SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 - For the fiscal year ended December 31, 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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Securities registered pursuant to Section 12(b) of the Act:
None.
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark:
If the Registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act. Yes No X
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If the Registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes No X
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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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Whether the Registrant is a large accelerated filer, an accelerated filer
or a non-accelerated filer (as defined in Rule 12b-2 of the Act). Large
accelerated filer Accelerated filer Non-accelerated filer X
--- --- ---
Whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes No X
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No common stock was held by nonaffiliates of the Registrant as of June 30, 2005
(the last business day of the Registrant's most recently-completed second fiscal
quarter).
As of February 28, 2006, 2,968 shares of the Registrant's common stock were
outstanding.
The Registrant is a wholly-owned subsidiary of Kronos Worldwide, Inc. (File
No. 1-31763) and meets the conditions set forth in General Instructions I(1) (a)
and (b) and is therefore filing this Form 10-K with the reduced disclosure
format.
Documents incorporated by reference
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None.
PART I
ITEM 1. BUSINESS
Kronos International, Inc., ("KII" or "the Company") is incorporated in the
State of Delaware, U.S.A., and is registered in the Commercial Register of the
Federal Republic of Germany. KII's principal place of business is in Leverkusen,
Germany. KII is a wholly-owned subsidiary of Kronos Worldwide, Inc. ("Kronos")
(NYSE: KRO). KII conducts Kronos' European value-added titanium dioxide pigments
("TiO2") operations.
At December 31, 2005, (i) Valhi, Inc. (NYSE: VHI) held approximately 57% of
Kronos' common stock and NL Industries, Inc. (NYSE: NL) held an additional 36%
of Kronos' common stock, (ii) Valhi held 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 such companies.
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that the statements in this
Annual Report on Form 10-K relating to matters that are not historical facts,
including, but not limited to, statements found in this Item 1 - "Business,"
Item 1A - "Risk Factors," Item 3 - "Legal Proceedings," Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Item 7A - "Quantitative and Qualitative Disclosures About Market Risk," 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. Among the factors that could cause actual future results to
differ materially from those described herein are the risks and uncertainties
discussed in this Annual Report and those described from time to time in the
Company's other filings with the SEC including, but 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 businesses,
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),
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 and the Norwegian
kroner),
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 benefits of
which have been recognized under the "more-likely-than-not" recognition
criteria,
o Environmental matters (such as those requiring compliance with emission and
discharge standards for existing and new facilities),
o Government laws and regulations and possible changes therein,
o The ultimate resolution of pending litigation, and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those currently 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.
Industry. Titanium dioxide pigments are inorganic chemical products used
for imparting whiteness, brightness and opacity to a diverse range of customer
applications and end-use markets, including coatings, plastics, paper and other
industrial and consumer "quality-of-life" products. TiO2 is considered a
"quality-of-life" product with demand affected by gross domestic product in
various regions of the world. TiO2, the largest commercially used whitening
pigment by volume, derives its value from its whitening properties and
opacifying ability (commonly referred to as hiding power). As a result of TiO2's
high refractive index rating, it can provide more hiding power than any other
commercially produced white pigment. In addition, TiO2 demonstrates excellent
resistance to chemical attack, good thermal stability and resistance to
ultraviolet degradation. TiO2 is supplied to customers in either a powder or
slurry form.
Per capita consumption of TiO2 in the United States and Western Europe far
exceeds that in other areas of the world and these regions are expected to
continue to be the largest consumers of TiO2. Significant regions for TiO2
consumption could emerge in Eastern Europe, the Far East or China as the
economies in these regions develop to the point that quality-of-life products,
including TiO2, experience greater demand. Geographic information is contained
in Note 2 to the Consolidated Financial Statements.
Products and operations. TiO2 is produced in two crystalline forms: rutile
and anatase. Both the chloride and sulfate production processes (discussed
below) produce rutile TiO2. Chloride process rutile is preferred for the
majority of customer applications. From a technical standpoint, chloride process
rutile has a bluer undertone and higher durability than sulfate process rutile
TiO2. Although many end-use applications can use either form of TiO2, chloride
process rutile TiO2 is the preferred form for use in coatings and plastics, the
two largest end-use markets. Anatase TiO2, which is produced only through the
sulfate production process, represents a much smaller percentage of annual
global TiO2 production and is preferred for use in selected paper, ceramics,
rubber tires, man-made fibers, food and cosmetics.
The Company believes that there are no effective substitutes for TiO2.
Extenders, such as kaolin clays, calcium carbonate and polymeric opacifiers, are
used in a number of end-used markets as white pigments, however the opacity in
these products is not able to duplicate the performance characteristics of TiO2,
and the Company believes these products are unlikely to replace TiO2.
The Company currently produces over 40 different TiO2 grades, sold under
the Kronos trademark, which provide a variety of performance properties to meet
customers' specific requirements. The Company's major customers include domestic
and international paint, plastics and paper manufacturers.
The Company and its distributors and agents sell and provide technical
services for its products to over 3,000 customers in over 100 countries with the
majority of sales in Europe. TiO2 is distributed by rail and truck in either dry
or slurry form and by ocean carrier in dry form. Kronos, the Company and its
predecessors have produced and marketed TiO2 in North America and Europe for
over 80 years. The Company believes that it has developed considerable expertise
and efficiency in the manufacture, sale, shipment and service of its products.
Sales of TiO2 represented about 87% of the Company's total sales in 2005.
Sales of other products, complementary to the Company's TiO2 business, comprise
the following:
o The Company owns an ilmenite mine in Norway and operated pursuant to a
governmental concession with an unlimited term. Ilmenite is a raw material
used directly as a feedstock by some sulfate-process TiO2 plants, including
all of the Company's European sulfate-process plants. The mine has
estimated reserves that are expected to last at least 50 years. Ilmenite
sales to third-parties represented approximately 6% of the Company's
consolidated net sales in 2005.
o The Company manufactures and sells iron-based chemicals, which are
by-products and processed by-products of the TiO2 pigment production
process. These co-product chemicals are marketed through the Company's
Ecochem division, and are used primarily as treatment and conditioning
agents for industrial effluents and municipal wastewater as well as in the
manufacture of ore pigments, cement and agricultural products. Sales of
iron-based chemical products were about 6% of sales in 2005.
o The Company manufactures and sells certain titanium chemical products
(titanium oxychloride and titanyl sulfate), which are side-stream products
from the production of TiO2. Titanium oxychloride is used in specialty
applications in the formulation of pearlescent pigments, production of
electroceramic capacitors for cell phones and other electronic devices.
Titanyl sulfate products are used primarily in pearlescent pigments. Sales
of these products were about 1% of sales in 2005.
Manufacturing process and raw materials. TiO2 is manufactured by the
Company using both the chloride process and the sulfate process. Approximately
65% of the Company's current production capacity is based on the chloride
process. The chloride process is a continuous process in which chlorine is used
to extract rutile TiO2. The chloride process typically has lower manufacturing
costs than the sulfate process due to higher yield and production of less waste
and lower energy requirements and labor costs. Because much of the chlorine is
recycled and feedstock bearing a higher titanium content is used, the chloride
process produces less waste than the sulfate process. The sulfate process is a
batch chemical process that uses sulfuric acid to extract TiO2. Sulfate
technology can produce either anatase or rutile pigment. Once an intermediate
TiO2 pigment has been produced by either the chloride or sulfate process, it is
"finished" into products with specific performance characteristics for
particular end-use applications through proprietary processes involving various
chemical surface treatments and intensive milling and micronizing. Due to
environmental factors and customer considerations, the proportion of TiO2
industry sales represented by chloride-process pigments has increased relative
to sulfate-process pigments and in 2005, chloride-process production facilities
represented approximately 64% of industry capacity.
The Company produced a Company record 335,000 metric tons of TiO2 in 2005,
compared to 328,000 metric tons produced in 2004 and 320,000 metric tons in
2003. The Company's average production capacity utilization rate was near
capacity in both 2005 and 2004. The production rates in 2004 and 2005 were
higher than 2003 due in part to debottlenecking activities, with only moderate
capital expenditures. The Company believes its current annual attainable
production capacity for 2006 is approximately 345,000 metric tons, with some
slight additional capacity available in 2007 through Kronos' continuing
debottlenecking efforts.
The primary raw materials used in the TiO2 chloride production process are
titanium-containing feedstock, chlorine and coke. Chlorine and coke are
available from a number of suppliers. Titanium-containing feedstock suitable for
use in the chloride process is available from a limited but increasing number of
suppliers around the world, principally in Australia, South Africa, Canada,
India and the United States. The Company purchased approximately 260,000 metric
tons of chloride feedstock in 2005, of which the vast majority was slag.
Through Kronos (US), Inc. ("KUS"), a wholly-owned subsidiary of Kronos, the
Company purchased chloride process grade slag in 2005 from a subsidiary of Rio
Tinto plc UK - Richards Bay Iron and Titanium Limited South Africa under a
long-term supply contract that expires at the end of 2007. Natural rutile ore is
purchased primarily from Iluka Resources, Limited (Australia), under a long-term
supply contract that expires at the end of 2009. The Company and KUS do not
expect to encounter difficulties obtaining long-term extensions to existing
supply contracts prior to the expiration of the contracts. Raw materials
purchased under these contracts and extensions thereof are expected to meet the
Company's chloride feedstock requirements over the next several years.
The primary raw materials used in the TiO2 sulfate production process are
titanium-containing feedstock derived primarily from rock and sand ilmenite and
sulfuric acid. Sulfuric acid is available from a number of suppliers.
Titanium-containing feedstock suitable for use in the sulfate process is
available from a limited number of suppliers around the world. Currently, the
principal active sources are located in Norway, Canada, Australia, India and
South Africa. As one of the few vertically integrated producers of
sulfate-process pigments, the Company owns and operates a rock ilmenite mine in
Norway, which provided all of the Company's feedstock for its sulfate-process
pigment plants in 2005. The Company produced approximately 816,000 metric tons
of ilmenite in 2005 of which approximately 317,000 metric tons were used
internally, with the remainder sold to third parties.
The number of sources of, and availability of, certain raw materials is
specific to the particular geographic region in which a facility is located. As
noted above, through KUS the Company purchases titanium-bearing ore from two
different suppliers in different countries under multiple-year contracts.
Political and economic instability in certain countries from which the Company
purchases its raw material supplies could adversely affect the availability of
such feedstock. Should the Company's vendors not be able to meet their
contractual obligations or should the Company be otherwise unable to obtain
necessary raw materials, the Company may incur higher costs for raw materials or
may be required to reduce production levels, which may have a material adverse
effect on the Company's consolidated financial position, results of operations
or liquidity.
The following table summarizes our raw materials procured or mined in 2005.
Quantities of Raw Materials Procured or
Mined
---------------------------------------------
Production Process/Raw Material (In thousands of metric tons)
Chloride process plants -
purchased slag or natural rutile ore 259
Sulfate process plants:
Raw ilmenite ore mined internally 317
Competition. The TiO2 industry is highly competitive. The Company competes
primarily on the basis of price, product quality and technical service, and the
availability of high performance pigment grades. Although certain TiO2 grades
are considered specialty pigments, the majority of the Company's grades and
substantially all of the Company's production are considered commodity pigments
with price generally being the most significant competitive factor. The Company
believes that it is the leading seller of TiO2 in Germany, is among the leading
marketers in the Benelux and Scandinavian markets and had an estimated 8% share
of worldwide TiO2 sales volume in 2005. Overall, the Company is Europe's second
largest producer of TiO2.
The Company's (along with KUS and Kronos Canada Inc., a wholly-owned
subsidiary of Kronos), principal competitors are E.I. du Pont de Nemours & Co.
("DuPont"); Millennium Chemicals, Inc.; Tronox Incorporated; Huntsman
International Holdings LLC; and Ishihara Sangyo Kaisha, Ltd. The Company's five
largest competitors have estimated individual shares of TiO2 production capacity
ranging from 24% to 4%, and an estimated aggregate 70% share of worldwide TiO2
production volume.
Worldwide capacity additions in the TiO2 market resulting from construction
of greenfield plants require significant capital expenditures and substantial
lead time (typically three to five years in the Company's experience). The
Company is not aware of any greenfield plant under construction in the United
States, Europe or any other part of the world. However, a competitor has
announced its intention to build a greenfield facility in China, but it is not
clear when construction will begin and it is not likely that any product would
be available until 2010, at the earliest. During 2004, certain competitors
either idled or shut down facilities. However, the Company does expect that
industry capacity will increase as the Company and its competitors continue to
debottleneck their existing facilities. Based on the factors described above,
the Company expects that the average annual increase in industry capacity from
announced debottlenecking projects will be less than the average annual demand
growth for TiO2 during the next three to five years. However, no assurance can
be given that future increases in the TiO2 industry production capacity and
future average annual demand growth rates for TiO2 will conform to the Company's
expectations. If actual developments differ from the Company's expectations, the
Company and the TiO2 industry's performances could be unfavorably affected.
Research and development. The Company's expenditures for research and
development and certain technical support programs were approximately $7 million
in 2003, $8 million in 2004 and $9 million in 2005. Research and development
activities are conducted principally at the Leverkusen, Germany facility. Such
activities are directed primarily toward improving both the chloride and sulfate
production processes, improving product quality and strengthening the Company's
competitive position by developing new pigment applications.
The Company continually seeks to improve the quality of its grades, and has
been successful at developing new grades for existing and new applications to
meet the needs of customers and increase product life cycle. Since 1999,
thirteen new grades have been added for plastics, coatings, fiber and paper
laminate applications.
Patents and trademarks. Patents held for products and production processes
are believed to be important to the Company and its continuing business
activities. The Company seeks patent protection for its technical developments,
principally in the United States, Canada and Europe, and from time to time
enters into licensing arrangements with third parties. The Company's existing
patents generally have a term of 20 years from the date of filing, and have
remaining terms ranging from one to 20 years. The Company seeks to protect its
intellectual property rights, including its patent rights, and from time to time
the Company is engaged in disputes relating to the protection and use of
intellectual property relating to its products.
The Company's major trademarks, including Kronos, are protected by
registration in the United States and elsewhere with respect to those products
it manufactures and sells. The Company also relies on unpatented proprietary
know-how and continuing technological innovation and other trade secrets to
develop and maintain its competitive position. The Company's proprietary
chloride production process is an important part of the Company's technology,
and the Company's business could be harmed if the Company should fail to
maintain confidentiality of its trade secrets used in this technology.
Foreign operations. The Company's chemical businesses have operated in the
European markets since the 1920s. The Company's current production capacity is
located in Europe with its net property and equipment aggregating approximately
$349 million at December 31, 2005. The Company's operations include production
facilities in Germany, Belgium and Norway and sales and distribution facilities
in England, France, Denmark and the Netherlands. Approximately $690 million of
the Company's 2005 consolidated sales were to European customers and
approximately $161 million were to customers in areas other than Europe,
including approximately $52 million of sales to customers in the U.S. through
affiliates. Foreign operations are subject to, among other things, currency
exchange rate fluctuations and the Company's results of operations have, in the
past, been both favorably and unfavorably affected by fluctuations in currency
exchange rates. Effects of fluctuations in currency exchange rates on the
Company's results of operations are discussed in Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Item 7A. "Quantitative and Qualitative Disclosures about Market Risk."
Political and economic uncertainties in certain of the countries in which
the Company operates may expose it to risk of loss. The Company does not believe
that there is currently any likelihood of material loss through political or
economic instability, seizure, nationalization or similar event. The Company
cannot predict, however, whether events of this type in the future could have a
material effect on its operations. The Company's manufacturing and mining
operations are also subject to extensive and diverse environmental regulation in
each of the foreign countries in which they operate. See "Regulatory and
Environmental Matters."
Customer base and annual seasonality. The Company believes that neither its
aggregate sales nor those of any of its principal product groups are
concentrated in or materially dependent upon any single customer or small group
of customers. The Company's ten largest TiO2 pigment customers, excluding sales
to Kronos and affiliates, accounted for approximately 20% of sales in 2005.
Neither the Company's business as a whole nor that of any of its principal
product groups is seasonal to any significant extent. Due in part to the
increase in paint production in the spring to meet the spring and summer
painting season demand, TiO2 sales are generally higher in the first half of the
year than in the second half of the year.
Employees. As of December 31, 2005, the Company employed approximately
1,945 persons. Hourly employees in European production facilities are
represented by a variety of labor unions, with labor agreements having various
expiration dates. The Company's union employees are covered by master collective
bargaining agreements in the chemicals industry that are renewed annually. The
Company believes its labor relations are good.
Regulatory and environmental matters. The Company's operations are governed
by various environmental laws and regulations. Certain of the Company's
businesses are, or have been, engaged in the handling, manufacture or use of
substances or compounds that may be considered toxic or hazardous within the
meaning of applicable environmental laws. As with other companies engaged in
similar businesses, certain past and current operations and products of the
Company have the potential to cause environmental or other damage. The Company
has implemented and continues to implement various policies and programs in an
effort to minimize these risks. The Company's policy is to maintain compliance
with applicable environmental laws and regulations at all its facilities and to
strive to improve its environmental performance. It is possible that future
developments such as stricter requirements in environmental laws and enforcement
policies thereunder, could adversely affect the Company's production, handling,
use, storage, transportation, sale or disposal of such substances as well as the
Company's consolidated financial position, results of operations or liquidity.
While the laws regulating operations of industrial facilities in Europe
vary from country to country, a common regulatory framework is provided by the
European Union (the "EU"). Germany and Belgium are members of the EU and follow
its initiatives. Norway, although not a member, generally patterns its
environmental regulatory actions after the EU. The Company believes that it has
obtained all required permits and is in substantial compliance with applicable
EU requirements.
At its sulfate plant facilities in Leverkusen and Nordenham, Germany, the
Company recycles weak sulfuric acid either through contracts with third parties
or using its own facilities. At the Company's Fredrikstad, Norway plant, the
Company ships its spent acid to a third party location where it is treated and
disposed. The Company has a contract with a third party to treat certain
sulfate-process effluents at its German sulfate plants. With regard to the
German plants, either party may terminate the contract after giving three or
four years advance notice, depending on the contract.
From time to time, the Company's facilities may be subject to environmental
regulatory enforcement under various non-U.S. statutes. Resolution of such
matters typically involves the establishment of compliance programs.
Occasionally, resolution may result in the payment of penalties, but to date
such penalties have not involved amounts having a material adverse effect on the
Company's consolidated financial position, results of operations or liquidity.
The Company believes that all of its plants are in substantial compliance with
applicable environmental laws.
The Company's capital expenditures related to its ongoing environmental
protection and improvement programs in 2005 were approximately $4 million, and
are currently expected to be approximately $6 million in 2006.
Website and other available information. The Company reports periodic
information with the SEC. The Company does not maintain a website on the
Internet. However, Kronos maintains a website on the Internet with the address
of www.kronostio2.com. Copies of this Annual Report on Form 10-K for the year
ended December 31, 2005, copies of the Company's Quarterly Reports on Form 10-Q
for 2004 and 2005 and any Current Reports on Form 8-K for 2004 and 2005, and any
amendments thereto, are or will be available free of charge at such website as
soon as reasonably practical after they are filed with the SEC. Information
contained on Kronos' website is not part of this report. The Company will also
provide to anyone without charge copies of such documents upon written request
to the Company. Such requests should be directed to the attention of the
Corporate Secretary at the Company's address on the cover page of this Form
10-K.
The general public may read and copy any materials the Company files with
the SEC at the SEC's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. The public may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The Company is
an electronic filer, and the SEC maintains an Internet website that contains
reports, proxy and information statements, and other information regarding
issuers that file electronically with the SEC, including the Company. The
Internet address of the SEC's website is www.sec.gov.
ITEM 1A. RISK FACTORS
Listed below are certain risk factors associated with the Company and its
businesses. In addition to the potential effect of these risk factors discussed
below, any risk factor which could result in reduced earnings or operating
losses, or reduced liquidity, could in turn adversely affect our ability to
service our liabilities or pay dividends on our common stock or adversely affect
the quoted market prices for our securities.
Demand for, and prices of, certain of our products are cyclical and we may
experience prolonged depressed market conditions for our products, which may
result in reduced earnings or operating losses. Approximately 87% of our
revenues is attributable to sales of TiO2. Pricing within the global TiO2
industry over the long term is cyclical, and changes in industry economic
conditions, especially in Western industrialized nations, can significantly
impact our earnings and operating cash flows. This may result in reduced
earnings or operating losses.
Historically, the markets for many of our products have experienced
alternating periods of tight supply, causing prices and profit margins to
increase, followed by periods of capacity additions, and demand reductions
resulting in oversupply and declining prices and profit margins. Selling prices
(in billing currencies) for TiO2 were generally: increasing during the first
quarter of 2003, flat during the second quarter of 2003, decreasing during the
last half of 2003 and the first quarter of 2004, flat during the second quarter
of 2004, increasing in the last half of 2004 and the first six months of 2005
and decreasing during the second half of 2005.
Our overall average TiO2 selling prices in billing currencies:
o were nominally higher in 2003 as compared to 2002;
o were 3% lower in 2004 as compared to 2003; and
o were 5% higher in 2005 as compared to 2004.
Future growth in demand for TiO2 may not be sufficient to alleviate any
future conditions of excess industry capacity, and such conditions may not be
sustained or may be further aggravated by anticipated or unanticipated capacity
additions or other events. The demand for TiO2 during a given year is also
subject to annual seasonal fluctuations. TiO2 sales are generally higher in the
first half of the year than in the second half of the year due in part to the
increase in paint production in the spring to meet the spring and summer
painting season demand.
As a global business, we are exposed to local business risks in different
countries, which could result in operating losses. We conduct all of our
businesses in several jurisdictions outside of the United States and are subject
to risks normally associated with international operations, which include trade
barriers, tariffs, exchange controls, national and regional labor strikes,
social and political risks, general economic risks, seizures, nationalizations,
compliance with a variety of foreign laws, including tax laws, and the
difficulty in enforcing agreements and collecting receivables through foreign
legal systems. For example, we have substantial net operating loss carryforwards
in Germany, and any change in German tax law that adversely impacts our ability
to fully utilize such carryforwards could adversely affect us.
We may incur losses from fluctuations in currency exchange rates. We
operate our businesses in several different countries, and sell our products
worldwide. Therefore, we are exposed to risks related to the prices that we
receive for our products and the need to convert currencies that we may receive
for some of our products into the currencies required to pay some of our debt,
or into currencies in which we may purchase certain raw materials or pay for
certain services, all of which could result in future losses depending on
fluctuations in foreign currency exchange rates.
We sell several of our products in mature and highly competitive industries
and face price pressures in the markets in which we operate, which may result in
reduced earnings or operating losses. The global markets in which we operate our
business are highly competitive. Competition is based on a number of factors,
such as price, product quality and service. Some of our competitors may be able
to drive down prices for our products because their costs are lower than our
costs. In addition, some of our competitors' financial, technological and other
resources may be greater than our resources, and such competitors may be better
able to withstand changes in market conditions. Our competitors may be able to
respond more quickly than we can to new or emerging technologies and changes in
customer requirements. Further, consolidation of our competitors or customers
may result in reduced demand for our products. In addition, new competitors
could emerge by modifying their existing production facilities so they could
manufacture products that compete with our products. The occurrence of any of
these events could result in reduced earnings or operating losses.
Higher costs or limited availability of our raw materials may decrease our
liquidity. The number of sources for, and availability of, certain raw materials
is specific to the particular geographical region in which a facility is
located. For example, titanium-containing feedstocks suitable for use in our
TiO2 facilities are available from a limited number of suppliers around the
world. Political and economic instability in the countries from which we
purchase our raw material supplies could adversely affect their availability.
Should our vendors not be able to meet their contractual obligations or should
we be otherwise unable to obtain necessary raw materials, we may incur higher
costs for raw materials or may be required to reduce production levels, either
of which may decrease our liquidity as we may be unable to offset such higher
costs with increased selling prices for our products.
We are subject to many environmental and safety regulations with respect to
our operating facilities that may result in unanticipated costs or liabilities.
Our facilities are subject to extensive laws, regulations, rules and ordinances
relating to the protection of the environment, including those governing the
discharge of pollutants in the air and water and the generation, management and
disposal of hazardous substances and wastes or other materials. We may incur
substantial costs, including fines, damages and criminal penalties or civil
sanctions, or experience interruptions in our operations for actual or alleged
violations or compliance requirements arising under environmental laws. Our
operations could result in violations under environmental laws, including spills
or other releases of hazardous substances to the environment. Some of our
operating facilities are in densely populated urban areas or in industrial areas
adjacent to other operating facilities. In the event of an accidental release or
catastrophic incident, we could incur material costs as a result of addressing
such an event and in implementing measures to prevent such incidents. Given the
nature of our business, violations of environmental laws may result in
restrictions imposed on our operating activities or substantial fines,
penalties, damages or other costs, including as a result of private litigation.
Our production facilities have been used for a number of years to
manufacture products or conduct mining operations. We may incur additional costs
related to compliance with environmental laws applicable to our historic
operations and these facilities. In addition, we may incur significant
expenditures to comply with existing or future environmental laws. Costs
relating to environmental matters will be subject to evolving regulatory
requirements and will depend on the timing of promulgation and enforcement of
specific standards that impose requirements on our operations. Costs beyond
those currently anticipated may be required under existing and future
environmental laws.
If our patents are declared invalid or our trade secrets become known to
competitors, our ability to compete may be adversely affected. Protection of our
proprietary processes and other technology is important to our competitive
position. Consequently, we rely on judicial enforcement for protection of our
patents, and our patents may be challenged, invalidated, circumvented or
rendered unenforceable. Furthermore, if any pending patent application filed by
us does not result in an issued patent, or if patents are issued to us but such
patents do not provide meaningful protection of our intellectual property, then
the use of any such intellectual property by our competitors could result in
decreasing our cash flows. Additionally, our competitors or other third parties
may obtain patents that restrict or preclude our ability to lawfully produce or
sell our products in a competitive manner, which could have the same effects.
We also rely on certain unpatented proprietary know-how and continuing
technological innovation and other trade secrets to develop and maintain our
competitive position. Although it is our practice to enter into confidentiality
agreements to protect our intellectual property, because these confidentiality
agreements may be breached, such agreements may not provide sufficient
protection for our trade secrets or proprietary know-how, or adequate remedies
may not be available in the event of an unauthorized use or disclosure of such
trade secrets and know-how. In addition, others could obtain knowledge of such
trade secrets through independent development or other access by legal means.
Loss of key personnel or our ability to attract and retain new qualified
personnel could hurt our businesses and inhibit our ability to operate and grow
successfully. Our success in the highly competitive markets in which we operate
will continue to depend to a significant extent on the leadership teams of our
businesses and other key management personnel. We generally do not have binding
employment agreements with any of these managers. This increases the risks that
we may not be able to retain our current management personnel and we may not be
able to recruit qualified individuals to join our management team, including
recruiting qualified individuals to replace any of our current personnel that
may leave in the future.
Our relationships with our union employees could deteriorate. At December
31, 2005, we employed approximately 1,945 persons worldwide in our various
businesses. A significant number of our employees are subject to collective
bargaining or similar arrangements. We may not be able to negotiate labor
agreements with respect to these employees on satisfactory terms or at all. If
our employees were to engage in a strike, work stoppage or other slowdown, we
could experience a significant disruption of our operations or higher ongoing
labor costs.
Our leverage may impair our financial condition or limit our ability to
operate our businesses. We currently have a significant amount of debt. As of
December 31, 2005, our total consolidated debt was approximately $454 million,
substantially all of which relates to our Senior Secured Notes. Our level of
debt could have important consequences to our stockholders and creditors,
including:
o making it more difficult for us to satisfy our obligations with
respect to our liabilities;
o increasing our vulnerability to adverse general economic and industry
conditions;
o requiring that a portion of our cash flow from operations be used for
the payment of interest on our debt, therefore reducing our ability to
use our cash flow to fund working capital, capital expenditures,
dividends on our common stock, acquisitions and general corporate
requirements;
o limiting our ability to obtain additional financing to fund future
working capital, capital expenditures, acquisitions and general
corporate requirements;
o limiting our flexibility in planning for, or reacting to, changes in
our business and the industry in which we operate; and
o placing us at a competitive disadvantage relative to other less
leveraged competitors.
In addition to our indebtedness, we are party to various lease and other
agreements pursuant to which, along with our indebtedness, we are committed to
pay approximately $71.3 million in 2006. Our ability to make payments on and
refinance our debt, and to fund planned capital expenditures, depends on our
future ability to generate cash flow. To some extent, this is subject to general
economic, financial, competitive, legislative, regulatory and other factors that
are beyond our control. In addition, our ability to borrow funds under our
subsidiaries' credit facilities in the future will in some instances depend in
part on these subsidiaries' ability to maintain specified financial ratios and
satisfy certain financial covenants contained in the applicable credit
agreement. Our business may not generate cash flows from operating activities
sufficient to enable us to pay our debts when they become due and to fund our
other liquidity needs. As a result, we may need to refinance all or a portion of
our debt before maturity. We may not be able to refinance any of our debt on
favorable terms, if at all. Any inability to generate sufficient cash flows or
to refinance our debt on favorable terms could have a material adverse effect on
our financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
During 2005, the Company operated four TiO2 plants (one in Leverkusen,
Germany; one in Nordenham, Germany; one in Langerbrugge, Belgium; and one in
Fredrikstad, Norway). TiO2 is produced using the chloride process at the
Leverkusen and Langerbrugge facilities and is manufactured using the sulfate
process in Nordenham, Leverkusen and Fredrikstad. The Company also owns an
ilmenite ore mine in Hauge i Dalane, Norway and operates it pursuant to a
governmental concession with an unlimited term. The Company's co-products are
produced at its Norwegian and Belgian facilities and its titanium chemicals are
produced at its Belgian facility.
The Company owns all of its principal production facilities described
above, except for the land under the Leverkusen and Fredrikstad facilities. The
Norwegian plant is located on public land and is leased until 2013, with an
option to extend the lease for an additional 50 years. The Company's principal
German operating subsidiary leases the land under its Leverkusen TiO2 production
facility pursuant to a lease with Bayer AG that expires in 2050. The Leverkusen
facility, which is owned by the Company and which represents approximately 50%
of the Company's current TiO2 production capacity, is located within Bayer's
extensive manufacturing complex. Rent for such land lease associated with the
Leverkusen facility is periodically established by agreement with Bayer AG for
periods of at least two years at a time. Under a separate supplies and services
agreement expiring in 2011, Bayer provides some raw materials, including
chlorine, auxiliary and operating materials and utilities and services necessary
to operate the Leverkusen facility.
The Company has under lease various corporate and administrative offices
located in Leverkusen, Germany and Brussels, Belgium and various sales offices
located in France, the Netherlands, Denmark and the United Kingdom.
The Company believes the transportation access to its facilities, which are
generally maintained by the applicable local government, are adequate for the
Company's purposes.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various environmental, contractual, product
liability and other claims and disputes incidental to its business. Certain
information called for by this Item is included in Note 13 to the Consolidated
Financial Statements, which information is incorporated herein by reference.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted pursuant to the General Instruction I of Form 10-K.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of KII's common stock is held by Kronos. There is no established public
trading market for KII's common stock. The indenture governing KII's 8.875%
Senior Notes Due 2009 limits the ability of the Company to pay dividends or make
other restricted payments, as defined. The aggregate amount of dividends and
other restricted payments since June 2002 may not exceed 75% of the aggregate
consolidated net income, as defined in the indenture, plus $25 million. KII
currently expects to pay dividends or make other restricted payments as
permitted by the indenture; however declaration and payment of future dividends
and the amount thereof is dependent upon the Company's results of operations,
financial condition, contractual limitations, cash requirements for its
businesses and other factors deemed relevant by the Company's Board of
Directors. See Note 6 to the Consolidated Financial Statements. At December 31,
2005, $92 million was available for dividends or other restricted payments, as
defined.
The Company paid $60 million in dividends to Kronos in 2004. The Company
did not pay any dividends to Kronos in 2005. The declaration and payment of
future dividends is discretionary, and the amount, if any, will be dependent
upon the Company's results of operations, financial condition, contractual
restrictions and other factors deemed relevant by the Company's Board of
Directors.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
the Company's Consolidated Financial Statements and Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Certain amounts have been reclassified to conform with the current year's
Consolidated Financial Statements.
