SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2005 Commission file number 333-100047
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KRONOS INTERNATIONAL, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 22-2949593
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
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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
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes No X
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Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Number of shares of the Registrant's common stock outstanding on October 31,
2005: 2,968.
The Registrant is a wholly owned subsidiary of Kronos Worldwide, Inc. (File No.
1-31763) and meets the conditions set forth in General Instructions H(1)(a) and
H(1)(b) of Form 10-Q for reduced disclosure format.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 2004; September 30, 2005 (Unaudited) 3
Consolidated Statements of Income -
Three and nine months ended September 30,
2004 and 2005 (Unaudited) 5
Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2004 and 2005 (Unaudited) 6
Consolidated Statement of Stockholder's Equity -
Nine months ended September 30, 2005 (Unaudited) 7
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2004 and 2005 (Unaudited) 8
Notes to Consolidated Financial Statements (Unaudited) 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 4. Controls and Procedures 26
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 6. Exhibits 27
- 2 -
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2004 2005
------------- --------------
(Unaudited)
Current assets:
Cash and cash equivalents $ 17,505 $ 54,688
Restricted cash 1,529 915
Accounts and other receivables 130,729 130,454
Receivables from affiliates 2,517 2,274
Refundable income taxes 2,586 866
Inventories 170,261 175,473
Prepaid expenses 3,141 5,529
----------- ----------
Total current assets 328,268 370,199
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Other assets:
Deferred financing costs, net 10,404 8,425
Restricted marketable debt securities 2,877 2,682
Unrecognized net pension obligation 7,524 6,836
Deferred income taxes 238,284 178,553
Other 1,591 993
----------- ----------
Total other assets 260,680 197,489
----------- ----------
Property and equipment:
Land 34,164 30,764
Buildings 153,442 139,248
Equipment 724,904 649,917
Mining properties 71,980 66,607
Construction in progress 13,560 18,397
----------- ----------
998,050 904,933
Less accumulated depreciation and amortization 601,815 559,707
----------- ----------
Net property and equipment 396,235 345,226
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$985,183 $ 912,914
=========== ==========
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KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2004 2005
------------- --------------
(Unaudited)
Current liabilities:
Current maturities of long-term debt $ 13,792 $ 158
Accounts payable and accrued liabilities 126,949 128,126
Payable to affiliates 11,042 4,601
Income taxes 17,080 10,662
Deferred income taxes 2,722 906
----------- ----------
Total current liabilities 171,585 144,453
----------- ----------
Noncurrent liabilities:
Long-term debt 519,403 457,620
Deferred income taxes 22,358 20,255
Accrued pension costs 48,441 44,922
Other 16,840 12,807
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Total noncurrent liabilities 607,042 535,604
----------- ----------
Minority interest 76 73
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Stockholder's equity:
Common stock 297 297
Additional paid-in capital 1,944,185 1,944,185
Retained deficit (1,399,118) (1,345,927)
Notes receivable from affiliate (209,526) (209,526)
Accumulated other comprehensive loss:
Currency translation (99,764) (126,651)
Pension liabilities (29,594) (29,594)
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Total stockholder's equity 206,480 232,784
----------- ----------
$ 985,183 $ 912,914
=========== ==========
Commitments and contingencies (Notes 9 and 11)
See accompanying notes to consolidated financial statements.
- 4 -
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------------- ----------------------
2004 2005 2004 2005
---- ---- ---- ----
(Restated)
Net sales $ 203,448 $ 205,979 $ 603,723 $ 643,087
Cost of sales 156,135 150,772 455,058 454,983
--------- --------- --------- ---------
Gross margin 47,313 55,207 148,665 188,104
Selling, general and administrative expense 25,052 26,504 75,779 82,514
Other operating income (expense):
Currency transaction gains (losses), net (399) 159 111 2,356
Disposition of property and equipment (7) (282) (9) (429)
Royalty income 1,543 1,730 4,560 5,145
Other income 140 328 227 440
--------- --------- --------- ---------
Income from operations 23,538 30,638 77,775 113,102
Other income (expense):
Trade interest income 272 214 672 406
Securities transaction gain - - - 5,439
Interest income from affiliates - 4,640 7 14,396
Interest expense to affiliates (5) - (5) -
Interest expense (8,542) (10,604) (26,021) (33,463)
--------- --------- --------- ---------
Income before income taxes and minority interest 15,263 24,888 52,428 99,880
Provision (benefit) for income taxes 6,104 18,461 (260,373) 46,680
Minority interest in after-tax earnings 18 1 38 9
--------- --------- --------- ---------
Net income $ 9,141 $ 6,426 $ 312,763 $ 53,191
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
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KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Net income $ 312,763 $ 53,191
Other comprehensive loss -
currency translation adjustment (209) (26,887)
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Comprehensive income $ 312,554 $ 26,304
========= =========
See accompanying notes to consolidated financial statements.
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KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
Nine months ended September 30, 2005
(In thousands)
(Unaudited)
Accumulated other
Notes comprehensive loss
Additional receivable -------------------------- Total
Common paid-in Retained from Currency Pension stockholder's
stock capital deficit affiliates translation liabilities equity
------ ----------- -------- ------------ ----------- ----------- -------------
Balance at December 31, 2004 $ 297 $1,944,185 $(1,399,118) $ (209,526) $ (99,764) $(29,594) $206,480
Net income - - 53,191 - - - 53,191
Other comprehensive loss - - - - (26,887) - (26,887)
------ ---------- ----------- ----------- --------- -------- --------
Balance at September 30, 2005 $ 297 $1,944,185 $(1,345,927) $ (209,526) $(126,651) $(29,594) $232,784
====== ========== =========== =========== ========= ======== ========
See accompanying notes to consolidated financial statements.
