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KRO > SEC Filings for KRO > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for KRONOS WORLDWIDE INC

Form 10-Q for KRONOS WORLDWIDE INC


5-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS:

Business 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, 2012, approximately one-half of our sales volumes were into European markets. Our production facilities are located in Europe and North America.

We consider TiO2 to be a "quality of life" product, with demand affected by gross domestic product, or GDP, and overall economic conditions in our markets located in various regions of the world. Over the long-term, we expect 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 influenced in part by their expectations for future changes in market TiO2 selling prices as well as their expectations for future availability of product. Although certain of our TiO2 grades are considered specialty pigments, the majority of our grades and substantially all of our production are considered commodity pigment products, with price and availability being the most significant competitive factors along with quality and customer service.

The factors having the most impact on our reported operating results are:

our TiO2 sales and production volumes,

TiO2 selling prices,

currency exchange rates (particularly the exchange rate for the U.S. dollar relative to the euro, Norwegian krone and Canadian dollar) and

manufacturing costs, particularly raw materials, maintenance and energy-related expenses.

Our key performance indicators are our TiO2 average selling prices and our TiO2 sales and production volumes. TiO2 selling prices generally follow industry trends and prices will increase or decrease generally as a result of competitive market pressures.

Executive summary

We reported net income of $35.2 million, or $.30 per share, in the third quarter of 2012 as compared to net income of $85.9 million, or $.74 per share, in the third quarter of 2011. For the first nine months of 2012, we reported net income of $236.6 million, or $2.04 per share, compared to net income of

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$235.2 million, or $2.03 per share, in the first nine months of 2011. Our net income for the third quarter of 2012 is lower as compared to the same period of 2011 due to lower income from operations resulting from the net effect of lower sales and production volumes and higher raw material costs offset in part by higher selling prices. We also had a lower effective income tax rate in the third quarter of 2012 as compared to the third quarter of 2011 (as discussed in Note 8 to our Condensed Consolidated Financial Statements). Our net income for the first nine months of 2012 is comparable to the first nine months of 2011, as the unfavorable effect of lower income from operations in 2012 due to the net effect of (i) lower sales and production volumes, (ii) higher raw material costs and (iii) higher average selling prices was substantially offset by the lower effective income tax rate in 2012.

Our results in the first nine months of 2011 include a net charge of $3.2 million ($2.1 million, or $.02 per share, net of income tax benefit), mostly in the first quarter, related to the redemption and open market purchases of 110.4 million principal amount of our Senior Notes, consisting of the call premium, the write-off of unamortized deferred financing costs and original issue discount associated with the redeemed and purchased Notes. Our results in the first nine months of 2012 include an aggregate second quarter charge of $7.2 million ($4.7 million, or $.04 per share, net of income tax benefit) consisting of the call premium paid, interest from the June 14, 2012 indenture discharge date to the July 20, 2012 redemption date and the write-off of unamortized deferred financing costs and original issue discount associated with the June 2012 redemption of the remaining 279.2 million principal amount of our Senior Notes.

Forward-looking information

This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Statements in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking in nature and represent management's beliefs and assumptions based on currently available information. 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 management's beliefs and assumptions based on currently available information. In some cases you can identify forward-looking statements by the use of words such as "believes," "intends," "may," "should," "could," "anticipates," "expects" 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. Such statements by their nature involve substantial risks and uncertainties that could significantly impact expected results. Actual future results could differ materially from those predicted. 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 are not limited to, the following:

Future supply and demand for our products;

The extent of the dependence of certain of our businesses on certain market sectors;

The cyclicality of our business;

Customer inventory levels;

Unexpected or earlier-than-expected industry capacity expansion;

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Changes in raw material and other operating costs (such as energy and ore costs);

Changes in the availability of raw materials (such as ore);

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);

Competitive products and substitute products;

Customer and competitor strategies;

Potential consolidation of our competitors;

The impact of pricing and production decisions;

Competitive technology positions;

The introduction of trade barriers;

Possible disruption of our business, or increases in our cost of doing business, resulting from terrorist activities or global conflicts;

Fluctuations in currency exchange rates (such as changes in the exchange rate between the U.S. dollar and each of the euro, the Norwegian krone and the Canadian dollar), or possible disruptions to our business resulting from potential instability resulting from uncertainties associated with the euro;

Operating interruptions (including, but not limited to, labor disputes, leaks, natural disasters, fires, explosions, unscheduled or unplanned downtime and transportation interruptions);

Our ability to renew or refinance credit facilities;

Our ability to maintain sufficient liquidity;

The ultimate outcome of income tax audits, tax settlement initiatives or other tax matters;

Our ability to utilize income tax attributes, the benefits of which have been recognized under the more-likely-than-not recognition criteria;

Environmental matters (such as those requiring compliance with emission and discharge standards for existing and new facilities);

Government laws and regulations and possible changes therein;

The ultimate resolution of pending litigation; and

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.