Years ended December 31,
------------------------------------------------------------
2001 2002 2003 2004 2005
---- ---- ---- ---- ----
(In millions, except ratios)
STATEMENTS OF OPERATIONS DATA:
Net sales $ 554.6 $ 579.7 $ 715.9 $ 808.0 $ 850.9
Net income 113.7 52.3 81.8 326.0 59.8
BALANCE SHEET DATA (at year end):
Total assets $ 532.5 $ 611.3 $ 750.5 $ 985.2 $ 955.3
Long-term debt including current maturities 482.9 325.9 356.7 533.2 453.8
Redeemable preferred stock and profit
participation certificates 617.4 - - - -
Stockholder's equity (deficit) (777.5) 76.8 111.6 206.5 181.8
STATEMENTS OF CASH FLOW DATA:
Net cash provided (used) by:
Operating activities $ 76.0 $ 68.2 $ 104.8 $ 142.3 $ 92.7
Investing activities (28.5) (29.7) (31.7) (34.2) (35.8)
Financing activities (52.8) (57.5) (54.9) (129.9) (8.5)
TiO2 OPERATING STATISTICS:
Sales volume* 265 297 310 336 326
Production volume* 269 293 320 328 335
Production rate as a percentage of capacity 87% 93% Full Full Full
OTHER FINANCIAL DATA:
Ratio of earnings to combined
fixed charges and preferred
dividends(unaudited)(1) 1.8 1.5 3.3 2.7 3.6
Ratio of earnings to
fixed charges (unaudited) (2) 4.2 2.7 3.3 2.7 3.6
__________________________________
* Metric tons in thousands
(1) Fixed charges represents, as applicable, the sum of (i) total interest
expense and (ii) the interest component of rent expense (calculated as
one-third of rent expense). Earnings represents, as applicable, the sum of
(i) fixed charges, (ii) income before income taxes and minority interest
and (iii) amortization of capitalized interest.
(2) Combined fixed charges and preferred dividends represents, as applicable,
the sum of (i) total interest expense, (ii) preferred stock dividends and
accretion and (iii) the interest component of rent expense (calculated as
one-third of rent expense). Earnings represents, as applicable, the sum of
(i) combined fixed charges, (ii) income before income taxes and minority
interest and (iii) amortization of capitalized interest.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Critical accounting policies and estimates
The accompanying "Management's Discussion and Analysis of Financial
Condition and Results of Operations" are based upon the Company's consolidated
financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America ("GAAP"). The
preparation of these financial statements requires the Company to make estimates
and judgments that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amount of revenues and expenses during the reported
period. On an on-going basis, the Company evaluates its estimates, including
those related to bad debts, inventory reserves, impairments of investments in
marketable securities and investments accounted for by the equity method, the
recoverability of other long-lived assets (including goodwill and other
intangible assets), pension benefit obligations and the underlying actuarial
assumptions related thereto, the realization of deferred income tax assets and
accruals for, litigation, income tax and other contingencies. The Company bases
its estimates on historical experience and on various other assumptions that it
believes to be reasonable under the circumstances, the results of which form the
basis for making judgments about the reported amounts of assets, liabilities,
revenues and expenses. Actual results may differ from previously-estimated
amounts under different assumptions or conditions.
The Company believes the following critical accounting policies affect its
more significant judgments and estimates used in the preparation of its
consolidated financial statements:
o The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments and
other factors. The Company takes into consideration the current financial
condition of its customers, the age of the outstanding balance and the
current economic environment when assessing the adequacy of the allowance.
If the financial condition of the Company's customers were to deteriorate,
resulting in an impairment of their ability to make payments, additional
allowances may be required. During 2003, 2004 and 2005, the net amount
written off against the allowance for doubtful accounts as a percentage of
the balance of the allowance for doubtful accounts as of the beginning of
the year ranged from 15% to 24%.
o The Company provides reserves for estimated obsolescence or unmarketable
inventories equal to the difference between the cost of inventory and the
estimated net realizable value using assumptions about future demand for
its products and market conditions. If actual market conditions are less
favorable than those projected by management, additional inventory reserves
may be required. The Company also provides reserves for tools and supplies
inventory based generally on both historical and expected future usage
requirements.
o The Company recognizes an impairment charge associated with its long-lived
assets, including property and equipment, whenever it determines that
recovery of such long-lived asset is not probable. Such determination is
made in accordance with the applicable GAAP requirements associated with
the long-lived asset, and is based upon, among other things, estimates of
the amount of future net cash flows to be generated by the long-lived asset
and estimates of the current fair value of the asset. Adverse changes in
such estimates of future net cash flows or estimates of fair value could
result in an inability to recover the carrying value of the long-lived
asset, thereby possibly requiring an impairment charge to be recognized in
the future.
Under applicable GAAP (SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets"), property and equipment is not assessed for
impairment unless certain impairment indicators, as defined, are present.
During 2005, no such impairment indicators, as defined, were present.
o The Company maintains various defined benefit pension plans. The amounts
recognized as defined benefit pension expenses, and the reported amounts of
prepaid and accrued pension costs, are actuarially determined based on
several assumptions, including discount rates, expected rates of returns on
plan assets and expected health care trend rates. Variances from these
actuarially assumed rates will result in increases or decreases, as
applicable, in the recognized pension obligations, pension expenses and
funding requirements. These assumptions are more fully described below
under "Assumptions on defined benefit pension plans."
o The Company records a valuation allowance to reduce its deferred income tax
assets to the amount that is believed to be realized under the
"more-likely-than-not" recognition criteria. While the Company has
considered future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for a valuation allowance, it is
possible that in the future the Company may change its estimate of the
amount of the deferred income tax assets that would "more-likely-than-not"
be realized in the future, resulting in an adjustment to the deferred
income tax asset valuation allowance that would either increase or
decrease, as applicable, reported net income in the period such change in
estimate was made. For example, the Company has substantial net operating
loss carryforwards in Germany (the equivalent of $593 million for German
corporate purposes and $104 million for German trade tax purposes at
December 31, 2005). During 2004, the Company concluded that the
more-likely-than-not recognition criteria had been met with respect to the
income tax benefit associated with the Company's net operating loss
carryforwards in 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.
In addition, the Company makes an evaluation at the end of each reporting
period as to whether or not some or all of the undistributed earnings of
its foreign subsidiaries are permanently reinvested (as that term is
defined in GAAP). While the Company may have concluded in the past that
some of such undistributed earnings are permanently reinvested, facts and
circumstances can change in the future, and it is possible that a change in
facts and circumstances, such as a change in the expectation regarding the
capital needs of its foreign subsidiaries, could result in a conclusion
that some or all of such undistributed earnings are no longer permanently
reinvested. In such an event, the Company would be required to recognize a
deferred income tax liability in an amount equal to the estimated
incremental U.S. income tax and withholding tax liability that would be
generated if all of such previously-considered permanently reinvested
undistributed earnings were distributed to the U.S.
o The Company records accruals for legal, income tax and other contingencies
and commitments when estimated future expenditures associated with such
contingencies become probable, and the amounts can be reasonably estimated.
However, new information may become available, or circumstances (such as
applicable laws and regulations) may change, thereby resulting in an
increase or decrease in the amount required to be accrued for such matters
(and therefore a decrease or increase in reported net income in the period
of such change).
Income from operations are impacted by certain of these significant
judgments and estimates, such as allowance for doubtful accounts, reserves for
obsolete or unmarketable inventories, impairment of equity method investees,
goodwill and other long-lived assets, defined benefit pension plans and loss
accruals. In addition, other income (expense) is impacted by the significant
judgments and estimates for deferred income tax asset valuation allowances and
loss accruals.
Executive summary
The Company reported net income of $59.8 million in 2005 compared to $326.0
million in 2004 and $81.8 million in 2003. The Company's net income increased
from 2003 to 2004 as the unfavorable effect of lower income from operations and
higher interest expense in 2004 was more than offset by the favorable effect of
a non-cash income tax benefit in 2004. The Company's net income decreased from
2004 to 2005 as the favorable effect of higher income from operations and lower
interest expense in 2005 was more than offset by the favorable effect of the
non-cash income tax benefit recognized in 2004.
Net income in 2005 includes (i) a third quarter net non-cash income tax
charge of $9.8 million for recent developments with respect to income tax
audits, primarily in Germany and Belgium and (ii) a second quarter securities
transaction gain of $3.5 million related to the sale of the Company's passive
interest in a Norwegian smelting operation. Net income in 2004 includes a second
quarter income tax benefit related to the reversal of the Company's deferred
income tax asset valuation allowance in Germany of $277.3 million. Net income in
2003 includes an income tax benefit relating to the refund of prior year German
income taxes of $24.6 million. Each of these items is more fully discussed below
and/or in the notes to the Consolidated Financial Statements.
The Company currently expects income from operations will be lower in 2006
compared to 2005, as the favorable effect of anticipated modest improvements in
sales volumes and average TiO2 selling prices are expected to be more than
offset by the effect of higher production costs, particularly raw material and
energy costs.
Relative changes in the Company's TiO2 sales and operating income during
the past three years are primarily due to (i) relative changes in TiO2 sales and
production volumes, (ii) relative changes in TiO2 average selling prices and
(iii) relative changes in foreign currency exchange rates.
Selling prices (in billing currencies) for TiO2, the Company's principal
product, were generally: increasing during the first quarter of 2003, flat
during the second quarter of 2003, decreasing during the second half of 2003 and
the first half of 2004, increasing during the second half of 2004 and first half
of 2005 and decreasing during the last half of 2005. Changes in the Company's
selling prices are largely driven by relative industry demand and supply
conditions and other economic factors.
Results of operations
Years ended December 31, % Change
------------------------------------- -----------------------
2003 2004 2005 2003-04 2004-05
---- ---- ---- ------- -------
(In millions, except selling price data)
Net sales $ 715.9 $ 808.0 $ 850.9 +13% + 5%
Cost of sales 516.9 609.6 613.2 +18% + 1%
-------- -------- --------
Gross margin 199.0 198.4 237.7 ** +20%
Selling, general and administrative (110.2)
expense (87.0) (104.1) +20% + 6%
Currency transaction gains (losses), net (3.7) (2.2) 4.1
Royalty income 6.1 6.0 6.8
Other operating income (expense), net - (.5) (.9)
-------- -------- --------
Income from operations $ 114.4 $ 97.6 $ 137.5 -15% +41%
======== ======== ========
TiO2 operating statistics:
Percent change in average selling
prices:
Using actual foreign currency
exchange rates + 4% + 7%
Impact of changes in foreign
currency exchange rates - 7% - 2%
---- ----
In billing currencies - 3% + 5%
==== ====
Sales volumes* 310 336 326 + 8% - 3%
Production volumes* 320 328 335 + 3% + 2%
Production rate as
percent of capacity Full Full Full
____________________________
* Thousands of metric tons
** less than 1%
Year ended December 31, 2005 compared to year ended December 31, 2004
The Company's sales increased $42.9 million (5%) in 2005 as compared to
2004 due primarily to the net effects of higher average TiO2 selling prices,
lower TiO2 sales volumes and the favorable effect of fluctuations in foreign
currency exchange rates, which increased sales by approximately $13 million 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 were 5% higher in 2005 as compared to 2004. When
translated from billing currencies into U.S. dollars using actual foreign
currency exchange rates prevailing during the respective periods, The Company's
average TiO2 selling prices in 2005 increased 7% as compared to 2004. See " -
Effects of foreign currency exchange rates" below for a discussion of the impact
of relative changes in currency exchange rates on the Company's operations.
The Company's TiO2 sales volumes in 2005 decreased 3% compared to 2004 with
volumes lower in all regions of the world. Approximately three-fourths of the
Company's 2005 TiO2 sales volumes were attributable to markets in Europe, with
10% attributable to North America and the balance to export markets. Overall
worldwide demand for TiO2 in 2005 is estimated to have declined by approximately
5% from the exceptionally strong demand levels in 2004. The Company attributes
the decline in overall sales and its own sales to slower overall economic growth
in 2005 and inventory destocking by its customers. The Company's operating
income comparisons were favorably impacted by higher production levels, which
increased 2%. The Company's operating rates were near full capacity in both
periods, and the Company's production volumes in 2005 set a new record for the
Company, which was the fourth consecutive year record production volumes were
achieved.
The Company's cost of sales increased $3.6 million (1%) in 2005 compared to
2004 as the effect of lower sales volumes was offset by higher raw material and
maintenance costs. However, the Company's cost of sales, as a percentage of net
sales, decreased from 75% in 2004 to 72% in 2005 due primarily to the effects of
higher average selling prices which more than offset higher costs.
The Company's gross margins increased $39.3 million (20%) from 2004 to 2005
due to the net effects of the aforementioned changes in sales and cost of sales
during such periods.
As a percentage of net sales, selling, general and administrative expenses
were relatively consistent at 13% for both 2004 and 2005.
The Company's income from operations increased $39.9 million (41%) in 2005
as compared to 2004, as the effect of higher average TiO2 selling prices and
higher production volumes more than offset the impact of lower sales volumes,
higher raw material and maintenance costs. See also " - Effects of foreign
currency exchange rates" below for a discussion of the impact of relative
changes in currency exchange rates on the Company's operations.
Year ended December 31, 2004 compared to year ended December 31, 2003
The Company's sales increased $92.1 million (13%) in 2004 as compared to
2003 as higher sales volumes and the favorable effect of fluctuations in foreign
currency exchange rates, which increased sales by approximately $56 million as
further discussed below, more than offset the impact of lower average TiO2
selling prices. 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 were 3% lower in 2004 as compared to 2003. When translated
from billing currencies into U.S. dollars using actual foreign currency exchange
rates prevailing during the respective periods, the Company's average TiO2
selling prices in 2004 increased 4% as compared to 2003. See " - Effects of
foreign currency exchange rates" below for a discussion of the impact of
relative changes in currency exchange rates on the Company's operations.
The Company's TiO2 sales volumes in 2004 increased 8% compared to 2003, due
to higher sales volumes in Europe and export markets. By volume, approximately
77% of the Company's 2004 TiO2 sales were attributable to markets in Europe,
with 14% attributable to export markets and the balance to North America. Demand
for TiO2 has remained strong throughout 2004, and while the Company believes
that the strong demand is largely attributable to the end-use demand of its
customers, it is possible that some portion of the strong demand resulted from
customers increasing their inventory levels of TiO2 in advance of implementation
of announced or anticipated price increases. The Company's operating income
comparisons were also favorably impacted by higher production levels, which
increased 3%. The Company's operating rates were near full capacity in both
periods, and the Company's sales and production volumes in 2004 were both new
records for the Company.
The Company's cost of sales increased $92.7 million (18%) in 2004 compared
to 2003 due to higher raw material and maintenance costs as well as higher sales
volumes and related effects of translating foreign currencies into the U.S.
dollar. The Company's cost of sales, as a percentage of net sales, increased
from 72% in 2003 to 75% in 2004 due primarily to the effects of lower average
selling prices and higher costs.
The Company's gross margins decreased $.6 million (less than 1%) from 2003
to 2004 due to the net effects of the aforementioned changes in sales and cost
of sales during such periods.
As a percentage of net sales, selling, general and administrative expenses
were relatively consistent from 2003 to 2004, increasing marginally from 12% to
13%, and increasing proportionately with the increased sales and production
volume.
The Company's income from operations decreased $16.8 million (15%) in 2004
as compared to 2003, as the effect of lower average TiO2 selling prices and
higher raw material and maintenance costs more than offset the impact of higher
sales and production volumes. See also " - Effects of foreign currency exchange
rates" below for a discussion of the impact of relative changes in currency
exchange rates on the Company's operations.
Effects of foreign currency exchange rates
The Company's sales are denominated in various currencies, including the
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 4% and 7%
increases in the Company's average TiO2 selling prices during 2004 and 2005,
respectively, as compared to the respective prior year using actual foreign
currency exchange rates prevailing during the respective periods (the GAAP
measure), and the 3% decrease and 5% increase in the Company's average TiO2
selling prices in billing currencies (the non-GAAP measure) during such periods
is due to the effect of changes in foreign currency exchange rates. The above
table presents (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 operations and assets are located outside the United States
(primarily 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. A portion of the Company's sales generated from its operations are
denominated in the U.S. dollar. 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 a net $13 million in 2005 as compared to 2004, and
increased sales by a net $56 million in 2004 as compared to 2003. 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 2005 and 2004 compared to the same periods of
the respective prior years. Overall, currency exchange rate fluctuations
resulted in a net $10 million increase in the Company's operating income in 2005
as compared to 2004, and resulted in a net increase in the Company's operating
income in 2004 of approximately $9 million as compared to 2003.
Outlook
The Company expects its income from operations in 2006 will be somewhat
lower than 2005, as the favorable effect of anticipated modest improvements in
sales volumes and average TiO2 selling prices are expected to be more than
offset by the effect of higher production costs, particularly raw material and
energy costs. 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 25% over the past ten years due to
debottlenecking programs, with only moderate capital expenditures. The Company
believes its annual attainable production capacity for 2006 is approximately
345,000 metric tons, with some slight additional capacity expected to be
available in 2007 through its continued debottlenecking efforts.
Other income (expense)
The following table sets forth certain information regarding other income
and expense items.
Years ended December 31, Change
----------------------------------- -----------------------
2003 2004 2005 2003-04 2004-05
---- ---- ---- ------- -------
(In millions)
(In millions)Interest income from
affiliates $ - $ 2.8 $ 18.9 $ 2.8 $ 16.1
Trade interest income .7 1.1 1.0 .4 (.1)
Securities transaction gain - - 5.4 - 5.4
Interest expense to affiliates (.1) - - .1 -
Interest expense (32.5) (36.7) (43.9) (4.2) (7.2)
------ ------ ------ ------ ------
$(31.9) $(32.8) $(18.6) $ (.9) $ 14.2
====== ====== ====== ====== ======
Interest income fluctuates in part based upon the amount of funds invested
and yields thereon. Aggregate interest income increased $16.0 million in 2005
compared to 2004 due primarily to interest on KII's notes receivable from Kronos
entered into during the fourth quarter of 2004. Aggregate interest income
increased $3.2 million in 2004 compared to 2003 primarily due to interest on
KII's notes receivable from Kronos entered into during the fourth quarter of
2004. The Company expects interest income will be slightly higher in 2006 than
2005 due to higher average yields expected on invested funds.
Securities transaction gain in 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 9 to the Consolidated Financial Statements.
The Company has a significant amount of indebtedness denominated in the
euro, including the Company's euro-denominated Senior Secured Notes.
Accordingly, the reported amount of interest expense will vary depending on
relative changes in foreign currency exchange rates. Interest expense in 2005
was higher than 2004 due primarily to higher levels of outstanding indebtedness
resulting from the issuance of an additional euro 90 million principal amount of
KII Senior Secured Notes in November 2004. In addition, the increase in interest
expense was due to relative changes in foreign currency exchange rates, which
increased the U.S. dollar equivalent of interest expense on the euro 285 million
principal amount of KII Senior Secured Notes outstanding during all of 2003,
2004 and 2005 by approximately $3 million in 2004 as compared to 2003 and by
approximately $1 million in 2005 as compared to 2004.
Assuming interest rates and foreign currency exchange rates do not increase
significantly from current levels, interest expense in 2006 is expected to be
comparable to 2005.
At December 31, 2005, approximately $453.8 million of consolidated
indebtedness, principally KII's Senior Secured Notes, bears interest at fixed
interest rates averaging 8.9% (2004 - $519.4 million with a weighted average
interest rate of 8.9%; 2003 - $356 million with a weighted average fixed
interest rate of 8.9%). The weighted average interest rate on $14 million of
outstanding variable rate borrowings at December 31, 2004 was 3.9% (2003 and
2005 - none outstanding). See Note 6 to the Consolidated Financial Statements.
As noted above, KII has a certain amount of indebtedness denominated in
currencies other than the U.S. dollar. See Item 7A, "Quantitative and
Qualitative Disclosures About Market Risk."
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 10 to the Consolidated Financial
Statements.
The Company's income tax expense in 2005 includes the net non-cash effects
of (i) the aggregate favorable effects of recent developments with respect to
certain non-U.S. income tax audits of Kronos, principally in Belgium, of $7.7
million and (ii) the unfavorable effect with respect to the loss of certain
income tax attributes of Kronos in Germany of $17.5 million.
At December 31, 2005, the Company had the equivalent of $593 million and
$104 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 Note 10 to the Consolidated Financial Statements, the Company had
previously provided a deferred income tax asset valuation allowance against
substantially all of these tax loss carryforwards and other deductible temporary
differences in Germany because the Company did not believe they met the
"more-likely-than-not" recognition criteria. During the first six months of
2004, the Company reduced its deferred income tax asset valuation allowance by
approximately $8.7 million, primarily as a result of utilization of these German
net operating loss carryforwards, the benefit of which had not previously been
recognized. At June 30, 2004, after considering all available evidence, the
Company concluded that these German tax loss carryforwards and other deductible
temporary differences now met the "more-likely-than-not" recognition criteria.
Under applicable GAAP related to accounting for income taxes at interim periods,
a change in estimate at an interim period resulting in a decrease in the
valuation allowance is segregated into two components, the portion related to
the remaining interim periods of the current year and the portion related to all
future years. The portion of the valuation allowance reversal related to the
former is recognized over the remaining interim periods of the current year, and
the portion of the valuation allowance related to the latter is recognized at
the time the change in estimate is made. Accordingly, as of June 30, 2004, the
Company reversed $268.6 million of the valuation allowance (the portion related
to future years), and KII reversed the remaining $3.4 million during the last
six months of 2004. 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.
In January 2004, the German federal government enacted new tax law
amendments that limit the annual utilization of income tax loss carryforwards
effective January 1, 2004 to 60% of taxable income after the first euro 1
million of taxable income. The new law will have a significant effect on the
Company's cash tax payments in Germany going forward, the extent of which will
be dependent upon the level of taxable income earned in Germany.
During 2003, the Company reduced its deferred income tax asset valuation
allowance by an aggregate of approximately $6.7 million, primarily as a result
of utilization of certain income tax attributes for which the benefit had not
previously been recognized. In addition, the Company recognized a $38.0 million
income tax benefit related to the net refund of certain prior year German income
taxes.
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.
Related party transactions. The Company is a party to certain transactions
with related parties. See Note 12 to the Consolidated Financial Statements. It
is the policy of the Company to engage in transactions with related parties on
terms, in the opinion of the Company, no less favorable to the Company than
could be obtained from unrelated parties.
Accounting principles newly adopted in 2003 and 2004. See Note 15 to the
Consolidated Financial Statements.
Accounting principles not yet adopted: See Note 16 to Consolidated
Financial Statements.
Defined benefit pension plans. The Company maintains various defined
benefit pension plans in Europe. See Note 11 to the Consolidated Financial
Statements.
The Company accounts for its defined benefit pension plans using SFAS No.
87, "Employer's Accounting for Pensions." Under SFAS No. 87, defined benefit
pension plan expense and prepaid and accrued pension costs are each recognized
based on certain actuarial assumptions, principally the assumed discount rate,
the assumed long-term rate of return on plan assets and the assumed increase in
future compensation levels. The Company recognized consolidated defined benefit
pension plan expense of $5.8 million in 2003, $10.4 million in 2004 and $11.5
million in 2005. The amount of funding requirements for these defined benefit
pension plans is generally based upon applicable regulations (such as ERISA in
the U.S.), and will generally differ from pension expense recognized under SFAS
No. 87 for financial reporting purposes. Contributions made by the Company to
all of its plans aggregated $10.2 million in 2003, $11.7 million in 2004 and
$13.3 million in 2005.
The discount rates the Company utilizes for determining defined benefit
pension expense and the related pension obligations are based on current
interest rates earned on long-term bonds that receive one of the two highest
ratings given by recognized rating agencies in the applicable country where the
defined benefit pension benefits are being paid. In addition, the Company
receives advice about appropriate discount rates from the Company's third-party
actuaries, who may in some cases utilize their own market indices. The discount
rates are adjusted as of each valuation date (September 30th) to reflect
then-current interest rates on such long-term bonds. Such discount rates are
used to determine the actuarial present value of the pension obligations as of
December 31st of that year, and such discount rates are also used to determine
the interest component of defined benefit pension expense for the following
year.
At December 31, 2005, approximately 79% and 17% of the projected benefit
obligation related to Company plans in Germany and Norway, respectively. The
Company uses several different discount rate assumptions in determining its
consolidated defined benefit pension plan obligations and expense because the
Company maintains defined benefit pension plans in several different countries
in Europe and the interest rate environment differs from country to country.
The Company used the following discount rates for its defined benefit
pension plans:
Discount rates used for:
-------------------------------------------------------------------------
Obligations at Obligations at Obligations at
December 31, 2003 and December 31, 2004 and December 31, 2005 and
expense in 2004 expense in 2005 expense in 2006
----------------------- --------------------- ---------------------
Germany 5.3% 5.0% 4.0%
Norway 5.5% 5.0% 4.5%
The assumed long-term rate of return on plan assets represents the
estimated average rate of earnings expected to be earned on the funds invested
or to be invested in the plans' assets provided to fund the benefit payments
inherent in the projected benefit obligations. Unlike the discount rate, which
is adjusted each year based on changes in current long-term interest rates, the
assumed long-term rate of return on plan assets will not necessarily change
based upon the actual, short-term performance of the plan assets in any given
year. Defined benefit pension expense each year is based upon the assumed
long-term rate of return on plan assets for each plan and the actual fair value
of the plan assets as of the beginning of the year. Differences between the
expected return on plan assets for a given year and the actual return are
deferred and amortized over future periods based either upon the expected
average remaining service life of the active plan participants (for plans for
which benefits are still being earned by active employees) or the average
remaining life expectancy of the inactive participants (for plans for which
benefits are not still being earned by active employees).
At December 31, 2005, approximately 69% and 26% of the plan assets related
to the Company's plans in Germany and Norway, respectively. The Company uses
several different long-term rates of return on plan asset assumptions in
determining its consolidated defined benefit pension plan expense because the
Company maintains defined benefit pension plans in several different countries
in Europe, the plan assets in different countries are invested in a different
mix of investments and the long-term rates of return for different investments
differ from country to country.
In determining the expected long-term rate of return on plan asset
assumptions, the Company considers the long-term asset mix (e.g. equity vs.
fixed income) for the assets for each of its plans and the expected long-term
rates of return for such asset components. In addition, the Company receives
advice about appropriate long-term rates of return from the Company's
third-party actuaries. Such assumed asset mixes are summarized below:
o In Germany, the composition of the Company's plan assets is established to
satisfy the requirements of the German insurance commissioner. The current
plan asset allocation at December 31, 2005 was 23% to equity managers, 48%
to fixed income managers and 29% to real estate (2004 - 23%, 48% and 29%,
respectively).
o In Norway, the Company currently has a plan asset target allocation of 14%
to equity managers, 64% to fixed income managers and the remainder
primarily to cash and liquid investments. The expected long-term rate of
return for such investments is approximately 8%, 4.5% to 6% and 2.5%,
respectively. The plan asset allocation at December 31, 2005 was 16% to
equity managers, 62% to fixed income managers and the remainder primarily
to cash and liquid investments (2004 - 16%, 64% and nil, respectively).
The Company regularly reviews its actual asset allocation for each of its
plans and will periodically rebalance the investments in each plan to more
accurately reflect the targeted allocation when considered appropriate.
The Company's assumed long-term rates of return on plan assets for 2003,
2004 and 2005 were as follows:
2003 2004 2005
---- ---- ----
Germany 6.5% 6.0% 5.5%
Norway 6.0% 6.0% 5.5%
The Company currently expects to utilize the same long-term rate of return
on plan asset assumptions in 2006 as it used in 2005 for purposes of determining
the 2006 defined benefit pension plan expense.
To the extent that a plan's particular pension benefit formula calculates
the pension benefit in whole or in part based upon future compensation levels,
the projected benefit obligations and the pension expense will be based in part
upon expected increases in future compensation levels. For all of the Company's
plans for which the benefit formula is so calculated, the Company generally
bases the assumed expected increase in future compensation levels upon average
long-term inflation rates for the applicable country.
In addition to the actuarial assumptions discussed above, because the
Company maintains its defined benefit pension plans outside the U.S., the amount
of recognized defined benefit pension expense and the amount of prepaid and
accrued pension costs will vary based upon relative changes in foreign currency
exchange rates.
As discussed above, assumed discount rates and rate of return on plan
assets are re-evaluated annually. A reduction in the assumed discount rate
generally results in an actuarial loss, as the actuarially-determined present
value of estimated future benefit payments will increase. Conversely, an
increase in the assumed discount rate generally results in an actuarial gain. In
addition, an actual return on plan assets for a given year that is greater than
the assumed return on plan assets results in an actuarial gain, while an actual
return on plan assets that is less than the assumed return results in an
actuarial loss. Other actual outcomes that differ from previous assumptions,
such as individuals living longer or shorter than assumed in mortality tables
which are also used to determine the actuarially-determined present value of
estimated future benefit payments, changes in such mortality table themselves or
plan amendments, will also result in actuarial losses or gains. Under GAAP, all
of such actuarial gains and losses are not recognized in earnings currently, but
instead are deferred and amortized into income in the future as part of net
periodic defined benefit pension cost. However, any actuarial gains generated in
future periods would reduce the negative amortization effect of any cumulative
unrecognized actuarial losses, while any actuarial losses generated in future
periods would reduce the favorable amortization effect of any cumulative
unrecognized actuarial gains.
During 2005, all of the Company's defined benefit pension plans generated a
net actuarial loss of $84.4 million. This actuarial loss resulted primarily from
the general overall reduction in the assumed discount rates as well as the
unfavorable effect of using updated mortality tables (which generally reflect
individuals living longer than prior mortality tables used), partially offset by
an actual return on plan assets in excess of the assumed return.
While actuarial gains and losses are deferred and amortized into income in
future periods, as discussed above, GAAP also requires that a minimum amount of
accrued pension cost be recognized in a statement of financial position for any
plans for which the accumulated benefit obligation is less than the fair value
of plan assets. To the extent GAAP accounting would otherwise result in an
accrued pension cost balance for such plans that was less than the excess of the
aggregate accumulated benefit obligation over the value of the related plan
assets, GAAP then requires that such excess be recognized as a component of the
consolidated accrued pension cost, with the offset to such additional accrued
pension cost (commonly referred to as an "additional minimum liability")
recognized (i) first as an intangible asset up to specified amounts (referred to
as "unrecognized net pension obligations" in the Company's balance sheet and
then (ii) second as part of accumulated other comprehensive income (loss). At
December 31, 2005, and primarily as a result of the aggregate $84.4 million
actuarial loss generated during 2005 as discussed above, the amount of the
additional minimum liability required to be recognized by the Company increased
by approximately $81 million at December 31, 2005 as compared to December 31,
2004, resulting in the Company recognizing aggregate accrued pension cost
(current and noncurrent) of $136.1 million at December 31, 2005 as compared to
$57.0 million at December 31, 2004.
Based on the actuarial assumptions described above and the Company's
current expectation for what actual average foreign currency exchange rates will
be during 2006, the Company expects its defined benefit pension expense will
approximate $17 million in 2006. In comparison, the Company expects to be
required to make approximately $12 million of contributions to such plans during
2006.
As noted above, defined benefit pension expense and the amounts recognized
as prepaid and accrued pension costs are based upon the actuarial assumptions
discussed above. The Company believes all of the actuarial assumptions used are
reasonable and appropriate. If the Company had lowered the assumed discount rate
by 25 basis points for all of its plans as of December 31, 2005, the Company's
aggregate projected benefit obligations would have increased by approximately
$12.7 million at that date, and the Company's defined benefit pension expense
would be expected to increase by approximately $1.6 million during 2006.
Similarly, if the Company lowered the assumed long-term rate of return on plan
assets by 25 basis points for all of its plans, the Company's defined benefit
pension expense would be expected to increase by approximately $500,000 during
2006.
Foreign operations
The Company's operations are located in Europe where the functional
currency is not the U.S. dollar. As a result, the reported amount of the
Company's assets and liabilities, and therefore the Company's consolidated net
assets, will fluctuate based upon changes in currency exchange rates. At
December 31, 2005, the Company had substantial net assets denominated in the
euro, Norwegian kroner and United Kingdom pound sterling.