- 7 -
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Cash flows from operating activities:
Net income $312,763 $ 53,191
Depreciation and amortization 27,936 27,608
Noncash interest expense 1,605 1,990
Deferred income taxes (271,690) 32,558
Minority interest 38 9
Net loss from disposition of property and equipment 9 429
Securities transaction gain - (5,439)
Pension cost, net 2,040 (1,082)
Other, net 641 (1,719)
Change in assets and liabilities:
Accounts and other receivables (24,451) (17,636)
Inventories 20,784 (24,990)
Prepaid expenses 1,197 (2,918)
Accounts with affiliates (5,584) (3,795)
Accounts payable and accrued liabilities 18,268 16,595
Income taxes 33,861 (1,904)
Other, net (799) (5,999)
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Net cash provided by operating activities 116,618 66,898
-------- --------
Cash flows from investing activities:
Capital expenditures (18,164) (18,933)
Change in restricted cash, net 409 592
Proceeds from disposal of interest in
Norwegian smelting operation - 3,542
Other, net 83 37
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Net cash used in investing activities (17,672) (14,762)
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Cash flows from financing activities:
Indebtedness:
Borrowings 99,968 -
Principal payments (100,030) (13,055)
Dividends paid (60,000) -
-------- --------
Net cash used in financing activities (60,062) (13,055)
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Cash and cash equivalents - net change from:
Operating, investing and financing activities 38,884 39,081
Currency translation 295 (1,898)
Cash and cash equivalents at beginning of period 37,121 17,505
-------- --------
Cash and cash equivalents at end of period $ 76,300 $ 54,688
======== ========
Supplemental disclosures:
Cash paid (received) for:
Interest, net of amounts capitalized $ 16,583 $ 21,591
Income taxes, net (22,233) 16,672
Noncash investing activity - inventory
received as partial consideration for
disposal of interest in Norwegian
smelting operation $ - $ 1,897
See accompanying notes to consolidated financial statements.
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KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Organization and basis of presentation:
Kronos International, Inc. ("KII") is incorporated in the state of
Delaware, U.S.A., with its seat of management in Leverkusen, Germany. KII is a
wholly-owned subsidiary of Kronos Worldwide, Inc. ("Kronos") (NYSE:KRO). The
Company's sole business segment is associated with the production and sale of
titanium dioxide pigments ("TiO2"). At September 30, 2005, (i) Valhi held
approximately 57% of Kronos' outstanding common stock and NL Industries, Inc.
(NYSE:NL) held an additional 36% of Kronos' common stock, (ii) Valhi owned
approximately 83% of NL's outstanding common stock and (iii) Contran Corporation
and its subsidiaries held approximately 92% of Valhi's outstanding common stock.
Substantially all of Contran's outstanding voting stock is held by trusts
established for the benefit of certain children and grandchildren of Harold C.
Simmons, of which Mr. Simmons is sole trustee, or is held by Mr. Simmons or
persons or other entities related to Mr. Simmons. Consequently, Mr. Simmons may
be deemed to control each of Contran, Valhi, NL, Kronos and the Company.
The consolidated balance sheet of KII at December 31, 2004 has been
condensed from the Company's audited consolidated financial statements at that
date. The consolidated balance sheet at September 30, 2005, and the consolidated
statements of income, comprehensive income, stockholder's equity and cash flows
for the interim periods ended September 30, 2004 and 2005, have been prepared by
the Company, without audit, in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). In the opinion of management,
all adjustments, consisting only of normal recurring adjustments, necessary to
state fairly the consolidated financial position, results of operations and cash
flows have been made.
The results of operations for the interim periods are not necessarily
indicative of the operating results for a full year or of future operations.
Certain information normally included in financial statements prepared in
accordance with GAAP has been condensed or omitted. The accompanying
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31, 2004 (the
"2004 Annual Report").
During the fourth quarter of 2004, the Company determined that it should
have recognized an additional $26.8 million net deferred income tax benefit
during the second quarter of 2004, related to the amount of the valuation
allowance related to the Company's German operations which should have been
reversed. While the additional tax benefit is not material to the Company's
second quarter 2004 results, the Company's year-to-date results of operations
for the nine months ended September 30, 2004, as presented herein, reflects this
additional income tax benefit.
The Company has not issued any stock options to purchase KII common stock.
However, certain employees of the Company have been granted options by NL to
purchase NL common stock. As disclosed in the 2004 Annual Report, the Company
accounts for stock-based employee compensation in accordance with Accounting
Principles Board Opinion ("APBO") No. 25, "Accounting for Stock Issued to
Employees," and its various interpretations. See Note 12. Under APBO No. 25, no
compensation cost is generally recognized for fixed stock options in which the
exercise price is greater than or equal to the market price on the grant date.
- 9 -
Prior to 2004, and following the cash settlement of certain stock options held
by employees of NL and the Company, the Company commenced accounting for its
stock options using the variable accounting method of APBO No. 25 because the
Company could not overcome the presumption that it would not similarly cash
settle the remaining stock options. Under the variable accounting method, the
intrinsic value of all unexercised stock options (including stock options with
an exercise price at least equal to the market price on the date of grant) is
accrued as an expense, with subsequent increases (decreases) in the Company's
market price resulting in the recognition of additional compensation expense
(income). Aggregate compensation expense related to NL stock options held by
employees of the Company was approximately $400,000 and $600,000 in the third
quarter and first nine months of 2004, respectively and aggregate compensation
expense (income) was approximately $300,000 and ($200,000) in the third quarter
and first nine months of 2005, respectively.
The following table presents what the Company's consolidated net income
would have been in the 2004 and 2005 periods presented if the Company and its
subsidiaries had each elected to account for their respective stock-based
employee compensation related to stock options in accordance with the fair
value-based recognition provisions of Statement of Financial Accounting
Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," for all
awards granted subsequent to January 1, 1995.
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2004 2005 2004 2005
---- ---- ---- ----
(In millions)
Net income as reported $ 9.1 $ 6.4 $312.8 $53.2
Adjustments, net of applicable income
tax effects and minority interest:
Stock-based employee compensation
expense determined under APBO
No. 25 .3 .2 .4 (.1)
Stock-based employee compensation
expense determined under SFAS
No. 123 - - - -
------ ----- ------ -----
Pro forma net income $ 9.4 $ 6.6 $313.2 $53.1
====== ===== ====== =====
Note 2 - Accounts and other receivables:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Trade receivables $120,969 $122,380
Insurance claims 32 21
Recoverable VAT and other receivables 11,388 9,499
Allowance for doubtful accounts (1,660) (1,446)
-------- --------
$130,729 $130,454
======== ========
- 10 -
Note 3 - Inventories:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Raw materials $ 34,303 $ 34,033
Work in process 13,044 16,004
Finished products 90,083 94,674
Supplies 32,831 30,762
-------- --------
$170,261 $175,473
======== ========
Note 4 - Accounts payable and accrued liabilities:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Accounts payable $ 67,463 $ 48,898
Employee benefits 27,863 28,460
Interest 152 10,224
Other 31,471 40,544
-------- --------
$126,949 $128,126
======== ========
Note 5 - Long-term debt:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
8.875% Senior Secured Notes $519,225 $457,572
Bank credit facility 13,622 -
Other 348 206
-------- --------
533,195 457,778
Less current maturities 13,792 158
-------- --------
$519,403 $457,620
======== ========
As previously reported in the 2004 Annual Report, the Company has pledged
65% of the common stock or other ownership interests of certain of its
first-tier operating subsidiaries as collateral for its Senior Secured Notes.