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Results of operations

Quarter ended September 30, 2012 compared to the

quarter ended September 30, 2011 -

                                                  Three months ended September 30,
                                                   2011                       2012
                                                        (Dollars in millions)
Net sales                                 $   548.0          100 %    $ 472.9           100 %
Cost of sales                                 337.1           62        386.9            82

Gross margin                                  210.9           38         86.0            18
Other operating income and expense, net        54.3           10         47.5            10

Income from operations                    $   156.6           28 %    $  38.5             8 %


                                                                                  % Change
TiO2 operating statistics:
Sales volumes*                                  136                       116           (15 )%
Production volumes*                             134                        98           (27 )%

Percentage change in net sales:
TiO2 product pricing                                                                      5 %
TiO2 sales volumes                                                                      (15 )
TiO2 product mix                                                                          2
Changes in currency exchange rates                                                       (6 )


Total                                                                                   (14 )%

* Thousands of metric tons

Current industry conditions - The TiO2 industry has experienced decreased sales and production volumes as the majority of TiO2 producers and consumers have been undertaking inventory correction initiatives in response to continued global economic weakness and uncertainty. While we operated our production facilities at full practical capacity rates throughout 2011 and the first quarter of 2012, we operated our facilities at reduced rates during the second and third quarters of 2012 (approximately 86% of practical capacity in the second quarter, and approximately 71% in the third quarter) in order to align production levels and inventories to current and anticipated near-term customer demand levels.

We also increased our TiO2 average selling prices throughout 2011, and as a result our average selling prices in the third quarter 2012 were 5% higher as compared to the third quarter of 2011. Our average selling prices at the end of the second quarter of 2012 were comparable to the end of 2011, but our average selling prices at the end of the third quarter of 2012 were 7% lower than at the end of the second quarter of 2012.

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Net sales - Net sales in the third quarter of 2012 decreased 14%, or $75.1 million, compared to the third quarter of 2011 primarily due to the net effects of a 15% decrease in sales volumes (which decreased net sales by approximately $82 million) and a 5% increase in average TiO2 selling prices (which increased net sales by approximately $27 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs. Based on the current conditions in the TiO2 industry, we currently expect our average selling prices in the fourth quarter of 2012 to be lower than the fourth quarter of 2011.

Our sales volumes decreased 15% in the third quarter of 2012 as compared to the third quarter of 2011 due to lower customer demand, primarily in European markets. In addition, we estimate the unfavorable effect of changes in currency exchange rates decreased our net sales by approximately $34 million, or 6%, as compared to the third quarter of 2011.

Cost of sales - Cost of sales increased $49.8 million or 15% in the third quarter of 2012 compared to 2011 due to the net impact of higher raw material costs of approximately $85 million (primarily feedstock ore and petroleum coke), a 15% decrease in sales volumes, a 27% decrease in TiO2 production volumes and currency fluctuations (primarily the euro). Cost of sales as a percentage of net sales increased to 82% in the third quarter of 2012 compared to 62% in the third quarter of 2011, primarily due to the net effect of higher raw material costs, the unfavorable effects of unabsorbed fixed production costs resulting from reduced production volumes and higher average selling prices. The reduction in our TiO2 production volumes during the third quarter of 2012, as discussed above, resulted in approximately $25 million of unabsorbed fixed production costs which were charged directly to cost of sales. We expect further increases in our manufacturing costs during the remainder of 2012, as discussed below.

Gross margin and income from operations - Income from operations decreased by $118.1 million from $156.6 million in the third quarter of 2011 to $38.5 million in the third quarter of 2012. Income from operations as a percentage of net sales decreased to 8% in the third quarter of 2012 from 28% in the same period of 2011. This decrease was driven by the decline in gross margin, which decreased to 18% for the third quarter of 2012 compared to 38% for the third quarter of 2011. As discussed and quantified above, our gross margin has decreased primarily due to the net effects of higher manufacturing costs (primarily raw materials), lower sales volumes, unabsorbed fixed costs related to lower production volumes and higher selling prices. Additionally, changes in currency exchange rates have positively affected our gross margin and income from operations. We estimate that changes in currency exchange rates increased income from operations by approximately $2 million in the third quarter of 2012 as compared to the same period in 2011.