LIQUIDITY AND CAPITAL RESOURCES
Consolidated cash flows
The Company's consolidated cash flows for each of the past three years are
presented below:
Years ended December 31,
------------------------------------------
2003 2004 2005
---- ---- ----
(in millions)
Operating activities $ 104.8 $ 142.2 $ 92.7
Investing activities (31.7) (34.2) (35.8)
Financing activities (54.9) (129.9) (8.5)
------- ------- -------
Net cash provided (used) by operating,
investing and financing activities $ 18.2 $ (21.9) $ 48.4
======= ======= =======
Operating activities. 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, non-cash interest expense, deferred
income taxes and asset impairment charges. Non-cash interest expense relates to
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.
Certain other items included in the determination of net income have no
impact on cash flows from operating activities, but such items do impact cash
flows from investing activities (although their impact on such cash flows
differs from their impact on net income). For example, realized gains and losses
from the disposal of long-lived assets are included in the determination of net
income, although the proceeds from any such disposal are shown as part of cash
flows from investing activities.
Changes in product pricing, production volumes and customer demand, among
other things, can significantly affect the liquidity of the Company. 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. Relative changes in accounts receivable are affected by, among other
things, the timing of sales and the collection of the resulting receivable.
Relative changes in inventories, 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")
decreased from 58 days at December 31, 2004 to 52 days at December 31, 2005, due
to the timing of collections. At December 31, 2005, the average number of days
in inventory ("DII") increased to 105 days from 99 days at December 31, 2004 due
to the effects of higher production volume and lower sales volume.
Cash flows provided from operating activities decreased from $142.2 million
in 2004 to $92.7 million in 2005. This $49.5 million decrease was due primarily
to the net effect of (i) lower net income of $266.2 million, (ii) higher
deferred income taxes of $304.8 million, (iii) a lower amount of net cash
provided from changes in the Company's inventories, receivables, payables,
accruals and accounts with affiliates of $60.3 million and (iv) higher cash paid
for income taxes of $43.8 million, due primarily to refunds of income taxes of
$23.8 million received in 2004.
Cash flows provided from operating activities increased from $104.8 million
in 2003 to $142.2 million in 2004. This $37.4 million increase was due primarily
to the net effect of (i) higher net income of $244.2 million, (ii) a larger
deferred income tax benefit of $312.7 million, (iii) higher depreciation and
amortization expense of $4.1 million, (iv) a higher amount of net cash provided
from changes in the Company's inventories, receivables, payables, accruals and
accounts with affiliates of $34.8 million and (v) higher cash received for
income taxes of $12.3 million, which included refunds of income taxes of $11.5
million received in 2003 and $23.8 million of refunds of income taxes received
in 2004.
Investing cash flows. The Company's capital expenditures were $31.5
million, $33.7 million and $39.5 million in 2003, 2004 and 2005, respectively.
In addition, the Company purchased additional shares of its majority-owned
French subsidiary for $575,000 in 2004 and the Company received $3.5 million in
2005 from the sale of its passive interest in a Norwegian smelting operation.
The Company's capital expenditures during the past three years include an
aggregate of approximately $14 million ($4 million in 2005) for the Company's
ongoing environmental protection and compliance programs. The Company's
estimated 2006 capital expenditures are $37 million and include approximately $6
million in the area of environmental protection and compliance.
Financing cash flows. During 2005, KII (i) repaid euro 10 million ($12.9
million when repaid) under its three-year euro 80 million secured revolving
credit facility ("European Credit Facility") and (ii) entered into additional
capital lease agreements for certain mining equipment for the equivalent of
approximately $4.4 million.
During 2004, (i) KII issued an additional euro 90 million principal amount
of its Senior Secured Notes at 107% of par (equivalent to $130 million when
issued) and (ii) KII's operating subsidiaries in Germany, Belgium and Norway
borrowed an aggregate of euro 90 million ($112 million when borrowed) of
borrowings under its European Credit Facility, of which euro 80 million ($100
million) were subsequently repaid. See Note 6 to the Consolidated Financial
Statements.
In the fourth quarter of 2004, KII transferred an aggregate euro 163.1
million ($209.5 million) to Kronos in return for two promissory notes. Interest
on both notes is payable to KII on a quarterly basis at an annual rate of 9.25%.
Due to the long-term investment nature of these notes, settlement of the
intercompany notes receivable is not contemplated within the foreseeable future
and as such have been presented as a separate component of the Company's
stockholder's equity.
In March 2003, the Company's operating subsidiaries in Germany, Belgium and
Norway borrowed euro 15 million ($16.1 million when borrowed), in April 2003,
repaid NOK 80 million ($11.0 million when repaid) and in the third quarter of
2003, repaid euro 30.0 million ($33.9 million when repaid) under the European
Credit Facility.
Deferred financing costs of $2.0 million paid in 2004 for the Notes and the
European Credit Facility are being amortized over the lives of the respective
agreements and are included in other noncurrent assets as of December 31, 2005.
Cash dividends paid during 2003 and 2004 totaled $25.0 million and $60.0
million, respectively. (No dividends were paid in 2005). The declaration and
payment of future dividends is discretionary, and the amount, if any, will be
dependent upon the Company's results of operations, financial condition,
contractual restrictions and other factors deemed relevant by the Company's
Board of Directors.
Provisions contained in certain of our credit agreements could result in
the acceleration of the applicable indebtedness prior to its stated maturity.
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 lease commitments
disclosed in Note 13 to the Consolidated Financial Statements, the Company is
not party to any material off-balance sheet financing arrangements.
KII's assets consist primarily of investments in its operating
subsidiaries, and its 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 obligation, or otherwise. None of its
subsidiaries have guaranteed the Senior Secured Notes, although KII 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.
Off-balance sheet financing. Other than operating lease commitments
disclosed in Note 13 to the Consolidated Financial Statements, the Company is
not party to any material off-balance sheet financing arrangements.
Cash, cash equivalents, restricted cash and restricted marketable debt
securities and borrowing availability. At December 31, 2005, the Company had
current cash and cash equivalents aggregating $63.3 million, had current
restricted cash equivalents of $1.4 million and noncurrent restricted marketable
debt securities of $2.6 million. At December 31, 2005, certain of the Company's
subsidiaries had approximately $92 million available for borrowing under the
European Credit Facility (based on borrowing availability). The European Credit
Facility matures in June 2008. At December 31, 2005, the Company had
approximately $92 million available for payment of dividends and other
restricted payments as defined in the Notes indenture.
Based upon the Company's expectations for the TiO2 industry and anticipated
demands on the Company's cash resources as discussed herein, (including debt
refinancing expectations) the Company expects to have sufficient liquidity to
meet its short-term obligations (defined as the twelve-month period ending
December 31, 2006) and its long-term obligations (defined as the five-year
period ending December 31, 2010, the time period for which the Company generally
does long-term budgeting), including operations, capital expenditures, debt
service and current dividend policy. To the extent that actual developments
differ from the Company's expectations, the Company's liquidity could be
adversely affected.
Legal proceedings and environmental matters. See Note 13 to the
Consolidated Financial Statements for certain legal proceedings and
environmental matters with respect to the Company.
Foreign operations. As discussed above, the Company's operations are
located outside the United States for which the functional currency is not the
U.S. dollar. As a result, the reported amount of the Company's assets and
liabilities related to its operations, and therefore the Company's consolidated
net assets, will fluctuate based upon changes in currency exchange rates. At
December 31, 2005, the Company had substantial net assets denominated in the
euro, Norwegian kroner and United Kingdom pound sterling.
Other. 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 in the past has sought, and in the future may seek,
to reduce, refinance, repurchase or restructure indebtedness; raise additional
capital; issue additional securities; restructure ownership interests; modify
its dividend policy; 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 the acquisition, divestiture, joint venture or other business
combinations in the chemicals or other industries, as well as the acquisition of
interests in related companies. In the event of any such acquisition or joint
venture transaction, the Company may consider using available cash, issuing
equity securities or increasing its indebtedness to the extent permitted by the
agreements governing the Company's existing debt. See Note 6 to the Consolidated
Financial Statements.
Non-GAAP financial measures. In an effort to provide investors with
additional information regarding the Company's results as determined by GAAP,
the Company has disclosed certain non-GAAP information which the Company
believes provides useful information to financial statement users. As discussed
above, the Company discloses percentage changes in its average TiO2 prices in
billing currencies, which excludes the effects of foreign currency translation.
Such disclosure of the percentage change in the Company's average TiO2 selling
price in billing 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 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 financial statement users 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 using actual exchange rates
prevailing during the respective periods.
Summary of debt and other contractual commitments
As more fully described in the notes to the Consolidated Financial
Statements, the Company is a party to various debt, lease and other agreements
which contractually and unconditionally commit the Company to pay certain
amounts in the future. See Notes 6 and 13 to the Consolidated Financial
Statements. The following table summarizes such contractual commitments of the
Company and its consolidated subsidiaries as of December 31, 2005 by the type
and date of payment.
Payment due date
--------------------------------------------------------------
2011 and
Contractual commitment 2006 2007/2008 2009/2010 after Total
---------------------- ---- --------- --------- --------- ------
(In millions)
Third-party indebtedness $ 1.0 $ 1.7 $ 451.1 $ - $ 453.8
Interest payments on third-party
indebtedness 39.1 77.8 38.8 - 155.7
Operating leases 3.3 4.6 2.7 21.0 31.6
Fixed asset acquisitions 6.1 - - - 6.1
Estimated tax obligations 21.8 - - - 21.8
------- ------- ------- ------- -------
$ 71.3 $ 84.1 $ 492.6 $ 21.0 $ 669.0
======= ======= ======= ======= =======
The timing and amount shown for the Company's commitments related to
indebtedness (principal and interest), operating leases and fixed asset
acquisitions are based upon the contractual payment amount and the contractual
payment date for such commitments. With respect to revolving credit facilities,
the amount shown for indebtedness is based upon the actual amount outstanding at
December 31, 2005, and the amount shown for interest for any outstanding
variable-rate indebtedness is based upon the December 31, 2005 interest rate and
assumes that such variable-rate indebtedness remains outstanding until the
maturity of the facility. The amount shown for income taxes is the consolidated
amount of income taxes payable at December 31, 2005, which is assumed to be paid
during 2006. A significant portion of the amount shown for indebtedness relates
to KII's Senior Secured Notes ($449.3 million at December 31, 2005). Such
indebtedness is denominated in euro. See Item 7A - "Quantative and Qualitative
Disclosures About Market Risk" and Note 6 to the Consolidated Financial
Statements.
The above table does not reflect any amounts that the Company might pay to
fund its defined benefit pension plans, as the timing and amount of any such
future fundings are unknown and dependent on, among other things, the future
performance of defined benefit pension plan assets, interest rate assumptions
and actual future retiree medical costs. Such defined benefit pension plans are
discussed above in greater detail. The above table also does not reflect any
amounts that the Company might pay related to its asset retirement obligations,
as the terms and amounts of such future fundings are unknown. See Notes 11 and
15 to the Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
General. The Company is exposed to market risk from changes in foreign
currency exchange rates, interest rates and equity security prices. In the past,
the Company has periodically entered into currency forward contracts, interest
rate swaps or other types of contracts in order to manage a portion of its
interest rate market risk. Otherwise, the Company does not generally enter into
forward or option contracts to manage such market risks, nor does the Company
enter into any such contract or other type of derivative instrument for trading
or speculative purposes. Other than as described below, the Company was not a
party to any material forward or derivative option contract related to foreign
exchange rates, interest rates or equity security prices at December 31, 2004
and 2005. See Notes 1 and 14 to the Consolidated Financial Statements.
Interest rates. The Company is exposed to market risk from changes in
interest rates, primarily related to indebtedness. At December 31, 2004 and
2005, substantially all of the Company's aggregate indebtedness was comprised of
fixed-rate instruments. The large percentage of fixed-rate debt instruments
minimizes earnings volatility that would result from changes in interest rates.
The following table presents principal amounts and weighted average interest
rates for the Company's aggregate outstanding indebtedness at December 31, 2005.
At December 31, 2004 and 2005, all outstanding fixed-rate indebtedness was
denominated in euros, and the outstanding variable rate borrowings were
denominated in euros. Information shown below for such foreign currency
denominated indebtedness is presented in its U.S. dollar equivalent at December
31, 2005 using exchange rates of 1.18 U.S. dollars per euro. Certain Norwegian
kroner denominated capital leases totaling $4.5 million in 2005 have been
excluded from the table below.
Amount
-------------------
Carrying Fair Interest Maturity
Indebtedness value value rate date
-------------- -------- ------- --------- ----------
(In millions)
Fixed-rate indebtedness -
euro-denominated
Senior Secured Notes $ 449.3 $ 463.6 8.9% 2009
======= =======
At December 31, 2004, euro-denominated fixed rate indebtedness aggregated
$519.2 million (fair value - $549.1 million) with a weighted-average interest
rate of 8.9%. Variable rate indebtedness at December 31, 2004 was $13.6 million
with a weighted average interest rate of 3.9%.
Foreign currency exchange rates. The Company is exposed to market risk
arising from changes in foreign currency exchange rates as a result of
manufacturing and selling its products worldwide. Earnings are primarily
affected by fluctuations in the value of the U.S. dollar relative to the euro,
the Norwegian kroner and the United Kingdom pound sterling.
As described above, at December 31, 2005, the Company had the equivalent of
$449.3 million of outstanding euro-denominated indebtedness (2004 - the
equivalent of $532.8 million of euro-denominated indebtedness). The potential
increase in the U.S. dollar equivalent of the principal amount outstanding
resulting from a hypothetical 10% adverse change in exchange rates at such date
would be approximately $44.4 million at December 31, 2005 (2004 - $52.4
million).
Other. The Company believes there may be a certain amount of incompleteness
in the sensitivity analysis presented above. For example, the hypothetical
effect of changes in exchange rates discussed above ignores the potential effect
on other variables which affect the Company's results of operations and cash
flows, such as demand for the Company's products, sales volumes and selling
prices and operating expenses. Accordingly, the amounts presented above are not
necessarily an accurate reflection of the potential losses the Company would
incur assuming the hypothetical changes in exchange rates were actually to
occur.
The above discussion and estimated sensitivity analysis amounts include
forward-looking statements of market risk which assume hypothetical changes in
currency exchange rates. Actual future market conditions will likely differ
materially from such assumptions. Accordingly, such forward-looking statements
should not be considered to be projections by the Company of future events,
gains or losses.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information called for by this Item is contained in a separate section
of this Annual Report. See "Index of Financial Statements and Schedules" (page
F-1).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. 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, have evaluated the Company's disclosure
controls and procedures as of December 31, 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 a
system of internal controls 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
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the Company's Consolidated Financial
Statements.
The Company currently expects that Section 404 of the Sarbanes-Oxley Act of
2002 will require the Company to annually include a management report on
internal control over financial reporting starting with the Company's Annual
Report on Form 10-K for the year ended December 31, 2007. The Company's
independent registered public accounting firm will also be required to annually
audit the Company's internal control over financial reporting. In order to
achieve compliance with Section 404, the Company has been documenting, testing
and evaluating its internal control over financial reporting since 2004, using a
combination of internal and external resources. The process of documenting,
testing and evaluating the Company's internal control over financial reporting
under the applicable guidelines is complex and time consuming, and available
internal and external resources necessary to assist the Company in the
documentation and testing required to comply with Section 404 are limited. While
the Company currently believes it has dedicated the appropriate resources, that
it will be able to fully comply with Section 404 in its Annual Report on Form
10-K for the year ended December 31, 2007 and be in a position to conclude that
the Company's internal control over financial reporting is effective as of
December 31, 2007, because the applicable requirements are complex and time
consuming, and because currently unforeseen events or circumstances beyond the
Company's control could arise, there can be no assurance that the Company will
ultimately be able to fully comply with Section 404 in its Annual Report on Form
10-K for the year ended December 31, 2007 or whether it will be able to conclude
that the Company's internal control over financial reporting is effective as of
December 31, 2007.
Changes in Internal Control Over Financial Reporting. There has been no
change to the Company's internal control over financial reporting during the
quarter ended December 31, 2005 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted pursuant to the General Instruction I of Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
Omitted pursuant to the General Instruction I of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Omitted pursuant to the General Instruction I of Form 10-K.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted pursuant to the General Instruction I of Form 10-K.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table shows the aggregate fees PricewaterhouseCoopers LLP,
the Company's independent registered public accounting firm ("PwC"), has billed
or is expected to bill to the Company and its subsidiaries for services rendered
for 2004 and 2005. No fees were billed or expected to be billed by PwC to the
Company for services performed in 2004 and 2005 for financial information
systems design and implementation.
December 31,
--------------
2004 2005
---- ----
(In thousands)
Audit(1) $ 1,149 $ 1,523
Audit related(2) 8 19
Tax(3) 12 21
--------- ---------
Total $ 1,169 $ 1,563
========= =========
1) Fees for the following services:
a) audits of the Company's consolidated year-end financials statements
for each year;
b) reviews of the unaudited quarterly financial statements appearing in
the Company's Forms 10-Q for each of the first three quarters of each
year;
c) consents and assistance with registration statements filed with the
Commission;
d) normally provided statutory or regulatory filings or engagements for
each year; and
e) the estimated out-of-pocket costs PwC incurred in providing all of
such services for which the Company reimburses PwC.
2) Fees for assurance and related services reasonably related to the audit or
review of the Company's financial statements for each year. These services
include employee benefit plan audits, accounting consultations and attest
services concerning financial accounting and reporting standards and advice
concerning internal controls.
3) Fees for tax compliance, tax advice and tax planning services.
See Appendix A to Kronos' proxy statement dated April 18, 2005 for the
Kronos' audit committee's Preapproval Policy.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) and (c) Financial Statements and Schedules
The Registrant
The consolidated financial statements and schedules of the Registrant
listed on the accompanying Index of Financial Statements and Schedules
(see page F-1) are filed as part of this Annual Report.
Financial Statements of Guarantors
The consolidated financial statements of Kronos Titan GmbH and Kronos
Denmark ApS listed on the accompanying Index of Financial Statements
and Schedules (see page F-1) are filed as part of this Annual Report
pursuant to Rule 3-16 of Regulation S-X. The Registrant is not
required to provide any other financial statements pursuant to Rule
3-16 of Regulation S-X.
(b) Exhibits
Included as exhibits are the items listed in the Exhibit Index. the
Company will furnish a copy of any of the exhibits listed below upon
payment of $4.00 per exhibit to cover the costs to the Company of
furnishing the exhibits. Pursuant to Item 601(b)(4)(iii) of Regulation
S-K, any instrument defining the rights of holders of long-term debt
issues and other agreements related to indebtedness which do not
exceed 10% of consolidated total assets as of December 31, 2005 will
be furnished to the Commission upon request.
Item No. Exhibit Index
3.1 Certificate of Incorporation of the Registrant - incorporated by
reference to Exhibit 3.1 to the Registrant's Registration Statement on
Form S-4 (File No. 333-100047).
3.2 Certificate of Amendment to Certificate of Incorporation of the
Registrant, dated March 15, 1989 - incorporated by reference to
Exhibit 3.2 to the Registrant's Registration Statement on Form S-4
(File No. 333-100047).
3.3 Certificate of Amendment to Certificate of Incorporation of the
Registrant, dated January 1, 1999 - incorporated by reference to
Exhibit 3.3 to the Registrant's Registration Statement on Form S-4
(File No. 333-100047).
3.4 Certificate of Amendment to Certificate of Incorporation of the
Registrant, dated February 8, 1999 - incorporated by reference to
Exhibit 3.4 to the Registrant's Registration Statement on Form S-4
(File No. 333-100047).
3.5 Certificate of Amendment to Certificate of Incorporation of the
Registrant, dated December 15, 1999 - incorporated by reference to
Exhibit 3.5 to the Registrant's Registration Statement on Form S-4
(File No. 333-100047).
3.6 Amended and Restated Bylaws of the Registrant - incorporated by
reference to Exhibit 3.6 to the Registrant's Registration Statement on
Form S-4 (File No. 333-100047).
4.1 Indenture governing the 8.875% Senior Secured Notes due 2009, dated as
of June 28, 2002, between the Registrant and The Bank of New York, as
trustee - incorporated by reference to Exhibit 4.1 to the Quarterly
Report on Form 10-Q of NL Industries, Inc. for the quarter ended June
30, 2002.
4.2 Form of certificate of 8.875% Senior Secured Note due 2009 (included
as Exhibit A to Exhibit 4.1) - incorporated by reference to Exhibit
4.2 to the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
4.3 Form of certificate of 8.875% Senior Secured Note due 2009 (included
as Exhibit B to Exhibit 4.1) - incorporated by reference to Exhibit
4.3 to the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
4.4 Purchase Agreement, dated as of June 19, 2002, among the Registrant,
Deutsche Bank AG London, Dresdner Bank AG, London Branch, and
Commerzbank Aktiengesellschaft, London Branch - incorporated by
reference to Exhibit 4.4 to the Quarterly Report on Form 10-Q of NL
Industries, Inc. for the quarter ended June 30, 2002.
4.5 Purchase Agreement dated November 18, 2004 between Kronos
International, Inc. and Deutsche Bank AG London - incorporated by
reference to Exhibit 4.4 to the Current Report on Form 8-K of the
Registrant dated November 24, 2004.
4.6 Form of Registration Rights Agreement as of November 26, 2004 between
Kronos International, Inc. and Deutsche Bank AG London - incorporated
by reference to Exhibit 4.5 to the Current Report on Form 8-K of the
Registrant dated November 24, 2004.
4.7 Collateral Agency Agreement, dated as of June 28, 2002, among The Bank
of New York, U.S. Bank, N.A. and the Registrant (filed herewith only
with respect to Sections 2, 5, 6 and 8 thereof) - incorporated by
reference to Exhibit 4.6 to the Quarterly Report on Form 10-Q of NL
Industries, Inc. for the quarter ended June 30, 2002.
4.8 Security Over Shares Agreement (shares of Kronos Limited), dated June
28, 2002, between the Registrant and The Bank of New York, U.S., as
trustee - incorporated by reference to Exhibit 4.7 to the Quarterly
Report on Form 10-Q of NL Industries, Inc. for the quarter ended June
30, 2002.
4.9 Pledge of Shares (shares of Kronos Denmark ApS), dated June 28, 2002,
between the Registrant and U.S. Bank, N.A., as collateral agent -
incorporated by reference to Exhibit 4.8 to the Quarterly Report on
Form 10-Q of NL Industries, Inc. for the quarter ended June 30, 2002.
4.10 Pledge Agreement (pledge of shares of Societe Industrielle du Titane,
S.A.), dated June 28, 2002, between the Registrant and U.S. Bank,
N.A., as collateral agent - incorporated by reference to Exhibit 4.9
to the Quarterly Report on Form 10-Q of NL Industries, Inc. for the
quarter ended June 30, 2002.
4.11 Partnership Interest Pledge Agreement (pledge of fixed capital
contribution in Kronos Titan GmbH & Co. OHG), dated June 28, 2002,
between the Registrant and U.S. Bank, N.A., as collateral agent -
incorporated by reference to Exhibit 4.10 to the Quarterly Report on
Form 10-Q of NL Industries, Inc. for the quarter ended June 30, 2002.
4.12 Recapitalization Agreement, dated as of June 5, 2002, between the
Registrant and Kronos, Inc. - incorporated by reference to Exhibit
4.12 to the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
4.13 Redemption Agreement, dated as of June 6, 2002, between the Registrant
and NL Industries, Inc. - incorporated by reference to Exhibit 4.13 to
the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
4.14 Form of Profit Participation Certificate (English translation from
German language document) - incorporated by reference to Exhibit 4.14
to the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
10.1 Euro 80,000,000 Facility Agreement, dated June 25, 2002, among Kronos
Titan GmbH & Co. OHG, Kronos Europe S.A./N.V., Kronos Titan A/S and
Titania A/S, as borrowers, Kronos Titan GmbH & Co. OHG, Kronos Europe
S.A./N.V. and Kronos Norge AS, as guarantors, Kronos Denmark ApS, as
security provider, Deutsche Bank AG, as mandated lead arranger,
Deutsche Bank Luxembourg S.A., as agent and security agent, and KBC
Bank NV, as fronting bank, and the financial institutions listed in
Schedule 1 thereto, as lenders - incorporated by reference to Exhibit
10.1 to the Quarterly Report on Form 10-Q of NL Industries, Inc. for
the quarter ended June 30, 2002.
10.2 First Amendment Agreement, dated September 3, 2004, Relating to a
Facility Agreement dated June 25, 2002 among Kronos Titan GmbH, Kronos
Europe S.A./N.V., Kronos Titan AS and Titania A/S, as borrowers,
Kronos Titan GmbH, Kronos Europe S.A./N.V. and Kronos Norge AS, as
guarantors, Kronos Denmark ApS, as security provider, with Deutsche
Bank Luxembourg S.A., acting as agent - incorporated by reference to
Exhibit 10.8 to the Registration Statement on Form S-1 of Kronos
Worldwide, Inc. (File No. 333-119639).
10.3 Second Amendment Agreement Relating to a Facility Agreement dated June
25, 2002 executed as of June 14, 2005 by and among Deutsche Bank AG,
as mandated lead arranger, Deutsche Bank Luxembourg S.A. as agent, the
participating lenders, Kronos Titan GmbH, Kronos Europe S.A./N.V,
Kronos Titan AS, Kronos Norge AS, Titania AS and Kronos Denmark ApS -
incorporated by reference to Exhibit 10.1 of the Registrant's Form 8-K
dated June 14, 2005. Certain schedules, exhibits, annexes and similar
attachments to this Exhibit 10.3 have not been filed; upon request,
the Reporting Persons will furnish supplementally to the Commission a
copy of any omitted exhibit, annex or attachment.
10.4 Lease Contract, dated June 21, 1952, between Farbenfabriken Bayer
Aktiengesellschaft and Titangesellschaft mit beschrankter Haftung
(German language version and English translation thereof) -
incorporated by reference to Exhibit 10.14 to the Annual Report on
Form 10-K of NL Industries, Inc. for the year ended December 31, 1985.
10.5 Contract on Supplies and Services, dated as of June 30, 1995, among
Bayer AG, Kronos Titan-GmbH & Co. OHG and the Registrant (English
translation from German language document) - incorporated by reference
to Exhibit 10.1 to Quarterly Report on Form 10-Q of NL Industries,
Inc. for the quarter ended September 30, 1995.
10.6 Amendment dated August 11, 2003 to the Contract on Supplies and
Services among Bayer AG, Kronos Titan-GmbH & Co. OHG and Kronos
International (English translation of German language document) -
incorporated by reference to Exhibit 10.32 of the Registration
statement on Form 10 of the Registrant (File No. 001-31763).
10.7 Master Technology Exchange Agreement, dated as of October 18, 1993,
among Kronos, Inc., Kronos Louisiana, Inc., the Registrant, Tioxide
Group Limited and Tioxide Group Services Limited - incorporated by
reference to Exhibit 10.8 to the Quarterly Report on Form 10-Q of NL
Industries, Inc. for the quarter ended September 30, 1993.
10.8 Intercorporate Services Agreement, dated as of January 1, 2005, among
Kronos Worldwide, Inc., Kronos (US), Inc., Kronos International, Inc.
and Kronos Canada, Inc.
10.9 Tax Agreement, dated as of May 28, 2002, between Kronos, Inc. and the
Registrant - incorporated by reference to Exhibit 10.7 to the
Registrant's Registration Statement on Form S-4 (File No. 333-100047).
10.10 Services Agreement, dated as of January 1, 2004, among Kronos
International, Inc., Kronos Europe S.A./N.V., Kronos (US), Inc.,
Kronos Titan GmbH, Kronos Denmark ApS, Kronos Canada, Inc., Kronos
Limited, Societe Industrielle Du Titane, S.A., Kronos B.V., Kronos
Titan AS and Titania AS.
10.11 Form of Assignment and Assumption Agreement, dated as of January 1,
1999, between Kronos, Inc. (formerly known as Kronos (USA), Inc.) and
the Registrant - incorporated by reference to Exhibit 10.9 to the
Registrant's Registration Statement on Form S-4 (File No. 333-100047).
10.12 Form of Cross License Agreement, effective as of January 1, 1999,
between Kronos Inc. (formerly known as Kronos (USA), Inc.) and the
Registrant - incorporated by reference to Exhibit 10.10 to the
Registrant's Registration Statement on Form S-4 (File No. 333-100047).
10.13** NL Industries, Inc. 1998 Long-Term Incentive Plan - incorporated by
reference to Appendix A to the Proxy Statement on Schedule 14A of NL
Industries, Inc. for the annual meeting of shareholders held on May 6,
1998.
10.14** Form of Kronos Worldwide, Inc. Long-Term Incentive Plan -
incorporated by reference to Exhibit 10.4 of Kronos Worldwide, Inc.'s
Registration Statement on Form 10 (File No. 001-31763).
10.15** Form of Indemnity Agreement between the Registrant and the officers
and directors of the Registrant - incorporated by reference to Exhibit
10.12 to the Registrant's Registration Statement on Form S-4 (File No.
333-100047).
10.16* Richards Bay Slag Sales Agreement, dated May 1, 1995, between
Richards Bay Iron and Titanium (Proprietary) Limited and Kronos, Inc.
- incorporated by reference to Exhibit 10.17 to the Annual Report on
Form 10-K for NL Industries, Inc. for the year ended December 31,
1995.
10.17* Amendment to Richards Bay Slag Sales Agreement, dated May 1, 1999,
between Richards Bay Iron and Titanium (Proprietary) Limited and
Kronos, Inc. - incorporated by reference to Exhibit 10.4 to the Annual
Report on Form 10-K for NL Industries, Inc. for the year ended
December 31, 1999.
10.18* Amendment to Richards Bay Slag Sales Agreement, dated June 1, 2001,
between Richards Bay Iron and Titanium (Proprietary) Limited and
Kronos, Inc. - incorporated by reference to Exhibit 10.5 to the Annual
Report on Form 10-K for NL Industries, Inc. for the year ended
December 31, 2001.
10.19* Amendment to Richards Bay Slag Sales Agreement dated December 20,
2002 between Richards Bay Iron and Titanium (Proprietary) Limited and
Kronos, Inc. - incorporated by reference to Exhibit 10.7 to the Annual
Report on Form 10-K for NL Industries, Inc. for the year ended
December 31, 2002.
10.20* Amendment to Richards Bay Slag Sales Agreement dated October 31,
2003 between Richards Bay Iron and Titanium (Proprietary) Limited and
Kronos, Inc - incorporated by reference to Exhibit 10.17 to Kronos
Worldwide, Inc.'s Annual Report on Form 10-K for the year ended
December 31, 2003.
10.21 Agreement between Sachtleben Chemie GmbH and Kronos Titan-GmbH
effective December 30, 1986 - incorporated by reference to Exhibit
10.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002.
10.22 Supplementary Agreement to the Agreement of December 30, 1986 between
Sachtleben Chemie GmbH and Kronos Titan-GmbH dated May 3, 1996 -
incorporated by reference to Exhibit 10.2 of the Registrant's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2002.
10.23 Second Supplementary Agreement to the Contract dated December 30,
1986 between Sachtleben Chemie GmbH and Kronos Titan-GmbH dated
January 8, 2002 - incorporated by reference to Exhibit 10.3 of the
Registrant's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002.
10.24** Summary of Consulting Arrangement, beginning on August 1, 2003,
between Lawrence A. Wigdor and Kronos Worldwide, Inc. - incorporated
by reference to Exhibit 10.50 to NL Industries, Inc.'s Annual Report
on Form 10-K for the year ended December 31, 2004.
10.25 Agency Agreement, dated as of January 1, 2004, among Kronos
International, Inc., Kronos Titan GmbH, Kronos Europe S.A./N.V.,
Kronos Canada, Inc., Kronos Titan AS and Societe Indutrielle Du
Titane, S.A.
10.26 Titanium Dioxide Products and Titanium Chemicals Distribution
Agreement, dated as of January 1, 2005, among Kronos Titan GmbH,
Kronos Europe S.A./N.V., Kronos Canada, Inc., Kronos Titan AS, Kronos
(US), Inc., Kronos Denmark ApS, Kronos Titan GmbH, Kronos Limited,
Societe Industrielle Du Titane, S.A. and Kronos B.V.
10.27 Raw Material Purchase and Sale Agreement, dated as of January 1,
2004, among Kronos (US), Inc., Kronos Titan GmbH, Kronos Europe
S.A./N.V. and Kronos Canada, Inc.
10.28 Promissory note in the amount of euro 65,000,000, dated as of October
12, 2004 between the Registrant and Kronos Worldwide, Inc.
10.29 Promissory note in the amount of euro 98,094,875, dated as of
November 26, 2004 between the Registrant and Kronos Worldwide, Inc.