Such operating subsidiaries are Kronos Titan GmbH, Kronos Denmark ApS, Kronos
Limited and Societe Industrielle Du Titane, S.A.
During the first nine months of 2005, the Company repaid an aggregate of
euro 10 million ($12.9 million when repaid) under its Credit Facility. During
the second quarter of 2005, the Company extended the maturity date of its Credit
Facility by three years to June 2008.
- 11 -
Note 6 - Other noncurrent liabilities:
December 31, September 30,
2004 2005
------------ -------------
(In thousands)
Employee benefits $ 5,107 $ 4,615
Insurance claims and expenses 1,505 955
Asset retirement obligations 958 941
Other 9,270 6,296
-------- --------
$ 16,840 $ 12,807
======== ========
Note 7 - Notes receivable from affiliate:
As disclosed in the 2004 Annual Report, the Company loaned an aggregate of
euro 163.1 million ($209.5 million) to Kronos in the fourth quarter of 2004 in
return for two promissory notes. Interest on both notes is payable to the
Company on a quarterly basis at an annual rate of 9.25%, and such interest is
expected to be paid quarterly to the Company by Kronos. The notes mature on
December 31, 2010, with all principal due at that date. The notes are unsecured,
contain no financial covenants and provide for default only upon Kronos' failure
to pay any amount when due (subject to a short grace period). Due to the
long-term investment nature of these notes, settlement of the principal balance
of the notes is not contemplated within the foreseeable future. The Company
currently expects that settlement of the principal amount of the notes will
occur through a capital transaction (i.e. a non-cash dividend to Kronos in the
form of distributing such notes receivable to Kronos). Accordingly, these notes
receivable have been classified as a separate component of stockholder's equity
in accordance with GAAP. Interest income on such notes, which is expected to be
paid quarterly, is recognized in income when earned. Rather than make a
distribution to Kronos in the form of a cash dividend, the Company loaned the
euro 163.1 million to Kronos pursuant to the two promissory notes. Until such
time as the notes are settled (which, as noted above, is expected to be through
a capital transaction in the form of a non-cash dividend), the Company benefits
from the interest income earned on the promissory notes.
Note 8 - Securities transaction gain:
A securities transaction gain in the second quarter of 2005, classified as
nonoperating income, relates to the sale of the Company's passive interest in a
Norwegian smelting operation, which had a nominal carrying value for financial
reporting purposes, for aggregate consideration of approximately $5.4 million
consisting of cash of $3.5 million and inventory with a value of $1.9 million.
- 12 -
Note 9 - Provision for income taxes:
Nine months ended
September 30,
------------------------
2004 2005
---- ----
(In millions)
Expected tax expense $ 18.3 $ 35.0
Non-U.S. tax rates (.3) .4
Loss of German tax attribute - 17.5
Tax contingency reserve adjustment - (8.7)
Change in deferred income tax valuation -
allowance, net (277.3)
Refund of prior year German income taxes (3.3) (.2)
Nondeductible expenses 2.1 2.6
Other, net .1 .1
------ ------
$(260.4) $ 46.7
======= ======
Certain of the Company's tax returns are being examined and tax authorities
have or may propose tax deficiencies, including penalties and interest. For
example:
o The Company received a preliminary tax assessment related to 1993 from the
Belgian tax authorities proposing tax deficiencies, including related
interest, of approximately euro 6 million ($7 million at September 30,
2005). The Company filed a protest to this assessment, and believed that a
significant portion of the assessment is without merit. The Belgian tax
authorities have filed a lien on the fixed assets of the Company's Belgian
TiO2 operations in connection with this assessment. In April 2003, the
Company received a notification from the Belgian tax authorities of their
intent to assess a tax deficiency related to 1999 that, including interest,
would have aggregated approximately euro 9 million ($11 million). The
Company filed a written response to the assessment, and in September 2005
the Belgian tax authorities withdrew the assessment.
o The Norwegian tax authorities have notified the Company of their intent to
assess tax deficiencies of approximately kroner 12 million ($2 million)
relating to the years 1998 through 2000. The Company has objected to this
proposed assessment.
During the third quarter of 2005, the Company reached an agreement in
principle with the German tax authorities regarding such tax authorities'
objection to the value assigned to certain intellectual property rights held by
the Company's operating subsidiary in Germany. Under the agreement in principle,
the value assigned to such intellectual property for German income tax purposes
will be reduced retroactively, resulting in a reduction in the amount of the
Company's net operating loss carryforward in Germany as well as a future
reduction in the amount of amortization expense attributable to such
intellectual property. As a result, the Company recognized a $17.5 million
non-cash deferred income tax expense in the third quarter of 2005 related to
such agreement. The $8.7 million tax contingency adjustment income tax benefit
in the first nine months of 2005 relates primarily to the withdrawal of the
Belgium tax authorities' withdrawal of its assessment related to 1999, as
discussed above.
- 13 -
No assurance can be given that these tax matters will be resolved in the
Company's favor in view of the inherent uncertainties involved in settlement
initiatives and court and tax proceedings. The Company believes that it has
provided adequate accruals for additional taxes and related interest expense
which may ultimately result from all such examinations and believes that the
ultimate disposition of such examinations should not have a material adverse
effect on its consolidated financial position, results of operations or
liquidity.
In October 2004, the American Jobs Creation Act of 2004 was enacted into
law. The new law provided for a special 85% deduction for certain dividends
received from a controlled foreign corporation in 2005. In the third quarter of
2005, the Company completed its evaluation of this new provision and determined
that it would not benefit from such special dividends received deduction. As
disclosed in the 2004 Annual Report, the Company does not provide U.S. deferred
income taxes or foreign withholding taxes with respect to undistributed earnings
of foreign subsidiaries that the Company intends to permanently reinvest for the
foreseeable future.
