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KRO > SEC Filings for KRO > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for KRONOS WORLDWIDE INC


8-May-2013

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 coatings, plastics, paper and other industrial and specialty products. For the three months ended March 31, 2013, 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 TiO2 market 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 the 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 a net loss of $41.1 million, or $.35 per share, in the first quarter of 2013 as compared to net income of $136.9 million, or $1.18 per share, in the first quarter of 2012. We had a net loss in the first quarter of 2013 compared to net income in the first quarter of 2012 principally due to a loss from operations resulting from the unfavorable effects of lower average selling prices, lower production volumes and higher raw material costs in 2013.

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Our results in the first quarter of 2013 include a non-cash pre-tax charge of $6.6 million ($4.3 million, or $.04 per share, net of income tax benefit) related to the voluntary prepayment of $290 million principal amount of our term loan, consisting of the write-off of original issue discount costs and deferred financing costs associated with such prepayment.

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 and producer inventory levels

Unexpected or earlier-than-expected industry capacity expansion

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

Potential consolidation of our customers

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

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

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

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

Quarter ended March 31, 2013 compared to the quarter ended March 31, 2012 -

                                                    Three months ended March 31,
                                                   2012                     2013
                                                        (Dollars in millions)
   Net sales                                 $ 561.3       100 %    $ 463.6         100  %
   Cost of sales                               299.8        53        459.7           99

   Gross margin                                261.5        47          3.9            1
   Other operating income and expense, net      52.1        10         50.8          (11 )

   Income (loss) from operations             $ 209.4        37 %    $ (46.9 )        (10 )%


                                                                                    %
                                                                                 Change
   TiO2 operating statistics:
   Sales volumes*                                130                    132            1 %
   Production volumes*                           140                    122          (13 )%
   Percentage change in net sales:
   TiO2 product pricing                                                              (21 )%
   TiO2 sales volumes                                                                  1
   TiO2 product mix                                                                    3
   Changes in currency exchange rates                                                 -

   Total                                                                             (17 )%

* Thousands of metric tons

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Current industry conditions - The TiO2 industry has experienced decreased selling prices 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 in the first quarter of 2012, we operated our facilities at reduced rates during the remainder of 2012 (approximately 86% of practical capacity in the second quarter, approximately 71% in the third quarter and approximately 80% in the fourth quarter) to align production levels and inventories to current and anticipated near-term customer demand levels. We continued to operate our production facilities at reduced capacity rates in the first quarter of 2013 (approximately 92% of practical capacity).

Our average selling prices declined during the second half of 2012, and continued to decline during the first quarter of 2013. Our average selling prices at the end of the first quarter of 2013 were 7% lower than at the end of 2012, and were 22% lower than at the end of the first quarter of 2012.

We experienced significantly higher costs for our raw materials such as third party feedstock ore and petroleum coke in 2012. As one of the few vertically-integrated producers of sulfate process TiO2, we operate two ilmenite mines in Norway which provide all of the feedstock for our European sulfate process facilities. Overall, the cost per metric ton of TiO2 we produced during 2012 was approximately 50% higher as compared to 2011, primarily due to the higher feedstock ore costs procured from third parties and unabsorbed fixed production costs resulting from reduced production volumes. However, as a substantial portion of the TiO2 products we sold in the first quarter of 2012 were produced with lower-cost feedstock ore purchased in 2011, our cost of sales per metric ton in the first quarter of 2012 was significantly lower as compared to the cost per metric ton for products we sold in the second, third and fourth quarters of 2012. We experienced some moderation in the cost of TiO2 feedstock ore procured from third parties in 2013, however our cost of sales per metric ton of TiO2 sold in the first quarter of 2013 was significantly higher than what we expect our cost of sales per metric ton of TiO2 to be in the remainder of 2013, as a substantial portion of the TiO2 products we sold in the first quarter of 2013 was produced with the higher-cost feedstock ore procured in 2012.

Net sales - Net sales in the first quarter of 2013 decreased 17%, or $97.7 million, compared to the first quarter of 2012 primarily due to a 21% decrease in average TiO2 selling prices (which decreased net sales by approximately $118 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 increased 1% in the first quarter of 2013 as compared to the first quarter of 2012 due to increased customer demand in export markets offset in part by slightly lower demand in North American and European markets. Our sales volumes in the first quarter of 2013 set a new record for a first quarter. We estimate that changes in currency exchange rates increased net sales by approximately $1 million as compared to the first quarter of 2012.