12.1 Statements of Computation of Ratio of Earnings to Combined Fixed
Charges and Preferred Dividends
12.2 Statements of Computation of Ratio of Earnings to Fixed Charges
31.1 Certification.
31.2 Certification.
32.1 Certification.
___________________________________
* Portions of the exhibit have been omitted pursuant to a request for
confidential treatment.
** Management contract, compensatory plan or arrangement
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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)
By:/s/ Harold C. Simmons
-------------------------
Harold C. Simmons
March 28, 2006
(Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
/s/ Dr. Henry Basson /s/ Gregory M. Swalwell
- -------------------------------- -----------------------------------
Dr. Henry Basson, March 28, 2006 Gregory M. Swalwell, March 28, 2006
(Director) (Vice President, Finance;
Principal Financial Officer)
/s/ Andrew Kasprowiak /s/ Volker Roth
- -------------------------------- -----------------------------------
Andrew Kasprowiak, March 28, 2006 Volker Roth, March 28, 2006
(Director) (Director)
/s/ Dr. Ulfert Fiand /s/ James W. Brown
- -------------------------------- -----------------------------------
Dr. Ulfert Fiand, March 28, 2006 James W. Brown, March 28, 2006
(Director) (Vice President, Controller,
Principal Accounting Officer)
KRONOS INTERNATIONAL, INC.
Annual Report on Form 10-K
Items 8, 15(a) and 15(d)
Index of Financial Statements and Schedules
Financial Statements Page
Report of Independent Registered Public Accounting Firm F-2
Consolidated Balance Sheets - December 31, 2004 and 2005 F-3
Consolidated Statements of Income -
Years ended December 31, 2003, 2004 and 2005 F-5
Consolidated Statements of Comprehensive Income (Loss) -
Years ended December 31, 2003, 2004 and 2005 F-6
Consolidated Statements of Stockholder's Equity -
Years ended December 31, 2003, 2004 and 2005 F-7
Consolidated Statements of Cash Flows -
Years ended December 31, 2003, 2004 and 2005 F-8
Notes to Consolidated Financial Statements F-10
Financial Statement Schedules
Schedule I - Condensed Financial Information of Registrant S-1
Schedule II - Valuation and Qualifying Accounts S-5
Schedules III and IV are omitted because they are not applicable.
Other Financial Statements filed pursuant to Rule 3-16 of Regulation S-X
Financial Statements of Kronos Titan GmbH FA-1
Financial Statements of Kronos Denmark ApS FB-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholder and Board of Directors of Kronos International, Inc.:
In our opinion, the consolidated financial statements listed in the
accompanying index present fairly, in all material respects, the financial
position of Kronos International, Inc. and Subsidiaries at December 31, 2004 and
2005, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedules listed in the accompanying index
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and financial statement schedules based on our audits. We
conducted our audits of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
March 28, 2006
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2005
(In thousands, except share data)
ASSETS
2004 2005
---- ----
Current assets:
Cash and cash equivalents $ 17,505 $ 63,284
Restricted cash 1,529 1,355
Accounts and other receivables 130,729 120,182
Receivables from affiliates 2,517 1,952
Refundable income taxes 2,586 1,053
Inventories 170,261 185,348
Prepaid expenses 3,141 2,680
---------- ----------
Total current assets 328,268 375,854
---------- ----------
Other assets:
Deferred financing costs, net 10,404 7,722
Restricted marketable debt securities 2,877 2,572
Unrecognized net pension obligation 7,524 6,108
Deferred income taxes 238,284 213,275
Other 1,591 960
---------- ----------
Total other assets 260,680 230,637
---------- ----------
Property and equipment:
Land 34,164 30,288
Buildings 153,442 138,925
Equipment 724,904 644,271
Mining properties 71,980 68,163
Construction in progress 13,560 12,112
---------- ----------
998,050 893,759
Less accumulated depreciation and amortization 601,815 544,984
---------- ----------
Net property and equipment 396,235 348,775
---------- ----------
$ 985,183 $ 955,266
========== ==========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
December 31, 2004 and 2005
(In thousands, except share data)
LIABILITIES AND STOCKHOLDER'S EQUITY
2004 2005
---- ----
Current liabilities:
Current maturities of long-term debt $ 13,792 $ 958
Accounts payable and accrued liabilities 126,949 118,285
Payable to affiliates 11,042 14,882
Income taxes 17,080 21,799
Deferred income taxes 2,722 4,136
---------- ----------
Total current liabilities 171,585 160,060
---------- ----------
Noncurrent liabilities:
Long-term debt 519,403 452,865
Deferred income taxes 22,358 19,265
Accrued pension cost 48,441 125,766
Other 16,840 15,434
---------- ----------
Total noncurrent liabilities 607,042 613,330
---------- ----------
Minority interest 76 75
---------- ----------
Stockholder's equity:
Common stock, $100 par value; 100,000 shares
authorized; 2,968 shares issued 297 297
Additional paid-in capital 1,944,185 1,944,185
Retained deficit (1,399,118) (1,339,332)
Notes receivable from affiliate (209,526) (209,526)
Accumulated other comprehensive loss:
Currency translation (99,764) (130,178)
Pension liabilities (29,594) (83,645)
---------- ----------
Total stockholder's equity 206,480 181,801
---------- ----------
$ 985,183 $ 955,266
========== ==========
See accompanying notes to consolidated financial statements.
Commitments and contingencies (Notes 10 and 13)
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net sales $ 715,906 $ 807,970 $ 850,873
Cost of sales 516,864 609,559 613,178
---------- ---------- ----------
Gross margin 199,042 198,411 237,695
Selling, general and administrative expense 86,965 104,110 110,185
Other operating income (expense):
Currency transaction gains (losses), net (3,721) (2,243) 4,090
Disposition of property and equipment (394) (895) (1,395)
Royalty income 6,122 6,034 6,827
Other income 489 426 576
Other expense (130) (72) (86)
---------- ---------- ----------
Income from operations 114,443 97,551 137,522
Other income (expense):
Interest income from affiliates 30 2,767 18,943
Trade interest income 700 1,147 951
Securities transaction gain - - 5,439
Interest expense to affiliates (81) (4) -
Other interest expense (32,529) (36,688) (43,950)
---------- ---------- ----------
Income before income taxes and minority interest 82,563 64,773 118,905
Provision (benefit) for income taxes 730 (261,260) 59,107
Minority interest 72 53 12
---------- ---------- ----------
Net income $ 81,761 $ 325,980 $ 59,786
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net income $ 81,761 $ 325,980 $ 59,786
---------- ---------- ----------
Other comprehensive (loss) income, net of tax:
Minimum pension liabilities adjustment (27,647) 4,803 (54,051)
Currency translation adjustment 5,600 33,661 (30,414)
---------- ---------- ----------
Total other comprehensive income (loss) (22,047) 38,464 (84,465)
---------- ---------- ----------
Comprehensive income (loss) $ 59,714 $ 364,444 $ (24,679)
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
Years ended December 31, 2003, 2004 and 2005
(In thousands)
Accumulated other
comprehensive
Notes income (loss) Total
Additional Retained receivable ------------------------ common
Common paid-in earnings from Currency Pension stockholder's
stock capital (deficit) affiliates translation liabilities equity
------- ----------- ---------- ------------ ----------- ----------- -------------
Balance at December 31, 2002 $ 297 $1,944,185 $(1,721,859) $ - $(139,025) $ (6,750) $ 76,848
Net income - - 81,761 - - - 81,761
Other comprehensive income (loss),
net of tax - - - 5,600 (27,647) (22,047)
Cash dividends - - (25,000) - - - (25,000)
----- ---------- ----------- --------- --------- -------- ---------
Balance at December 31, 2003 297 1,944,185 (1,665,098) - (133,425) (34,397) 111,562
Net income - - 325,980 - - - 325,980
Other comprehensive income (loss),
net of tax - - - - 33,661 4,803 38,464
Change in notes receivable
from affiliates - - - (209,526) - - (209,526)
Cash dividends - - (60,000) - - - (60,000)
----- ---------- ----------- --------- --------- -------- ---------
Balance at December 31, 2004 297 1,944,185 (1,399,118) (209,526) (99,764) (29,594) 206,480
Net income - - 59,786 - - - 59,786
Other comprehensive loss,
net of tax - - - - (30,414) (54,051) (84,465)
----- ---------- ----------- --------- --------- -------- ---------
Balance at December 31, 2005 $ 297 $1,944,185 $(1,339,332) $(209,526) $(130,178) $(83,645) $ 181,801
===== ========== =========== ========= ========= ======== =========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from operating activities:
Net income $ 81,761 $ 325,980 $ 59,786
Depreciation and amortization 33,634 37,726 36,504
Noncash interest expense 1,944 2,044 2,566
Deferred income taxes 38,690 (273,985) 30,815
Minority interest 72 53 12
Net loss from disposition of property and equipment 394 895 1,395
Securities transaction gain - - (5,439)
Defined benefit pension plan expense greater
(less) than cash funding (3,805) (800) (2,335)
Other, net 250 987 (1,839)
Change in assets and liabilities:
Accounts and other receivables 1,104 (6,227) (9,641)
Inventories 232 11,582 (38,938)
Prepaid expenses 1,345 (233) (228)
Accounts payable and accrued liabilities 5,495 27,922 10,781
Income taxes (37,231) 25,557 7,917
Accounts with affiliates (14,424) (6,103) 4,674
Other noncurrent assets (3,779) 1,981 (690)
Other noncurrent liabilities (894) (5,124) (2,636)
---------- ---------- ----------
Net cash provided by operating activities 104,788 142,255 92,704
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (31,518) (33,679) (39,522)
Purchase of interest in subsidiary - (575) -
Proceeds from disposal of interest in Norwegian
smelting operation - - 3,542
Change in restricted cash equivalents and restricted
marketable debt securities, net (554) (70) 129
Proceeds from disposition of property and equipment 383 99 37
---------- ---------- ----------
Net cash used by investing activities (31,689) (34,225) (35,814)
---------- ---------- ----------
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from financing activities:
Indebtedness:
Borrowings $ 16,106 $ 241,648 $ 4,620
Principal payments (46,006) (100,073) (13,159)
Deferred financing fees - (1,989) -
Loans to affiliates - (209,524) -
Dividends paid (25,000) (60,000) -
Distributions to minority interests (14) - -
---------- ---------- ----------
Net cash used by financing activities (54,914) (129,938) (8,539)
---------- ---------- ----------
Cash and cash equivalents - net change from:
Operating, investing and financing activities 18,185 (21,908) 48,351
Currency translation 3,913 2,292 (2,572)
---------- ---------- ----------
22,098 (19,616) 45,779
Balance at beginning of year 15,023 37,121 17,505
---------- ---------- ----------
Balance at end of year $ 37,121 $ 17,505 $ 63,284
========== ========== ==========
Supplemental disclosures - cash paid
(received) for:
Interest $ 28,147 $ 33,425 $ 40,912
Income taxes (11,480) (23,776) 20,033
Inventories received as partial
consideration for disposal of interest
in Norwegian smelting operations $ - $ - $ 1,897
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Summary of significant accounting policies:
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 or the Company is a wholly-owned subsidiary of Kronos
Worldwide, Inc. ("Kronos") (NYSE:KRO). At December 31, 2005, (i) Valhi, Inc.
(NYSE:VHI) 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 such companies.
Management's estimates. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America ("GAAP") requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amount of revenues and expenses during the reporting period. Actual
results may differ significantly from previously-estimated amounts under
different assumptions or conditions.
Principles of consolidation. The consolidated financial statements include
the accounts of KII and its wholly-owned and majority-owned subsidiaries. All
material intercompany accounts and balances have been eliminated. Minority
interest relates to the Company's majority-owned subsidiary in France, which
conducts the Company's marketing and sales activities in that country. During
2004, the Company increased its ownership interest by approximately 5% to 99% in
such subsidiary by acquiring shares previously held by certain of its other
stockholders for an aggregate of $575,000.
Translation of foreign currencies. Assets and liabilities of subsidiaries
whose functional currency is other than the U.S. dollar are translated at
year-end rates of exchange and revenues and expenses are translated at average
exchange rates prevailing during the year. Resulting translation adjustments are
accumulated in stockholder's equity as part of accumulated other comprehensive
income (loss), net of related deferred income taxes and minority interest.
Currency transaction gains and losses are recognized in income currently.
Derivatives and hedging activities. Derivatives are recognized as either
assets or liabilities and measured at fair value in accordance with SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
The accounting for changes in fair value of derivatives depends upon the
intended use of the derivative, and such changes are recognized either in net
income or other comprehensive income. As permitted by the transition
requirements of SFAS No. 133, the Company has exempted from the scope of SFAS
No. 133 all host contracts containing embedded derivatives that were issued or
acquired prior to January 1, 1999.
Cash and cash equivalents. Cash equivalents include bank deposits with
original maturities of three months or less.
Restricted marketable debt securities. Restricted marketable debt
securities are primarily invested in corporate debt securities and include
amounts restricted in accordance with applicable Norwegian law regarding certain
requirements of the Company's Norwegian defined benefit pension plans ($2.9
million and $2.6 million at December 31, 2004 and 2005, respectively). The
restricted marketable debt securities are generally classified as either a
current or noncurrent asset depending upon the maturity date of each such debt
security and are carried at market which approximates cost.
Accounts receivable. The Company provides an allowance for doubtful
accounts for known and estimated potential losses arising from sales to
customers based on a periodic review of these accounts.
Property and equipment and depreciation. Property and equipment are stated
at cost. The Company has a governmental concession with an unlimited term to
operate an ilmenite mine in Norway. Mining properties consist of buildings and
equipment used in the Company's Norwegian ilmenite mining operations. While the
Company owns the land and ilmenite reserves associated with the mine, such land
and reserves were acquired for nominal value and the Company has no material
asset recognized for the land and reserves related to such mining operations.
Depreciation of property and equipment for financial reporting purposes
(including mining properties) is computed principally by the straight-line
method over the estimated useful lives of ten to 40 years for buildings and
three to 20 years for equipment. Accelerated depreciation methods are used for
income tax purposes, as permitted. Upon sale or retirement of an asset, the
related cost and accumulated depreciation are removed from the accounts and any
gain or loss is recognized in income currently.
Expenditures for maintenance, repairs and minor renewals are expensed;
expenditures for major improvements are capitalized. The Company performs
planned major maintenance activities during the year. Repair and maintenance
costs estimated to be incurred in connection with planned major maintenance
activities are accrued in advance and are included in cost of sales. Accrued
repair and maintenance costs, included in other current liabilities and
consisting primarily of materials and supplies, was $3.9 million and $3.4
million at December 31, 2004 and 2005, respectively.
Interest costs related to major long-term capital projects and renewals are
capitalized as a component of construction costs. Interest costs capitalized
were not significant in 2003, 2004 or 2005.
When events or changes in circumstances indicate that assets may be
impaired, an evaluation is performed to determine if an impairment exists. Such
events or changes in circumstances include, among other things, (i) significant
current and prior periods or current and projected periods with operating
losses, (ii) a significant decrease in the market value of an asset or (iii) a
significant change in the extent or manner in which an asset is used. All
relevant factors are considered. The test for impairment is performed by
comparing the estimated future undiscounted cash flows (exclusive of interest
expense) associated with the asset to the asset's net carrying value to
determine if a write-down to market value or discounted cash flow value is
required. The Company assesses impairment of property and equipment in
accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."
Long-term debt. Long-term debt is stated net of any unamortized original
issue premium or discount. Amortization of deferred financing costs and any
premium or discount associated with the issuance of indebtedness, all included
in interest expense, is computed by the interest method over the term of the
applicable issue.
Employee benefit plans. Accounting and funding policies for retirement
plans are described in Note 11.
Income taxes. Prior to December 2003, KII, Kronos and its qualifying
subsidiaries were members of NL's consolidated U.S. federal income tax group
(the "NL Tax Group"). As a member of the NL Tax Group, the Company was a party
to a tax sharing agreement (the "NL Tax Agreement"). The NL Tax Group, including
KII, is included in the consolidated U.S. federal tax return of Contran (the
"Contran Tax Group"). As a member of the Contran Tax Group, NL is a party to a
separate tax sharing agreement (the "Contran Tax Agreement"). The Contran Tax
Agreement provides that NL and its qualifying subsidiaries, including KII,
compute provisions for U.S. income taxes on a separate-company basis using the
tax elections made by Contran. Pursuant to the Kronos Tax Sharing Agreement and
using the tax elections made by Contran, KII made payments to or received
payments from Kronos in amounts it would have paid to or received from the U.S.
Internal Revenue Service had it not been a member of NL's consolidated tax group
but instead was a separate taxpayer. Refunds are limited to amounts previously
paid under the NL Tax Sharing Agreement.
Effective December 2003, following NL's distribution of 48.8% of the
outstanding shares of Kronos common stock to NL stockholders, Kronos and its
qualifying subsidiaries, including KII, ceased being members of the NL Tax
Group, but remained as members of the Contran Tax Group. Kronos entered into a
new tax sharing agreement with Valhi and Contran, which contains similar terms
to the NL Tax Agreement. As a member of the Contran Tax Group, KII is jointly
and severally liable for the federal income tax liability of Contran and the
other companies included in the Contran Tax Group for all periods in which the
Company is included in the Contran Tax Group. See Note 10. Kronos and its
consolidating subsidiaries, including KII, are also included in Contran's
consolidated unitary state income tax returns in certain qualifying U.S.
jurisdictions. The terms of the Contran Tax Agreement also apply to state
provisions in these jurisdictions. The Company made no payments to Kronos for
income taxes in 2003, 2004 or 2005.
Deferred income tax assets and liabilities are recognized for the expected
future tax consequences of temporary differences between the income tax and
financial reporting carrying amounts of assets and liabilities, including
investments in the Company's subsidiaries and affiliates who are not members of
the Contran Tax Group and undistributed earnings of foreign subsidiaries which
are not deemed to be permanently reinvested. Earnings of foreign subsidiaries
deemed to be permanently reinvested aggregated $527 million at December 31, 2004
and $707 million at December 31, 2005. Determination of the amount of the
unrecognized deferred income tax liability related to such earnings is not
practicable due to the complexities associated with the U.S. taxation on
earnings of foreign subsidiaries repatriated to the U.S. The Company
periodically evaluates its deferred tax assets in the various taxing
jurisdictions in which it operates and adjusts any related valuation allowance
based on the estimate of the amount of such deferred tax assets that the Company
believes does not meet the "more-likely-than-not" recognition criteria.
Net sales. Sales are recorded when products are shipped and title and other
risks and rewards of ownership have passed to the customer, or when services are
performed. Shipping terms of products shipped are generally FOB shipping point,
although in some instances shipping terms are FOB destination point (for which
sales are not recognized until the product is received by the customer). Amounts
charged to customers for shipping and handling are included in net sales. Sales
are stated net of price, early payment and distributor discounts and volume
rebates.
Inventories and cost of sales. Inventories are stated at the lower of cost
(principally average cost) or market, net of allowance for slow-moving
inventories ($7.3 million and $6.5 million at December 31, 2004 and 2005,
respectively). Amounts are removed from inventories at average cost. Cost of
sales includes costs for materials, packing and finishing, utilities, salary and
benefits, maintenance and depreciation.
Selling, general and administrative expenses; shipping and handling costs.
Selling, general and administrative expenses include costs related to marketing,
sales, distribution, shipping and handling, research and development, legal and
administrative functions such as accounting, treasury and finance, and includes
costs for salaries and benefits, travel and entertainment, promotional materials
and professional fees. Shipping and handling costs are included in selling,
general and administrative expense and were $43 million in 2003, $49 million in
2004 and $52 million in 2005. Advertising costs are expensed as incurred and
were $1 million in each of 2003, 2004 and 2005. Research, development and
certain sales technical support costs are expensed as incurred and approximated
$7 million in 2003, $8 million in 2004 and $9 million in 2005.
Stock options. The Company has not issued any stock options. However,
certain employees of the Company have been granted options by NL to purchase NL
common stock. The Company has elected the disclosure alternative prescribed by
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended, and to
account for its stock-based employee compensation related to stock options in
accordance with Accounting Principles Board Opinion ("APBO") No. 25, "Accounting
for Stock Issued to Employees," and its various interpretations. Under APBO No.
25, no compensation cost is generally recognized for fixed stock options in
which the exercise price is not less than the market price on the grant date.
Prior to 2003, and following NL's cash settlement of options to purchase NL
common stock held by certain individuals, NL and the Company commenced
accounting for its stock options using the variable accounting method because NL
could not overcome the presumption that it would not similarly cash settle its
remaining stock options. Under the variable accounting method, the intrinsic
value of all unexercised stock options (including those with an exercise price
at least equal to the market price on the date of grant) are accrued as an
expense over their vesting period, with subsequent increases (decreases) in NL's
market price resulting in additional compensation expense (income). Upon
exercise of such options to purchase NL common stock held by employees of the
Company, the Company pays NL an amount equal to the difference between the
market price of NL's common stock on the date of exercise and the exercise price
of such stock option. Aggregate compensation expense related to NL stock options
held by employees of the Company was $300,000 in 2003 and $1.0 million in 2004,
and compensation income was $600,000 in 2005. The total income tax benefit
related to such compensation cost recognized by the Company was approximately
$100,000 in 2003 and $400,000 in 2004, and the total income tax provision
related to the compensation income was $200,000 in 2005. No compensation cost
was capitalized as part of assets (inventory or fixed assets) during 2003, 2004
and 2005.
The following table presents what the Company's consolidated net income,
and related per share amounts, would have been in 2003, 2004 and 2005 if the
Company had applied the fair value-based recognition provisions of SFAS No. 123,
for all awards granted subsequent to January 1, 1995.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In millions)
Net income (loss) as reported $ 81.8 $ 326.0 $ 59.8
Adjustments, net of applicable income
tax effects and minority interest:
Stock-based employee compensation expense
(income) determined under APBO No. 25 .1 .6 (.3)
Stock-based employee compensation expense
determined under SFAS No. 123 (.1) - -
------- ------- -------
Pro forma net income (loss) $ 81.8 $ 326.6 $ 59.5
======= ======= =======
Note 2 - Geographic information:
The Company's operations are associated with the production and sale of
TiO2. Titanium dioxide pigments are used to impart whiteness, brightness and
opacity to a wide variety of products, including paints, plastics, paper, fibers
and ceramics. All of the Company's net assets are located in Europe.
For geographic information, net sales are attributed to the place of
manufacture (point of origin) and the location of the customer (point of
destination); property and equipment are attributed to their physical location.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Geographic areas
Net sales - point of origin:
Germany $ 510,105 $ 576,138 $ 613,081
Belgium 150,728 186,445 186,951
Norway 131,457 144,492 160,529
Eliminations (76,384) (99,105) (109,688)
---------- ---------- ----------
$ 715,906 $ 807,970 $ 850,873
========== ========== ==========
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Net sales - point of destination:
Europe $ 567,630 $ 666,271 $ 689,516
North America 58,293 42,015 51,922
Other 89,983 99,684 109,435
---------- ---------- ----------
$ 715,906 $ 807,970 $ 850,873
========== ========== ==========
December 31,
--------------
2004 2005
---- ----
(In thousands)
Identifiable assets -
net property and equipment:
Germany $ 269,922 $ 235,932
Belgium 68,314 57,943
Norway 57,808 54,759
Other 191 141
---------- ----------
$ 396,235 $ 348,775
========== ==========
Note 3 - Accounts and other receivables:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Trade receivables $ 120,969 $ 110,268
Insurance claims 32 26
Recoverable VAT and other receivables 11,388 11,317
Allowance for doubtful accounts (1,660) (1,429)
---------- ----------
$ 130,729 $ 120,182
========== ==========
Note 4 - Inventories
December 31,
--------------
2004 2005
---- ----
(In thousands)
Raw materials $ 34,303 $ 42,807
Work in process 13,044 13,654
Finished products 90,083 98,004
Supplies 32,831 30,883
---------- ----------
$ 170,261 $ 185,348
========== ==========
Note 5 - Accounts payable and accrued liabilities:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Accounts payable $ 67,463 $ 63,382
Employee benefits 27,863 27,147
Other 31,623 27,756
---------- ----------
$ 126,949 $ 118,285
========== ==========
Note 6 - Long-term debt:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Long-term debt:
8.875% Senior Secured Notes $ 519,225 $ 449,298
Bank credit facility 13,622 -
Other 348 4,525
---------- ----------
533,195 453,823
Less current maturities 13,792 958
---------- ----------
$ 519,403 $ 452,865
========== ==========
In June 2002, KII issued at par value euro 285 million principal amount
($280 million when issued) of its 8.875% Senior Secured Notes due 2009, and in
November 2004 KII issued at 107% of par an additional euro 90 million principal
amount ($130 million when issued) of the KII Senior Secured Notes (collectively,
the "Notes"). The Notes are collateralized by a pledge of 65% of the common
stock or other ownership interests of certain of KII's first-tier operating
subsidiaries. Such operating subsidiaries are Kronos Titan GmbH, Kronos Denmark
ApS, Kronos Limited and Societe Industrielle Du Titane, S.A. The Notes are
issued pursuant to an indenture which contains a number of covenants and
restrictions which, among other things, restricts the ability of KII and its
subsidiaries to incur debt, incur liens, pay dividends or merge or consolidate
with, or sell or transfer all or substantially all of their assets to, another
entity. The Notes are redeemable, at KII's option, at redemption prices ranging
from 104.437% of the principal amount, declining to 100% on or after December
30, 2008. In the event of a change of control of KII, as defined, KII would be
required to make an offer to purchase its Notes at 101% of the principal amount.
KII would also be required to make an offer to purchase a specified portion of
its Notes at par value in the event KII generates a certain amount of net
proceeds from the sale of assets outside the ordinary course of business, and
such net proceeds are not otherwise used for specified purposes within a
specified time period. At December 31, 2005, KII was in compliance with all the
covenants, and the quoted market price of the Notes was approximately euro 1,045
per euro 1,000 principal amount (2004 - euro 1,075 per euro 1,000 principal
amount). At December 31, 2005, the carrying amount of the Notes includes euro
4.8 million ($5.7 million) of unamortized premium associated with the November
2004 issuance (2004 - euro 6.2 million, or $8.4 million).
KII's operating subsidiaries in Germany, Belgium and Norway (collectively,
the "Borrowers") have a euro 80 million secured revolving bank credit facility
that matures in June 2008 ("European Credit Facility"). Borrowings may be
denominated in euros, Norwegian kroners or U.S. dollars, and bear interest at
the applicable interbank market rate plus 1.125%. The facility also provides for
the issuance of letters of credit up to euro 5 million. The European Credit
Facility is collateralized by the accounts receivable and inventories of the
borrowers, plus a limited pledge of all of the other assets of the Belgian
borrower. The European Credit Facility contains certain restrictive covenants
which, among other things, restricts the ability of the borrowers to incur debt,
incur liens, pay dividends or merge or consolidate with, or sell or transfer all
or substantially all of their assets to, another entity. In addition, the
European Credit Facility contains customary cross-default provisions with
respect to other debt and obligations of Borrowers, KII and its other
subsidiaries. At December 31, 2005, no amounts were outstanding under the
European Credit Facility and the equivalent of $92.3 million was available for
additional borrowing by the subsidiaries.
Under the cross-default provisions of the Notes, the Notes may be
accelerated prior to their stated maturity if KII or any of KII's subsidiaries
default under any other indebtedness in excess of $20 million due to a failure
to pay such other indebtedness at its due date (including any due date that
arises prior to the stated maturity as a result of a default under such other
indebtedness). Under the cross-default provisions of the European Credit
Facility, any outstanding borrowings under the European Credit Facility may be
accelerated prior to their stated maturity if the Borrowers or KII default under
any other indebtedness in excess of euro 5 million due to a failure to pay such
other indebtedness at its due date (including any due date that arises prior to
the stated maturity as a result of a default under such other indebtedness). The
European Credit Facility contains provisions that allow the lender to accelerate
the maturity of the applicable facility in the event of a change of control, as
defined, of the applicable borrower. In the event the cross-default provisions
of either the Notes or the European Credit Facility become applicable, and such
indebtedness is accelerated, the Company would be required to repay such
indebtedness prior to their stated maturity.
Aggregate maturities of long-term debt at December 31, 2005 are shown in
the table below.
Years ending December 31, Amount
- -------------------------- --------------
(In thousands)
2006 $ 958
2007 861
2008 872
2009 450,200
2010 932
2011 and thereafter -
--------
$453,823
========
Restrictions. Certain of the credit facilities described above require the
respective borrower to maintain minimum levels of equity, require the
maintenance of certain financial ratios, limit dividends and additional
indebtedness and contain other provisions and restrictive covenants customary in
lending transactions of this type. At December 31, 2005, the restricted net
assets of consolidated subsidiaries approximated $90 million.
Note 7 - Other noncurrent liabilities:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Insurance claims and expenses $ 1,505 $ 1,255
Employee benefits 5,107 4,735
Asset retirement obligations 958 934
Other 9,270 8,510
---------- ----------
$ 16,840 $ 15,434
========== ==========
The asset retirement obligations are discussed in Note 15.
Note 8 - Common stock and notes receivable from affiliates:
NL common stock options held by employees of the Company. At December 31,
2005, employees of the company held options to purchase approximately 68,000
shares of NL common stock, which are exercisable at various dates through 2010
(approximately 33,000) at exercise prices ranging from $2.66 to $9.34 per share,
and exercisable at various dates through 2011 (approximately 35,000) at an
exercise price of $11.49 per share. Such options generally vest over five years,
and vesting ceases at the date the employee separates from service from the
Company (including retirement).
The pro forma information required by SFAS No. 123 is based on an
estimation of the fair value of options issued subsequent to January 1, 1995.
See Note 1. No options were granted in 2003, 2004 or 2005. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting periods.
Common stock dividends. KII paid $25.0 million in cash dividends to Kronos
during 2003, $60.0 million during 2004 and nil in 2005.
Notes receivable from affiliates - contra equity. In the fourth quarter of
2004, KII loaned an aggregate euro 163.1 million ($209.5 million) to Kronos in
return for two promissory notes. Interest on both notes is payable to KII on a
quarterly basis at an annual rate of 9.25%, such interest was and 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 the Company's
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.
Cash flows related to principal amounts on such loans made to affiliates
included in contra equity are reflected in financing activities in the
accompanying Consolidated Statements of Cash Flows.
Note 9 - Securities transaction gain:
A securities transaction gain in 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.
Note 10 - Income taxes:
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In millions)
Pre-tax income (loss):
Germany $ 45.8 $ 30.2 $ 64.3
Other non-U.S. 36.8 34.6 54.6
-------- -------- --------
$ 82.6 $ 64.8 $ 118.9
======== ======== ========
Expected tax expense (benefit), at U.S.
federal statutory income tax rate of 35% $ 28.9 $ 22.7 $ 41.6
Non-U.S. tax rates (.9) .3 .5
Loss of German tax attribute - - 17.5
Nondeductible expenses 2.7 4.2 4.6
Change in deferred income tax valuation
allowance, net (6.7) (280.7) -
Tax contingency reserve adjustment, net 13.4 (4.6) (7.7)
Assessment (refund) of prior year income taxes (38.0) (2.6) 2.1
Other, net 1.3 (.6) .5
-------- -------- --------
$ .7 $ (261.3) $ 59.1
======== ======== ========
Components of income tax expense (benefit):
Currently payable (refundable):
Germany $ (56.9) $ (.2) $ 10.8
Other non - U.S. 18.9 12.9 17.5
-------- -------- --------
(38.0) 12.7 28.3
-------- -------- --------
Deferred income taxes (benefit):
Germany 44.4 (270.5) 31.2
Other non - U.S. (5.7) (3.5) (.4)
-------- -------- --------
38.7 (274.0) 30.8
-------- -------- --------
$ .7 $ (261.3) $ 59.1
======== ======== ========
Comprehensive provision for
income taxes (benefit) allocable to:
Net income $ .7 $ (261.3) $ 59.1
Other comprehensive income -
pension liabilities (9.5) (8.1) (32.4)
-------- -------- --------
$ (8.8) $ (269.4) $ 26.7
======== ======== ========
The components of the net deferred tax liability at December 31, 2004 and
2005, and changes in the deferred income tax valuation allowance during the past
three years, are summarized in the following tables.