Note 10 - Employee benefit plans:
The components of net periodic defined benefit pension cost are presented
in the table below.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Service cost $ 1,431 $ 1,562 $ 3,877 $ 4,701
Interest cost 3,462 3,416 10,472 10,678
Expected return on plan assets (3,054) (2,968) (9,235) (9,272)
Amortization of prior service cost 114 117 343 365
Amortization of net transition obligations 89 (77) 271 81
Recognized actuarial losses 572 741 1,726 2,305
------- ------- ------- -------
$ 2,614 $ 2,791 $ 7,454 $ 8,858
======= ======= ======= =======
Note 11 - Commitments and contingencies:
Reference is made to the 2004 Annual Report for a discussion of certain
other legal proceedings to which the Company is a party.
As noted in the 2004 Annual Report, the Company's principal German
operating subsidiary, Kronos Titan GmbH, leases the land under its Leverkusen
TiO2 production facility pursuant to a lease with Bayer AG that expires in 2050.
The Leverkusen facility itself, which is owned by the Company and which
represents approximately one-half of the Company's current TiO2 production
capacity, is located within Bayer's extensive manufacturing complex. Rent for
the land lease associated with the Leverkusen facility is periodically
established by agreement with Bayer for periods of at least two years at a time.
The lease agreement provides for no formula, index or other mechanism to
determine changes in the rent for such land lease; rather, any change in the
rent is subject solely to periodic negotiation between Bayer and the Company.
Any change in the rent based on such negotiations is recognized as part of lease
expense starting from the time such change is agreed upon by both parties, as
any such change in the rent is deemed "contingent rentals" under GAAP.
The Company and its affiliates are from time to time involved in various
environmental, contractual, product liability, patent (or intellectual
property), employment and other claims and disputes incidental to its past and
current operations. In certain cases, the Company has insurance coverage for
- 14 -
such items. The Company currently believes that the disposition of all claims
and disputes, individually or in the aggregate, should not have a material
adverse effect on its consolidated financial position, results of operations or
liquidity.
Note 12 - Accounting principles not yet implemented:
Inventory costs. The Company will adopt SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," for inventory costs incurred on or after
January 1, 2006. SFAS No. 151 requires that the allocation of fixed production
overhead costs to inventory shall be based on normal capacity. Normal capacity
is not defined as a fixed amount; rather, normal capacity refers to a range of
production levels expected to be achieved over a number of periods under normal
circumstances, taking into account the loss of capacity resulting from planned
maintenance shutdowns. The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of idle plant or production levels
below the low end of normal capacity, but instead a portion of fixed overhead
costs is charged to expense as incurred. Alternatively, in periods of production
above the high end of normal capacity, the amount of fixed overhead costs
allocated to each unit of production is decreased so that inventories are not
measured above cost. SFAS No. 151 also clarifies existing GAAP to require that
abnormal freight and wasted materials (spoilage) are to be expensed as incurred.
The Company believes its production cost accounting already complies with the
requirements of SFAS No. 151, and the Company does not expect adoption of SFAS
No. 151 will have a material effect on its consolidated financial statements.
Stock options. As permitted by regulations of the Securities and Exchange
Commission ("SEC") the Company will adopt SFAS No. 123R, "Share-Based Payment,"
as of January 1, 2006. SFAS No. 123R, among other things, eliminates the
alternative in existing GAAP to use the intrinsic value method of accounting for
stock-based employee compensation under APBO No. 25. Upon adoption of SFAS No.
123R, the Company will generally be required to recognize the cost of employee
services received in exchange for an award of equity instruments based on the
grant-date fair value of the award, with the cost recognized over the period
during which an employee is required to provide services in exchange for the
award (generally, the vesting period of the award). No compensation cost will be
recognized in the aggregate for equity instruments for which the employee does
not render the requisite service (generally, if the instrument is forfeited
before it has vested). The grant-date fair value will be estimated using
option-pricing models (e.g. Black-Scholes or a lattice model). Under the
transition alternatives permitted under SFAS No. 123R, the Company will apply
the new standard to all new awards granted on or after January 1, 2006, and to
all awards existing as of December 31, 2005 which are subsequently modified,
repurchased or cancelled. Additionally, as of January 1, 2006, the Company will
be required to recognize compensation cost for the portion of any non-vested
award existing as of December 31, 2005 over the remaining vesting period.
Because the number of non-vested awards as of December 31, 2005 with respect to
options granted by NL to employees of the Company is not expected to be
material, and because the Company has not granted any options, does not expect
to grant any options prior to January 1, 2006 and does not expect that Kronos
will grant any options to employees of the Company prior to January 1, 2006, the
effect of adopting SFAS No. 123R is not expected to be significant in so far as
it relates to existing stock options. Should the Company or its subsidiaries and
affiliates, however, either grant a significant number of options to employees
of the Company or modify, repurchase or cancel existing options in the future,
the effect on the Company's consolidated financial statements could be material.
- 15 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Executive summary
Relative changes in the Company's TiO2 sales and income from operations
during the 2004 and 2005 periods presented are primarily due to the net effects
of (i) higher average TiO2 selling prices, (ii) lower TiO2 selling volumes and
(iii) relative changes in foreign currency exchange rates. Selling prices for
TiO2 (in billing currencies) were generally decreasing during the first half of
2004, increasing during the last half of 2004 and the first six months of 2005
and decreasing during the third quarter of 2005. The Company reported net income
of $6.4 million in the third quarter of 2005 as compared to net income of $9.1
million in the third quarter of 2004. The Company reported net income of $53.2
million in the first nine months of 2005 as compared to net income of $312.8
million in the first nine months of 2004. The Company reported lower net income
in 2005 as the favorable effect of higher income from operations and a security
transaction gain in 2005 was more than offset by a $254.3 million non-cash
income tax benefit recognized in 2004. Net income in the first nine months of
2005 includes (i) a net third quarter non-cash income tax charge of
approximately $8.8 million for recent developments with respect to income tax
audits in Germany and Belgium and (ii) a security transaction gain of
approximately $5.4 million related to the sale of the Company's passive interest
in a Norwegian smelting operation. Each of these items is more fully discussed
below and/or in the notes to the Consolidated Financial Statements.
Forward-looking information
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that the statements in this
Quarterly Report on Form 10-Q relating to matters that are not historical facts
are forward-looking statements that represent management's beliefs and
assumptions based on currently available information. Forward-looking statements
can be identified by the use of words such as "believes," "intends," "may,"
"should," "could," "anticipates," "expected" or comparable terminology, or by
discussions of strategies or trends. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
cannot give any assurances that these expectations will prove to be correct.
