planned major maintenance.
We will restate retroactively our financial statements in the fourth quarter of
2006 to reflect the direct expense method of accounting. The adoption of the FSP
will have the following effect on our previously reported net income for periods
indicated:
Increase (decrease) in net income
---------------------------------
2005 2006
---- ----
Quarter Ended: (In millions)
March 31 $ 1.3 $ .7
June 30 (.7) (.2)
September 30 (.1) -
December 31 (.5) na
----- -----
Total $ - $ .5
===== =====
Quantifying Financial Statement Misstatements - In September 2006 the SEC
issued Staff Accounting Bulletin ("SAB") No. 108 expressing their views
regarding the process of quantifying financial statement misstatements. The SAB
is effective for us no later than the fourth quarter of 2006. According to SAB
No. 108 both the "rollover" and "iron curtain" approaches must be considered
when evaluating a misstatement for materiality. We do not expect the adoption of
SAB No. 108 to have any material effect on our previously-reported consolidated
financial position or results of operations at the date of adoption.
Fair Value Measurements - In September 2006 the FASB issued SFAS No. 157,
Fair Value Measurements, which will become effective for us on January 1, 2007.
SFAS No. 157 generally provides a consistent, single fair value definition and
measurement techniques for GAAP pronouncements. SFAS No. 157 also establishes a
fair value hierarchy for different measurement techniques based on the objective
nature of the inputs in various valuation methods. We will be required to ensure
all of our fair value measurements are in compliance with SFAS No. 157 on a
prospective basis beginning in the first quarter of 2007. In addition, we will
be required to expand our disclosures regarding the valuation methods and level
of inputs we utilize in the first quarter of 2007. The adoption of this standard
will not have a material effect on our Consolidated Financial Statements.
Pension and Other Postretirement Plans - In September, 2006 the FASB issued
SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans. SFAS No. 158 requires us to recognize an asset or
liability for the over or under funded status of each of our individual defined
benefit pension and postretirement benefit plans on our Consolidated Balance
Sheets. We will recognize through other comprehensive income prior unrecognized
gains and losses and prior service costs or credits, net of tax, as of December
31, 2006 that we currently amortize through net periodic benefit cost. All
future changes in the funded status of these plans will be recognized through
comprehensive income, net of tax (either net income or other comprehensive
income). We will also provide certain new disclosures related to these plans. In
addition, we currently use September 30 as a measurement date for our pension
and postretirement benefit plans, but under this standard we will be required to
use December 31 as the measurement date for our plans. The measurement date
requirement of SFAS No. 158 will become effective for us by the end of 2008 and
provides two alternate transition methods; we have not yet determined which
transition method we will select. This standard does not change the existing
recognition and measurement requirements that determine the amount of periodic
benefit cost recognized in net income.
The asset and liability recognition and disclosure requirements of this
standard will become effective for us as of December 31, 2006 and will be
adopted prospectively. We will not complete the 2006 assessment of the funded
status of our pension and postretirement benefit plans until after December 31,
2006. At December 31, 2005, our pension and post retirement benefit plans were
under funded by $202.9 million in the aggregate, and we had a net $163.5 million
liability recognized on our Consolidated Balance Sheet related to these plans.
Our 2006 funded status will be based in part on certain actuarial assumptions
that we cannot yet determine and differences between the actual and expected
return on plan assets during the year. Therefore, we are not able to determine
the impact this standard will have on our Consolidated Financial Statements;
however we believe the net effect of adopting SFAS No. 158 will reduce our
stockholders' equity at December 31, 2006. The full disclosure of the funded
status of our defined benefit pension and postretirement benefit plans at
December 31, 2005 can be found in Note 14 to our 2005 Annual Report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Business and results of operations overview
We are a leading global producer and marketer of value-added titanium
dioxide pigments ("TiO2"). TiO2 is used for a variety of manufacturing
applications, including plastics, paints, paper and other industrial products.