December 31,
--------------------------------------------------
2004 2005
----------------------- -----------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
(In millions)
Tax effect of temporary differences
related to:
Inventories $ 1.5 $ (4.4) $ 1.6 $ (4.5)
Property and equipment 37.8 (22.9) 25.5 (20.5)
Accrued (prepaid) pension cost 19.4 (40.4) 51.9 (35.6)
Other accrued liabilities and
deductible differences 46.1 - 25.6 -
Other taxable differences - (43.5) - (28.6)
Investment in subsidiaries/affiliates
not in tax group 1.9 - - -
Tax loss and tax credit carryforwards 217.8 - 174.5 -
------ ------- ------ -------
Adjusted gross deferred tax assets
(liabilities) 324.5 (111.2) 279.1 (89.2)
Netting of items by tax jurisdiction (86.2) 86.2 (65.8) 65.8
------ ------- ------ -------
238.3 (25.0) 213.3 (23.4)
Less net current deferred tax
asset (liability) - (2.7) - (4.1)
------ ------- ------ -------
Net noncurrent deferred tax asset
(liability) $238.3 $ (22.3) $213.3 $ (19.3)
====== ======= ====== =======
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In millions)
Increase (decrease) in valuation allowance:
Recognition of certain deductible tax
attributes for which the benefit had not
previously been recognized under the
"more-likely-than-not" recognition criteria $ (6.7) $ (280.7) $ -
Foreign currency translation 28.2 (3.0) -
Offset to the change in gross deferred
income tax assets due principally to
redeterminations of certain tax attributes
and implementation of certain tax
planning strategies (12.5) 121.0 -
-------- -------- --------
$ 9.0 $ (162.7) $ -
======== ======== ========
Certain of the Company's non-U.S. tax returns are being examined and tax
authorities have or may propose tax deficiencies, including non-income related
items 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 December 31,
2005). The Company filed a protest to this assessment, and believes that a
significant portion of the assessment was 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, Kronos
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). Kronos 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 $7.7 million tax contingency adjustment income tax benefit
in the year ended December 31, 2005 relates primarily to the withdrawal of the
Belgium tax authorities' assessment related to 1999, as discussed above.
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.
At December 31, 2003, the Company had a significant amount of net operating
loss carryforwards for German corporate and trade tax purposes, all of which
have no expiration date. These net operating loss carryforwards were generated
by KII principally during the 1990's when KII had a significantly higher level
of outstanding indebtedness than is currently outstanding. For financial
reporting purposes, however, the benefit of such net operating loss
carryforwards had not previously been recognized because Kronos did not believe
they met the "more-likely-than-not" recognition criteria, and accordingly the
Company had a deferred income tax asset valuation allowance offsetting the
benefit of such net operating loss carryforwards and the Company's other tax
attributes in Germany. At the end of the second quarter of 2004, and based on
all available evidence, the Company concluded that the benefit of the net
operating loss carryforwards and other German tax attributes now met the
"more-likely-than-not" recognition criteria, and that reversal of the deferred
income tax asset valuation allowance related to Germany was appropriate. Given
the magnitude of the German net operating loss carryforwards and the fact that
current provisions of German law limit the annual utilization of net operating
loss carryforwards to 60% of taxable income after the first euro 1 million of
taxable income, KII believes it will take several years to fully utilize the
benefit of such loss carryforwards. However, given that the Company had
generated positive taxable income in Germany in recent years, combined with the
fact that the net operating loss carryforwards have no expiration date, the
Company concluded, among other reasons, that it was now appropriate to reverse
all of the valuation allowance related to the net operating loss carryforwards
because the benefit of such operating loss carryforwards now meet the
"more-likely-than-not" recognition criteria. Of the $280.7 million valuation
allowance related to Germany which was reversed during 2004, and in accordance
with the applicable GAAP related to accounting for income taxes at interim
periods, (i) $8.7 million was reversed during the first six months of 2004 that
related primarily to the utilization of the German net operating loss
carryforwards during such period, (ii) $268.6 million was reversed as of June
30, 2004 and (iii) $3.4 million was reversed during the last six months of 2004.
In the first quarter of 2003, KII was notified by the German Federal Fiscal
Court that the Court had ruled in KII's favor concerning a claim for refund suit
in which KII sought refunds of prior taxes paid during the periods 1990 through
1997. KII and KII's German operating subsidiary were required to file amended
tax returns with the German tax authorities to receive refunds for such years,
and all of such amended returns were filed during 2003. Such amended returns
reflected an aggregate net refund of taxes and related interest to KII and its
German operating subsidiary of euro 26.9 million ($32.1 million), and the
Company recognized the benefit of these net refunds in its 2003 results of
operations. For the year ended December 31, 2004, the Company recognized a net
refund of euro 2.5 million ($3.1 million) related to additional net interest
which has accrued on the outstanding refund amount. In 2004, KII and its German
operating subsidiary had received net refunds of euro 35.6 million ($44.7
million when received). All refunds relating to the periods 1990 to 1997 were
received by December 31, 2004. In addition to the refunds for the 1990 to 1997
periods, the court ruling also resulted in a refund of 1999 income taxes and
interest, and the Company recognized euro 21.5 million ($24.6 million) in 2003.
At December 31, 2005, the net operating loss carryforwards for German
corporate and trade tax purposes aggregated the equivalent of $593 million and
$104 million, respectively, all of which have no expiration date.
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.
Note 11 - Employee benefit plans:
The Company maintains various defined benefit pension plans. Employees are
covered by plans in their respective countries. Variances from actuarially
assumed rates will result in increases or decreases in accumulated pension
obligations, pension expense and funding requirements in future periods. In 2002
the Company amended its defined benefit pension plans for KEU, TAS and TIA to
exclude the admission of new employees to the plans. New employees at these
locations are eligible to participate in Company-sponsored defined contribution
plans. The Company's expense related to the Company-sponsored defined
contribution plans was not material in 2004 or 2005. At December 31, 2005, the
Company currently expects to contribute the equivalent of approximately $12
million to all of its defined benefit pension plans during 2006.
The funded status of the Company's defined benefit pension plans, the
components of net periodic defined benefit pension cost related to the Company's
consolidated business segments and charged to continuing operations and the
rates used in determining the actuarial present value of benefit obligations are
presented in the tables below. The Company uses a September 30th measurement
date for their defined benefit pension plans.
Years ended December 31,
-------------------------
2004 2005
---- ----
(In thousands)
Change in projected benefit obligations ("PBO"):
Benefit obligations at beginning of the year $ 272,204 $ 307,582
Service cost 5,398 5,885
Interest cost 14,132 14,038
Participant contributions 1,362 1,469
Actuarial losses 3,134 84,365
Change in foreign currency exchange rates 26,588 (43,954)
Benefits paid (15,236) (16,808)
---------- ----------
Benefit obligations at end of the year $ 307,582 $ 352,577
========== ==========
Change in plan assets:
Fair value of plan assets at beginning of the year $ 167,302 $ 196,573
Actual return on plan assets 14,175 7,132
Employer contributions 11,726 13,323
Participant contributions 1,362 1,469
Change in foreign currency exchange rates 17,244 (24,793)
Benefits paid (15,236) (16,808)
---------- ----------
Fair value of plan assets at end of year $ 196,573 $ 176,896
========== ==========
Funded status at end of the year:
Plan assets less than PBO $ (111,009) $ (175,681)
Unrecognized actuarial losses 107,581 175,482
Unrecognized prior service cost 6,829 5,550
Unrecognized net transition obligations 952 749
---------- ----------
$ 4,353 $ 6,100
========== ==========
Amounts recognized in the balance sheet:
Unrecognized net pension obligations $ 7,524 $ 6,108
Accrued pension costs:
Current (8,587) (10,314)
Noncurrent (48,441) (125,766)
Accumulated other comprehensive loss 53,857 136,072
---------- ----------
$ 4,353 $ 6,100
========== ==========
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Net periodic pension cost:
Service cost benefits $ 4,060 $ 5,398 $ 5,885
Interest cost on PBO 12,378 14,132 14,038
Expected return on plan assets (12,264) (12,318) (12,051)
Amortization of prior service cost 255 463 482
Amortization of net transition obligations 527 368 107
Recognized actuarial losses 827 2,335 3,035
-------- -------- --------
$ 5,783 $ 10,378 $ 11,496
======== ======== ========
In determining the expected long-term rate of return on plan asset
assumptions, the Company considers the long-term asset mix (e.g. equity vs.
fixed income) for the assets for each of its plans and the expected long-term
rates of return for such asset components. In addition, the Company receives
advice about appropriate long-term rates of return from the Company's
third-party actuaries. Such assumed asset mixes are summarized below:
o In Germany, the composition of the Company's plan assets is established to
satisfy the requirements of the German insurance commissioner. The plan
asset allocation at December 31, 2005 was 23% to equity managers, 48% to
fixed income managers and 29% to real estate (2004 - 23%, 48% and 29%,
respectively).
o In Norway, the Company currently has a plan asset target allocation of 14%
to equity managers, 64% to fixed income managers and the remainder
primarily to liquid investments and cash. The expected long-term rate of
return for such investments is approximately 8% and 4.5% to 6% and 2.5%,
respectively. The plan asset allocation at December 31, 2005 was 16% to
equity managers, 62% to fixed income managers and the remainder invested
primarily to cash and liquid investments (2004 - 16%, 64% and 20%,
respectively).
The Company regularly reviews its actual asset allocation for each of its
plans, and will periodically rebalance the investments in each plan to more
accurately reflect the targeted allocation when considered appropriate.
The weighted-average rate assumptions used in determining the actuarial
present value of benefit obligations as of December 31, 2004 and 2005 are
presented in the table below. Such weighted-average rates were determined using
the projected benefit obligations at each date.
Rate December 31,
---- --------------
2004 2005
---- ----
Discount rate 5.0% 4.1%
Increase in future compensation levels 2.8% 2.8%
The weighted-average rate assumptions used in determining the net periodic
pension cost for 2003, 2004 and 2005 are presented in the table below. The
weighted-average discount rate and the weighted-average increase in future
compensation levels were determined using the projected benefit obligations as
of the beginning of each year, and the weighted-average long-term return on plan
assets was determined using the fair value of plan assets as of the beginning of
each year.
Rate December 31,
---- --------------------------------------------
2003 2004 2005
---- ---- ----
Discount rate 5.8% 5.3% 5.0%
Increase in future compensation levels 2.6% 2.8% 2.8%
Long-term return on plan assets 6.9% 6.4% 6.0%
At December 31, 2005, the accumulated benefit obligation related to the
Company's defined benefit pension plans aggregated $316 million (2004 - $257
million). At December 31, 2004 and 2005, all of the Company's defined benefit
pension plans have accumulated benefit obligations in excess of fair value of
plan assets.
The Company expects future benefits paid from all defined benefit pension
plans to be as follows:
Amount
Years ending December 31, (In thousands)
- -------------------------- --------------
2006 $ 17,287
2007 16,277
2008 18,033
2009 16,764
2010 16,937
2011 to 2012 90,812
Note 12 - Related party transactions:
The Company may be deemed to be controlled by Harold C. Simmons. See Note
1. Corporations that may be deemed to be controlled by or affiliated with Mr.
Simmons sometimes engage in (a) intercorporate transactions such as guarantees,
management and expense sharing arrangements, shared fee arrangements, joint
ventures, partnerships, loans, options, advances of funds on open account, and
sales, leases and exchanges of assets, including securities issued by both
related and unrelated parties and (b) common investment and acquisition
strategies, business combinations, reorganizations, recapitalizations,
securities repurchases, and purchases and sales (and other acquisitions and
dispositions) of subsidiaries, divisions or other business units, which
transactions have involved both related and unrelated parties and have included
transactions which resulted in the acquisition by one related party of a
publicly-held minority equity interest in another related party. While no
transactions of the type described above are planned or proposed with respect to
the Company other than as set forth in these financial statements, the Company
continuously considers, reviews and evaluates, and understands that Contran and
related entities consider, review and evaluate such transactions. Depending upon
the business, tax and other objectives then relevant, it is possible that the
Company might be a party to one or more such transactions in the future.
Under the terms of various intercorporate services agreements ("ISAs")
entered into between the Company and various related parties, including Contran,
employees of one company will provide certain management, tax planning,
financial and administrative services to the other company on a fee basis. Such
charges are based upon estimates of the time devoted by the employees of the
provider of the services to the affairs of the recipient, and the compensation
and associated expenses of such persons. Because of the large number of
companies affiliated with Contran, Kronos and NL, the Company believes it
benefits from cost savings and economies of scale gained by not having certain
management, financial and administrative staffs duplicated at each entity, thus
allowing certain individuals to provide services to multiple companies but only
be compensated by one entity. These ISA agreements are reviewed and approved by
the applicable independent directors of the companies that are parties to the
agreements. The net ISA fee charged to the Company and included in selling,
general and administrative expense was $1.5 million in 2003, $2.8 million in
2004 and $2.9 million in 2005.
Sales of TiO2 to Kronos (US), Inc. ("KUS") and Kronos Canada, Inc. ("KC"),
affiliates of the Company, aggregated $68.7 million in 2003, $50.8 million in
2004 and $63.6 million in 2005.
KUS purchases the rutile and slag feedstock used as a raw material in all
of the Company's chloride process TiO2 facilities. The Company purchases such
feedstock from KUS for use in its facilities for an amount equal to the amount
paid by KUS to the third-party supplier plus a 2.5% administrative fee. Such
feedstock purchases were $93.3 million in 2003, $106.2 million in 2004 and
$120.1 million in 2005.
Purchases of TiO2 from KUS were $100,000 in 2003, $3.5 million in 2004 and
nil in 2005. Purchases of TiO2 from KC were $500,000 in 2003, $700,000 in 2004
and $600,000 in 2005.
Royalty income received from KC for use of certain of the Company's
intellectual property was $6.1 million in 2003, $6.0 million in 2004 and $6.8
million in 2005.
Tall Pines Insurance Company, and EWI RE, Inc. provide for or broker
certain insurance policies for Contran and certain of its subsidiaries and
affiliates, including the Company. Tall Pines is wholly-owned by a subsidiary of
Valhi, and EWI is a wholly-owned subsidiary of NL. Consistent with insurance
industry practices, Tall Pines and EWI receive commissions from insurance and
reinsurance underwriters and/or assess fees for the policies that they provide
or broker. The aggregate premiums paid to Tall Pines (including amounts paid to
Valmont Insurance Company, another subsidiary of Valhi that was merged into Tall
Pines in 2004) and EWI by the Company and its joint venture were $5.2 million in
2003, $5.3 million in 2004 and $5.5 million in 2005. These amounts principally
included payments for insurance and reinsurance premiums paid to third parties,
but also included commissions paid to Tall Pines and EWI. Tall Pines purchases
reinsurance for substantially all of the risks it underwrites. The Company
expects that these relationships with Tall Pines and EWI will continue in 2006.
Contran and certain of its subsidiaries and affiliates, including the
Company, purchase certain of their insurance policies as a group, with the costs
of the jointly-owned policies being apportioned among the participating
companies. With respect to certain of such policies, it is possible that
unusually large losses incurred by one or more insureds during a given policy
period could leave the other participating companies without adequate coverage
under that policy for the balance of the policy period. As a result, Contran and
certain of its subsidiaries and its affiliates, including the Company, have
entered into a loss sharing agreement under which any uninsured loss is shared
by those entities who have submitted claims under the relevant policy. The
Company believes the benefits in the form of reduced premiums and broader
coverage associated with the group coverage for such policies justifies the risk
associated with the potential for uninsured loss.
Net amounts between the Company and KUS were generally related to product
sales and raw material purchases. Net amounts between the Company and KC were
generally related to product sales and royalties. See Note 8 for discussion of
notes receivable from affiliates.
Current receivables from and payables to affiliates are summarized in the
table below.
December 31,
-------------------------
2004 2005
---- ----
(In thousands)
Current receivables from affiliates:
KC $ 2,516 $ 1,948
Other 1 4
------- -------
$ 2,517 $ 1,952
======= =======
Current payables to affiliates:
KUS $11,033 $14,882
NL 9 -
------- -------
$11,042 $14,882
======= =======
Interest income on all loans to related parties was less than $50,000 in
2003, $2.8 million in 2004 and $18.9 million in 2005. Interest expense on all
loans from related parties was less than $100,000 in 2003 and nil in each of
2004 and 2005.
Note 13 - Commitments and contingencies:
Environmental matters. The Company's operations are governed by various
environmental laws and regulations. Certain of the Company's businesses are, or
have been engaged in the handling, manufacture or use of substances or compounds
that may be considered toxic or hazardous within the meaning of applicable
environmental laws. As with other companies engaged in similar businesses,
certain past and current operations and products of the Company have the
potential to cause environmental or other damage. The Company has implemented
and continues to implement various policies and programs in an effort to
minimize these risks. The Company's policy is to maintain compliance with
applicable environmental laws and regulations at all its facilities and to
strive to improve its environmental performance. From time to time, the Company
may be subject to environmental regulatory enforcement under various statutes,
resolution of which typically involves the establishment of compliance programs.
It is possible that future developments, such as stricter requirements of
environmental laws and enforcement policies thereunder, could adversely affect
the Company's production, handling, use, storage, transportation, sale or
disposal of such substances. The Company believes all its plants are in
substantial compliance with applicable environmental laws.
Litigation matters. The Company's Belgian subsidiary and certain of its
employees are the subject of civil and criminal proceedings relating to an
accident that resulted in two fatalities at the Company's Belgian facility in
2000. In May 2004, the court ruled and, among other things, imposed a fine of
euro 200,000 against the Company and fines aggregating less than euro 40,000
against various Company employees. The Company and the individual employees have
appealed the ruling.
In addition to the litigation described above, the Company and its
affiliates are also involved in various other environmental, contractual,
product liability, patent (or intellectual property), employment and other
claims and disputes incidental to its present and former businesses.
The Company currently believes the disposition of all claims and disputes,
individually or in the aggregate, should not have a material adverse effect on
its consolidated financial condition, results of operations or liquidity.
Concentrations of credit risk. Sales of TiO2 accounted for about 90% of net
sales during each of the past three years. The remaining sales result from the
mining and sale of ilmenite ore (a raw material used in the sulfate pigment
production process), and the manufacture and sale of iron-based water treatment
chemicals (derived from co-products of the TiO2 production processes). TiO2 is
generally sold to the paint, plastics and paper industries. Such markets are
generally considered "quality-of-life" markets whose demand for TiO2 is
influenced by the relative economic well-being of the various geographic
regions. TiO2 is sold to over 3,000 customers, with the top ten customers
approximating 20%, 21%, and 20% respectively of net sales in 2003, 2004 and
2005. Approximately 73% of the Company's TiO2 sales by volume were to Europe in
2003, approximately 77% were to Europe in 2004 and approximately 76% were to
Europe in 2005. Approximately 13% of sales by volume were attributable to North
America in 2003, 9% attributable to North America in 2004 and 10% attributable
to North America in 2005.
Long-term contracts. KUS has long-term supply contracts that provide for
certain of its affiliates', including the Company's, TiO2 feedstock requirements
through 2010. The agreements require KUS to purchase certain minimum quantities
of feedstock with minimum annual purchase commitments aggregating approximately
$681 million at December 31, 2005. The agreements require that the Company and
certain of its affiliates purchase chloride feedstock underlying these long-term
supply contracts from KUS.
Operating leases. The Company's principal German operating subsidiary
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. Under a separate supplies and services agreement expiring in 2011,
the lessor provides some raw materials, including chlorine, auxiliary and
operating materials, utilities and services necessary to operate the Leverkusen
facility.
The Company also leases various other manufacturing facilities and
equipment. Some of the leases contain purchase and/or various term renewal
options at fair market and fair rental values, respectively. In most cases the
Company expects that, in the normal course of business, such leases will be
renewed or replaced by other leases. Net rent expense approximated $9 million in
2003 and $8 million in each of 2004 and 2005. At December 31, 2005, future
minimum payments under noncancellable operating leases having an initial or
remaining term of more than one year were as follows:
Amount
Years ending December 31, (In thousands)
- -------------------------- --------------
2006 $ 3,328
2007 2,411
2008 2,150
2009 1,562
2010 1,126
2011 and thereafter 21,029
-------
$31,606
=======
Approximately $20.1 million of the $31.6 million aggregate future minimum
rental commitments at December 31, 2005 relates to the Company's Leverkusen
facility lease discussed above. The minimum commitment amounts for such lease
included in the table above for each year through the 2050 expiration of the
lease are based upon the current annual rental rate as of December 31, 2005. As
discussed above, any change in the rent is based solely on negotiations between
Bayer and the Company, and any such change in the rent is deemed "contingent
rentals" under GAAP which is excluded from the future minimum lease payments
disclosed above.
Income taxes. Contran and Valhi have agreed to a policy providing for the
allocation of tax liabilities and tax payments as described in Note 1. Under
applicable law, the Company, as well as every other member of the Contran Tax
Group, are each jointly and severally liable for the aggregate federal income
tax liability of Contran and the other companies included in the Contran Tax
Group for all periods in which the Company is included in the Contran Tax Group.
Contran has agreed, however, to indemnify the Company for any liability for
income taxes of the Contran Tax Group in excess of the Company's tax liability
previously computed and paid by Valhi in accordance with the tax allocation
policy.
Note 14 - Financial instruments:
Summarized below is the estimated fair value and related net carrying value
of the Company's financial instruments.
December 31, December 31,
2004 2005
--------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- ------------- -------------------------
(In millions)
Cash, cash equivalents, restricted cash
and current and noncurrent restricted
marketable debt securities $ 21.9 $ 21.9 $ 67.2 $ 67.2
Long-term debt:
Fixed rate with market quotes -
8.875% Senior Secured Notes $519.2 $ 549.1 $449.3 $ 463.6
Variable rate debt 13.6 13.6 - -
Fair value of the Company's noncurrent restricted marketable debt
securities and 8.875% Senior Secured Notes are based upon quoted market prices
at each balance sheet date.
Note 15 - Accounting principles newly adopted in 2003 and 2004:
Asset retirement obligations. The Company adopted SFAS No. 143, "Accounting
for Asset Retirement Obligations," on January 1, 2003. Under SFAS No. 143, the
fair value of a liability for an asset retirement obligation covered under the
scope of SFAS No. 143 is recognized in the period in which the liability is
incurred, with an offsetting increase in the carrying amount of the related
long-lived asset. Over time, the liability would be accreted to its present
value, and the capitalized cost is depreciated over the useful life of the
related asset. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss upon settlement.
Under the transition provisions of SFAS No. 143, at the date of adoption on
January 1, 2003 the Company recognized (i) an asset retirement cost capitalized
as an increase to the carrying value of its property, plant and equipment, (ii)
accumulated depreciation on such capitalized cost and (iii) a liability for the
asset retirement obligation. Amounts resulting from the initial application of
SFAS No. 143 are measured using information, assumptions and interest rates all
as of January 1, 2003. The amount recognized as the asset retirement cost is
measured as of the date the asset retirement obligation was incurred. Cumulative
accretion on the asset retirement obligation, and accumulated depreciation on
the asset retirement cost, is recognized for the time period from the date the
asset retirement cost and liability would have been recognized had the
provisions of SFAS No. 143 been in effect at the date the liability was
incurred, through January 1, 2003. The difference, if any, between the amounts
to be recognized as described above and any associated amounts recognized in the
Company's balance sheet as of December 31, 2002 is recognized as a cumulative
effect of a change in accounting principles as of the date of adoption. The
effect of adopting SFAS No. 143 as of January 1, 2003 was not material, as
summarized in the table below, and is not separately recognized in the
accompanying Statement of Income.
Amount
(in millions)
--------------
Increase in carrying value of net property, plant and equipment:
Cost $ .4
Accumulated depreciation (.1)
Decrease in carrying value of previously-accrued closure and
post-closure activities .3
Asset retirement obligation recognized (.6)
----
Net impact $ -
====
The change in the asset retirement obligations from January 1, 2003
($600,000) to December 31, 2003 ($800,000), to December 31, 2004 ($1 million)
and to December 31, 2005 ($900,000) is primarily due to accretion expense and
the effects of currency translation. Accretion expense, which is reported as a
component of cost of goods sold in the accompanying Consolidated Statement of
Operations, approximated $100,000 for each of the years ended December 31, 2003,
2004 and 2005.
Estimates of the ultimate cost to be incurred to settle the Company's asset
retirement obligations require a number of assumptions, are inherently difficult
to develop and the ultimate outcome may differ from current estimates. As
additional information becomes available, cost estimates will be adjusted as
necessary. It is possible that technological, regulatory or enforcement
developments, the results of studies or other factors could necessitate the
recording of additional liabilities.
Costs associated with exit or disposal activities. The Company adopted SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," on
January 1, 2003 for exit or disposal activities initiated on or after that date.
Under SFAS No. 146, costs associated with exit activities, as defined, that are
covered by the scope of SFAS No. 146 will be recognized and measured initially
at fair value, generally in the period in which the liability is incurred. Costs
covered by the scope of SFAS No. 146 include termination benefits provided to
employees, costs to consolidate facilities or relocate employees, and costs to
terminate contracts (other than a capital lease). Under prior GAAP, a liability
for such an exit cost is recognized at the date an exit plan is adopted, which
may or may not be the date at which the liability has been incurred. The effect
of adopting SFAS No. 146 as of January 1, 2003 was not material as the Company
was not involved in any exit or disposal activities covered by the scope of the
new standard as of such date.
Variable interest entities. The Company complied with the consolidation
requirements of FASB Interpretation ("FIN") No. 46R, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51," as amended, as of March 31,
2004. The Company does not have any involvement with any variable interest
entity (as that term is defined in FIN No. 46R) covered by the scope of FIN No.
46R that would require the Company to consolidate such entity under FIN No. 46R
which had not already been consolidated under prior applicable GAAP, and
therefore the impact to the Company of adopting the consolidation requirements
of FIN No. 46R was not material.
Note 16 - Accounting principles not yet adopted:
Stock options. The Company will adopt SFAS No. 123R, "Share-Based Payment,"
as of January 1, 2006. SFAS No. 123R, among other things, eliminated the
alternative in previously 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, 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 previously measured
under SFAS No. 123 for the portion of any non-vested award existing as of
December 31, 2005 over the remaining vesting period. Because the Company has not
granted any options to purchase its common stock and did not grant any options
prior to January 1, 2006 and 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, the effect of adopting SFAS No. 123R is
not expected to be significant in so far as it relates to the recognition of
compensation cost in the Company's consolidated statements of income for
existing stock options. Should the Company, however, grant a significant number
of options in the future, the Company could recognize material amounts of
compensation cost related to such options in its consolidated financial
statements.
Also upon adoption of SFAS No. 123R, any cash income tax benefit resulting
from the exercise of stock options in excess of the cumulative income tax
benefit related to such options previously recognized for GAAP financial
reporting purposes in the Company's consolidated statements of income, if any,
will be reflected as a cash inflow from financing activities in the Company's
consolidated statements of cash flows, and the Company's cash flows from
operating activities will reflect the effect of cash paid for income taxes
exclusive of such cash income tax benefit.
SFAS No. 123R also requires certain expanded disclosures regarding the
Company's stock options, and such expanded disclosures have been provided in
Note 8.
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 are 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.
Note 17 - Quarterly results of operations (unaudited):
Quarter ended
----------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
--------- --------- --------- ---------
(In millions)
Year ended December 31, 2004
Net sales $ 192.2 $ 208.1 $ 203.4 $ 204.3
Gross margin $ 49.6 $ 51.8 $ 47.3 $ 49.7
Net income $ 13.2 $ 290.5 $ 9.1 $ 13.2
Year ended December 31, 2005
Net sales $ 209.5 $ 227.6 $ 206.0 $ 207.8
Gross margin $ 62.4 $ 70.5 $ 55.2 $ 49.6
Net income $ 18.2 $ 28.5 $ 6.4 $ 6.7
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT
Condensed Balance Sheets
December 31, 2004 and 2005
(In thousands)
2004 2005
---- ----
Current assets:
Cash and cash equivalents $ 6,283 $ 9,622
Accounts and notes receivable 8,838 9,013
Receivable from affiliates 20,214 36,210
Deferred income taxes 206 68
Other 48 56
---------- ----------
Total current assets 35,589 54,969
---------- ----------
Other assets:
Investment in subsidiaries 493,532 463,377
Deferred income taxes 222,643 168,642
Other 10,508 7,399
Property and equipment, net 6,917 5,814
---------- ----------
Total other assets 733,600 645,232
---------- ----------
$ 769,189 $ 700,201
========== ==========
Current liabilities:
Payable to affiliates $ 25,621 $ 34,715
Accounts payable and accrued liabilities 6,072 3,865
Income taxes 10,638 29,483
Deferred income taxes 15 14
---------- ----------
Total current liabilities 42,346 68,077
---------- ----------
Noncurrent liabilities:
Long-term debt 519,225 449,298
Other 1,138 1,025
---------- ----------
Total noncurrent liabilities 520,363 450,323
---------- ----------
Stockholder's equity 206,480 181,801
---------- ----------
$ 769,189 $ 700,201
========== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
Condensed Statements of Income
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Revenues and other income:
Net sales $ 35,601 $ 40,038 $ 47,682
Equity in earnings of subsidiaries 293,623 66,049 90,702
Interest income from affiliates 50 2,782 18,947
Royalty income 16,568 18,508 19,187
Currency translation gains (losses), net (599) (575) 248
Other income, net (38) 71 1
---------- ---------- ----------
345,205 126,873 176,767
---------- ---------- ----------
Costs and expenses:
Cost of sales 18,306 21,371 26,995
General and administrative 21,209 28,351 30,929
Interest 29,847 33,772 42,212
Interest expense to affiliates - 5,754 10,302
---------- ---------- ----------
69,362 89,248 110,438
---------- ---------- ----------
Income before income taxes 275,843 37,625 66,329
Provision (benefit) for income taxes 194,082 (288,355) 6,543
---------- ---------- ----------
Net income $ 81,761 $ 325,980 $ 59,786
========== ========== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
Condensed Statements of Cash Flows
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from operating activities:
Net income $ 81,761 $ 325,980 $ 59,786
Cash distributions from subsidiaries 402 50,902 -
Noncash interest expense 1,472 1,487 2,124
Deferred income taxes 238,814 (276,806) 21,827
Equity in earnings of subsidiaries (293,623) (66,049) (90,702)
Other, net (3,570) (637) (719)
Net change in assets and liabilities 115 25,963 11,901
---------- ---------- ----------
Net cash provided by operating activities 25,371 60,840 4,217
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (2,406) (1,544) (1,493)
Collection of loans to affiliates - 88,656 -
Purchase of interest in subsidiaries - (575) -
Other, net 9 - -
---------- ---------- ----------
Net cash provided (used) by
investing activities (2,397) 86,537 (1,493)
---------- ---------- ----------
Cash flows from financing activities:
Indebtedness:
Borrowings - 129,524 -
Deferred financing fees - (1,989) -
Loans to affiliates - (209,524) -
Dividends paid (25,000) (60,000) -
---------- ---------- ----------
Net cash used by financing activities (25,000) (141,989) -
---------- ---------- ----------
Net change during the year from operating
investing and financing activities (2,026) 5,388 2,724
Currency translation 129 347 615
Balance at beginning of year 2,445 548 6,283
---------- ---------- ----------
Balance at end of year $ 548 $ 6,283 $ 9,622
========== ========== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)
Notes to Condensed Financial Information
Note 1 - Basis of presentation:
The Consolidated Financial Statements of Kronos International, Inc. and the
related Notes to Consolidated Financial Statements are incorporated herein by
reference.