Such statements by their nature involve substantial risks and uncertainties that
could significantly impact expected results, and actual future results could
differ materially from those described in such forward-looking statements. While
it is not possible to identify all factors, the Company continues to face many
risks and uncertainties. Factors that could cause actual future results to
differ materially from those described herein are the risks and uncertainties
discussed in this Quarterly Report and those described from time to time in the
Company's other filings with the SEC include, but are not limited to, the
following:
o Future supply and demand for the Company's products,
o The extent of the dependence of certain of the Company's businesses on
certain market sectors,
o The cyclicality of the Company's business,
o Customer inventory levels (such as the extent to which the Company's
customers may, from time to time, accelerate purchases of TiO2 in advance
of anticipated price increases or defer purchases of TiO2 in advance of
anticipated price decreases),
- 16 -
o Changes in raw material and other operating costs (such as energy costs),
o The possibility of labor disruptions,
o General global economic and political conditions (such as changes in the
level of gross domestic product in various regions of the world and the
impact of such changes on demand for TiO2),
o Competitive products and substitute products,
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o Competitive technology positions,
o The introduction of trade barriers,
o Fluctuations in currency exchange rates (such as changes in the exchange
rate between the U.S. dollar and each of the euro, the Norwegian kroner and
the Canadian dollar),
o Operating interruptions (including, but not limited to, labor disputes,
leaks, fires, explosions, unscheduled or unplanned downtime and
transportation interruptions),
o The ability of the Company to renew or refinance credit facilities,
o The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of which
has been recognized under the "more-likely-than-not" recognition criteria,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
o Government laws and regulations and possible changes therein,
o The ultimate resolution of pending litigation, and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecasted or expected. The
Company disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of changes in information, future
events or otherwise.
- 17 -
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------------
2004 2005 % Change 2004 2005 % Change
---- ---- -------- ---- ---- --------
(In millions, except percentages and volumes)
Net sales $203.4 $206.0 +1% $603.7 $643.1 +7%
Cost of sales 156.1 150.8 -3% 455.0 455.0 **
------ ------ ------ ------
Gross margin 47.3 55.2 +17% 148.7 188.1 +26%
Selling, general and
administrative expense (25.0) (26.5) +6% (75.8) (82.5) +9%
Currency transaction gains
(losses), net (.4) .2 .1 2.4
Royalty income 1.5 1.7 4.6 5.1
Other income .1 - .2 -
------ ------ ------ ------
Income from operations $ 23.5 $ 30.6 +30% $ 77.8 $113.1 +45%
====== ====== ====== ======
TiO2 operating statistics:
Percent change in average
selling prices:
Using actual foreign
currency exchange
rates +6% +11%
Impact of changes in
foreign currency
exchange rates -1% -6%
---- ----
In billing currencies +5% +5%
==== ====
Sales volumes* 85 82 -4% 256 244 -5%
Production volumes* 84 83 -1% 246 250 +2%
________________________________
* Thousands of metric tons
** less than 1%
The Company's sales increased $2.6 million (1%) in the third quarter of
2005 compared to the third quarter of 2004 and increased $39.4 million (7%) in
the first nine months of 2005 as compared to the same period in 2004 due
primarily to the net effects of higher average TiO2 selling prices, lower TiO2
selling volumes and the favorable effect of fluctuations in foreign currency
exchange rates, which increased sales by approximately $2 million and $22
million in the quarter and year-to-date periods, respectively, as further
discussed below. Excluding the effect of fluctuations in the value of the U.S.
dollar relative to other currencies, the Company's average TiO2 selling prices
in billing currencies in each of the third quarter and first nine months of 2005
were 5% higher as compared to the third quarter and the first nine months of
2004. When translated from billing currencies to U.S. dollars using actual
foreign currency exchange rates prevailing during the respective periods, the
Company's average TiO2 selling prices in the third quarter of 2005 increased 6%
compared to the third quarter of 2004 and were 11% higher for the first nine
months of 2005 compared to the first nine months of 2004.
- 18 -
The Company's sales are denominated in various currencies, including the
U.S. dollar, the euro and other major European currencies. The disclosure of the
percentage change in the Company's average TiO2 selling prices in billing
currencies (which excludes the effects of fluctuations in the value of the U.S.
dollar relative to other currencies) is considered a "non-GAAP" financial
measure under regulations of the SEC. The disclosure of the percentage change in
the Company's average TiO2 selling prices using actual foreign currency exchange
rates prevailing during the respective periods is considered the most directly
comparable financial measure presented in accordance with GAAP ("GAAP measure").
The Company discloses percentage changes in its average TiO2 prices in billing
currencies because the Company believes such disclosure provides useful
information to investors to allow them to analyze such changes without the
impact of changes in foreign currency exchange rates, thereby facilitating
period-to-period comparisons of the relative changes in average selling prices
in the actual various billing currencies. Generally, when the U.S. dollar either
strengthens or weakens against other currencies, the percentage change in
average selling prices in billing currencies will be higher or lower,
respectively, than such percentage changes would be using actual exchange rates
prevailing during the respective periods. The difference between the 6% and 11%
increases in the Company's average TiO2 selling prices during the third quarter
and first nine months of 2005 as compared to the third quarter and first nine
months of 2004 using actual foreign currency exchange rates prevailing during
the respective periods (the GAAP measure), and the 5% increases in the Company's
average TiO2 selling prices in billing currencies (the non-GAAP measure) during
each of such periods is due to the effect of changes in foreign currency
exchange rates. The above table presents in a tabular format (i) the percentage
change in the Company's average TiO2 selling prices using actual foreign
currency exchange rates prevailing during the respective periods (the GAAP
measure), (ii) the percentage change in the Company's average TiO2 selling
prices in billing currencies (the non-GAAP measure) and (iii) the percentage
change due to changes in foreign currency exchange rates (or the reconciling
item between the non-GAAP measure and the GAAP measure).
The Company's TiO2 sales volumes in the third quarter and first nine months
of 2005 decreased 4% and 5%, respectively, compared to the same periods of 2004,
due primarily to lower volumes in European markets. The Company's production
levels decreased 1% and increased 2% respectively, in the third quarter and
first nine months of 2005 as compared to the same periods in 2004. The Company's
operating rates were near full capacity in those periods, and the Company's
production volume in the first nine months of 2005 was a new record for the
Company for a first nine-month period.