For the nine months ended September 30, 2006, approximately one-half of our
sales volumes were into European markets. We believe we are the third largest
producer of TiO2 in Europe with an estimated 20% share of European TiO2 sales
volumes. In addition, we also have an estimated 15% share of North American TiO2
sales volumes. Our production facilities are located throughout Europe and North
America.
We reported net income of $11.6 million, or $.24 per diluted share, in the
third quarter of 2006 as compared to net income of $8.0 million, or $.16 per
diluted share, in the third quarter of 2005. For the first nine months of 2006,
we reported net income of $40.2 million, or $.82 per diluted share, compared to
net income of $62.2 million, or $1.27 per diluted share, in the first nine
months of 2005. Our increased net income for the third quarter 2006 compared to
the third quarter of 2005 is due to the favorable effects of lower interest
expense and lower income taxes in 2006 related to our European operations,
offset somewhat by the effects of lower income from operations. Our net income
for the first nine months of 2006 declined from the first nine months of 2005
due primarily to the net effect of (i) lower income from operations in 2006,
(ii) a gain from the sale of our passive interest in a Norwegian smelting
operation in 2005, (iii) a charge from the 2006 redemption of our 8.875% Senior
Secured Notes and the favorable effect of certain net income tax benefits
recognized in 2006.
Our 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 developments
with respect to ongoing income tax audits primarily in Germany, Belgium and
Canada and (ii) a second quarter gain of $.07 per diluted share related to the
sale of our passive interest in a Norwegian smelting operation. Our net income
in the first nine months of 2006 includes (i) a second quarter charge related to
the prepayment of our 8.875% Senior Secured Notes of $.30 per diluted share and
(ii) a net income tax benefit of $.19 per diluted share (expense of $.07 per
diluted share in the third quarter) related to the net effect of the withdrawal
of certain income tax assessments previously made by the Belgian and Norwegian
tax authorities, the resolution of certain income tax issues related to our
German and Belgian operations and the enactment of a reduction in the Canadian
federal income tax rate.
Forward-looking information
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Statements in this Quarterly
Report on Form 10-Q that are not historical in nature are forward-looking in
nature about our future that are not statements of historical fact. Statements
in this report including, but not limited to, statements found in Item 2 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," are forward-looking statements that represent our beliefs and
assumptions based on currently available information. In some cases you can
identify these forward-looking statements 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 we
believe the expectations reflected in forward-looking statements are reasonable,
we do not know if these expectations will be correct. Forward-looking statements
by their nature involve substantial risks and uncertainties that could
significantly impact expected results. Actual future results could differ
materially from those predicted. While it is not possible to identify all
factors, we continue to face many risks and uncertainties. Among the factors
that could cause our 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 our other filings with the SEC
including, but not limited to, the following:
o Future supply and demand for our products,
o The extent of our dependence on certain market sectors,
o The cyclicality of our businesses,
o Customer inventory levels (such as the extent to which our 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, natural disasters, fires, explosions, unscheduled or
unplanned downtime and transportation interruptions),
o The timing and amounts of insurance recoveries,
o Our ability 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 compliance with
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. We
disclaim any intention or obligation to update or revise any forward-looking
statement whether as a result of changes in information, future events or
otherwise.
Results of operations
We consider TiO2 to be a "quality of life" product, with demand affected by
gross domestic product (or "GDP") in various regions of the world. Over the
long-term, we expect that demand for TiO2 will grow by 2% to 3% per year,
consistent with our expectations for the long-term growth in GDP. However, even
if we and our competitors maintain consistent shares of the worldwide market,
demand for TiO2 in any interim or annual period may not change in the same
proportion as the change in GDP, in part due to relative changes in the TiO2
inventory levels of our customers. We believe that our customers' inventory
levels are partly influenced by their expectation for future changes in market
TiO2 selling prices.