Cost of sales - Cost of sales increased $159.9 million or 53% in the first quarter of 2013 compared to 2012 primarily due to the net impact of higher raw material costs of approximately $110 million (primarily feedstock ore) and a 13% decrease in TiO2 production volumes. Our cost of sales per

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metric ton of TiO2 sold in the first quarter of 2013 was significantly higher than TiO2 sold in the first quarter of 2012, as a substantial portion of the TiO2 products we sold in the first quarter of 2012 was produced with lower-cost feedstock ore purchased in 2011, while a substantial portion of the TiO2 products we sold in 2013 was produced with higher-cost feedstock ore purchased in 2012. Overall and as discussed above, the cost per metric ton of TiO2 we produced during 2012 was approximately 50% higher as compared to 2011, primarily due to the higher feedstock ore costs and unabsorbed fixed production costs resulting from reduced production volumes. Cost of sales as a percentage of net sales increased to 99% in the first quarter of 2013 compared to 53% in the same period of 2012 primarily due to the effects of higher raw materials costs as discussed above.

Gross margin and income (loss) from operations - Income (loss) from operations decreased by $256.3 million from income of $209.4 million in the first quarter of 2012 to a loss of $46.9 million in the first quarter of 2013. Income (loss) from operations as a percentage of net sales decreased to (10)% in the first quarter of 2013 from 37% in the same period of 2012. This decrease was driven by the decline in gross margin, which decreased to 1% for the first quarter of 2013 compared to 47% for the first quarter of 2012. As discussed and quantified above, our gross margin decreased primarily due to the effects of lower selling prices and higher manufacturing costs (primarily raw materials). 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 $6 million in the first quarter of 2013 as compared to the same period in 2012.

Other non-operating income (expense) - We recognized an aggregate $6.6 million pre-tax charge, consisting of the write-off of unamortized original issue discount costs and deferred financing costs, in the first quarter of 2013 related to the voluntary prepayment of $290 million of our term loan. See Note 7 to our Condensed Consolidated Financial Statements.

Interest and dividend income decreased $2.0 million to $.3 million in the first quarter of 2013 primarily due to lower balances available for investment, principally related to our loan to Valhi which was completely repaid in December 2012. Interest income on our loan to Valhi was $1.6 million in the first quarter of 2012.

Income tax provision - We recognized an income tax benefit of $18.5 million in the first quarter of 2013 compared to a provision of $68.5 million in the same period last year. This difference is primarily due to our decreased earnings. See Note 8 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax provision to our actual tax provision.

We have substantial net operating loss carryforwards in Germany (the equivalent of $744 million and $100 million for German corporate and trade tax purposes, respectively, at December 31, 2012). At March 31, 2013, 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 we were to generate losses

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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.

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 March 31, 2013 vs March 31, 2012

                                                                 Translation           Total
                                  Transaction  gains               loss -            currency
                                      recognized                  impact of           impact
                            2012          2013      Change      rate changes       2013 vs 2012
                                                       (in millions)
Impact on:
Net sales                   $    -        $  -      $    -      $           1      $           1
Income from operations           -            2           2                (8 )               (6 )

Outlook

During the first quarter of 2013 we operated our production facilities at 92% of practical capacity, which was a higher utilization rate as compared to our utilization rates during the last three quarters of 2012. If economic conditions improve in the various regions of the world in the remainder of 2013, we expect demand for our TiO2 products would increase and our sales volumes would be expected to be higher in 2013 as compared to 2012. During 2013, we will continue to monitor current and anticipated near-term customer demand levels and align our production and inventories accordingly.

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We experienced some moderation in the cost of TiO2 feedstock ore procured in 2013, however our cost of sales per metric ton of TiO2 sold in the first quarter of 2013 was significantly higher than what we expect our cost of sales per metric ton of TiO2 to be in the remainder of 2013, as a substantial portion of the TiO2 products we sold in the first quarter of 2013 was produced with the higher-cost feedstock ore procured in 2012. Although the cost of feedstock ore has moderated recently, such reductions have been inadequate to compensate for the decline in selling prices for our products. We started 2013 with selling prices 16% lower than as compared to the start of 2012, and prices declined by an additional 7% in the first quarter of 2013. We expect to implement increases in our selling prices during 2013 in order to adequately compensate for our raw material production costs, and in this regard, in February 2013 we announced certain price increases for all of our markets, implementation of which would begin in the second quarter of 2013. Industry data indicates that overall TiO2 inventory held by producers has been significantly decreased. In addition, we believe most customers hold very low inventories of TiO2 with many operating on a just-in-time basis. Shortages of certain TiO2 grades have recently occurred, and lead times for delivery are increasing. We also believe TiO2 prices have generally stabilized, and price increases have been realized in some accounts. The extent to which we will be able to achieve these and other possible additional price increases during 2013 will depend on market conditions.