The Company's cost of sales decreased $5.3 million (3%) in the third
quarter of 2005 compared to the third quarter of 2004, and decreased less than
1% in the year-to-date period largely due to the lower sales volumes in the 2005
periods as compared to the corresponding periods in 2004. As a result of the
higher average TiO2 selling prices in billing currencies, the Company's cost of
sales, as a percentage of net sales, decreased from 77% in the third quarter of
2004 to 73% in the third quarter of 2005 and decreased from 75% in the first
nine months of 2004 to 71% in the first nine months of 2005.
The Company's gross margins for the third quarter of 2005 increased $7.9
million (17%) from the third quarter of 2004 and increased $39.4 million (26%)
in the first nine months of 2005 as compared to the first nine months of 2004,
due to the net effects of the aforementioned increases in sales.
Selling, general and administrative expenses increased $1.5 million (6%)
and $6.7 million (9%), respectively, in the third quarter and first nine months
of 2005 as compared to the corresponding periods in 2004. These increases are
- 19 -
largely attributable to the impact of translating foreign currencies (primarily
the euro) into U.S. dollars.
The Company's operations and assets are located outside the United States
(particularly in Germany, Belgium and Norway). A significant amount of the
Company's sales generated from its operations are denominated in currencies
other than the U.S. dollar, principally the euro and other major European
currencies. Certain raw materials, primarily titanium-containing feedstocks, are
purchased in U.S. dollars, while labor and other production costs are
denominated primarily in local currencies. Consequently, the translated U.S.
dollar value of the Company's foreign sales and operating results are subject to
currency exchange rate fluctuations which may favorably or adversely impact
reported earnings and may affect the comparability of period-to-period operating
results. Overall, fluctuations in the value of the U.S. dollar relative to other
currencies, primarily the euro, increased TiO2 sales by approximately a net $2
million in the third quarter of 2005 as compared to the same period in 2004 and
increased TiO2 sales in the first nine months of 2005 by approximately $22
million compared to the same period in 2004. Fluctuations in the value of the
U.S. dollar relative to other currencies similarly impacted the Company's
foreign currency-denominated operating expenses. The Company's operating costs
that are not denominated in the U.S. dollar, when translated into U.S. dollars,
were higher in the third quarter and first nine months of 2005 compared to the
third quarter and first nine months of 2004. Overall, the net impact of currency
exchange rate fluctuations on the Company's operating income comparisons were
not significant in the third quarter of 2005 compared to the same period in 2004
and resulted in a net $5 million increase in the Company's income from
operations in the first nine months of 2005 as compared to the corresponding
period in 2004.
Outlook
The Company expects its income from operations in 2005 will be
significantly higher than 2004, due primarily to higher overall average selling
prices on a year-to-year comparison basis. The Company's expectations as to the
future prospects of the Company and the TiO2 industry are based upon a number of
factors beyond the Company's 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 the Company's expectations, the Company's results of
operations could be unfavorably affected.
The Company's efforts to debottleneck its production facilities to meet
long-term demand continue to prove successful. Such debottlenecking efforts
included, among other things, the addition of finishing capacity in the German
facility and equipment upgrades and enhancements in several locations to allow
for reduced downtime for maintenance activities. The Company's production
capacity has increased by approximately 30% over the past ten years due to
debottlenecking programs, with only moderate capital expenditures. The Company
believes its annual attainable production capacity for 2005 is approximately
334,000 metric tons, with approximately 10,000 metric tons additional capacity
expected to be available in 2006 through its continued debottlenecking efforts.
- 20 -
Other income (expense)
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------------
2004 2005 Difference 2004 2005 Difference
---- ---- ---------- ---- ---- ----------
(In millions, except percentages and volumes)
Trade interest income $ .3 $ .2 $ (.1) $ .7 $ .4 $ (.3)
Securities transaction gain - - - - 5.4 5.4
Interest income from affiliates - 4.6 4.6 - 14.4 14.4
Interest expense (8.5) (10.6) (2.1) (26.0) (33.4) (7.4)
------ ------ ------ ------ ------ ------
$ (8.2) $ (5.8) $ 2.4 $(25.3) $(13.2) $ 12.1
====== ====== ====== ====== ====== ======
Securities transaction gain in the second quarter of 2005 relates to the
sale of the Company's passive interest in a Norwegian smelting operation, which
had a nominal carrying value for financial reporting purposes, for aggregate
consideration of approximately $5.4 million consisting of cash of $3.5 million
and inventory with a value of $1.9 million. See Note 8 to the Consolidated
Financial Statements.
Interest income from affiliates increased $4.6 million in the third quarter
of 2005 as compared to the third quarter of 2004 and increased $14.4 million in
the first nine months of 2005 as compared to the first nine months of 2004 as a
result of the Company's notes receivable from Kronos. See Note 7 to the
Consolidated Financial Statements. The Company expects interest income will
continue to be higher in 2005 as compared to 2004 as these notes receivable from
Kronos are expected to be outstanding during the full year.
The Company has a significant amount of outstanding indebtedness
denominated in the euro, including its euro 375 million Senior Secured Notes.
Accordingly, the reported amount of interest expense will vary depending on
relative changes in foreign currency exchange rates. Interest expense in the
third quarter and first nine months of 2005 was $10.6 million and $33.4 million,
respectively, or $2.1 million and $7.4 million higher than the respective
periods of 2004. The increases were due primarily to higher levels of
outstanding indebtedness resulting from the issuance of an additional euro 90
million principal amount of KII's Senior Secured Notes in November 2004. In
addition, the increases in interest expense were due to relative changes in
foreign currency exchange rates, which increased the U.S. dollar equivalent of
interest expense on the Company's euro 285 million Senior Secured Notes
outstanding during both periods by approximately $100,000 in the third quarter
of 2005 and $1.0 million in the first nine months of 2005 as compared to the
third quarter and first nine months of 2004. Assuming no significant change in
interest rates or foreign currency exchange rates, interest expense for the
full-year 2005 is expected to be higher than amounts for the same periods in
2004 due primarily to the effect of the additional euro 90 million Senior
Secured Notes issued in November 2004.
Provision for income taxes
The principal reasons for the difference between the Company's effective
income tax rates and the U.S. federal statutory income tax rates are explained
in Note 9 to the Consolidated Financial Statements.
