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KRO > SEC Filings for KRO > Form 10-Q on 7-Aug-2014All Recent SEC Filings

Show all filings for KRONOS WORLDWIDE INC

Form 10-Q for KRONOS WORLDWIDE INC


7-Aug-2014

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 six months ended June 30, 2014, 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,

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

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

Our key performance indicators are our TiO2 average selling prices, our level of TiO2 sales and production volumes and the cost of our third-party feedstock ore. 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 $33.1 million, or $.29 per share, in the second quarter of 2014 as compared to a net loss of $33.9 million, or $.29 per share, in the second quarter of 2013. For the first six months of 2014, we reported net income of $47.4 million, or $.41 per share, compared to a net loss of $75.0 million, or $.65 per share, in the first six months of 2013. We reported income in the second quarter and first half of 2014 compared to a loss in the second quarter and first half of 2013 principally due to improved results from operations resulting primarily from lower raw material costs and higher production volumes, partially offset by lower average selling prices and lower sales volumes in 2014.

Our results in the first six months of 2013 include a first quarter 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. Our results in the second quarter of 2014 include an aggregate non-cash income tax benefit of $5.7 million ($.05 per share) related to a net reduction in our reserve for uncertain tax positions.

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

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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

- 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.

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Results of operations

Quarter ended June 30, 2014 compared to the quarter ended June 30, 2013

                                                    Three months ended June 30,
                                                 2013                       2014
                                                       (Dollars in millions)
  Net sales                               $ 481.1        100  %     $ 443.5           100 %
  Cost of sales                             471.5          98         349.7            79
  Gross margin                                9.6           2          93.8            21
  Other operating income and expense, net    57.3          12          49.5            11
  Income (loss) from operations           $ (47.7 )       (10 )%    $  44.3            10 %

                                                                                % Change
  TiO2 operating statistics:
  Sales volumes*                              144                       133            (8 )%
  Production volumes*                         124                       134             9 %
  Percentage change in net sales:
  TiO2 product pricing                                                                 (4 )%
  TiO2 sales volumes                                                                   (8 )
  TiO2 product mix                                                                      1
  Changes in currency exchange rates                                                    3
  Total                                                                                (8 )%

* Thousands of metric tons

Current industry conditions - As previously discussed, after about a year of decreasing selling prices within the TiO2 industry, our TiO2 selling prices generally stabilized during the second half of 2013. Our average selling prices at the end of the second quarter of 2014 were 5% lower than at the end of 2013, with most of the decline occurring in the first quarter of 2014, and with lower prices in most major markets, most notably in certain export markets. As a result, we experienced significantly lower sales to our generally lower-margin export markets in the second quarter and first half of 2014 as compared to the same periods of 2013. Demand for TiO2 products has generally been stable in 2014 in most European and North American markets.

We operated our production facilities at reduced capacity rates in 2013 (approximately 92%, 90%, 82% and 81% of practical capacity in the first through fourth quarter periods, respectively). While our production capacity utilization rates in the second half of 2013 were impacted by the union labor lockout at our Canadian production facility that ended in December 2013, our utilization rates were also impacted by such lockout in the first quarter of 2014, as restart of production at the facility did not begin until February 2014. We operated our production facilities at overall average capacity utilization rates of 97% in the second quarter of 2014, up from 90% in the first quarter of 2014.

Our cost of sales per metric ton of TiO2 sold in the first half of 2013 (particularly in the first quarter) was significantly higher than TiO2 sold in the first half of 2014, as a substantial portion of the TiO2 products we sold in the first quarter (and to a lesser-extent the second quarter) of 2013 was produced with the higher-cost feedstock ore procured in 2012. We have seen moderation in the cost of TiO2 feedstock ore procured from third parties in 2013 and continuing into 2014, but such reductions did not begin to be significantly reflected in our cost of sales until the third quarter of 2013.

Net sales - Net sales in the second quarter of 2014 decreased 8%, or $37.6 million, compared to the second quarter of 2013 primarily due to the effects of an 8% decrease in sales volumes (which decreased net sales by approximately $38 million) and a 4% decrease in average TiO2 selling prices (which decreased net sales by approximately $19 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.