The factors having the most impact on our reported operating results are:
o Our TiO2 selling prices,
o Foreign currency exchange rates (particularly the exchange rate for
the U.S. dollar relative to the euro and the Canadian dollar),
o Our TiO2 sales and production volumes, and
o Manufacturing costs, particularly maintenance and energy-related
expenses.
Our key performance indicators are our TiO2 average selling prices, and our
level of TiO2 sales and production volumes.
Quarter ended September 30, 2005 compared to the
Quarter ended September 30, 2006 -
Three months ended
September 30,
---------------------------------------------
2005 2006
-------------------- -------------------
(Dollars in millions)
Net sales $292.1 100 % $331.6 100 %
Cost of sales 216.2 74 % 256.2 77 %
------ ---- ------ ----
Gross margin 75.9 26 % 75.4 23 %
Other operating income and expenses, net 37.7 13 % 41.2 12 %
------ ---- ------ ----
Income from operations $ 38.2 13 % $ 34.2 11 %
====== ==== ====== ====
%
Change
Ti02 operating statistics:
Sales volumes* 119 132 11 %
Production volumes* 122 126 3 %
Percent change in net sales:
TiO2 product pricing (1)%
TiO2 sales volumes 11 %
TiO2 product mix 1 %
Changes in currency exchange rates 3 %
----
Total 14 %
====
* Thousands of metric tons
Net sales - Net sales increased 14% or $39.5 million compared to the third
quarter of 2005 primarily due to an 11% increase in TiO2 sales volumes and the
impact of currency exchange rates. The benefit of higher sales volumes was
offset somewhat by a 1% decrease in average TiO2 selling prices. We estimate the
favorable effect of changes in currency exchange rates increased our net sales
by approximately $9 million, or 3%, compared to the same period in 2005. We
expect average selling prices in the fourth quarter of 2006 to decline slightly
from the third quarter of 2006.
Our 11% increase in sales volumes in the third quarter of 2006 is primarily
due to higher sales volumes in Europe the United States, and export markets,
which were somewhat offset by lower sales volumes in Canada. Our sales volumes
in Canada have been impacted by decreased demand for TiO2 used in paper
products. We expect overall demand will continue to remain high for the
remainder of the year.
Cost of sales - Cost of sales increased $40.0 million or 19% in the third
quarter of 2006 compared to 2005 primarily due to the impact of increased sales
volumes, a 24% increase in utility costs (primarily energy costs), a 4% increase
in raw material costs and currency fluctuations (primarily the Canadian dollar).
The cost of sales as a percentage of net sales increased to 77% in the third
quarter of 2006 compared to 74% in the third quarter of 2005 primarily due to
increases in operating costs.
The negative impact of the increase in other operating costs and raw
materials was somewhat offset by record production levels. TiO2 production
volumes increased 3% in the third quarter of 2006 compared to the same period in
2005, which favorably impacted our operating income comparisons. We continued to
gain operational efficiencies at our existing TiO2 facilities by enhancing our
processes and debottlenecking production to meet long-term demand. Our operating
rates were near full capacity in both periods.
Through our debottlenecking program, we added finishing capacity in the
German chloride-process facility which, along with equipment upgrades and
enhancements in several locations, have allowed us to reduce downtime for
maintenance activities. Our production capacity has increased by approximately
30% over the past ten years with only moderate capital expenditures. We believe
our annual attainable TiO2 production capacity for 2006 is approximately 515,000
metric tons, with some additional capacity expected to be available in 2007
through our continued debottlenecking efforts.
Income from operations - Income from operations for the third quarter of
2006 declined by 10% to $34.2 million compared to the same period in 2005;
income from operations as a percentage of net sales declined to 11% in the third
quarter of 2006 from 13% in the same period for 2005. This decrease is driven by
the decline in gross margin, which fell to 23% in 2006 compared to 26% in 2005.