At September 30, 2005, the Company has the equivalent of $564 million and
$146 million of income tax loss carryforwards for German corporate and trade tax
purposes, respectively, all of which have no expiration date. As more fully
described in the 2004 Annual Report, during 2004 the Company concluded the
- 21 -
benefit of such net carryforwards met the "more-likely-than-not"
recognition criteria of GAAP, and accordingly in 2004 the Company reversed the
deferred income tax asset valuation allowance related to such German
carryforwards and other net deductible temporary differences related to Germany.
Prior to the complete utilization of such carryforwards, it is possible that the
Company might conclude in the future that the benefit of such carryforwards
would no longer meet the "more-likely-than-not" recognition criteria, at which
point the Company would be required to recognize a valuation allowance against
the then-remaining tax benefit associated with the carryforwards. The Company's
income tax benefit in the first nine months of 2004 includes a $277.3 million
tax benefit related to reversal of the German deferred income tax asset
valuation allowance (including the $268.6 million tax benefit recognized in the
second quarter of 2004).
Accounting principles not yet implemented
See Note 12 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES:
Consolidated cash flows
The Company's consolidated cash flows from operating, investing and
financing activities for the nine months ended September 30, 2004 and 2005 are
presented below:
Nine months ended
September 30,
----------------------------
2004 2005
---- ----
(In millions)
Net cash provided (used) by:
Operating activities $116.6 $ 66.9
Investing activities (17.7) (14.8)
Financing activities (60.0) (13.0)
------ ------
Net cash provided by operating,
investing and financing activities $ 38.9 $ 39.1
====== ======
Summary
The Company's primary source of liquidity on an ongoing basis is its cash
flows from operating activities, which is generally used to (i) fund capital
expenditures, (ii) repay any short-term indebtedness incurred primarily for
working capital purposes and (iii) provide for the payment of dividends. In
addition, from time-to-time the Company may incur indebtedness, generally to (i)
fund short-term working capital needs, (ii) refinance existing indebtedness or
(iii) fund major capital expenditures or the acquisition of other assets outside
the ordinary course of business. Also, the Company may from time-to-time sell
assets outside the ordinary course of business, the proceeds of which are
generally used to (i) repay existing indebtedness (including indebtedness which
may have been collateralized by the assets sold), (ii) make investments in
marketable and other securities, (iii) fund major capital expenditures or the
acquisition of other assets outside the ordinary course of business or (iv) pay
dividends.
Operating activities
The TiO2 industry is cyclical and changes in economic conditions within the
industry significantly impact the earnings and operating cash flows of the
Company. Cash flow from operations is considered the primary source of liquidity
- 22 -
for the Company. Changes in TiO2 pricing, production volume and customer demand,
among other things, could significantly affect the liquidity of the Company.
Trends in cash flows from operating activities (excluding the impact of
significant asset dispositions and relative changes in assets and liabilities)
are generally similar to trends in the Company's earnings. However, certain
items included in the determination of net income are non-cash, and therefore
such items have no impact on cash flows from operating activities. Non-cash
items included in the determination of net income include depreciation and
amortization expense, deferred income taxes and non-cash interest expense.
Non-cash interest expense consists of amortization of original issue discount or
premium on certain indebtedness and amortization of deferred financing costs.
Certain other items included in the determination of net income may have an
impact on cash flows from operating activities, but the impact of such items on
cash flows from operating activities will differ from their impact on net
income. For example, the amount of periodic defined benefit pension plan expense
depends upon a number of factors, including certain actuarial assumptions, and
changes in such actuarial assumptions will result in a change in the reported
expense. In addition, the amount of such periodic expense generally differs from
the outflows of cash required to be currently paid for such benefits.
Relative changes in assets and liabilities generally result from the timing
of production, sales, purchases and income tax payments. Such relative changes
can significantly impact the comparability of cash flow from operations from
period to period, as the income statement impact of such items may occur in a
different period from when the underlying cash transaction occurs. For example,
raw materials may be purchased in one period, but the payment for such raw
materials may occur in a subsequent period. Similarly, inventory may be sold in
one period, but the cash collection of the receivable may occur in a subsequent
period.
Cash flows provided by operating activities decreased from $116.6 million
in the first nine months of 2004 to $66.9 million in the first nine months of
2005. This $49.7 million decrease was due primarily to the net effects of (i)
lower net income of $259.6 million, (ii) higher deferred income taxes of $304.2
million, (iii) a higher amount of net cash used from relative changes in the
Company's inventories, receivables, payables and accruals of $38.8 million in
the first nine months of 2005 as compared to the first nine months of 2004 and
(iv) higher cash paid for income taxes of $38.9 million, due in large part to an
aggregate $33.5 million of tax refunds received during the first nine months of
2004. Relative changes in accounts receivable are affected by, among other
things, the timing of sales and the collection of the resulting receivables.
Relative changes in inventories and accounts payable and accrued liabilities are
affected by, among other things, the timing of raw material purchases and the
payment for such purchases and the relative difference between production
volumes and sales volumes. The Company's average days sales outstanding ("DSO")
of 57 days at September 30, 2005 was consistent with the Company's DSO at
December 31, 2004. At September 30, 2005, the average number of days in
inventory ("DII") increased from 99 days at December 31, 2004 to 105 days at
September 30, 2005, due to the effects of higher production volume and lower
sales volume.
- 23 -
Investing and financing activities
The Company's capital expenditures were $18.2 million and $18.9 million in
the first nine months of 2004 and 2005, respectively. During the second quarter
of 2005, the Company received $3.5 million from the sale of its passive interest
in a Norwegian smelting operation.
During the first nine months of 2005, the Company repaid euro 10 million
($12.9 million when repaid) under its Credit Facility.
At September 30, 2005, unused credit available under the Company's existing
credit facilities approximated $99 million, including approximately $96 million
under its revolving credit facility. At September 30, 2005, KII had
approximately $89 million allowed for payment of dividends and other restrictive
payments as permitted by the provisions of the Senior Secured Notes indenture.
Provisions contained in certain of the Company's credit agreements could
result in the acceleration of the applicable indebtedness prior to its stated
maturity for reasons other than defaults from failing to comply with typical
financial covenants. For example, certain credit agreements allow the lender to
accelerate the maturity of the indebtedness upon a change of control (as
defined) of the borrower. In addition, certain credit agreements could result in
the acceleration of all or a portion of the indebtedness following a sale of
assets outside the ordinary course of business. Other than operating leases
discussed in the 2004 Annual Report, neither the Company nor any of its
subsidiaries or affiliates are parties to any off-balance sheet financing
arrangements.