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Our sales volumes decreased 8% in the second quarter of 2014 as compared to the second quarter of 2013 due to lower sales primarily in certain export and European markets. We estimate that changes in currency exchange rates increased our net sales by approximately $13 million as compared to the second quarter of 2013.

Cost of sales - Cost of sales decreased $121.8 million or 26% in the second quarter of 2014 compared to 2013 due to the net impact of lower raw materials and other production costs of approximately $91 million (primarily caused by the lower third-party feedstock ore costs, as discussed above), an 8% decrease in sales volumes, a 9% increase in TiO2 production volumes and currency fluctuations (primarily the euro). Our cost of sales as a percentage of net sales decreased to 79% in the second quarter of 2014 compared to 98% in the same period of 2013, primarily due to lower raw material costs as discussed above.

Gross margin and income (loss) from operations - Income from operations increased by $92.0 million from a loss of $47.7 million in the second quarter of 2013 to income of $44.3 million in the second quarter of 2014. Income (loss) from operations as a percentage of net sales increased to 10% in the second quarter of 2014 from (10)% in the same period of 2013. This increase was driven by the increase in gross margin, which increased to 21% for the second quarter of 2014 compared to 2% for the second quarter of 2013. As discussed and quantified above, our gross margin increased primarily due to the net effect of lower manufacturing costs (primarily raw materials), higher production volumes, lower selling prices and lower sales volumes. 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 $12 million in the second quarter of 2014 as compared to the same period in 2013.

Other non-operating income (expense) - Interest expense decreased $1.0 million from $5.7 million in the second quarter of 2013 to $4.7 million in the second quarter of 2014 primarily due to lower average interest rates on our outstanding borrowings in the second quarter of 2014, partially offset by slightly higher average debt levels. We currently expect our interest expense for all of 2014 will be comparable to 2013, as the favorable impact of lower average interest rates on outstanding borrowings will be offset by the impact of higher overall average debt levels resulting from the new term loan we issued in February 2014.

Income tax expense (benefit) - We recognized income tax expense of $6.8 million in the second quarter of 2014 compared to a benefit of $19.2 million in the same period last year. This difference is primarily due to our increased earnings. In addition, our income tax expense in the second quarter of 2014 was favorably impacted by an aggregate non-cash income tax benefit of $5.7 million related to a net reduction in our reserve for uncertain tax positions. 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 $842 million and $127 million for German corporate and trade tax purposes, respectively, at December 31, 2013) and in Belgium (the equivalent of $102 million for Belgian corporate tax purposes at December 31, 2013). At June 30, 2014, 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 German 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 in our German and Belgian 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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Six months ended June 30, 2014 compared to the six months ended June 30, 2013

                                                     Six months ended June 30,
                                                 2013                       2014
                                                       (Dollars in millions)
  Net sales                               $ 944.7        100  %     $ 863.6           100 %
  Cost of sales                             931.2          99         689.3            80
  Gross margin                               13.5           1         174.3            20
  Other operating income and expense, net   108.1          11         104.0            12
  Income (loss) from operations           $ (94.6 )       (10 )%    $  70.3             8 %
                                                                                % Change
  TiO2 operating statistics:
  Sales volumes*                              276                       255            (8 )%
  Production volumes*                         246                       254             3 %
  Percentage change in net sales:
  TiO2 product pricing                                                                 (5 )%
  TiO2 sales volumes                                                                   (8 )
  TiO2 product mix                                                                      2
  Changes in currency exchange rates                                                    2
  Total                                                                                (9 )%

* Thousands of metric tons

Net sales - Net sales in the six months ended June 30, 2014 decreased 9%, or $81.1 million, compared to the six months ended June 30, 2013 primarily due to the effects of an 8% decrease in sales volumes (which decreased net sales by approximately $75 million) and a 5% decrease in average TiO2 selling prices (which decreased net sales by approximately $47 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 8% in the first six months of 2014 as compared to the first six months of 2013 primarily due to lower sales in certain export markets. We estimate that changes in currency exchange rates increased our net sales by approximately $20 million as compared to the first six months of 2013.