While our sales volumes are higher in 2006, our gross margin has decreased as
pricing has not improved to offset the negative impact of our increased
operating costs (primarily energy costs and raw materials). Changes in currency
rates have also negatively affected our gross margin. We estimate the negative
effect of changes in foreign currency exchange rates decreased income from
operations by approximately $3 million. We expect income from operations for the
fourth quarter of 2006 will be lower than the fourth quarter of 2005.
Other non-operating income (expense) - Interest expense decreased $900,000
from $10.6 million in the third quarter of 2005 to $9.7 million in the third
quarter of 2006 due to the redemption of the 8.875% Senior Secured Notes and the
issuance of the 6.5% Senior Secured Notes in the second quarter of 2006, which
is partially offset by unfavorable changes in currency exchange rates in 2006
compared to 2005. Excluding the effect of currency exchange rates, we expect
interest expense will be lower in fourth quarter of 2006 as compared to the
fourth quarter of 2005.
We have a significant amount of indebtedness denominated in the euro,
primarily the Senior Secured Notes. The interest expense we recognize will vary
with fluctuations in the euro exchange rate.
Provision for income taxes - Our provision for income taxes was $13.8
million in the third quarter of 2006 compared to $20 million in the same period
last year. Our income tax expense for the third quarter 2006 includes an
aggregate provision for income taxes of $3.4 million, principally for
unfavorable developments with respect to ongoing income tax audits in Germany.
Our income tax expense in the third quarter of 2005 includes an income tax
benefit of $12.5 million for the aggregate effect of favorable developments with
respect to income tax audits in Belgium and Canada offset by a charge of $17.5
million for the unfavorable effect related to the loss of certain of our German
income tax attributes. See Note 7 to the Condensed Consolidated Financial
Statements.
Nine months ended September 30, 2005 compared to the
Nine months ended September 30, 2006 -
Nine months ended
September 30,
---------------------------------------------
2005 2006
-------------------- -------------------
(Dollars in millions)
Net sales $895.7 100 % $981.0 100 %
Cost of sales 640.9 72 % 748.8 76 %
------ ---- ------ ----
Gross margin 254.8 28 % 232.2 24 %
Other operating income and expense, net 112.4 12 % 126.8 13 %
------ ---- ------ ----
Income from operations $142.4 16 % $105.4 11 %
====== ==== ====== ====
% Change
Ti02 operating statistics:
Sales volumes* 356 396 11 %
Production volumes* 371 383 3 %
Percent change in net sales:
TiO2 product pricing - %
TiO2 sales volumes 11 %
TiO2 product mix - %
Changes in currency exchange rates (1)%
----
Total 10 %
====
* Thousands of metric tons
Net sales - Net sales increased 10% or $85.3 million compared to the nine
months ended September 30, 2005, primarily due to an 11% increase in TiO2 sales
volumes, offset somewhat by the impact of currency exchange rates. We estimate
the unfavorable effect of changes in currency exchange rates decreased our net
sales by approximately $11 million, or 1%, compared to the same period in 2005.
Our 11% increase in sales volumes in the nine months ended September 30,
2006 is primarily due to higher sales volumes in the United States, Europe and
in export markets, which were somewhat offset by lower sales volumes in Canada.
Our sales volumes in the first nine months of 2006 was a new record for us.
Cost of sales - Cost of sales increased $107.9 million or 17% in the nine
months ended September 30, 2006, compared to the same period in 2005, primarily
due to the impact of increased sales volumes, a 21% increase in utility costs
(primarily energy costs) and a 5% increase in raw material costs and currency
fluctuations (primarily the Canadian dollar). The cost of sales as a percentage
of net sales increased to 76% in the nine months ended September 30, 2006,
compared to 72% in the same period of 2005 primarily due to increases in raw
material and other operating costs (including energy costs).