Note 2 - Investment in and advances to subsidiaries:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Current:
Receivable from:
Kronos Titan GmbH ("TG") - income taxes $ 14,386 $ 30,172
Kronos Chemie GmbH ("KCH") - income taxes 76 582
Kronos Titan A/S 1,667 1,575
Kronos Europe S.A./N.V 2,168 1,721
Kronos Canada 1,482 1,716
Titania A/S 432 431
Other 3 13
---------- ----------
$ 20,214 $ 36,210
========== ==========
Payable to:
TG 25,032 32,833
Kronos (US), Inc. 145 -
KCH 255 1,826
Other 189 56
---------- ----------
$ 25,621 $ 34,715
========== ==========
December 31,
--------------
2004 2005
---- ----
(In thousands)
Investment in:
TG $ 322,434 $ 278,117
Kronos Denmark ApS ("KDK") 147,904 162,418
Other 23,194 22,842
---------- ----------
$ 493,532 $ 463,377
========== ==========
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Equity in income from continuing
operations of subsidiaries:
TG $ 270,541 $ 40,951 $ 52,233
KDK 26,892 23,816 35,427
Other (3,810) 1,282 3,042
---------- ---------- ----------
$ 293,623 $ 66,049 $ 90,702
========== ========== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Additions
Balance at charged to Balance
beginning costs and Net Currency at end
Description of year expenses deductions translation Other of year
- --------------------------------------- ----------- ---------- ---------- ----------- ------ ---------
Year ended December 31, 2003:
Allowance for doubtful accounts $ 1,907 $ 233 $ (281) $ 363 $ - $ 2,222
======= ======= ======= ======= ====== =======
Allowance for slow-moving inventory $ 6,521 $ 116 $ - $ (189) $ - $ 6,448
======= ======= ======= ======= ====== =======
Accrual for planned major maintenance
activities $ 3,259 $ 1,432 $ (915) $ 684 $ - $ 4,460
======= ======= ======= ======= ====== =======
Year ended December 31, 2004:
Allowance for doubtful accounts $ 2,222 $ (169) $ (540) $ 147 $ - $ 1,660
======= ======= ======= ======= ====== =======
Allowance for slow-moving inventory $ 6,448 $ 372 $ (142) $ 637 $ - $ 7,315
======= ======= ======= ======= ====== =======
Accrual for planned major maintenance
activities $ 4,460 $ 3,563 $(4,479) $ 310 $ - $ 3,854
======= ======= ======= ======= ====== =======
Year ended December 31, 2005:
Allowance for doubtful accounts $ 1,660 $ 313 $ (333) $ (211) $ - $ 1,429
======= ======= ======= ======= ====== =======
Allowance for slow-moving inventory $ 7,315 $ 135 $ (14) $ (926) $ - $ 6,510
======= ======= ======= ======= ====== =======
Accrual for planned major maintenance
activities $ 3,854 $ 4,731 $(4,644) $ (510) $ - $ 3,431
======= ======= ======= ======= ====== =======
Note - Certain information has been omitted from this Schedule because it
is disclosed in the notes to the Consolidated Financial Statements.
KRONOS TITAN GMBH AND SUBSIDIARY
Index of Consolidated Financial Statements
Financial Statements Pages
Report of Independent Registered Public Accounting Firm FA-2
Consolidated Balance Sheets - December 31, 2004 and 2005 FA-3
Consolidated Statements of Income - Years ended
December 31, 2003, 2004 and 2005 FA-5
Consolidated Statements of Comprehensive Income (Loss) - Years ended
December 31, 2003, 2004 and 2005 FA-6
Consolidated Statements of Partners' Capital/Owners'
Equity - Years ended December 31, 2003, 2004 and 2005 FA-7
Consolidated Statements of Cash Flows - Years ended
December 31, 2003, 2004 and 2005 FA-8
Notes to Consolidated Financial Statements FA-10
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Owner of Kronos Titan GmbH:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, comprehensive income (loss),
partners' capital/owners' equity and cash flows present fairly, in all material
respects, the financial position of Kronos Titan GmbH and Subsidiary at December
31, 2004 and 2005, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2005 in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
March 28, 2006
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2005
(In thousands)
ASSETS
2004 2005
---- ----
Current assets:
Cash and cash equivalents $ 6,444 $ 50,765
Accounts and notes receivable 76,732 73,059
Receivable from affiliates 32,355 43,021
Refundable income taxes 59 14,695
Inventories 101,850 113,677
Prepaid expenses 2,078 1,629
---------- ----------
Total current assets 219,518 296,846
---------- ----------
Other assets:
Note receivable from Kronos Titan A/S 5,449 -
Unrecognized net pension obligations 3,672 3,000
Deferred income taxes 18,077 47,044
Other 1,201 808
---------- ----------
Total other assets 28,399 50,852
---------- ----------
Property and equipment:
Land 14,929 13,460
Buildings 111,349 101,151
Machinery and equipment 496,428 434,895
Construction in progress 10,022 9,853
---------- ----------
632,728 559,359
Less accumulated depreciation and depletion 373,938 332,840
---------- ----------
Net property and equipment 258,790 226,519
---------- ----------
$ 506,707 $ 574,217
========== ==========
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS (CONTINUED)
December 31, 2004 and 2005
(In thousands)
LIABILITIES AND OWNERS' EQUITY
2004 2005
---- ----
Current liabilities:
Accounts payable and accrued liabilities $ 76,952 $ 71,987
Payables to affiliates 35,260 75,447
Deferred income taxes 1,912 3,508
---------- ----------
Total current liabilities 114,124 150,942
---------- ----------
Noncurrent liabilities:
Note payable to affiliate 12,941 11,239
Accrued pension cost 45,015 120,872
Other 12,193 13,047
---------- ----------
Total noncurrent liabilities 70,149 145,158
---------- ----------
Owners' equity:
Subscribed capital 12,496 12,496
Paid in capital 227,037 227,037
Retained earnings (deficit) (9,685) 42,548
Accumulated other comprehensive income (loss):
Currency translation 111,996 68,897
Pension liabilities (19,410) (72,861)
---------- ----------
Total owners' equity 322,434 278,117
---------- ----------
$ 506,707 $ 574,217
========== ==========
Commitments and contingencies (Notes 6, 9 and 12)
See accompanying notes to consolidated financial statements
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net sales $ 487,337 $ 552,216 $ 584,219
Cost of sales 379,187 451,888 462,558
---------- ---------- ----------
Gross margin 108,150 100,328 121,661
Selling, general and administrative expense 42,925 47,824 50,140
Other operating income (expense):
Currency transaction gains (losses), net (3,519) (2,533) 3,906
Disposition of property and equipment (390) (293) (1,080)
---------- ---------- ----------
Income from operations 61,316 49,678 74,347
Other income (expense):
Trade interest income 447 949 733
Interest and other income from affiliates 3,918 8,813 13,224
Interest and other expense to affiliates (442) (304) (791)
Interest expense (368) (651) (595)
---------- ---------- ----------
Income before income taxes 64,871 58,485 86,918
Income tax provision (benefit) (205,670) 17,507 34,685
---------- ---------- ----------
Net income $ 270,541 $ 40,978 $ 52,233
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net income $ 270,541 $ 40,978 $ 52,233
---------- ---------- ----------
Other comprehensive income (loss), net of tax:
Minimum pension liabilities adjustment (17,946) 4,400 (53,451)
Currency translation adjustment 37,674 36,472 (43,099)
---------- ---------- ----------
Total other comprehensive income 19,728 40,872 (96,550)
---------- ---------- ----------
Comprehensive income (loss) $ 290,269 $ 81,850 $ (44,317)
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL / OWNERS' EQUITY
Years ended December 31, 2003, 2004 and 2005
(In thousands)
Accumulated other
comprehensive
Owners' Equity income (loss)
Partners' ----------------------- Retained ----------------------------
capital Subscribed Paid-in earnings Currency Pension
(deficit) capital capital (deficit) translation liabilities Total
-------- ---------- ------- --------- ----------- ----------- ------
Balance at December 31, 2002 $118,589 $ - $ - $ - $ 37,850 $ (5,864) $150,575
Net income 270,541 - - - - - 270,541
Other comprehensive income (loss),
net of tax - - - - 37,674 (17,946) 19,728
Partnership conversion (389,130) 12,496 376,634 - - - -
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2003 - 12,496 376,634 - 75,524 (23,810) 440,844
Net income - - - 40,978 - - 40,978
Dividends declared - - - (50,663) - - (50,663)
Other comprehensive income, net of tax - - - - 36,472 4,400 40,872
Noncash capital transaction - - (149,597) - - - (149,597)
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2004 - 12,496 227,037 (9,685) 111,996 (19,410) 322,434
Net income - - - 52,233 - - 52,233
Other comprehensive income, net of tax - - - - (43,099) (53,451) (96,550)
-------- -------- -------- -------- -------- -------- --------
Balance at December 31, 2005 $ - $ 12,496 $227,037 $ 42,548 $ 68,897 $(72,861) $278,117
======== ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements.
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from operating activities:
Net income $ 270,541 $ 40,978 $ 52,233
Depreciation, depletion and amortization 20,452 23,583 20,980
Noncash interest expense 140 200 141
Deferred income taxes (39,770) 6,178 9,427
Net loss from disposition of property and equipment 390 293 1,080
Pension, net (5,021) (4,540) (3,328)
Other, net 12 167 155
Change in assets and liabilities:
Accounts and notes receivable 1,827 (3,205) (9,294)
Inventories 1,830 5,837 (26,334)
Prepaid expenses 1,107 559 (144)
Accounts payable and accrued liabilities 2,637 13,683 5,412
Income taxes (130,136) 126,599 (13,859)
Accounts with affiliates (85,431) (82,855) 29,420
Other noncurrent assets 481 (146) 109
Other noncurrent liabilities (555) (5,334) (713)
---------- ---------- ----------
Net cash provided by operating activities 38,504 121,997 65,285
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (18,715) (20,396) (22,896)
Proceeds from disposition of property and equipment 4 - -
---------- ---------- ----------
Net cash provided (used) by investing activities (18,711) (20,396) (22,896)
---------- ---------- ----------
KRONOS TITAN GMBH AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from financing activities:
Indebtedness:
Borrowings $ - $ 49,984 $ -
Principal payments - (49,984) -
Loans from affiliates:
Loans - 11,597 4,860
Repayments - (88,656) -
Cash distributions - (50,663) -
---------- ---------- ----------
Net cash used by financing activities - (127,722) 4,860
---------- ---------- ----------
Cash and cash equivalents - net change from:
Operating, investing and financing
activities 19,793 (26,121) 47,249
Currency translation 3,241 1,706 (2,928)
Balance at beginning of year 7,825 30,859 6,444
---------- ---------- ----------
Balance at end of year $ 30,859 $ 6,444 $ 50,765
========== ========== ==========
Supplemental disclosures:
Cash paid (received) for:
Interest $ 674 $ 626 $ 516
Income taxes (166) (132,629) 6,517
See accompanying notes to consolidated financial statements.
KRONOS TITAN GMBH AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization and basis of presentation:
Kronos Titan GmbH ("TG") is a wholly-owned subsidiary of Kronos
International, Inc. ("KII"). KII is a wholly-owned subsidiary of Kronos
Worldwide, Inc. (NYSE:KRO) ("Kronos"). At December 31, 2005, (i) Valhi, Inc.
(NYSE: VHI) held approximately 57% of Kronos' common stock and NL Industries,
Inc. (NYSE: NL) held an additional 36% of the outstanding common stock of
Kronos, (ii) Valhi owned 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 such companies.
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"), with the U.S. dollar as the reporting currency. TG also
prepares financial statements on other bases, as required in Germany.
Effective December 31, 2003, Kronos Titan GmbH & Co. OHG was converted from
a partnership into a limited liability company under German law, and was renamed
TG. The conversion resulted in a reclassification of partner's capital
aggregating $389 million at the date of conversion into other capital accounts
(subscribed capital and paid-in capital) and had no material effect on TG's
consolidated financial statements, other than with respect to deferred income
taxes. In 2004, the Company forgave a $150 million receivable from KII which is
reflected as a noncash capital transaction in the accompanying Consolidated
Statement of Partners' Capital/Owners' Equity.
TG is not a registrant with the U.S. Securities and Exchange Commission
("SEC") and therefore is not subject to the SEC's periodic reporting
requirements, except as may be required by Rule 3-16 of Regulation S-X.
Note 2 - Summary of significant accounting policies:
Management's estimates. The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amount of revenues and expenses during the reporting period. Actual
results may differ from previously-estimated amounts under different assumptions
or conditions.
Principles of consolidation. The consolidated financial statements include
the accounts of TG and its wholly-owned subsidiary (collectively, the
"Company"). All material intercompany accounts and balances have been
eliminated. The Company has no involvement with any variable interest entity
covered by the scope of FASB Interpretation ("FIN") No. 46R, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51," as amended as of
March 31, 2004.
Translation of foreign currencies. The functional currency of the Company
is the euro. Assets and liabilities of the Company are translated to U.S.
dollars at year-end rates of exchange and revenues and expenses are translated
at weighted average exchange rates prevailing during the year. Resulting
translation adjustments are included in other comprehensive income (loss), net
of related income taxes, if applicable. Currency transaction gains and losses
are recognized in income currently.
Derivatives and hedging activities. Derivative instruments are recognized
as either assets or liabilities and measured at fair value in accordance with
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended. The accounting for changes in fair value of derivatives is dependent
upon the intended use of the derivative, and such changes are recognized either
in net income or other comprehensive income. As permitted by the transition
requirements of SFAS No. 133, as amended, the Company exempted from the scope of
SFAS No. 133 all host contracts containing embedded derivatives which were
issued or acquired prior to January 1, 1999.
Cash equivalents. Cash equivalents include bank deposits with original
maturities of three months or less.
Accounts receivable. The Company provides an allowance for doubtful
accounts for known and estimated potential losses arising from sales to
customers based on a periodic review of the accounts.
Property and equipment and depreciation. Property and equipment are stated
at cost. Depreciation of property and equipment for financial reporting purposes
is computed principally by the straight-line method over the estimated useful
lives of ten to 40 years for buildings and three to 20 years for equipment.
Accelerated depreciation methods are used for income tax purposes, as permitted.
Upon sale or retirement of an asset, the related cost and accumulated
depreciation are removed from the accounts and any gain or loss is recognized in
income currently.
Expenditures for maintenance, repairs and minor renewals are expensed;
expenditures for major improvements are capitalized. The Company performs
planned major maintenance activities during the year. Repair and maintenance
costs estimated to be incurred in connection with planned major maintenance
activities are accrued in advance and are included in cost of sales. Accrued
repair and maintenance costs, included in other current liabilities and
consisting primarily of materials and supplies, was $3.2 million and $2.2
million at December 31, 2004 and 2005, respectively.
Interest costs related to major long-term capital projects and renewals are
capitalized as a component of construction costs. Interest costs capitalized
were not significant in 2003, 2004 or 2005.
When events or changes in circumstances indicate that assets may be
impaired, an evaluation is performed to determine if an impairment exists. Such
events or changes in circumstances include, among other things, (i) significant
current and prior periods or current and projected periods with operating
losses, (ii) a significant decrease in the market value of an asset or (iii) a
significant change in the extent or manner in which an asset is used. All
relevant factors are considered. The test for impairment is performed by
comparing the estimated future undiscounted cash flows (exclusive of interest
expense) associated with the asset to the asset's net carrying value to
determine if a write-down to market value or discounted cash flow value is
required. The Company assesses impairment of other long-lived assets (such as
property and equipment and mining properties) in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."
Long-term debt. Long-term debt is stated net of any unamortized original
issue premium or discount. Amortization of deferred financing costs, included in
interest expense, is computed by the interest method over the term of the
applicable issue.
Employee benefit plans. Accounting and funding policies for retirement
plans are described in Note 8.
Income taxes. As a partnership under German law during 2003, TG was not
subject to corporate income taxes, but was subject to trade income taxes.
Deferred trade income tax assets and liabilities were recognized for the
expected future tax consequences of temporary differences between the trade
income tax and financial reporting carrying amounts of assets and liabilities.
Effective December 31, 2003, the Company was converted from a partnership to a
limited liability company. Subsequent to that date, the Company is subject to
the German corporation tax, with a statutory rate of 25%, in addition to
solidarity-surcharge of 5.5% of corporate income tax and trade income taxes. The
Company periodically evaluates its deferred tax assets in the various taxing
jurisdictions in which it operates and adjusts any related valuation allowance
based on the estimate of the amount of such deferred tax assets that the Company
believes does not meet the "more-likely-than-not" recognition criteria. See Note
9.
Net sales. Sales are recorded when products are shipped and title and other
risks and rewards of ownership have passed to the customer, or when services are
performed. Shipping terms of products shipped are generally FOB shipping point.
Amounts charged to customers for shipping and handling are included in net
sales. Sales are stated net of price, early payment and distributor discounts
and volume rebates.
Inventories and cost of sales. Inventories are stated at the lower of cost
(principally average cost) or market, net of allowance for obsolete or
slow-moving inventories. Amounts are removed from inventories at average cost.
Cost of sales includes costs for materials, packaging and finishing, utilities,
salary and benefits, maintenance and depreciation.
Selling, general and administrative expenses; shipping and handling costs.
Selling, general and administrative expenses include costs related to marketing,
sales, distribution, shipping and handling, research and development, legal and
administrative functions, such as accounting, treasury and finance, and includes
costs for salary and benefits, travel and entertainment, promotional materials
and professional fees. Shipping and handling costs are included in selling,
general and administrative expense and were $19.8 million in 2003, $22.3 million
in 2004 and $23.1 million in 2005. Advertising costs are expensed as incurred
and were approximately $300,000 in each of 2003, 2004 and 2005.
Stock options. The Company has not issued any stock options. However,
certain employees of the Company have been granted options by NL to purchase NL
common stock. The Company has elected the disclosure alternative prescribed by
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended, and to
account for its stock-based employee compensation related to stock options in
accordance with Accounting Principles Board Opinion ("APBO") No. 25, "Accounting
for Stock Issued to Employees," and its various interpretations. Under APBO No.
25, no compensation cost is generally recognized for fixed stock options in
which the exercise price is not less than the market price on the grant date.
Prior to 2003, and following NL's cash settlement of options to purchase NL
common stock held by certain individuals, NL and the Company, commenced
accounting for its stock options using the variable accounting method because NL
could not overcome the presumption that it would not similarly cash settle its
remaining stock options. Under the variable accounting method, the intrinsic
value of all unexercised stock options (including those with an exercise price
at least equal to the market price on the date of grant) are accrued as an
expense over their vesting period, with subsequent increases (decreases) in NL's
market price resulting in additional compensation expense (income). Upon
exercise of such options to purchase NL common stock held by employees of the
Company, the Company pays NL an amount equal to the difference between the
market price of NL's common stock on the date of exercise and the exercise price
of such stock option. Aggregate compensation expense related to NL stock options
held by employees of the Company was $12,000 in 2003 and $167,000 in 2004 and
compensation income was $74,000 in 2005. The total income tax benefit related to
such compensation cost recognized by the Company was approximately $4,000 in
2003 and $66,000 in 2004 and the total income tax provision related to the
compensation income was $29,000 in 2005. No compensation cost was capitalized as
part of assets (inventory or fixed assets) during 2003, 2004 and 2005.
The following table illustrates the effect on net income if the Company had
applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Net income - as reported $270,541 $ 40,978 $ 52,233
Adjustments, net of applicable income
tax effects:
Stock-based employee compensation
(income) expense determined under
APBO No. 25 10 102 (45)
Stock-based employee compensation
expense determined under SFAS No. 123 (9) (4) (1)
-------- -------- --------
Pro forma net income $270,542 $ 41,076 $ 52,187
======== ======== ========
Note 3 - Accounts and notes receivable:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Trade receivables $ 71,914 $ 69,019
Recoverable VAT and other receivables 6,058 5,189
Allowance for doubtful accounts (1,240) (1,149)
---------- ----------
$ 76,732 $ 73,059
========== ==========
Note 4 - Inventories:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Raw materials $ 20,379 $ 21,386
Work in process 10,173 11,884
Finished products 55,349 65,242
Supplies 15,949 15,165
---------- ----------
$ 101,850 $ 113,677
========== ==========
Note 5 - Accounts payable and accrued liabilities:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Accounts payable $ 39,732 $ 39,206
Accrued liabilities:
Employee benefits 15,957 16,632
Waste acid recovery 9,598 9,149
Other 11,665 7,000
---------- ----------
$ 76,952 $ 71,987
========== ==========
Note 6 - Long-term debt:
The Company and certain of KII's subsidiaries in Belgium and Norway (Kronos
Europe S.A./N.V.-"KEU", Kronos Titan A/S - "TAS" and Titania A/S - "TIA," Kronos
Norge A/S, the parent company of TAS and TIA, and Kronos Denmark ApS, the parent
company of Kronos Norge and KEU), referred to as the "Borrowers", have a euro 80
million secured revolving credit facility that matures in June 2008. Borrowings
may be denominated in euros, Norwegian kroner or U.S. dollars, and bear interest
at the applicable interbank market rate plus 1.125%. The facility also provides
for the issuance of letters of credit up to euro 5 million. The credit facility
is collateralized by the accounts receivable and inventories of the borrowers,
plus a limited pledge of all of the other assets of the Belgian borrower. The
credit facility contains certain restrictive covenants which, among other
things, restrict the ability of the borrowers to incur debt, incur liens, pay
dividends or merge or consolidate with, or sell or transfer all or substantially
all of their assets to, another entity. In addition, the credit facility
contains customary cross-default provisions with respect to other debt and
obligations of Borrowers, KII and its other subsidiaries. At December 31, 2005,
no amounts were outstanding under the European Credit Facility and the
equivalent of $92.3 million was available for additional borrowing by the
Borrowers. The Company, KEU and Kronos Denmark are unconditionally jointly and
severally liable for any and all outstanding borrowings under the credit
facility. TAS, TIA and Kronos Norge A/S are jointly and severally liable for any
and all outstanding borrowings under the credit facility to the extent permitted
by Norwegian law.
In June 2002, KII issued at par value euro 285 million principal amount
($280 million when issued) of its 8.875% Senior Secured Notes due 2009 and in
November 2004 KII issued at 107% of par an additional euro 90 million principal
amount ($130 million when issued) of the KII senior secured notes (collectively
the "Notes"). The Notes are collateralized by a pledge of 65% of the common
stock or other ownership interests of certain of KII's first-tier operating
subsidiaries. Such operating subsidiaries are the Company, Kronos Denmark ApS,
Kronos Limited and Societe Industrielle Du Titane, S.A. The Notes are issued
pursuant to an indenture which contains a number of covenants and restrictions
which, among other things, restricts the ability of KII and its subsidiaries, to
incur debt, incur liens, or merge or consolidate with, or sell or transfer all
or substantially all of their assets to, another entity. The Notes are
redeemable, at KII's option, at redemption prices ranging from 104.437% of the
principal amount, declining to 100% on or after December 30, 2008. In the event
of a change of control of KII, as defined, KII would be required to make an
offer to purchase its Notes at 101% of the principal amount. KII would also be
required to make an offer to purchase a specified portion of its Notes at par
value in the event KII generates a certain amount of net proceeds from the sale
of assets outside the ordinary course of business, and such net proceeds are not
otherwise used for specified purposes within a specified time period.
Under the cross-default provisions of the Notes, the Notes may be
accelerated prior to their stated maturity if KII or any of KII's subsidiaries
default under any other indebtedness in excess of $20 million due to a failure
to pay such other indebtedness at its due date (including any due date that
arises prior to the stated maturity as a result of a default under such other
indebtedness). Under the cross-default provisions of the Credit Facility, any
outstanding borrowings under the Credit Facility may be accelerated prior to
their stated maturity if the Borrowers or KII default under any other
indebtedness in excess of euro 5 million due to a failure to pay such other
indebtedness at its due date (including any due date that arises prior to the
stated maturity as a result of a default under such other indebtedness). The
Credit Facility contains provisions that allow the lender to accelerate the
maturity of the Credit Facility in the event of a change of control, as defined,
of the applicable borrower. In the event any of these cross-default or
change-of-control provisions become applicable, and such indebtedness is
accelerated, KII would be required to repay such indebtedness prior to their
stated maturity.
Note 7 - Other noncurrent liabilities:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Employee benefits $ 4,111 $ 3,842
Insurance claims expense 1,362 1,124
Other 6,720 8,081
---------- ----------
$ 12,193 $ 13,047
========== ==========
Note 8 - Employee benefit plans:
The Company maintains a defined benefit pension plan and certain other
benefits covering substantially all employees. Variances from actuarially
assumed rates will result in increases or decreases in accumulated pension
obligations, pension expense and funding requirements in future periods. At
December 31, 2005, the Company expects to contribute the equivalent of
approximately $11 million to its defined benefit pension plans during 2006.
Certain actuarial assumptions used in measuring the defined benefit pension
assets, liabilities and expenses are presented below. The Company uses a
September 30th measurement date for their defined benefit pension plans.
The weighted-average rate assumptions used in determining the actuarial
present value of benefit obligations as of December 31, 2004 and 2005 are
presented in the table below. Such weighted-average rates were determined using
the projected benefit obligations at each date.
December 31,
------------------
Rate 2004 2005
---- ---- ----
Discount rate 5.0% 4.0%
Increase in future compensation levels 2.8% 2.8%
The weighted-average rate assumptions used in determining the net periodic
pension cost for 2003, 2004 and 2005 are presented in the table below. The
weighted-average discount rate and the weighted-average increase in future
compensation levels were determined using the projected benefit obligations at
the beginning of each year, and the weighted-average long-term return on plan
assets was determined using the fair value of plan assets at the beginning of
each year.
Years ended December 31,
------------------------------
Rate 2003 2004 2005
---- ---- ---- ----
Discount rate 5.3% 5.3% 5.0%
Increase in future compensation levels 2.8% 2.8% 2.8%
Long-term return on plan assets 6.5% 6.5% 6.0%
Plan assets are comprised primarily of investments in corporate equity and
debt securities, short-term investments, mutual funds and group annuity
contracts.
The components of the net periodic defined benefit pension cost are set
forth below.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Net periodic pension cost:
Service cost benefits $ 2,621 $ 3,289 $ 3,742
Interest cost on projected benefit
obligation ("PBO") 9,354 10,558 10,540
Expected return on plan assets (8,831) (9,448) (8,841)
Amortization of prior service cost - 196 200
Amortization of net transition obligation 251 69 -
Recognized actuarial losses 20 782 1,644
-------- -------- --------
$ 3,415 $ 5,446 $ 7,285
======== ======== ========
The funded status of the Company's defined benefit pension plan is set
forth below.
December 31,
--------------
2004 2005
---- ----
(In thousands)
Change in projected benefit obligations ("PBO"):
Benefit obligations at beginning of year $ 205,440 $ 232,308
Service cost 3,289 3,742
Interest cost 10,558 10,540
Participant contributions 1,206 1,316
Actuarial losses 4,968 81,199
Benefits paid (12,442) (35,385)
Change in currency exchange rates 19,289 (13,780)
---------- ----------
Benefit obligations at end of year $ 232,308 $ 279,940
---------- ----------
Change in fair value of plan assets:
Fair value of plan assets at beginning of year $ 116,275 $ 136,919
Actual return on plan assets 10,026 4,596
Employer contributions 10,432 11,182
Participant contributions 1,206 1,316
Change in currency exchange rates 11,422 (18,204)
Benefits paid (12,442) (13,780)
---------- ----------
Fair value of plan assets at end of year $ 136,919 $ 122,029
---------- ----------
Funded status at year end:
Plan assets less than PBO $ (95,389) $ (157,911)
Unrecognized actuarial loss 79,381 147,873
Unrecognized prior service cost 3,672 3,000
---------- ----------
$ (12,336) $ (7,038)
========== ==========
Amounts recognized in the balance sheet:
Unrecognized net pension obligations $ 3,672 $ 3,000
Accrued pension cost:
Current (8,587) (120,872)
Noncurrent (45,015) (9,858)
Accumulated other comprehensive loss 37,594 120,692
---------- ----------
$ (12,336) $ (7,038)
========== ==========
SFAS No. 87, "Employers' Accounting for Pension Costs" requires that an
additional pension liability be recognized when the unfunded accumulated pension
benefit obligation exceeds the unfunded accrued pension liability. The
accumulated benefit obligation of the Company's defined benefit pension plan was
$255.4 million at December 31, 2005 (2004 - $193.6 million). Variances from
actuarially assumed rates will change the actuarial valuation of accrued pension
liabilities, pension expense and funding requirements in future periods.
In determining the expected long-term rate of return on plan asset
assumptions, the Company considers the long-term asset mix (e.g. equity vs.
fixed income) for the assets for each of its plans and the expected long-term
rates of return for such asset components. In addition, the Company receives
advice about appropriate long-term rates of return from the Company's
third-party actuaries. The composition of the Company's plan assets is
established to satisfy the requirements of the German insurance commissioner.
The plan asset allocation at December 31, 2005 was 23% to equity managers, 48%
to fixed income managers and 29% to real estate (2004 - 23%, 48% and 29%,
respectively). The Company regularly reviews its actual asset allocation for
each of its plans, and will periodically rebalance the investments in each plan
to more accurately reflect the targeted allocation when considered appropriate.
The Company expects total defined benefit pension plan expense to be
approximately $12 million in 2006. The Company expects future benefits paid from
all defined benefit pension plans to be as follows:
Amount
Years ending December 31, (In thousands)
- -------------------------- --------------
2006 $13,274
2007 13,392
2008 13,510
2009 13,628
2010 13,746
2011 to 2015 69,319
Note 9 - Income taxes:
The components of (i) the difference between the provision for income taxes
attributable to pretax income and the amounts that would be expected using the
German statutory corporation tax rate of 25% in 2003 and 26.4% in 2004 and 2005,
(ii) the provision for income taxes and (iii) the comprehensive tax provision
are presented below.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Pretax income $ 64,871 $ 58,485 $ 86,918
========= ========= =========
Expected tax expense $ 16,218 $ 15,440 $ 22,946
Trade income tax 11,365 7,773 11,212
German tax refund (123,033) (2,508) -
Change in deferred income tax
valuation allowance, net - (3,146) -
Tax contingency reserve adjustment - - 1,387
Organschaft adjustment (94,079) - -
No corporation tax provision due
to partnership structure (16,218) - -
Other, net 77 (52) (860)
--------- --------- ---------
Income tax expense (benefit) $(205,670) $ 17,507 $ 34,685
========= ========= =========
Provision for income taxes:
Current income tax expense (benefit) $(165,900) $ 11,329 $ 25,258
Deferred income tax expense (benefit) (39,770) 6,178 9,427
--------- --------- ---------
$(205,670) $ 17,507 $ 34,685
========= ========= =========
Comprehensive provision (benefit) for income
taxes allocable to:
Pretax income $(205,670) $ 17,507 $ 34,685
Other comprehensive loss - pension
liabilities (5,331) (8,081) (32,649)
--------- --------- ---------
$(211,001) $ 9,426 $ 2,036
========= ========= =========
The components of the net deferred tax liability are summarized below.
December 31,
---------------------------------------------------
2004 2005
----------------------- -----------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
Tax effect of temporary differences
relating to:
Inventories $ - $ (1,816) $ - $ (2,375)
Property and equipment 38,327 - 26,362 -
Accrued (prepaid) pension cost 14,770 (27,598) 47,420 (24,398)
Other taxable differences - (7,518) - (3,473)
Tax loss and tax credit carryforwards - - - -
------- -------- -------- --------
Gross deferred tax assets (liabilities) 53,097 (36,932) 73,782 (30,246)
Reclassification, principally netting by
tax jurisdiction (35,020) 35,020 (26,738) 26,738
------- -------- -------- --------
Net total deferred tax liabilities 18,077 (1,912) 47,044 (3,508)
Net current deferred tax liabilities - (1,912) - (3,508)
------- -------- -------- --------
Net noncurrent deferred tax liabilities $18,077 $ - $ 47,044 $ -
======= ======== ======== ========
The Company's has no deferred income tax valuation allowance as of December
31, 2004 and 2005.
During 2003, the Company's legal form was as a partnership. As a
partnership, the Company was not subject to corporation tax, although the
Company was subject to trade income tax. Effective December 31, 2003, the
Company was converted to a limited liability company and was also subject to the
German corporation tax in years following 2003. As a result of the conversion of
the Company from a partnership, the Company recognized net deferred income tax
assets of approximately $52 million related to the expected future tax
consequences of temporary differences between the corporate income tax and
financial reporting carrying amounts of its assets and liabilities.
In the first quarter of 2003, the Company was notified by the German
Federal Fiscal Court (the "Court") that the Court had ruled in the Company's
favor concerning a claim for refund suit in which the Company sought refunds of
prior taxes paid during the periods 1990 through 1997. The Company was required
to file amended tax returns with the German tax authorities in order to receive
its refunds for such years, and all of such amended returns were filed during
2003. Such amended returns reflected an aggregate refund of taxes and related
interest to the Company of euro 103.2 million ($123.0 million) and the Company
recognized the benefit for these net funds in its 2003 results of operations.
For the year ended December 31, 2004, the Company recognized a refund of euro
4.0 million ($5.3 million) related to additional net interest which has accrued
on the outstanding refund amount. In 2004, TG had received net refunds of euro
107.2 million ($135.4 million when received). All refunds relating from the
periods 1990 to 1997 were received by December 31, 2004. In addition to the
refunds for the 1990 to 1997 periods, the court ruling also resulted in a refund
of 1999 income taxes and interest, and the Company received euro 21.5 million
($24.6 million) in 2003.