Cost of sales - Cost of sales decreased $241.9 million or 26% in the six months ended June 30, 2014 compared to this same period in 2013 primarily due to the net impact of lower raw materials and other production costs of approximately $185 million (primarily caused by lower third-party feedstock ore costs), a 3% increase in TiO2 production volumes, an 8% decrease in sales volumes and currency fluctuations (primarily the euro). Our cost of sales as a percentage of net sales decreased to 80% in the first six months of 2014 compared to 99% in the same period of 2013, primarily due to lower raw material costs as discussed above.

Gross margin and income (loss) from operations - Income from operations increased by $164.9 million from a loss of $94.6 million in the first six months of 2013 to income of $70.3 million in the first six months of 2014. Income
(loss) from operations as a percentage of net sales increased to 8% in the first six months of 2014 from (10)% in the same period of 2013. This increase was driven by the increase in gross margin, which increased to 20% for the first six months of 2014 compared to 1% for the first six months of 2013. As discussed and quantified above, our gross margin increased primarily due to the net effect of lower manufacturing costs (primarily raw materials), higher production volumes, lower selling prices and lower sales volumes. 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 $20 million in the first six months of 2014 as compared to the same period in 2013.

Other non-operating 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 prior term loan. See Note 7 to our Condensed Consolidated Financial Statements.

Interest expense decreased $3.4 million from $12.1 million in the six months ended June 30, 2013 to $8.7 million in the six months ended June 30, 2014 primarily due to lower average interest rates on outstanding borrowings in the first six months of 2014 partially offset by slightly higher average debt levels.

Income tax expense (benefit) - We recognized income tax expense of $14.7 million in the first six months of 2014 compared to an income tax benefit of $37.7 million in the same period last year. This difference is primarily due to our increased earnings. In

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addition, our income tax expense in the first six months of 2014 was favorably impacted by an aggregate non-cash income tax benefit of $5.5 million related to a net reduction in our reserve for uncertain tax positions. See Note 8 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax provision to our actual tax provision.

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 June 30, 2014 vs June 30, 2013
                                                                                             Translation
                                                Transaction gains recognized                 gain/loss -       Total currency
                                                                                              impact of            impact
                                        2013                  2014            Change        rate changes        2014 vs 2013
                                                                           (In millions)
Impact on:
Net sales                            $         -           $        -       $         -     $          13     $             13

Income from operations (3 ) 3 6 6 12

                                        Impact of changes in currency exchange rates
                                      six months ended June 30, 2014 vs June 30, 2013
                                                                                           Translation
                                               Transaction gains recognized                gain/loss -       Total currency
                                                                                            impact of            impact
                                        2013                 2014            Change       rate changes        2014 vs 2013
                                                                          (In millions)
Impact on::
Net sales                            $        -           $        -       $        -     $          20     $             20
Income from operations come from
operations                                   (1 )                  -                1                19                   20

Outlook

During the first half of 2014 we operated our production facilities at 93% of practical capacity. This reflects an increased plant utilization rate as compared to the last half of 2013. While our production capacity utilization rates in the second half of 2013 were impacted by the lockout at our Canadian production facility that ended in December 2013, our utilization rates were also impacted by such lockout in the first quarter of 2014, as restart of production at the facility did not begin until February 2014. While we expect our production volumes to be higher in 2014 as compared to 2013, we expect to continue to operate below production capacity in 2014. The less-than-full production utilization is principally due to the ramp-up of operations at our Canadian facility following the end of the lockout as well as the implementation of certain productivity-enhancing capital improvement projects at other facilities which will result in longer-than-normal maintenance shutdowns in certain instances. We will continue to monitor current and anticipated near-term customer demand levels and align our production and inventories accordingly.

We experienced moderation in the cost of TiO2 feedstock ore procured in 2013 and continuing into 2014, and consequently our cost of sales per metric ton of TiO2 sold in the first half of 2014 was significantly lower than our cost of sales per metric ton of TiO2 sold in the first half of 2013. Given the time lag between when we procure third-party feedstock ore and when the TiO2 product produced with such third-party feedstock is sold and recognized in our cost of sales, we expect our cost of sales per metric ton of TiO2 sold in calendar 2014 will be lower than the cost of sales per metric ton of TiO2 sold in calendar 2013, and our cost of sales per metric ton of TiO2 sold in the second half of 2014 will be lower than the cost per metric ton of TiO2 sold in the first half of 2014. Although

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the cost of feedstock ore has and continues to moderate, such reductions have . . .

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