Overall, we expect that income from operations in 2013 will be significantly lower as compared to 2012. The first quarter of 2012 income from operations was positively affected by the sale of TiO2 produced with lower-cost feedstock ore purchased in 2011, as compared to our first quarter 2013 loss from operations which was negatively impacted by the sale of TiO2 produced with higher-cost feedstock ore purchased in 2012. This negative fluctuation in operating income between the first quarter of 2012 and the first quarter of 2013 would more than offset any favorable effect of higher sales and production volumes that would result assuming demand levels continue to improve, as well as the favorable impact of increases in our selling prices that we may be able to achieve during the remainder of 2013.

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, continued operation of competitors, unexpected or earlier-than-expected capacity additions or reductions and technological advances. If actual developments differ from our expectations, our results of operations could be unfavorably affected.

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.

Cash used in operating activities was $104.7 million in the first three months of 2012 compared to $39.3 million used in the first three months of 2013. This $65.4 million net decrease in the amount of cash used was primarily due to the net effects of the following items:

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lower income from operations in 2013 of $256.3 million,

lower net cash used in 2013 of $263.4 million associated with relative changes in our inventories, receivables, payables and accruals, primarily due to the relative decreases in our inventories and receivables, as discussed below,

higher net distributions from our TiO2 manufacturing joint venture in 2013 of $28.6 million, primarily due to the timing of the joint venture's working capital needs,

lower net cash paid for income taxes in 2013 of $16.8 million resulting from our decreased profitability and

higher cash paid for interest in 2013 of $5.9 million, primarily due to the timing of interest payments on our term loan in 2013.

Changes in working capital were affected by accounts receivable and inventory changes. As shown below:

Our average days sales outstanding, or DSO, increased from December 31, 2012 to March 31, 2013 due to higher average daily net sales resulting from higher sales volumes partially offset by lower selling prices in the first quarter of 2013.

Our average days sales in inventory, or DSI, decreased from December 31, 2012 to March 31, 2013 principally due to lower inventory costs and lower inventory volumes in the first quarter of 2013.

For comparative purposes, we have also provided comparable prior year numbers below.

                   December 31,      March 31,       December 31,      March 31,
                       2011             2012             2012             2013
            DSO          55 days        69 days            61 days        65 days
            DSI         104 days       110 days           102 days        68 days

Investing activities

Our capital expenditures of $23.3 million and $19.0 million in the three months ended March 31, 2012 and 2013, respectively, were primarily to maintain and improve the cost effectiveness of our existing manufacturing facilities.

Financing activities

During the three months ended March 31, 2013, we:

Voluntarily prepaid $290.0 million principal amount on our term loan,

borrowed $190.0 million under our new note payable with Contran, and subsequently repaid $5.0 million,

borrowed $1.8 million from a Canadian economic development agency, and

paid a quarterly dividend to stockholders of $.15 per share for an aggregate dividend of $17.4 million.

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Outstanding debt obligations

At March 31, 2013, our consolidated debt comprised:

$185.0 million under our note payable to Contran due in June 2018,

$100.0 million outstanding ($98.6 million carrying value, net of unamortized original issue discount) under our term loan due in June 2018,

10 million ($12.8 million) under our European revolving credit facility which matures in September 2017, and

approximately $3.3 million of other indebtedness.

Our term loan, North American and European revolvers and our note payable to Contran contain a number of covenants and restrictions which, among other things, restrict our ability to incur additional debt, incur liens, pay dividends or merge or consolidate with, or sell or transfer substantially all of our assets to, another entity, and contains other provisions and restrictive covenants customary in lending transactions of this type. Our term loan requires that a specified financial covenant (leverage to EBITDA, as defined) be maintained at a ratio less than or equal to 3.5 to 1.0, and our European revolving credit facility also requires the maintenance of certain financial ratios. Certain of our credit agreements also contain provisions which could . . .

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