Pursuant to the Company's conversion to a limited liability company
effective December 31, 2003, the Company is included in KII's Organschaft
effective January 1, 2004.
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.
Note 10 - Related party transactions:
The Company may be deemed to be controlled by Harold C. Simmons. See Note
1. Corporations that may be deemed to be controlled by or affiliated with Mr.
Simmons sometimes engage in (a) intercorporate transactions such as guarantees,
management and expense sharing arrangements, shared fee arrangements, tax
sharing agreements, joint ventures, partnerships, loans, options, advances of
funds on open account, and sales, leases and exchanges of assets, including
securities issued by both related and unrelated parties and (b) common
investment and acquisition strategies, business combinations, reorganizations,
recapitalizations, securities repurchases, and purchases and sales (and other
acquisitions and dispositions) of subsidiaries, divisions or other business
units, which transactions have involved both related and unrelated parties and
have included transactions which resulted in the acquisition by one related
party of a publicly held minority equity interest in another related party.
While no transactions of the type described above are planned or proposed with
respect to the Company other than as set forth in these financial statements,
the Company from time to time considers, reviews and evaluates such transactions
and understands that Contran, Valhi, NL, Kronos, KII and related entities
consider, review and evaluate, such transactions. Depending upon the business,
tax and other objectives then relevant, and restrictions under the KII
indenture, the Credit Facility and other agreements, it is possible that the
Company might be a party to one or more such transactions in the future.
The Company is a party to services and cost sharing agreements among
several affiliates of the Company whereby Kronos, KII, KEU and other affiliates
provide certain management, financial, insurance and administrative services to
the Company on a fee basis. The Company's expense was approximately $7.1 million
in 2003, $7.8 million in 2004 and $7.9 million in 2005 related to these services
and costs.
The Company charges affiliates for certain management, financial and
administrative services costs, which totaled approximately $4.3 million, $4.4
million and $4.8 million in 2003, 2004 and 2005, respectively. These charges to
affiliates were reflected primarily as a reduction of selling, general and
administrative expense.
Tall Pines Insurance Company and EWI RE, Inc. ("EWI") provide for or broker
certain insurance policies for Contran and certain of its subsidiaries and
affiliates, including KII, Kronos and the Company. Tall Pines is wholly owned by
a subsidiary of Valhi, and EWI is a wholly-owned subsidiary of NL. Consistent
with insurance industry practices, Tall Pines and EWI receive commissions from
insurance and reinsurance underwriters and/or assess fees for the policies that
they provide or broker. The aggregated premiums paid to Tall Pines (including
amounts paid to Valmont Insurance Company, another subsidiary of Valhi that was
merged into Tall Pines in 2004) and EWI by the Company were $4.1 million, $4.0
million and $3.5 million in 2003, 2004 and 2005, respectively. These amounts
principally included payments for insurance, but also included commissions paid
to Tall Pines and EWI. Tall Pines purchases reinsurance for substantially all of
the risks it underwrites. The Company expects that these relationships with Tall
Pines and EWI will continue in 2006.
Contran and certain of its subsidiaries and affiliates, including the
Company, purchase certain of their insurance policies as a group, with the costs
of the jointly-owned policies being apportioned among the participating
companies. With respect to certain of such policies, it is possible that
unusually large losses incurred by one or more insureds during a given policy
period could leave the other participating companies without adequate coverage
under that policy for the balance of the policy period. As a result, Contran and
certain of its subsidiaries and its affiliates, including Kronos, have entered
into a loss sharing agreement under which any uninsured loss is shared by those
entities who have submitted claims under the relevant policy. The Company
believes the benefits in the form of reduced premiums and broader coverage
associated with the group coverage for such policies justifies the risk
associated with the potential for uninsured loss.
The Company purchases from and sells to its affiliates a significant amount
of titanium dioxide pigments ("TiO2"). Intercompany sales to (purchases from)
affiliates of TiO2 are summarized in the following table.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Sales to:
Kronos (US), Inc. ("KUS") $ 37,550 $ 21,448 $ 25,977
Societe Industrielle du Titane,
S.A. ("SIT") 32,969 39,091 40,116
KEU 22,417 23,872 26,943
Kronos Limited ("KUK") 22,151 18,677 21,162
Kronos Canada, Inc. ("KC") 5,026 5,414 8,623
Other affiliates 16,368 24,936 31,178
--------- --------- ---------
$ 136,481 $ 133,438 $ 153,999
========= ========= =========
Purchases from:
KEU $ 33,061 $ 42,836 $ 43,914
TAS 5,722 10,796 11,296
KC - 271 41
--------- --------- ---------
$ 38,783 $ 53,903 $ 55,251
========= ========= =========
KUS purchases the rutile and slag feedstock used as a raw material in the
Company's chloride process TiO2 facility. The Company purchases such feedstock
from KUS for use in its facility for an amount equal to the amount paid by KUS
to the third-party supplier plus a 2.5% administrative fee. Such feedstock
purchases were $56.2 million in 2003, $66.7 million in 2004 and $72.3 million in
2005.
The Company sells water treatment chemicals (derived from co-products of
the TiO2 production processes) to KII. Such water treatment chemical sales were
$12.8 million in 2003, $16.1 million in 2004 and $18.8 million in 2005.
The Company purchases ilmenite (sulfate feedstock) from TIA on a
year-to-year basis. Such feedstock purchases were $15.5 million in 2003, $17.4
million in 2004 and $21.4 million in 2005.
At January 1, 2002, the Company is party to an accounts receivable
factoring agreement with certain European affiliates of the Company pursuant to
which these affiliates factored their export accounts receivable without
recourse to the Company for a fee of 0.85%. Upon non-recourse transfer from
these affiliates, the Company assumes all risk pertaining to the factored
receivables, including, but not limited to, exchange control risks, risks
pertaining to the bankruptcy of a customer and risks related to late payments.
Export receivables purchased by the Company during 2003, 2004 and 2005
aggregated $101 million, $120 million and $124 million, respectively.
Net amounts currently receivable from (payable to) affiliates are
summarized in the following table.
December 31,
--------------
2004 2005
---- ----
(In thousands)
Receivable from:
KUK $ 862 $ -
SIT 1,632 -
KEU - 9,068
Kronos B.V. 2,055 -
KII 25,032 32,833
KC 1,496 227
Other affiliates 1,278 893
---------- ----------
$ 32,355 $ 43,021
========== ==========
Current payable to:
KII - income taxes $ 14,386 $ 30,173
KUS 5,390 9,553
TIA 8,817 25,090
Kronos B.V. - 8,596
KEU 4,456 -
TAS 2,139 521
Other affiliates 72 1,514
---------- ----------
$ 35,260 $ 75,447
========== ==========
Noncurrent receivable from TAS $ 5,449 $ -
========== ==========
Noncurrent payables to KDK $ 12,941 $ 11,239
========== ==========
Such amounts receivable from affiliates were generally related to product
sales (including water treatment chemical sales to KII) and services rendered.
Amounts payable to affiliates, net were related primarily to raw material
purchases, accounts receivable factoring and services received.
The Company borrowed euro 9.5 million from KDK in October 2004 ($11.2
million at December 31, 2005). This note bears an interest rate of 2.675% and is
due on March 31, 2006, with an option to renew.
The Company loaned TAS euro 4 million ($5.4 million) during 2004. This note
receivable bore interest at 3.1% and was repaid in 2005.
Included in other affiliate income and other affiliate expense was other
affiliate interest income/expense, factoring fees and service fees.
Note 11 - NL common stock options held by employees of the Company:
At December 31, 2005, employees of the Company held options to purchase
approximately 9,000 shares of NL common stock, which are exercisable at various
dates through 2010 (approximately 4,000) at an exercise of $5.63 per share, and
exercisable at various dates through 2011 (approximately 5,000) at an exercise
price of $11.49 per share.
The pro forma information required by SFAS No. 123 is based on an
estimation of the fair value of options issued subsequent to January 1, 1995.
See Notes 2 and 15. No options were granted during 2003, 2004 or 2005. For
purposes of pro forma disclosures, the estimated fair value of the options is
amortized to expense over the options' vesting period.
Note 12 - Commitments and contingencies:
Operating leases. The Company leases, pursuant to operating leases, various
manufacturing facilities and equipment. Most of the leases contain purchase
and/or various term renewal options at fair market and fair rental values,
respectively. In most cases management expects that, in the normal course of
business, leases will be renewed or replaced by other leases.
The Company 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
two-thirds of the Company's current TiO2 production capacity, is located within
the lessor'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. Under a separate supplies and services
agreement expiring in 2011, the lessor provides some raw materials, including
chlorine, auxiliary and operating materials, utilities and services necessary to
operate the Leverkusen facility.
Net rent expense aggregated $5 million in 2003 and $4 million in each of
2004 and 2005. At December 31, 2005, minimum rental commitments under the terms
of noncancellable operating leases were as follows:
Amount
--------------
(in thousands)
Years ending December 31,
- --------------------------
2006 $ 2,248
2007 1,522
2008 1,370
2009 1,294
2010 1,034
2011 and thereafter 20,931
-------
$28,399
=======
Approximately $20.1 million of the $28.4 million aggregate future minimum
rental commitments at December 31, 2005 relates to the Company's Leverkusen
facility lease discussed above. The minimum commitment amounts for such lease
included in the table above for each year through the 2050 expiration of the
lease are based upon the current annual rental rate as of December 31, 2005. As
discussed above, any change in the rent is based solely on negotiations between
Bayer and the Company, and any such change in the rent is deemed "contingent
rentals" under GAAP which is excluded from the future minimum lease payments
disclosed above.
Purchase commitments. KUS has long-term supply contracts that provide for
certain affiliates' chloride feedstock requirements through 2010. The Company
purchases chloride feedstock underlying these long-term supply contracts from
KUS. The agreements require KUS to purchase certain minimum quantities of
feedstock with minimum purchase commitments aggregating approximately $618
million at December 31, 2005.
Environmental, product liability and litigation matters. The Company's
operations are governed by various environmental laws and regulations. Certain
of the Company's operations are and have been engaged in the handling,
manufacture or use of substances or compounds that may be considered toxic or
hazardous within the meaning of applicable environmental laws. As with other
companies engaged in similar businesses, certain past and current operations and
products of the Company have the potential to cause environmental or other
damage. The Company has implemented and continues to implement various policies
and programs in an effort to minimize these risks. The Company's policy is to
maintain compliance with applicable environmental laws and regulations at all of
its facilities and to strive to improve its environmental performance. It is
possible that future developments, such as stricter requirements of
environmental laws and enforcement policies thereunder, could adversely affect
the Company's production, handling, use, storage, transportation, sale or
disposal of such substances. The Company believes all of its plants are in
substantial compliance with applicable environmental laws.
Concentrations of credit risk. Sales of TiO2 accounted for more than 97% of
net sales during each of 2003, 2004 and 2005. The remaining sales result from
the manufacture and sale of iron-based water treatment chemicals (derived from
co-products of the TiO2 production processes). TiO2 is generally sold to the
paint, plastics and paper, as well as fibers, rubber, ceramics, inks and
cosmetics markets. Such markets are generally considered "quality-of-life"
markets whose demand for TiO2 is influenced by the relative economic well-being
of the various geographic regions. TiO2 is sold to over 1,000 customers, with
the top ten external customers approximating 20% of net sales in 2003, 22% of
net sales in 2004 and 21% of net sales in 2005. Approximately 74% of the
Company's TiO2 sales by volume were to Europe in 2003 and 78% in each of 2004
and 2005. Approximately 11% in 2003 and 7% in each of 2004 and 2005 of sales by
volume were to North America.
Note 13 - Financial instruments:
Summarized below is the estimated fair value and related net carrying value
of the Company's financial instruments.
December 31, December 31,
2004 2005
--------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- ------------- -------------------------
(In millions)
Cash and cash equivalents $ 6.4 $ 6.4 $ 50.8 $ 50.8
Note payable to affiliate 12.9 12.9 11.2 11.2
The Company periodically uses interest rate swaps, currency swaps and other
types of contracts to manage interest rate and foreign exchange risk with
respect to financial assets or liabilities. The Company has not entered into
these contracts for trading or speculative purposes in the past, nor does it
currently anticipate doing so in the future. The Company was not a party to any
such contracts during 2003, 2004 and 2005.
Other than as described above, the Company was not a party to any material
derivative financial instruments during 2003, 2004 or 2005. There was no impact
on the Company's financial statements from adopting SFAS No. 133.
Note 14- Accounting principles newly adopted in 2003 and 2004:
Costs associated with exit or disposal activities. The Company adopted SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," on
January 1, 2003 for exit or disposal activities initiated on or after that date.
Under SFAS No. 146, costs associated with exit activities, as defined, that are
covered by the scope of SFAS No. 146 will be recognized and measured initially
at fair value, generally in the period in which the liability is incurred. Costs
covered by the scope of SFAS No. 146 include termination benefits provided to
employees, costs to consolidate facilities or relocate employees, and costs to
terminate contracts (other than a capital lease). Under prior GAAP, a liability
for such an exit cost is recognized at the date an exit plan is adopted, which
may or may not be the date at which the liability has been incurred. The effect
of adopting SFAS No. 146 as of January 1, 2003 was not material as the Company
was not involved in any exit or disposal activities covered by the scope of the
new standard as of such date.
Variable interest entities. The Company complied with the consolidation
requirements of FASB Interpretation ("FIN") No. 46R, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51," as amended as of March 31,
2004. The Company does not have any involvement with any variable interest
entity (as that term is defined in FIN No. 46R) covered by the scope of FIN No.
46R that would require the Company to consolidate such entity under FIN No. 46R,
which had not already been consolidated under prior applicable GAAP, and
therefore the impact to the Company of adopting the consolidation requirements
of FIN No. 46R was not material.
Note 15- Accounting principles not yet adopted:
Stock options. The Company will adopt SFAS No. 123R, "Share-Based Payment",
as of January 1, 2006. SFAS No. 123R, among other things, eliminated the
alternative in previously 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, 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 previously measured
under SFAS No. 123 for the portion of any non-vested award existing as of
December 31, 2005 over the remaining vesting period. Because the Company has not
granted any options to purchase its common stock and did not grant any options
prior to January 1, 2006, and 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, the effect of adopting SFAS No. 123R is
not expected to be significant in so far as it relates to the recognition of
compensation cost in the Company's consolidated statements of income for
existing stock options. Should the Company or one of its affiliates, however,
grant a significant number of options in the future to employees of the Company,
the Company could recognize material amounts of compensation cost related to
such options in its consolidated financial statements.
Also upon adoption of SFAS No. 123R, any cash income tax benefit resulting
from the exercise of stock options in excess of the cumulative income tax
benefit related to such options previously recognized for GAAP financial
reporting purposes in the Company's consolidated statements of income, if any,
will be reflected as a cash inflow from financing activities in the Company's
consolidated statements of cash flows, and the Company's cash flows from
operating activities will reflect the effect of cash paid for income taxes
exclusive of such cash income tax benefit.
SFAS No. 123R also requires certain expanded disclosures regarding the
Company's stock options, and such expanded disclosures have been provided in
Note 2.
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 are 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.
KRONOS DENMARK APS AND SUBSIDIARIES
Index of Consolidated Financial Statements
Financial Statements Pages
Report of Independent Registered Public Accounting Firm FB-2
Consolidated Balance Sheets - December 31, 2004 and 2005 FB-3
Consolidated Statements of Income - Years ended
December 31, 2003, 2004 and 2005 FB-5
Consolidated Statements of Comprehensive Income - Years ended
December 31, 2003, 2004 and 2005 FB-6
Consolidated Statements of Stockholder's Equity - Years ended
December 31, 2003, 2004 and 2005 FB-7
Consolidated Statements of Cash Flows - Years ended
December 31, 2003, 2004 and 2005 FB-8
Notes to Consolidated Financial Statements FB-10
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of Kronos Denmark ApS:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, comprehensive income, stockholder's
equity and cash flows present fairly, in all material respects, the financial
position of Kronos Denmark ApS and Subsidiaries at December 31, 2004 and 2005,
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2005 in conformity with accounting
principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
March 28, 2006
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2005
(In thousands, except share data)
ASSETS
2004 2005
---- ----
Current assets:
Cash and cash equivalents $ 3,566 $ 1,042
Restricted cash 1,529 1,355
Accounts and notes receivable 18,422 17,319
Receivable from affiliates 16,029 27,493
Refundable income taxes 1,542 205
Inventories 65,282 69,506
Prepaid expenses 908 900
---------- ----------
Total current assets 107,278 117,820
---------- ----------
Other assets:
Note receivable from affiliate 12,941 11,239
Other 7,013 6,153
---------- ----------
Total other assets 19,954 17,392
---------- ----------
Property and equipment:
Land 19,236 16,829
Buildings 41,196 36,995
Machinery and equipment 190,748 176,849
Mining properties 72,384 68,163
Construction in progress 3,443 1,964
---------- ----------
327,007 300,800
Less accumulated depreciation and amortization 200,873 188,090
---------- ----------
Net property and equipment 126,134 112,710
---------- ----------
$ 253,366 $ 247,922
========== ==========
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
December 31, 2004 and 2005
(In thousands, except share data)
LIABILITIES AND STOCKHOLDER'S EQUITY
2004 2005
---- ----
Current liabilities:
Current maturities of long-term debt $ 13,792 $ 958
Accounts payable and accrued liabilities 38,776 38,406
Payable to affiliates 10,142 9,058
Income taxes 6,427 6,564
Deferred income taxes 2,363 2,194
---------- ----------
Total current liabilities 71,500 57,180
---------- ----------
Noncurrent liabilities:
Long-term debt 178 3,567
Note payable to affiliate 5,449 -
Deferred income taxes 22,358 19,266
Accrued pension costs 2,493 4,129
Other 3,484 1,362
---------- ----------
Total noncurrent liabilities 33,962 28,324
---------- ----------
Stockholder's equity:
Common stock - 100 Danish kroner par value;
10,000 shares authorized; 10,000 shares
issued and outstanding 136 136
Additional paid-in capital 216,996 216,996
Accumulated deficit (69,643) (34,216)
Accumulated other comprehensive loss:
Currency translation adjustment 9,686 (10,584)
Minimum pension liability (9,271) (9,914)
---------- ----------
Total stockholder's equity 147,904 162,418
---------- ----------
$ 253,366 $ 247,922
========== ==========
Commitments and contingencies (Notes 7, 10 and 13)
See accompanying notes to consolidated financial statements.
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net sales $ 292,611 $ 345,962 $ 364,865
Cost of sales 234,881 284,902 291,075
---------- ---------- ----------
Gross margin 57,730 61,060 73,790
Selling, general and administrative expense 19,596 23,874 24,868
Other operating income (expense):
Currency transaction gains (losses), net 355 980 173
Disposition of property and equipment 37 (596) (220)
Other, net 350 286 489
---------- ---------- ----------
Income from operations 38,876 37,856 49,364
Other income (expense):
Trade interest income 163 73 88
Securities transaction gain - - 5,439
Other income from affiliates 198 202 387
Interest and other expense to affiliates (2,608) (2,943) (2,572)
Interest expense (2,309) (1,529) (1,142)
---------- ---------- ----------
Income before income taxes 34,320 33,659 51,564
Provision for income taxes 7,428 9,843 16,137
---------- ---------- ----------
Net income $ 26,892 $ 23,816 $ 35,427
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Net income $ 26,892 $ 23,816 $ 35,427
---------- ---------- ----------
Other comprehensive income (loss), net of tax:
Currency translation adjustment 10,998 13,890 (20,270)
Minimum pension liability (10,459) 1,188 (643)
---------- ---------- ----------
Total other comprehensive income 539 15,078 (20,913)
---------- ---------- ----------
Comprehensive income $ 27,431 $ 38,894 $ 14,514
========== ========== ==========
See accompanying notes to consolidated financial statements.
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
Years ended December 31, 2003, 2004 and 2005
(In thousands)
Accumulated other
comprehensive income (loss)
---------------------------
Additional Currency Minimum
Common paid-in Accumulated translation pension
stock capital deficit adjustment liability Total
-------- ----------- ----------- ------------- --------- -----
Balance at December 31, 2002 $ 136 $ 216,996 $(120,351) $ (15,202) $ - $ 81,579
Net income - - 26,892 - - 26,892
Other comprehensive income (loss),
net of tax - - - 10,998 (10,459) 539
-------- --------- --------- --------- --------- ---------
Balance at December 31, 2003 136 216,996 (93,459) (4,204) (10,459) 109,010
Net income - - 23,816 - - 23,816
Other comprehensive income, net of tax - - - 13,890 1,188 15,078
-------- --------- --------- --------- --------- ---------
Balance at December 31, 2004 136 216,996 (69,643) 9,686 (9,271) 147,904
Net income - - 35,427 - - 35,427
Other comprehensive income, net of tax - - - (20,270) (643) (20,913)
-------- --------- --------- --------- --------- ---------
Balance at December 31, 2005 $ 136 $ 216,996 $ (34,216) $ (10,584) $ (9,914) $ 162,418
======== ========= ========= ========= ========= =========
See accompanying notes to consolidated financial statements.
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from operating activities:
Net income $ 26,892 $ 23,816 $ 35,427
Depreciation and amortization 11,446 12,041 13,379
Noncash interest expense 332 358 302
Deferred income taxes (5,405) (2,983) (265)
Securities transaction gain - - (5,439)
Net loss (gain) from disposition of
property and equipment (37) 596 220
Pension, net 2,278 4,372 1,469
Change in assets and liabilities:
Accounts and notes receivable 437 (967) (1,727)
Inventories (2,250) 6,500 (12,685)
Prepaid expenses 143 17 (104)
Accounts payable and accrued liabilities 4,107 3,130 5,324
Income taxes (2,902) (453) 2,379
Accounts with affiliates 10,403 (37,220) (13,683)
Other noncurrent assets (4,181) 2,257 (552)
Other noncurrent liabilities 547 (1,420) (1,936)
---------- ---------- ----------
Net cash provided by operating activities 41,810 10,044 22,109
---------- ---------- ----------
Cash flows from investing activities:
Capital expenditures (10,274) (11,725) (15,044)
Loans to affiliates - (11,597) -
Proceeds from disposal of interest in
Norwegian smelting operation - - 3,542
Change in restricted cash equivalents and restricted 129
marketable debt securities, net (554) (70)
Proceeds from disposition of property and equipment 350 100 29
---------- ---------- ----------
Net cash used by investing activities (10,478) (23,292) (11,344)
---------- ---------- ----------
KRONOS DENMARK APS AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Years ended December 31, 2003, 2004 and 2005
(In thousands)
2003 2004 2005
---- ---- ----
Cash flows from financing activities:
Indebtedness:
Borrowings $ 16,106 $ 62,140 $ 4,620
Principal payments (46,006) (50,089) (13,159)
Loans from affiliates - repayments - - (4,648)
---------- ---------- ----------
Net cash provided (used) by financing activities (29,900) 12,051 (13,187)
---------- ---------- ----------
Cash and cash equivalents:
Net change during the year from:
Operating, investing and financing
activities 1,432 (1,197) (2,422)
Currency translation 336 82 (102)
Balance at beginning of period 2,913 4,681 3,566
---------- ---------- ----------
Balance at end of period $ 4,681 $ 3,566 $ 1,042
========== ========== ==========
Supplemental disclosures:
Cash paid for:
Interest $ 4,638 $ 4,198 $ 446
Income taxes 11,525 13,331 13,885
Inventories received as partial consideration
for disposal of interest in Norwegian
smelting operation $ - $ - $ 1,897
See accompanying notes to consolidated financial statements.
KRONOS DENMARK APS AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization and basis of presentation:
Kronos Denmark ApS ("KDK") was incorporated in Denmark in October 1999 and
is a wholly-owned subsidiary of Kronos International, Inc. ("KII"). KII is a
wholly-owned subsidiary of Kronos Worldwide, Inc. (NYSE:KRO). At December 31,
2005, (i) Valhi, Inc (NYSE: VHI) owned approximately 57% of Kronos' common stock
and NL Industries, Inc. (NYSE: NL) held an additional 36% of the outstanding
common stock of Kronos, (ii) Valhi owned 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 such companies.
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP") with the U.S. dollar as the reporting currency. KDK and its
subsidiaries also prepare financial statements on other bases, as required in
countries in which such entities are resident.
KDK's current operations are conducted primarily through its Belgian and
Norwegian subsidiaries with a titanium dioxide pigments ("TiO2") plant in
Belgium and a TiO2 plant and ilmenite ore mining operation in Norway. KDK also
operates TiO2 sales and distribution facilities in Denmark and the Netherlands.
KDK is not a registrant with the U.S. Securities and Exchange Commission
("SEC") and is not subject to the SEC's periodic reporting requirements, except
as may be required by Rule 3-16 of Regulation S-X.
Note 2 - Summary of significant accounting policies:
Management's estimates. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States of
America ("GAAP") requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amount of revenues and expenses during the reporting period. Actual
results may differ from previously-estimated amounts under different assumptions
or conditions.
Principles of consolidation. The consolidated financial statements include
the accounts of KDK and its wholly-owned subsidiaries (collectively, the
"Company"). All material intercompany accounts and balances have been
eliminated.
Translation of foreign currencies. The functional currencies of the Company
include the Danish kroner, the euro and the Norwegian kroner. Assets and
liabilities of subsidiaries whose functional currency is other than the U.S.
dollar are translated at year-end rates of exchange and revenues and expenses
are translated at average exchange rates prevailing during the year. Resulting
translation adjustments are accumulated in stockholder's equity as part of
accumulated other comprehensive income, net of related deferred income taxes.
Currency transaction gains and losses are recognized in income currently.
Derivatives and hedging activities. Derivatives are recognized as either
assets or liabilities and measured at fair value in accordance with SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
The accounting for changes in fair value of derivatives depends upon the
intended use of the derivative, and such changes are recognized either in net
income or other comprehensive income. As permitted by the transition
requirements of SFAS No. 133, as amended, the Company has exempted from the
scope of SFAS No. 133 all host contracts containing embedded derivatives that
were issued or acquired prior to January 1, 1999.
Cash and cash equivalents. Cash equivalents include bank deposits with
original maturities of three months or less.
Restricted marketable debt securities. Restricted marketable debt
securities are primarily invested in corporate debt securities and include
amounts restricted in accordance with applicable Norwegian law regarding certain
requirements of the Company's Norwegian defined benefit pension plans ($2.9
million and $2.6 million at December 31, 2004 and 2005, respectively). The
restricted marketable debt securities are generally classified as either a
current or noncurrent asset depending upon the maturity date of each such debt
security and are carried at market, which approximates cost.
Accounts receivable. The Company provides an allowance for doubtful
accounts for known and estimated potential losses arising from sales to
customers based on a periodic review of these accounts.
Property and equipment and depreciation. Property and equipment are stated
at cost. The Company has a governmental concession with an unlimited term to
operate an ilmenite mine in Norway. Mining properties consist of buildings and
equipment used in the Company's Norwegian ilmenite mining operations. While the
Company owns the land and ilmenite reserves associated with the mine, such land
and reserves were acquired for nominal value and the Company has no material
asset recognized for the land and reserves related to such mining operations.
Depreciation of property and equipment for financial reporting purposes
(including mining properties) is computed principally by the straight-line
method over the estimated useful lives of ten to 40 years for buildings and
three to 20 years for equipment. Accelerated depreciation methods are used for
income tax purposes, as permitted. Upon sale or retirement of an asset, the
related cost and accumulated depreciation are removed from the accounts and any
gain or loss is recognized in income currently.
Expenditures for maintenance, repairs and minor renewals are expensed;
expenditures for major improvements are capitalized. The Company performs
planned major maintenance activities during the year. Repair and maintenance
costs estimated to be incurred in connection with planned major maintenance
activities are accrued in advance and are included in cost of sales. Accrued
repair and maintenance costs, included in other current liabilities and
consisting primarily of materials and supplies, was $600,000 and $1.2 million at
December 31, 2004 and 2005, respectively.
Interest costs related to major long-term capital projects and renewals are
capitalized as a component of construction costs. Interest costs capitalized
were not significant in 2003, 2004 or 2005.
When events or changes in circumstances indicate that assets may be
impaired, an evaluation is performed to determine if an impairment exists. Such
events or changes in circumstances include, among other things, (i) significant
current and prior periods or current and projected periods with operating
losses, (ii) a significant decrease in the market value of an asset or (iii) a
significant change in the extent or manner in which an asset is used. All
relevant factors are considered. The test for impairment is performed by
comparing the estimated future undiscounted cash flows (exclusive of interest
expense) associated with the asset to the asset's net carrying value to
determine if a write-down to market value or discounted cash flow value is
required. The Company assesses impairment of other long-lived assets (such as
property and equipment and mining properties) in accordance with SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."
Long-term debt. Long-term debt is stated net of any unamortized original
issue premium or discount. Amortization of deferred financing costs, included in
interest expense, is computed by the interest method over the term of the
applicable issue.
Employee benefit plans. Accounting and funding policies for retirement
plans are described in Note 9.
Income taxes. Deferred income tax assets and liabilities are recognized for
the expected future tax consequences of temporary differences between the income
tax and financial reporting carrying amounts of assets and liabilities,
including investments in the Company's subsidiaries and affiliates who are not
members of the Contran Tax Group and undistributed earnings of foreign
subsidiaries which are not deemed to be permanently reinvested. The Company
periodically evaluates its deferred tax assets in the various taxing
jurisdictions in which it operates and adjusts any related valuation allowance
based on the estimate of the amount of such deferred tax assets that the Company
believes does not meet the "more-likely-than-not" recognition criteria.
Net sales. Sales are recorded when products are shipped and title and other
risks and rewards of ownership have passed to the customer, or when services are
performed. Shipping terms of products shipped are generally FOB shipping point;
although in some instances shipping terms are FOB destination point (for which
sales are not recognized until the product is received by the customer). Amounts
charged to customers for shipping and handling are included in net sales. Sales
are stated net of price, early payment and distributor discounts and volume
rebates.
Inventories and cost of sales. Inventories are stated at the lower of cost
(principally average cost) or market, net of allowance for slow-moving
inventories. Amounts are removed from inventories at average cost. Cost of sales
includes costs for materials, packaging and finishing, utilities, salary and
benefits, maintenance and depreciation.
Selling, general and administrative expenses; shipping and handling costs.
Selling, general and administrative expenses include costs related to marketing,
sales, distribution, shipping and handling, research and development, legal and
administrative functions, such as accounting, treasury and finance, and includes
costs for salaries and benefits, travel and entertainment, promotional materials
and professional fees. Shipping and handling costs are included in selling,
general and administrative expense and were $11.2 million in 2003, $13.1 million
in 2004 and $13.2 million in 2005. Advertising costs are expensed as incurred
and were approximately $100,000 in each of 2003, 2004 and 2005. Research,
development and certain sales technical support costs are expensed as incurred
and approximated $300,000 in 2003, $200,000 in 2004 and $300,000 in 2005.
Stock options. The Company has not issued any stock options. However,
certain employees of the Company have been granted options by NL to purchase NL
common stock. The Company has elected the disclosure alternative prescribed by
SFAS No. 123, "Accounting for Stock-Based Compensation," as amended, and to
account for its stock-based employee compensation related to stock options in
accordance with Accounting Principles Board Opinion ("APBO") No. 25, "Accounting
for Stock Issued to Employees," and its various interpretations. Under APBO No.
25, no compensation cost is generally recognized for fixed stock options in
which the exercise price is not less than the market price on the grant date.
Prior to 2003, and following NL's cash settlement of options to purchase NL
common stock held by certain individuals, NL and the Company, commenced
accounting for its stock options using the variable accounting method because NL
could not overcome the presumption that it would not similarly cash settle its
remaining stock options. Under the variable accounting method, the intrinsic
value of all unexercised stock options (including those with an exercise price
at least equal to the market price on the date of grant) are accrued as an
expense over their vesting period, with subsequent increases (decreases) in NL's
market price resulting in additional compensation expense (income). Upon
exercise of such options to purchase NL common stock held by employees of the
Company, the Company pays NL an amount equal to the difference between the
market price of NL's common stock on the date of exercise and the exercise price
of such stock option. Compensation cost recognized by the Company in accordance
with APBO No. 25 and the amount charged to the Company by NL for stock option
exercises was $117,000 in 2003 and $319,000 in 2004, and compensation income was
$185,000 in 2005. The total income tax benefit related to such compensation cost
recognized by the Company was approximately $41,000 in 2003 and $96,000 in 2004,
and the total income tax provision related to the compensation income was
$52,000 in 2005. No compensation cost was capitalized as part of assets
(inventory or fixed assets) during 2003, 2004 and 2005.