The negative impact of the increase in energy costs and raw materials was
somewhat offset by record production levels. TiO2 production volumes increased
3% in the nine months ended September 30, 2006 compared to the same period in
2005, which favorably impacted our income from operations comparisons. Our
operating rates were near full capacity in both periods. Production volume was a
record aided by enhancing our processes and continuing debottlenecking.
Income from operations - Income from operations for the nine months ended
September 30, 2006 declined by 26% to $105.4 million compared to the same period
in 2005; the income from operations as a percentage of net sales declined to 11%
in the nine months ended September 30, 2006 from 16% in the same period for
2005. The decline in income from operations is driven by the decline in gross
margin, which fell to 24% in 2006 compared to 28% in 2005. While our sales
volumes are higher in 2006, our gross margin has decreased as pricing has not
improved to offset the negative impact of our increased operating costs
(primarily energy and raw materials). Changes in currency rates have also
negatively affected our gross margin. We estimate the negative effect of changes
in foreign currency exchange rates decreased income from operations by
approximately $18 million.
Other non-operating income (expense) - In the second quarter of 2006, we
issued our euro 400 million principal amount of 6.5% Senior Secured Notes, and
used the proceeds to redeem our euro 375 million principal amount of 8.875%
Senior Secured Notes. As a result of our prepayment of the 8.875% Senior Secured
Notes, we recognized a $22.3 million pre-tax interest charge ($14.8 million net
of income tax benefit) in the second quarter of 2006 for the prepayment of the
notes, representing (1) the call premium on the notes, (2) the write-off of
deferred financing costs and (3) write off of the existing unamortized premium
on the notes. See Note 6 to the Condensed Consolidated Financial Statements.
Annual interest expense on the 6.5% Senior Secured Notes will be approximately
euro 6 million less than on the 8.875% Senior Secured Notes.
Interest expense decreased $500,000 from $34.0 million in the nine months
ended September 30, 2005 to $33.5 million in the nine months ended September 30,
2006 due to the redemption of the 8.875% Senior Secured Notes and the issuance
of the 6.5% Senior Secured Notes, which is partially offset by changes in
currency exchange rates in 2006 compared to 2005.
Provision for income taxes - Our provision for income taxes was $12.1
million in the first nine months of 2006 compared to $52.8 million in the same
period last year. Our income tax expense in 2006 includes (i) an income tax
benefit of $2.0 million related to the favorable resolution of certain income
tax audit issues in Germany and Belgium, (ii) a $2.0 million provision for
income taxes related to the unfavorable resolution of certain income tax audit
issues in Germany, (iii) an income tax benefit of $9.5 million resulting from
the reduction in our income tax contingency reserves related to favorable
developments with income tax audits in Belgium and Norway, (iv) a $1.4 million
provision for income taxes resulting from the increase in our income tax
contingency reserve related to our ongoing income tax audits, principally in
Germany, and (v) a $1.1 million benefit resulting from the enactment of a
reduction in Canadian income tax rates. Our income tax expense in the first nine
months of 2005 includes (i) an income tax benefit of $12.5 million for the
aggregate effect of favorable developments with respect to income tax audits in
Belgium and Canada and (ii) a charge of $17.5 million for the unfavorable effect
related to the loss of certain of our German income tax attributes. See Note 7
to the Condensed Consolidated Financial Statements for a tabular reconciliation
of our statutory tax expense to our actual tax expense.
Currency exchange
We have substantial operations and assets located outside the United States
(primarily in Germany, Belgium, Norway and Canada). The majority of our foreign
operations' sales are denominated in foreign currencies, principally the euro,
other major European currencies and the Canadian dollar. A portion of our sales
generated from our foreign operations are denominated in the U.S. dollar.
Certain raw materials used worldwide, primarily titanium-containing feedstocks,
are purchased in U.S. dollars, while labor and other production costs are
purchased primarily in local currencies. Consequently, the translated U.S.
dollar value of our 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 foreign currency exchange rates had the following
effects on our sales and income from operations in 2006 as compared to 2005.