Other
At September 30, 2005, the Company and its subsidiaries had (i) current
cash and cash equivalents aggregating $54.7 million, (ii) current restricted
cash equivalents of $900,000 and (iii) noncurrent restricted marketable debt
securities of $2.7 million.
At September 30, 2005, the Company's outstanding debt was comprised of (i)
$457.6 million related to KII's Senior Secured Notes and (ii) approximately
$200,000 of other indebtedness. During the second quarter of 2005, the Company
extended the maturity date of its Credit Facility by three years to June 2008.
The Company's assets consist primarily of investments in its operating
subsidiaries, and the Company's ability to service its parent level obligations,
including the Senior Secured Notes, depends in large part upon the distribution
of earnings of its subsidiaries, whether in the form of dividends, advances or
payments on account of intercompany obligations, or otherwise. None of the
Company's subsidiaries have guaranteed the Senior Secured Notes, although the
Company has pledged 65% of the common stock or other ownership interest of
certain of its first-tier operating subsidiaries as collateral of such Senior
Secured Notes.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact the Company's earnings and operating
cash flows. Cash flows from operations is considered the primary source of
liquidity for the Company. Changes in TiO2 pricing, production volumes and
customer demand, among other things, could significantly affect the liquidity of
the Company.
- 24 -
Based upon the Company's expectations for the TiO2 industry and anticipated
demand for the Company's cash resources as discussed herein, the Company expects
to have sufficient short-term (defined as the twelve-month period ending
September 30, 2006) and long-term (defined as the five-year period ending
December 31, 2009, the time period for which the Company generally does
long-term budgeting) liquidity to meet its obligations including operations,
capital expenditures, debt service and dividends. To the extent that actual
developments differ from the Company's expectations, the Company's liquidity
could be adversely affected.
See Note 9 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of the Company's income
tax returns in various jurisdictions, and see Note 11 to the Consolidated
Financial Statements for discussion of legal proceedings with respect to the
Company.
The Company periodically evaluates its liquidity requirements, alternative
uses of capital, capital needs and availability of resources in view of, among
other things, its dividend policy, its debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, the Company has in the past and may in the future seek to reduce,
refinance, repurchase or restructure indebtedness, raise additional capital,
modify its dividend policy, restructure ownership interests, sell interests in
subsidiaries or other assets, or take a combination of such steps or other steps
to manage its liquidity and capital resources. In the normal course of its
business, the Company may review opportunities for acquisitions, divestitures,
joint ventures or other business combinations in the chemicals or other
industries, as well as the acquisition of interests in, and loans to, related
entities. In the event of any such transaction, the Company may consider using
its available cash, issuing its equity securities or increasing its indebtedness
to the extent permitted by the agreements governing the Company's existing debt.
The Company's operations are located outside the United States where the
functional currency is not the U.S. dollar. As a result, the reported amounts of
the Company's assets and liabilities related to its non-U.S. operations, and
therefore the Company's consolidated net assets, will fluctuate based upon
changes in currency exchange rates.
Non-GAAP financial measures
In an effort to provide investors with additional information regarding the
Company's results of operations as determined by GAAP, the Company has disclosed
certain non-GAAP information which the Company believes provides useful
information to investors.
o The Company discloses percentage changes in its average TiO2 selling prices
in billing currencies, which excludes the effects of foreign currency
translation. The Company believes disclosure of such percentage changes
allows investors to analyze such changes without the impact of changes in
foreign currency exchange rates, thereby facilitating period-to-period
comparisons of the relative changes in average selling prices in the actual
various billing currencies. Generally, when the U.S. dollar either
strengthens or weakens against other currencies, the percentage change in
average selling prices in billing currencies will be higher or lower,
respectively, than such percentage changes would be using actual exchange
rates prevailing during the respective periods. See page 18.
- 25 -
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company maintains a
system of disclosure controls and procedures. The term "disclosure controls and
procedures," as defined by regulations of the SEC, means controls and other
procedures that are designed to ensure that information required to be disclosed
in the reports that the Company files or submits to the SEC under the Securities
Exchange Act of 1934, as amended (the "Act"), is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits to the SEC under the Act is
accumulated and communicated to the Company's management, including its
principal executive officer and its principal financial officer, or persons
performing similar functions, as appropriate to allow timely decisions to be
made regarding required disclosure. Each of Harold C. Simmons, the Company's
Chief Executive Officer, and Gregory M. Swalwell, the Company's Vice President,
Finance and Chief Financial Officer, has evaluated the Company's disclosure
controls and procedures as of September 30, 2005. Based upon their evaluation,
these executive officers have concluded that the Company's disclosure controls
and procedures are effective as of the date of such evaluation.
Internal Control Over Financial Reporting. The Company also maintains
internal control over financial reporting. The term "internal control over
financial reporting," as defined by regulations of the SEC, means a process
designed by, or under the supervision of, the Company's principal executive and
principal financial officers, or persons performing similar functions, and
effected by the Company's board of directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with GAAP, and includes those policies and procedures that:
o Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the assets of the
Company,
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and
that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company,
and
o Provide reasonable assurance regarding prevention or timely detection of an
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the Company's Consolidated Financial
Statements.
There has been no change to the Company's internal control over financial
reporting during the quarter ended September 30, 2005 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
Reference is made to the 2004 Annual Report and Note 11 to the Consolidated
Financial Statements for descriptions of certain legal proceedings.
- 26 -
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
The Company has retained a signed original of any of the above exhibits
that contains signatures, and the Company will provide such exhibit to the
Commission or its staff upon request. The Company will also furnish, without
charge, a copy of Kronos' Code of Business Conduct and Ethics, its Audit
Committee Charter and its Corporate Governance Guidelines, each as adopted by
Kronos' board of directors, upon request. Such requests should be directed to
the attention of Kronos' Corporate Secretary at Kronos' corporate offices
located at 5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240.
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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 INTERNATIONAL, INC.
----------------------------
(Registrant)
Date November 3, 2005 By /s/ Gregory M. Swalwell
---------------- ------------------------------
Gregory M. Swalwell
Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
Date November 3, 2005 By /s/ James W. Brown
---------------- ------------------------------
James W. Brown
Vice President and Controller
(Principal Accounting Officer)
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