The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In millions, except per share amounts)
Net income - as reported $ 26,892 $ 23,816 $ 35,427
Adjustments, net of applicable income tax
effects:
Stock-based employee compensation
(income) expense determined under
APBO No. 25 77 223 (133)
Stock-based employee compensation
expense determined under SFAS No. 123 (38) (8) (3)
-------- -------- --------
Pro forma net income $ 26,931 $ 24,031 $ 35,291
======== ======== ========
Note 3 - Accounts and notes receivable:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Trade receivables $ 15,487 $ 13,992
Recoverable VAT and other receivables 2,960 3,349
Allowance for doubtful accounts (25) (22)
---------- ----------
$ 18,422 $ 17,319
========== ==========
Note 4 - Inventories:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Raw materials $ 13,804 $ 21,359
Work in process 2,871 1,771
Finished products 31,725 30,659
Supplies 16,882 15,717
---------- ----------
$ 65,282 $ 69,506
========== ==========
Note 5 - Other noncurrent assets:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Unrecognized net pension obligations $ 3,852 $ 3,108
Restricted marketable debt securities 2,877 2,572
Deferred financing costs, net 198 400
Other 86 73
---------- ----------
$ 7,013 $ 6,153
========== ==========
Note 6 - Accounts payable and accrued liabilities:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Accounts payable $ 21,695 $ 20,048
---------- ----------
Accrued liabilities:
Employee benefits 10,462 9,664
Other 6,619 8,694
---------- ----------
17,081 18,358
---------- ----------
$ 38,776 $ 38,406
========== ==========
Note 7 - Notes payable and long-term debt:
December 31,
--------------
2004 2005
---- ----
(In thousands)
Long-term debt:
Bank credit facility $ 13,622 $ -
Other 348 4,525
---------- ----------
13,970 4,525
Less current maturities 13,792 958
---------- ----------
$ 178 $ 3,567
========== ==========
The Company and certain of KII's subsidiaries in Belgium and Norway (Kronos
Europe S.A./N.V.-"KEU", Kronos Titan A/S - "TAS" and Titania A/S - "TIA," Kronos
Norge A/S, the parent company of TAS and TIA, and Kronos Titan GmbH "TG"),
referred to as the "Borrowers", have a euro 80 million secured revolving credit
facility that matures in June 2008. Borrowings may be denominated in euros,
Norwegian kroner or U.S. dollars, and bear interest at the applicable interbank
market rate plus 1.125%. The facility also provides for the issuance of letters
of credit up to euro 5 million. The Credit Facility is collateralized by the
accounts receivable and inventories of the borrowers, plus a limited pledge of
all of the other assets of the Belgian borrower. The credit facility contains
certain restrictive covenants which, among other things, restrict the ability of
the borrowers to incur debt, incur liens, pay dividends or merge or consolidate
with, or sell or transfer all or substantially all of their assets to, another
entity. In addition, the Credit Facility contains customary cross-default
provisions with respect to other debt and obligations of Borrowers, KII and its
other subsidiaries. At December 31, 2005, no amounts were outstanding under the
European Credit Facility and the equivalent of $92.3 million was available for
additional borrowing by the Borrowers. The Company, KEU and TG are
unconditionally jointly and severally liable for any and all outstanding
borrowings under the credit facility. TAS, TIA and Kronos Norge A/S are jointly
and severally liable for any and all outstanding borrowings under the credit
facility to the extent permitted by Norwegian law.
Deferred financing costs of $1.4 million for the Credit Facility ($1.0
million paid by the Company, with the remaining $.4 million paid by the German
operating subsidiary) are being amortized over the life of the Credit Facility
and are included in other noncurrent assets as of December 31, 2005.
In June 2002, KII issued at par value euro 285 million principal amount
($280 million when issued) of its 8.875% Senior Secured Notes due 2009, and in
November 2004 KII issued at 107% of par an additional euro 90 million principal
amount ($130 million when issued) of the KII Senior Secured Notes (collectively
the "Notes"). The Notes are collateralized by a pledge of 65% of the common
stock or other ownership interests of certain of KII's first-tier operating
subsidiaries. Such operating subsidiaries are the Company, Kronos Titan GmbH,
Kronos Limited and Societe Industrielle Du Titane, S.A. The Notes are issued
pursuant to an indenture which contains a number of covenants and restrictions
which, among other things, restricts the ability of KII and its subsidiaries to
incur debt, incur liens, pay dividends or merge or consolidate with, or sell or
transfer all or substantially all of their assets to, another entity. The Notes
are redeemable, at KII's option, at redemption prices ranging from 104.437% of
the principal amount, declining to 100% on or after December 30, 2008. In the
event of a change of control of KII, as defined, KII would be required to make
an offer to purchase its Notes at 101% of the principal amount. KII would also
be required to make an offer to purchase a specified portion of its Notes at par
value in the event KII generates a certain amount of net proceeds from the sale
of assets outside the ordinary course of business, and such net proceeds are not
otherwise used for specified purposes within a specified time period.
Under the cross-default provisions of the Notes, the Notes may be
accelerated prior to their stated maturity if KII or any of KII's subsidiaries
default under any other indebtedness in excess of $20 million due to a failure
to pay such other indebtedness at its due date (including any due date that
arises prior to the stated maturity as a result of a default under such other
indebtedness). Under the cross-default provisions of the Credit Facility, any
outstanding borrowings under the Credit Facility may be accelerated prior to
their stated maturity if the Borrowers or KII default under any other
indebtedness in excess of euro 5 million due to a failure to pay such other
indebtedness at its due date (including any due date that arises prior to the
stated maturity as a result of a default under such other indebtedness). The
Credit Facility contains provisions that allow the lender to accelerate the
maturity of the Credit Facility in the event of a change of control, as defined,
of the applicable borrower. In the event any of these cross-default or
change-of-control provisions become applicable, and such indebtedness is
accelerated, KII would be required to repay such indebtedness prior to their
stated maturity.
Other long-term debt relates primarily to certain capital lease agreements
which expire at various dates through 2011.
The aggregate maturities of long-term debt at December 31, 2005 are shown
in the table below.
Amount
--------------
(In thousands)
Years ending December 31,
- --------------------------
2006 $ 958
2007 861
2008 872
2009 902
2010 932
------
$4,525
======
Note 8 - Securities transaction gain:
A securities transaction gain in 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.
Note 9 - Employee benefit plans:
The Company maintains various defined benefit pension plans. Personnel are
covered by plans in their respective countries. Variances from actuarially
assumed rates will result in increases or decreases in accumulated pension
obligations, pension expense and funding requirements in future periods. In 2002
the Company amended its defined benefit pension plans for KEU, TAS and TIA to
exclude the admission of new employees to the plans. New employees at these
locations are eligible to participate in Company-sponsored defined contribution
plans. The Company's expense related to the Company-sponsored defined
contribution plans was not material in 2004 or 2005. At December 31, 2005, the
Company expects to contribute the equivalent of approximately $1.6 million to
its defined benefit pension plans during 2006.
Certain actuarial assumptions used in measuring the defined benefit pension
assets, liabilities and expenses are presented below. The Company uses a
September 30th measurement date for their defined benefit pension plans.
The weighted-average rate assumptions used in determining the actuarial
present value of benefit obligations as of December 31, 2004 and 2005 are
presented in the table below. Such weighted-average rates were determined using
the projected benefit obligations at each date.
Rate December 31,
---- --------------
2004 2005
---- ----
Discount rate 5.0% 4.4%
Increase in future compensation levels 3.0% 3.0%
The weighted-average rate assumptions used in determining the net periodic
pension cost for 2003, 2004 and 2005 are presented in the table below. The
weighted-average discount rate and the weighted-average increase in future
compensation levels were determined using the projected benefit obligations as
of the beginning of each year, and the weighted-average long-term return on plan
assets was determined using the fair value of plan assets as of the beginning of
each year.
Rate December 31,
---- ----------------------------------------
2003 2004 2005
---- ---- ----
Discount rate 5.9% 5.5% 5.0%
Increase in future compensation levels 3.0% 3.0% 3.0%
Long-term return on plan assets 7.0% 6.0% 6.0%
Plan assets are comprised primarily of investments in corporate equity and
debt securities, short-term investments, mutual funds and group annuity
contracts.
The components of the net periodic defined benefit pension cost are set
forth below.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Net periodic pension cost:
Service cost benefits $ 1,430 $ 2,096 $ 2,133
Interest cost on projected benefit
obligation ("PBO") 2,907 3,436 3,345
Expected return on plan assets (3,335) (2,815) (3,142)
Amortization of prior service cost 255 267 282
Amortization of net transition obligation 296 321 129
Recognized actuarial losses 732 1,428 1,276
-------- -------- --------
$ 2,285 $ 4,733 $ 4,023
======== ======== ========
The funded status of the Company's defined benefit pension plans is set
forth below.
December 31,
--------------
2004 2005
---- ----
(In thousands)
Change in projected benefit obligations ("PBO"):
Benefit obligations at beginning of year $ 64,161 $ 72,361
Service cost 2,096 2,133
Interest cost 3,436 3,345
Participant contributions 152 149
Actuarial gains (losses) (1,891) 2,933
Change in currency exchange rates 7,081 (8,259)
Benefits paid (2,674) (2,886)
---------- ----------
Benefit obligations at end of year $ 72,361 $ 69,776
---------- ----------
Change in fair value of plan assets:
Fair value of plan assets at beginning of year $ 49,540 $ 57,754
Actual return on plan assets 3,881 2,203
Employer contributions 1,170 1,977
Participant contributions 152 149
Change in currency exchange rates 5,685 (6,375)
Benefits paid (2,674) (2,886)
---------- ----------
Fair value of plan assets at end of year $ 57,754 $ 52,822
---------- ----------
Funded status at year end:
Plan assets less than PBO $ (14,607) $ (16,954)
Unrecognized actuarial loss 26,344 26,024
Unrecognized prior service cost 3,157 2,550
Unrecognized net transition obligation 999 770
---------- ----------
$ 15,893 $ 12,390
========== ==========
Amounts recognized in the balance sheet:
Accrued pension cost:
Current $ - $ (456)
Non current (2,469) (4,129)
Unrecognized net pension obligations 3,852 3,108
Accumulated other comprehensive loss 14,510 13,867
---------- ----------
$ 15,893 $ 12,390
========== ==========
SFAS No. 87, "Employers' Accounting for Pension Costs" requires that an
additional pension liability be recognized when the unfunded accumulated pension
benefit obligation exceeds the unfunded accrued pension liability. Variances
from actuarially assumed rates will change the actuarial valuation of accrued
pension liabilities, pension expense and funding requirements in future periods.
The accumulated benefit obligation of the Company's defined benefit pension
plans was $58.0 million at December 31, 2005 (2004 - $60.8 million).
In determining the expected long-term rate of return on plan asset
assumptions, the Company considers the long-term asset mix (e.g. equity vs.
fixed income) for the assets for each of its plans and the expected long-term
rates of return for such asset components. In addition, the Company receives
advice about appropriate long-term rates of return from the Company's
third-party actuaries. The Company currently has a plan asset target allocation
of 14% to equity managers, 64% to fixed income managers and the remainder
primarily to cash and liquid investments. The expected long-term rate of return
for such investments is approximately 8%, 4.5% to 6% and 2.5%, respectively. The
plan asset allocation at December 31, 2005 was 16% to equity managers, 62% to
fixed income managers and the remainder invested primarily cash and liquid
investments (2004 - 16%, 64% and 20%, respectively). The Company regularly
reviews its actual asset allocation for each of its plans, and will periodically
rebalance the investments in each plan to more accurately reflect the targeted
allocation when considered appropriate.
The Company expects future benefits paid from its defined benefit plans to
be as follows:
Amount
Years ending December 31, (In thousands)
- -------------------------- -------------
2006 $3,921
2007 2,790
2008 4,425
2009 3,036
2010 3,087
2011 to 2015 20,926
Note 10 - Income taxes:
The components of (i) income from continuing operations before income taxes
("pretax income"), (ii) the difference between the provision for income taxes
attributable to pretax income and the amounts that would be expected using the
Danish statutory income tax rate of 30% in 2003 and 2004 and 28% in 2005, (iii)
the provision for income taxes and (iv) the comprehensive tax provision are
presented below.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Pretax income (loss):
Denmark $ 170 $ (101) $ 526
Non-Denmark 34,150 33,760 51,038
-------- -------- --------
$ 34,320 $ 33,659 $ 51,564
======== ======== ========
Expected tax expense $ 10,296 $ 10,099 $ 14,438
Non-Denmark tax rates 428 527 1,360
Non deductible expenses - - 281
Tax contingency reserve adjustment (5,100) (125) (653)
Refund of prior year taxes - (595) (45)
Tax on partnership income 1,245 (358) -
Other, net 559 295 756
-------- -------- --------
Income tax expense $ 7,428 $ 9,843 $ 16,137
======== ======== ========
Provision for income taxes:
Current income tax expense:
Denmark $ 63 $ 2 $ 224
Non-Denmark 12,770 12,824 16,178
-------- -------- --------
12,833 12,826 16,402
-------- -------- --------
Deferred income tax expense (benefit):
Denmark (5,104) (139) (644)
Non-Denmark (301) (2,844) 379
-------- -------- --------
(5,405) (2,983) (265)
-------- -------- --------
$ 7,428 $ 9,843 $ 16,137
======== ======== ========
Comprehensive provision for income taxes
allocable to:
Pretax income $ 7,428 $ 9,843 $ 16,137
Other comprehensive loss -
pension liabilities (4,068) 5 180
-------- -------- --------
$ 3,360 $ 9,848 $ 16,317
======== ======== ========
The components of the net deferred tax liability are summarized below.
December 31,
---------------------------------------------------
2004 2005
----------------------- -----------------------
Assets Liabilities Assets Liabilities
------ ----------- ------ -----------
(In thousands)
Tax effect of temporary differences relating to:
Inventories $ 61 $ (2,546) $ 72 $ (2,067)
Property and equipment 181 (20,214) - (18,199)
Accrued (prepaid) pension cost 4,063 (4,624) 3,883 (3,659)
Accrued liabilities and other deductible differences 199 - 1,420 -
Other taxable differences - (3,746) - (2,910)
Incremental tax and rate differences on equity in
earnings of non-tax group companies 1,905 - - -
------ -------- ------ --------
Gross deferred tax assets (liabilities) 6,409 (31,130) 5,375 (26,835)
Reclassification, principally netting by tax
jurisdiction (6,409) 6,409 (5,375) 5,375
------ -------- ------ --------
Net total deferred tax assets (liabilities) - (24,721) - (21,460)
Net current deferred tax assets (liabilities) - (2,363) - (2,194)
------ -------- ------ --------
Net noncurrent deferred tax liabilities $ - $(22,358) $ - $(19,266)
====== ======== ====== ========
Changes in the Company's deferred income tax valuation allowance are
summarized below:
December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In millions)
Balance at beginning of year $ 658 $ 683 $ -
Increase in certain deductible
temporary differences which the Company
believes do not meet the
"more-likely-than-not" recognition criteria - - -
Foreign currency translation 25 - -
Offset to the change in gross deferred
income tax assets due principally
to redeterminations of certain tax
attributes and implementation of
certain planning strategies - (683) -
----- ----- -----
Balance at end of year $ 683 $ - $ -
===== ===== =====
Certain of the Company's U.S. and non-U.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 December 31,
2005). The Company filed a protest to this assessment, and believes that a
significant portion of the assessment was 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.
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.
Note 11 - Related party transactions:
The Company may be deemed to be controlled by Harold C. Simmons. See Note
1. Corporations that may be deemed to be controlled by or affiliated with Mr.
Simmons sometimes engage in (a) intercorporate transactions such as guarantees,
management and expense sharing arrangements, shared fee arrangements, tax
sharing agreements, joint ventures, partnerships, loans, options, advances of
funds on open account, and sales, leases and exchanges of assets, including
securities issued by both related and unrelated parties and (b) common
investment and acquisition strategies, business combinations, reorganizations,
recapitalizations, securities repurchases, and purchases and sales (and other
acquisitions and dispositions) of subsidiaries, divisions or other business
units, which transactions have involved both related and unrelated parties and
have included transactions which resulted in the acquisition by one related
party of a publicly held minority equity interest in another related party.
While no transactions of the type described above are planned or proposed with
respect to the Company other than as set forth in these financial statements,
the Company from time to time considers, reviews and evaluates such transactions
and understands that Contran, Valhi, NL, Kronos, KII and related entities
consider, review and evaluate such transactions. Depending upon the business,
tax and other objectives then relevant, it is possible that the Company might be
a party to one or more such transactions in the future.
The Company is a party to services and cost sharing agreements among
several affiliates of the Company whereby Kronos, KII and other affiliates
provide certain management, financial, insurance and administrative services to
the Company on a fee basis. The Company's expense was approximately $1.9 million
in 2003, $2.1 million in 2004 and $2.5 million in 2005 related to these services
and costs.
Tall Pines Insurance Company and EWI RE, Inc. provide for or broker certain
insurance policies for Contran and certain of its subsidiaries and affiliates,
including the Company. Tall Pines is wholly-owned by a subsidiary of Valhi, and
EWI is a wholly-owned subsidiary of NL. Consistent with insurance industry
practices, Tall Pines and EWI receive commissions from insurance and reinsurance
underwriters and/or assess fees for the policies that they provide or broker.
The aggregate premiums paid to Tall Pines (including amounts paid to Valmont
Insurance Company, another subsidiary of Valhi that was merged into Tall Pines
in 2004) and EWI by the Company were $900,000 in 2003, $1.1 million in 2004 and
$2.0 million in 2005. These amounts principally included payments for insurance
and reinsurance premiums paid to third parties, but also included commissions
paid to Tall Pines and EWI. Tall Pines purchases reinsurance for substantially
all of the risks it underwrites. The Company expects that these relationships
with Tall Pines and EWI will continue in 2006.
Contran and certain of its subsidiaries and affiliates, including the
Company, purchase certain of their insurance policies as a group, with the costs
of the jointly-owned policies being apportioned among the participating
companies. With respect to certain of such policies, it is possible that
unusually large losses incurred by one or more insureds during a given policy
period could leave the other participating companies without adequate coverage
under that policy for the balance of the policy period. As a result, Contran and
certain of its subsidiaries and its affiliates, including NL, have entered into
a loss sharing agreement under which any uninsured loss is shared by those
entities who have submitted claims under the relevant policy. The Company
believes the benefits in the form of reduced premiums and broader coverage
associated with the group coverage for such policies justifies the risk
associated with the potential for uninsured loss.
Intercompany sales to (purchases from) affiliates of TiO2 are summarized in
the following table.
Years ended December 31,
-----------------------------------------
2003 2004 2005
---- ---- ----
(In thousands)
Sales to:
TG $ 38,783 $ 53,631 $ 55,210
Kronos Limited ("KUK") 18,856 25,285 20,408
Kronos (US), Inc. ("KUS") 18,792 19,180 25,445
Societe Industrielle du Titane, S.A. ("SIT") 8,138 8,868 9,054
Kronos Canada, Inc. ("KC") 4,308 2,596 3,009
-------- -------- --------
$ 88,877 $109,560 $113,126
======== ======== ========
Purchases from:
TG $ 38,785 $ 48,808 $ 58,121
KUS 101 3,489 -
KC 223 22 103
-------- -------- --------
$ 39,109 $ 52,319 $ 58,224
======== ======== ========
Sales of ilmenite to TG were $15.5 million in 2003, $17.4 million in 2004
and $21.4 million in 2005.
KUS purchases the rutile and slag feedstock used as a raw material in all
of the Company's chloride process TiO2 facilities. The Company purchases such
feedstock from KUS for use in its facilities for an amount equal to the amount
paid by KUS to the third-party supplier plus a 2.5% administrative fee. Such
feedstock purchases were $39.5 million in 2003, $40.5 million in 2004 and $47.8
million in 2005.
Royalties paid to KII for use of certain of KII's intellectual property
totaled $10.4 million in 2003, $12.5 million in 2004 and $12.4 million in 2005,
and was included as a component of cost of sales.
During 2003, 2004 and 2005, the Company was party to an accounts receivable
factoring agreement (the "Factoring Agreement") with one or more of its
affiliates whereby the Company factored its export accounts receivable without
recourse for a fee of 0.85% for the Company's export receivables related to
Kronos Europe S.A./N.V. ("KEU") and 1.2% for export receivables related to its
Norwegian operating subsidiaries, Kronos Titan A/S ("TAS") and Titania A/S
("TIA"). Upon non-recourse transfer from the Company, the affiliate assumed all
risk pertaining to the factored receivables, including, but not limited to,
exchange control risks, risks pertaining to the bankruptcy of a customer and
risks related to late payments. Export receivables sold by the Company pursuant
to the Factoring Agreement during 2003, 2004 and 2005 aggregated $101.4 million,
and $119.9 million and $124.5 million, respectively.
Net amounts currently receivable from (payable to) affiliates are
summarized in the following table.
December 31,
--------------
2004 2005
---- ----
(In thousands)
Receivable from:
SIT $ 814 $ 864
KUK 1,766 1,638
TG 13,342 24,967
Other 107 24
---------- ----------
$ 16,029 $ 27,493
========== ==========
Noncurrent receivable from TG $ 12,941 $ 11,239
========== ==========
Payable to:
KII $ 4,266 $ 3,740
KUS 5,486 5,317
KC 390 -
---------- ----------
$ 10,142 $ 9,057
========== ==========
Noncurrent payable to TG $ 5,449 $ -
========== ==========
Net amounts between the Company, KUS, TG, SIT, KUK and KC were generally
related to product purchases and sales. Net amounts with TG also include
accounts receivable factoring fees.
Note 12 - NL common stock options held by employees of the Company:
At December 31, 2005, employees of the Company held options to purchase
approximately 23,000 shares of NL common stock, of which 13,000 are exercisable
at various dates through 2010 at an exercise price ranging from $2.66 to $5.63
per share and 10,000 are exercisable at various dates through 2011 at an
exercise price of $11.49 per share.
The pro forma information required by SFAS No. 123 is based on an
estimation of the fair value of options issued subsequent to January 1, 1995.
See Note 2. No options were granted during 2003, 2004, or 2005. For purposes of
pro forma disclosures, the estimated fair value of the options is amortized to
expense over the options' vesting period.
Note 13 - Commitments and contingencies:
Operating leases. The Company leases, pursuant to operating leases, various
manufacturing and office space and transportation equipment. Most of the leases
contain purchase and/or various term renewal options at fair market and fair
rental values, respectively. In most cases management expects that, in the
normal course of business, leases will be renewed or replaced by other leases.
Net rent expense aggregated $3 million in each of 2003, 2004 and 2005. At
December 31, 2005, minimum rental commitments under the terms of noncancellable
operating leases were as follows:
Equipment
--------------
(in thousands)
Years ending December 31,
- --------------------------
2006 $ 603
2007 520
2008 516
2009 253
2010 92
2011 and thereafter 99
------
$2,083
======
Long-term contracts. KUS has long-term supply contracts that provide for
certain of its affiliates', including KDK's, chloride feedstock requirements
through 2010. The Company and certain of its affiliates purchase chloride
feedstock underlying these long-term supply contracts from KUS. The agreements
require KUS to purchase certain minimum quantities of feedstock with minimum
purchase commitments aggregating approximately $681 million at December 31,
2005.
Environmental matters. The Company's operations are governed by various
environmental laws and regulations. Certain of the Company's businesses are, or
have been engaged in the handling, manufacture or use of substances or compounds
that may be considered toxic or hazardous within the meaning of applicable
environmental laws and regulations. As with other companies engaged in similar
businesses, certain past and current operations and products of the Company have
the potential to cause environmental or other damage. The Company has
implemented and continues to implement various policies and programs in an
effort to minimize these risks. The Company's policy is to maintain compliance
with applicable environmental laws and regulations at all its facilities and to
strive to improve its environmental performance. From time to time, the Company
may be subject to environmental regulatory enforcement under various statutes,
resolution of which typically involves the establishment of compliance programs.
It is possible that future developments, such as stricter requirements of
environmental laws and enforcement policies thereunder, could adversely affect
the Company's production, handling, use, storage, transportation, sale or
disposal of such substances. The Company believes all of its plants are in
substantial compliance with applicable environmental laws.
Litigation matters. The Company's Belgian subsidiary and certain of its
employees are the subject of civil and criminal proceedings relating to an
accident that resulted in two fatalities at the Company's Belgian facility in
2000. In May 2004, the court ruled and, among other things, imposed a fine of
euro 200,000 against the Company and fines aggregating less than euro 40,000
against various Company employees. The Company and the individual employees have
appealed the ruling.
In addition to the litigation described above, the Company and its
affiliates are also involved in various other environmental, contractual,
product liability, patent (or intellectual property), employment and other
claims and disputes incidental to its present and former businesses.
The Company currently believes the disposition of all claims and disputes,
individually or in the aggregate, should not have a material adverse effect on
its consolidated financial condition, results of operations or liquidity.
Concentrations of credit risk. Sales of TiO2 accounted for approximately
78%, 79% and 78% of net sales during 2003, 2004 and 2005, respectively. The
remaining sales result from the mining and sale of ilmenite ore (a raw material
used in the sulfate pigment production process) and the manufacture and sale of
certain titanium chemical products (derived from co-products of the TiO2
production process). TiO2 is generally sold to the paint, plastics and paper
industries. Such markets are generally considered "quality-of-life" markets
whose demand for TiO2 is influenced by the relative economic well-being of the
various geographic regions. TiO2 is sold to over 1,000 customers, with the top
ten external customers approximating 26% of net sales in 2003, 24% of net sales
in 2004 and 17% of net sales in 2005. Approximately 80% of the Company's TiO2
sales by volume were to Europe in each of 2003, 2004 and 2005. Approximately 10%
of sales by volume were to North America in each of 2003, 2004 and 2005.
Note 14 - Financial instruments:
Summarized below is the estimated fair value and related net carrying value
of the Company's financial instruments.
December 31, December 31,
2004 2005
--------------------------- -------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------- ------------- -------------------------
(In millions)
Cash, cash equivalents, restricted cash
equivalents and noncurrent restricted
marketable debt securities $ 8.0 $ 8.0 $ 5.0 $ 5.0
Notes payable and long-term debt -
variable rate debt $ 13.6 $ 13.6 $ - $ -
The Company held no derivative financial instruments during 2003, 2004 or
2005.
Note 15 - Accounting principles recently adopted in 2003 and 2004:
Asset retirement obligations. The Company adopted SFAS No. 143, "Accounting
for Asset Retirement Obligations," effective January 1, 2003. Under SFAS No.
143, the fair value of a liability for an asset retirement obligation covered
under the scope of SFAS No. 143 would be recognized in the period in which the
liability is incurred, with an offsetting increase in the carrying amount of the
related long-lived asset. Over time, the liability would be accreted to its
present value, and the capitalized cost would be depreciated over the useful
life of the related asset. Upon settlement of the liability, an entity would
either settle the obligation for its recorded amount or incur a gain or loss
upon settlement.
Under the transition provisions of SFAS No. 143, at the date of adoption on
January 1, 2003, the Company will recognize (i) an asset retirement cost
capitalized as an increase to the carrying value of its property, plant and
equipment, (ii) accumulated depreciation on such capitalized cost and (iii) a
liability for the asset retirement obligation. Amounts resulting from the
initial application of SFAS No. 143 are measured using information, assumptions
and interest rates all as of January 1, 2003. The amount recognized as the asset
retirement cost is measured as of the date the asset retirement obligation was
incurred. Cumulative accretion on the asset retirement obligation, and
accumulated depreciation on the asset retirement cost, is recognized for the
time period from the date the asset retirement cost and liability would have
been recognized had the provisions of SFAS No. 143 been in effect at the date
the liability was incurred, through January 1, 2003. The difference, if any,
between the amounts to be recognized as described above and any associated
amounts recognized in the Company's balance sheet as of December 31, 2002 is
recognized as a cumulative effect of a change in accounting principle as of the
date of adoption. The effect of adopting SFAS No. 143 as of January 1, 2003 was
not material, as summarized in the table below and is not separately recognized
in the accompanying Statement of Income.
Amount
-------------
(in millions)
Increase in carrying value of net property, plant and equipment:
Cost $ .4
Accumulated depreciation (.1)
Decrease in liabilities previously accrued for
closure and post closure activities
.3
Asset retirement obligation recognized (.6)
----
Net impact $ -
====
The change in the asset retirement obligations from January 1, 2003
($600,000) to December 31, 2003 ($800,000), to December 31, 2004 ($1 million)
and to December 31, 2005 ($900,000) is primarily due to accretion expense and
the effects of currency translation. Accretion expense, which is reported as a
component of cost of sales in the accompanying Consolidated Statements of
Income, approximated $100,000 for each of the years ended December 31, 2003,
2004 and 2005.
Estimates of the ultimate cost to be incurred to settle the Company's asset
retirement obligations require a number of assumptions, are inherently difficult
to develop and the ultimate outcome may differ from current estimates. As
additional information becomes available, cost estimates will be adjusted as
necessary. It is possible that technological, regulatory or enforcement
developments, the results of studies or other factors could necessitate the
recording of additional liabilities.
Costs associated with exit or disposal activities. The Company adopted SFAS
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," on
January 1, 2003 for exit or disposal activities initiated on or after that date.
Under SFAS No. 146, costs associated with exit activities, as defined, that are
covered by the scope of SFAS No. 146 will be recognized and measured initially
at fair value, generally in the period in which the liability is incurred. Costs
covered by the scope of SFAS No. 146 include termination benefits provided to
employees, costs to consolidate facilities or relocate employees, and costs to
terminate contracts (other than a capital lease). Under prior GAAP, a liability
for such an exit cost is recognized at the date an exit plan is adopted, which
may or may not be the date at which the liability has been incurred. The effect
of adopting SFAS No. 146 as of January 1, 2003 was not material as the Company
was not involved in any exit or disposal activities covered by the scope of the
new standard as of such date.
Variable interest entities. The Company complied with the consolidation
requirements of FASB Interpretation ("FIN") No. 46R, "Consolidation of Variable
Interest Entities, an interpretation of ARB No. 51," as amended as of March 31,
2004. The Company does not have any involvement with any variable interest
entity (as that term is defined in FIN No. 46R) covered by the scope of FIN No.
46R that would require the Company to consolidate such entity under FIN No. 46R,
which had not already been consolidated under prior applicable GAAP, and
therefore the impact to the Company of adopting the consolidation requirements
of FIN No. 46R was not material.
Note 16 - Accounting principles not yet adopted:
Stock options. The Company will adopt SFAS No. 123R, "Share-Based Payment,"
as of January 1, 2006. SFAS No. 123R, among other things, eliminated the
alternative in previously 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, 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 June 30, 2005 which are subsequently
modified, repurchased or cancelled. Additionally, as of January 1, 2006, the
Company will be required to recognize compensation cost previously measured
under SFAS No. 123 for the portion of any non-vested award existing as of
December 31, 2005 over the remaining vesting period. Because the Company has not
granted any options to purchase its common stock and did not grant any options
prior to January 1, 2006 and because the number of non-vested awards as of
December 31, 2005 with respect to options granted by NL to employees of the
Company was not material, the effect of adopting SFAS No. 123R was not
significant in so far as it relates to the recognition of compensation cost in
the Company's consolidated statements of income for existing stock options.
Should the Company, however, grant a significant number of options in the
future, the Company could recognize material amounts of compensation cost
related to such options in its consolidated financial statements.
Also upon adoption of SFAS No. 123R, any cash income tax benefit resulting
from the exercise of stock options in excess of the cumulative income tax
benefit related to such options previously recognized for GAAP financial
reporting purposes in the Company's consolidated statements of income, if any,
will be reflected as a cash inflow from financing activities in the Company's
consolidated statements of cash flows, and the Company's cash flows from
operating activities will reflect the effect of cash paid for income taxes
exclusive of such cash income tax benefit.
SFAS No. 123R also requires certain expanded disclosures regarding the
Company's stock options, and such expanded disclosures have been provided in
Note 12.
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 are 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.