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
------------------ ------------------
Increase (decrease), in millions
-----------------------------------------------
Impact on:
Net sales $ 9 $ (11)
Income from operations $ (3) $ (18)
Outlook
We expect income from operations for the fourth quarter of 2006 will be
lower than the fourth quarter of 2005 due primarily to continued downward
pricing pressures and increased energy costs and raw materials. Our expectations
as to the future of the TiO2 industry are based upon a number of factors beyond
our 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 our expectations, our
results of operations could be unfavorably affected.
Other
On September 22, 2005, the chloride-process TiO2 facility operated by our
50%-owned joint venture, Louisiana Pigment Company ("LPC"), temporarily halted
production due to Hurricane Rita. Although there was minimal storm damage to
core processing facilities, 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 and full operations until
late 2005. LPC expects the majority of its property damage and unabsorbed fixed
costs for periods in which normal production levels were not achieved will be
covered by insurance, and we believe insurance will cover our lost profits
(subject to applicable deductibles) resulting from our share of the loss of
production at LPC. Both we and LPC have filed claims with our insurers. We
currently expect to recover our losses through the insurer in the fourth quarter
of 2006 or early 2007, although we do not know the amount and timing of the
insurance recovery yet. Accordingly, we have not accrued a receivable for the
amount of the insurance claim and will not record the claim until negotiations
with the insurer are finalized. The effect on our financial results will depend
on the timing and amount of insurance recoveries.
LIQUIDITY AND CAPITAL RESOURCES
Consolidated cash flows
Operating activities
Trends in cash flows as a result of our operating activities (excluding the
impact of significant asset dispositions and relative changes in assets and
liabilities) are generally similar to trends in our earnings.
Our cash flows from operating activities provided $50.3 million in the
first nine months of 2006, compared to $69.3 million provided in the first nine
months of 2005. This decrease was due primarily to the net effects of the
following items:
o Lower income from operations in 2006 of $37.0 million;
o Payment of the $20.9 million call premium as a result of the May 2006
prepayment of our 8.875% Senior Secured Notes, which is required to be
included in cash flows from operating activities; and
o Higher cash paid for income taxes in 2006 of $4.9 million, in part due
to the net payment of $4.3 million in 2006 associated with the
settlement of prior year income tax audits; offset by
o Lower cash paid for interest in 2006 of $5.5 million, primarily as a
result of the May 2006 redemption of our 8.875% Senior Secured Notes
(which paid interest semiannually in September and December) and the
April 2006 issuance of our 6.5% Senior Secured Notes (which will pay
interest semiannually in April and October); and
o Lower net cash used from relative changes in our inventories,
receivables, payables and accruals of $20.0 million in the first nine
months of 2006 as compared to the first nine months of 2005, due
primarily to relative changes in our inventory levels, as discussed
below.
Changes in working capital were affected by accounts receivable and
inventory changes. Our average days sales outstanding ("DSO") increased from 55
days at December 31, 2005 to 65 days at September 30, 2006 due to the timing of
collection on higher accounts receivable balances at the end of September. For
comparative purposes, our average DSO increased from 60 days at December 31,
2004 to 61 days at September 30, 2005. Our average days sales in inventory
("DSI") decreased from 102 days at December 31, 2005 to 87 days at September 30,
2006, as our record TiO2 sales volumes in the first nine months of 2006 exceeded
our record TiO2 production volumes during the period. For comparative purposes,
our TiO2 production volumes were higher than our TiO2 sales volumes in the first
nine months of 2005, and our average DSI increased to 105 days at September 30,
2005 from 97 days at December 31, 2004.
Investing activities
Capital expenditures were $20.9 million and $26.8 million in the nine
months ended September 30, 2005 and 2006, respectively. Capital expenditures are
primarily for improvements and upgrades to existing facilities.