Other non-operating income (expense) - Interest expense decreased $1.1 million from $8.1 million in the third quarter of 2011 to $7.0 million in the third quarter of 2012 due to lower average interest rates on outstanding borrowings. See Note 7 to our Condensed Consolidated Financial Statements.

We expect interest expense for the fourth quarter of 2012 to be comparable to the same period of 2011 due to the net effect of higher average outstanding debt levels associated with borrowings under the new term loan and European revolver, and lower average interest rates on outstanding borrowings, as the term loan and European revolver bear interest at a lower average interest rate compared to the redeemed 6.5% Senior Secured Notes.

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Income tax provision (benefit) - We had an income tax benefit of $1.4 million in the third quarter of 2012 compared to an income tax provision of $63.8 million in the same period last year. This decrease in expense is primarily due to our lower income from operations in 2012. In addition, our provision for income taxes in the third quarter of 2011 includes $13.2 million for U.S. incremental income taxes on current earnings repatriated from our Germany subsidiary, which earnings were used to fund a portion of the repurchases of our Senior Secured Notes. Our income tax benefit in the third quarter of 2012 includes an incremental tax benefit of $11.1 million as we determined during the third quarter that due to global changes in the business we would not remit certain dividends from non-U.S. jurisdictions. As a result, certain current year tax attributes are available for carryback to offset prior year tax expense. See Note 8 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax (benefit) provision to our actual tax provision.

We have substantial net operating loss carryforwards in Germany (the equivalent of $799 million and $188 million for German corporate and trade tax purposes, respectively, at December 31, 2011). At September 30, 2012, we have concluded that no deferred income tax asset valuation allowance is required to be recognized with respect to such carryforwards, principally because (i) such carryforwards have an indefinite carryforward period, (ii) we have utilized a portion of such carryforwards during the most recent three-year period and
(iii) we currently expect to utilize the remainder of such carryforwards over the long term. However, prior to the complete utilization of such carryforwards, particularly if the economic recovery were to be short-lived or we were to generate losses in our German operations for an extended period of time, it is possible that we might conclude the benefit of such carryforwards would no longer meet the more-likely-than-not recognition criteria, at which point we would be required to recognize a valuation allowance against some or all of the then-remaining tax benefit associated with the carryforwards.

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Nine months ended September 30, 2012 compared to the

nine months ended September 30, 2011 -

                                                   Nine months ended September 30,
                                                  2011                       2012
                                                        (Dollars in millions)
 Net sales                                 $ 1,505.9       100 %    $ 1,579.5           100 %
 Cost of sales                                 951.6        63        1,068.7            68

 Gross margin                                  554.3        37          510.8            32
 Other operating income and expense, net       151.1        10          152.3             9

 Income from operations                    $   403.2        27 %    $   358.5            23 %


                                                                                  % Change
 TiO2 operating statistics:
 Sales volumes*                                  406                      368            (9 )%
 Production volumes*                             409                      356           (13 )%

 Percentage change in net sales:
 TiO2 product pricing                                                                    20 %
 TiO2 sales volumes                                                                      (9 )
 TiO2 product mix                                                                        (1 )
 Changes in currency exchange rates                                                      (5 )


 Total                                                                                    5 %

* Thousands of metric tons

Net sales - Net sales in the nine months ended September 30, 2012 increased 5%, or $73.6 million, compared to the nine months ended September 30, 2011 primarily due to the net effects of a 20% increase in average TiO2 selling prices (which increased net sales by approximately $300 million) and a 9% decrease in sales volumes (which decreased net sales by approximately $136 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs.

Our sales volumes decreased 9% in the first nine months of 2012 as compared to the first nine months of 2011 due to decreased customer demand, primarily in European markets. In addition, we estimate the unfavorable effect of changes in currency exchange rates decreased our net sales by approximately $70 million, or 5%, as compared to the first nine months of 2011.