Financing activities
In the second quarter of 2006 we redeemed our euro 375 million principal
amount of 8.875% Senior Secured Notes ($470.5 million when redeemed) and issued
euro 400 million principal amount of 6.5% Senior Secured Notes at 99.306%
($498.5 million when issued). See Note 6 to the Condensed Consolidated Financial
Statements. During the nine months ended September 30, 2006, we had net
borrowings of $3.4 million under our U.S. credit facility and $4.5 million under
our Canadian credit facility.
In each of the nine months ended September 30, 2005 and 2006, we paid a
quarterly dividend to stockholders of $.25 per share for an aggregate dividend
$36.7 million in each nine-month period.
Outstanding debt obligations
At September 30, 2006, our consolidated debt was comprised of:
o euro 400 million principal amount of our 6.5% Senior Secured Notes
($505.2 million at September 30, 2006) due in 2013;
o $14.9 million under our U.S. revolving credit facility which matures
in September 2008;
o Cdn. 5 million ($4.5 million at September 30, 2006) under our Canadian
revolving credit facility which matures in January 2009; and
o Approximately $4.6 million of other indebtedness.
Certain of our credit agreements contain provisions which could result in
the acceleration of indebtedness prior to its stated maturity for reasons other
than defaults for failure to comply with applicable covenants. For example,
certain credit agreements allow the lender to accelerate the maturity of the
indebtedness upon a change of control (as defined in the agreement) 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. We are in compliance with all of our
debt covenants at September 30, 2006. See Note 6 to the Condensed Consolidated
Financial Statements.
Our assets consist primarily of investments in operating subsidiaries, and
our ability to service parent level obligations, including the Senior Secured
Notes, depends in large part upon the distribution of earnings of our
subsidiaries, whether in the form of dividends, advances or payments on account
of intercompany obligation or otherwise. None of our subsidiaries have
guaranteed the Senior Secured Notes, although KII has pledged 65% of the common
stock or other ownership interests of certain of KII's first-tier operating
subsidiaries as collateral of the Senior Secured Notes.
Future cash requirements
Liquidity
Our primary source of liquidity on an ongoing basis is cash flows from
operating activities. From time-to-time we 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. We will also from time-to-time sell
assets outside the ordinary course of business, the proceeds of which are
generally used to (i) repay existing indebtedness, (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.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact earnings and operating cash flows.
Changes in TiO2 pricing, production volumes and customer demand, among other
things, could significantly affect our liquidity.
We routinely evaluate our liquidity requirements, alternative uses of
capital, capital needs and availability of resources in view of, among other
things, our dividend policy, our debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, we have in the past and may in the future seek to reduce, refinance,
repurchase or restructure indebtedness, raise additional capital, repurchase
shares of our common stock, modify our dividend policy, restructure ownership
interests, sell interests in our subsidiaries or other assets, or take a
combination of these steps or other steps to manage our liquidity and capital
resources. Such activities have in the past and may in the future involve
related companies. In the normal course of our business, we may investigate,
evaluate, discuss and engage in acquisition, joint venture, strategic
relationship and other business combination opportunities in the TiO2 industry.
In the event of any future acquisition or joint venture opportunity, we may
consider using then-available liquidity, issuing our equity securities or
incurring additional indebtedness.
At September 30, 2006, unused credit available under all of our existing
credit facilities was approximately $137 million. Based upon our expectation for
the TiO2 industry and anticipated demands on cash resources, we expect to have
sufficient liquidity to meet our future obligations including operations,
capital expenditures, debt service and current dividend policy. If actual
developments differ from our expectations, our liquidity could be adversely
affected.
Capital expenditures
We intend to spend approximately $45 million for major improvements and
upgrades to our existing facilities during 2006, including the $26.8 million we
have spent though September 30, 2006.
Off-balance sheet financing
We do not have any off-balance sheet financing agreements other than the
operating leases discussed in our 2005 Annual Report.