Cost of sales - Cost of sales increased $117.1 million or 12% in the nine months ended September 30, 2012 compared to the same period in 2011 due to the net impact of higher raw material costs of approximately $201 million (primarily feedstock ore and petroleum coke), a 9% decrease in sales volumes, a 13% decrease in production volumes and currency fluctuations (primarily the euro). Cost of sales as a percentage of net sales increased to 68% in the first nine months of 2012 compared to 63% in the same period in 2011 primarily due to the net effects of higher raw material costs, the unfavorable effects of unabsorbed fixed production costs resulting from reduced production volumes and higher average selling prices. The reduction in our TiO2 production volumes during the first nine months of 2012, as

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discussed above, resulted in approximately $25 million of unabsorbed fixed production costs which were charged directly to cost of sales. Additionally, the first nine months of 2012 reflects the benefit of lower raw material costs (as compared to current costs) in the first quarter of 2012 as lower cost raw materials purchased at the end of 2011 were used in the 2012 production process.

Gross margin and income from operations - Income from operations decreased by $44.7 million from $403.2 million in the first nine months of 2011 to $358.5 million in the first nine months of 2012. Income from operations as a percentage of net sales decreased to 23% in the first nine months of 2012 from 27% in the same period for 2011. This decrease was driven by the decline in gross margin, which decreased to 32% for the first nine months of 2012 compared to 37% for the same period in 2011. As discussed and quantified above, our gross margin has decreased primarily due to the net effects of higher manufacturing costs (primarily raw materials), higher selling prices, lower sales volumes and unabsorbed fixed costs related to lower production volumes. Additionally, changes in currency exchange rates have negatively affected our gross margin and income from operations. We estimate that changes in currency exchange rates decreased income from operations by approximately $1 million in the first nine months of 2012 as compared to the same period in 2011.

Other non-operating income (expense) - In March 2011, we redeemed 80 million of our 6.5% Senior Secured Notes and borrowed under our European revolving credit facility in order to fund the redemption. During the third quarter of 2011, we repurchased in open market transactions an aggregate 30.4 million principal amount of our Senior Notes. As a result of these redemptions and open market purchases, we recognized a net $3.2 million pre-tax interest charge consisting of the call premium and the write-off of unamortized deferred financing costs and original issue discount associated with the redeemed and repurchased Senior Notes.

As discussed above, we recognized an aggregate $7.2 million pre-tax charge in the second quarter of 2012 related to the early extinguishment of our remaining Senior Secured Notes. See Note 7 to our Condensed Consolidated Financial Statements.

Interest expense decreased $6.2 million from $26.2 million in the nine months ended September 30, 2011 to $20.0 million in the nine months ended September 30, 2012 primarily due to the effects of lower 2012 average debt levels of our Senior Secured Notes resulting from the March 2011 redemption and open market purchases in the third and fourth quarters of 2011.

Income tax provision - Our income tax provision was $101.3 million in the first nine months of 2012 compared to an income tax provision of $143.1 million in the same period last year. This decrease in provision for income taxes was primarily due to lower income from operations in the first nine months of 2012 compared to the same period in 2011. In addition, our provision for income taxes in the third quarter of 2011 includes $13.2 million for U.S. incremental income taxes on current earnings repatriated from our Germany subsidiary, which earnings were used to fund a portion of the repurchases of our Senior Secured Notes. Our income tax benefit in the third quarter of 2012 includes an incremental tax benefit of $11.1 million as we determined during the third quarter that due to global changes in the business we would not remit certain dividends from non-U.S. jurisdictions. As a result, certain current year tax attributes are available for carryback to offset prior year tax expense. See Note 8 to our Condensed Consolidated Financial Statements.

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Effects of Currency Exchange Rates

We have substantial operations and assets located outside the United States (primarily in Germany, Belgium, Norway and Canada). The majority of our sales from 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 our sales generated from our non-U.S. operations is 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 non-U.S. sales and operating results are subject to currency exchange rate fluctuations which may favorably or unfavorably impact reported earnings and may affect the comparability of period-to-period operating results. In addition to the impact of the translation of sales and expenses over time, our non-U.S. operations also generate currency transaction gains and losses which primarily relate to the difference between the currency exchange rates in effect when non-local currency sales or operating costs are initially accrued and when such amounts are settled with the non-local currency.

Overall, we estimate that fluctuations in currency exchange rates had the following effects on our sales and income from operations for the periods indicated.

Impact of changes in currency exchange rates Three months ended September 30, 2012 vs. September 30, 2011

                                                                    Translation            Total
                                     Transaction losses             gain/loss -          currency
                                         recognized                  impact of            impact
                               2011         2012       Change      rate changes        2012 vs. 2011
                                                           (in millions)
Impact on:
Net sales                     $   -         $  -       $    -      $         (34 )    $           (34 )

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