Commitments and contingencies
See Notes 7 and 11 to the Condensed Consolidated Financial Statements
for a description of certain income tax examinations currently underway and
legal proceedings.
Recent accounting pronouncements
See Note 12 to the Condensed Consolidated Financial Statements.
Critical accounting policies
For a discussion of our critical accounting policies, refer to Part I, Item
7 - "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our 2005 Annual Report. There have been no changes in our
critical accounting policies during the first nine months of 2006.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk, including foreign currency exchange rates,
interest rates and security prices. For a discussion of such market risk items,
refer to Part I, Item 7A. - "Quantitative and Qualitative Disclosure About
Market Risk" in our 2005 Annual Report. There have been no material changes in
these market risks during the first nine months of 2006.
We have 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 our assets and liabilities related to our non-U.S. operations, and
therefore our consolidated net assets, will fluctuate based upon changes in
currency exchange rates.
We periodically use currency forward contracts to manage a very nominal
portion of foreign exchange rate risk associated with trade receivables
denominated in a currency other than the holder's functional currency or similar
exchange rate risk associated with future sales. We had no forward contracts
outstanding at September 30, 2006. We have not entered into these contracts for
trading or speculative purposes in the past, nor do we currently anticipate
entering into such contracts for trading or speculative purposes in the future.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
We maintain 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 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
we are required to disclose in the reports we file or submit to the SEC under
the Act is accumulated and communicated to our management, including our
principal executive officer and our 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, our Chief
Executive Officer, and Gregory M. Swalwell, our Vice President, Finance and
Chief Financial Officer, have evaluated the design and effectiveness of our
disclosure controls and procedures as of September 30, 2006. Based upon their
evaluation, these executive officers have concluded that our disclosure controls
and procedures are effective as of September 30, 2006.
Internal control over financial reporting
We also maintain 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, our principal
executive and principal financial officers, or persons performing similar
functions, and effected by our 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 our
assets,
o Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with GAAP, and that our receipts and expenditures are being made only
in accordance with authorizations of our management and directors, and
o Provide reasonable assurance regarding prevention or timely detection
of an unauthorized acquisition, use or disposition of our assets that
could have a material effect on our Condensed Consolidated Financial
Statements.
As permitted by the SEC, our 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 our financial
statement schedules required by Article 12 of Regulation S-X. However, our
assessment of internal control over financial reporting with respect to our
equity method investees did include our controls over the recording of amounts
related to our investment that are recorded in our Condensed Consolidated
Financial statements, including controls over the selection of accounting
methods for our investments, the recognition of equity method earnings and
losses and the determination, valuation and recording of our investment account
balances.
Changes in internal control over financial reporting
There has been no change to our internal control over financial reporting
during the quarter ended September 30, 2006 that has materially affected, or is
reasonably likely to materially affect, the internal control over financial
reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Note 11 of the Condensed Consolidated Financial Statements and to
the 2005 Annual Report for descriptions of certain legal proceedings.
Item 1A. Risk Factors
For a discussion of the risk factors related to our businesses, refer to
Part I, Item 1A., "Risk Factors," in our 2005 Annual report. There have been no
material changes to such risk factors during the nine months ended September 30,
2006.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
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 6, 2006 By /s/ Gregory M. Swalwell
------------------ ------------------------------
Gregory M. Swalwell
Vice President, Finance and Chief
Financial Officer (Principal
Financial Officer)
Date November 6, 2006 By /s/ Tim C. Hafer
------------------ -----------------------------
Tim C. Hafer
Vice President and Controller
(Principal Accounting Officer)
EXHIBIT 31.1
CERTIFICATION
I, Harold C. Simmons, 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 6, 2006
/s/ Harold C. Simmons
- -----------------------------------
Harold C. Simmons
Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Gregory M. Swalwell, 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 6, 2006
/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, 2006 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. ss. 1350,
as adopted pursuant to ss. 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 6, 2006
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.
