SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended March 31, 2006 Commission file number 333-100047
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KRONOS INTERNATIONAL, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 22-2949593
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934).
Large accelerated filer Accelerated filer Non-accelerated filer X
--- --- ---
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X --- --- Number of shares of the Registrant's
common stock outstanding on April 28, 2006: 2,968.
The Registrant is a wholly owned subsidiary of Kronos Worldwide, Inc. (File No.
1-31763) and meets the conditions set forth in General Instructions H(1)(a) and
H(1)(b) of Form 10-Q for reduced disclosure format.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 2005; March 31, 2006 (Unaudited) 3
Consolidated Statements of Income -
Three months ended March 31, 2005 and 2006 (Unaudited) 5
Consolidated Statements of Comprehensive Income -
Three months ended March 31, 2005 and 2006 (Unaudited) 6
Consolidated Statement of Stockholder's Equity -
Three months ended March 31, 2006 (Unaudited) 7
Consolidated Statements of Cash Flows -
Three months ended March 31, 2005 and 2006 (Unaudited) 8
Notes to Consolidated Financial Statements (Unaudited) 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosure About
Market Risk 23
Item 4. Controls and Procedures 23
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 1A. Risk Factors 24
Item 6. Exhibits 24
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, March 31,
2005 2006
------------ -----------
(Unaudited)
Current assets:
Cash and cash equivalents $ 63,284 $ 55,751
Restricted cash 1,355 951
Accounts and other receivables, net 120,182 148,642
Receivables from affiliates 1,952 4,217
Refundable income taxes 1,053 864
Inventories, net 185,348 182,782
Prepaid expenses 2,680 4,594
Deferred income taxes - 52
---------- ----------
Total current assets 375,854 397,853
---------- ----------
Other assets:
Deferred financing costs, net 7,722 7,261
Restricted marketable debt securities 2,572 2,635
Unrecognized net pension obligation 6,108 6,229
Deferred income taxes 213,275 212,513
Other 960 1,123
---------- ----------
Total other assets 230,637 229,761
---------- ----------
Property and equipment:
Land 30,288 30,760
Buildings 138,925 142,797
Equipment 644,271 660,184
Mining properties 68,163 68,950
Construction in progress 12,112 5,988
---------- ----------
893,759 908,679
Less accumulated depreciation and amortization 544,984 559,854
---------- ----------
Net property and equipment 348,775 348,825
---------- ----------
$ 955,266 $ 976,439
========== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, March 31,
2005 2006
------------ -----------
(Unaudited)
Current liabilities:
Current maturities of long-term debt $ 958 $ 959
Accounts payable and accrued liabilities 118,285 127,797
Payable to affiliates 14,882 84
Income taxes 21,799 24,137
Deferred income taxes 4,136 679
---------- ----------
Total current liabilities 160,060 153,656
---------- ----------
Noncurrent liabilities:
Long-term debt 452,865 459,245
Deferred income taxes 19,265 22,048
Accrued pension costs 125,766 124,639
Other 15,434 17,027
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Total noncurrent liabilities 613,330 622,959
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Minority interest 75 78
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Stockholder's equity:
Common stock 297 297
Additional paid-in capital 1,944,185 1,944,185
Retained deficit (1,339,332) (1,326,184)
Notes receivable from affiliates (209,526) (209,526)
Accumulated other comprehensive loss:
Currency translation (130,178) (125,381)
Pension liabilities (83,645) (83,645)
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Total stockholder's equity 181,801 199,746
---------- ----------
$ 955,266 $ 976,439
========== ==========
Commitments and contingencies (Notes 8 and 10)
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three months ended March 31, 2005 and 2006
(In thousands)
(Unaudited)
2005 2006
---- ----
Net sales $ 209,536 $ 208,636
Cost of sales 147,166 155,589
---------- ----------
Gross margin 62,370 53,047
Selling, general and administrative expense 28,084 27,661
Other operating income (expense):
Currency transaction gains (losses), net 770 (1,207)
Disposition of property and equipment (34) (433)
Royalty income 1,502 2,153
Other income 36 9
---------- ----------
Income from operations 36,560 25,908
Other income (expense):
Trade interest income 74 460
Interest income from affiliates 4,941 4,451
Interest expense (11,611) (10,303)
---------- ----------
Income before income taxes and minority interest 29,964 20,516
Provision for income taxes 11,722 7,366
Minority interest in after-tax earnings 4 2
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Net income $ 18,238 $ 13,148
========== ==========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended March 31, 2005 and 2006
(In thousands)
(Unaudited)
2005 2006
---- ----
Net income $ 18,238 $ 13,148
Other comprehensive income, net of tax - currency translation
adjustment 2,378 4,797
---------- ----------
Comprehensive income $ 20,616 $ 17,945
========== ==========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
Three months ended March 31, 2006
(In thousands)
(Unaudited)
Accumulated other
Notes comprehensive loss
Additional receivable -------------------------- Total
Common paid-in Retained from Currency Pension stockholder's
stock capital deficit affiliates translation liabilities equity
------- ----------- ------------ ------------ ------------ ----------- -------------
Balance at December 31, 2005 $ 297 $1,944,185 $(1,339,332) $ (209,526) $(130,178) $(83,645) $181,801
Net income - - 13,148 - - - 13,148
Other comprehensive income - - - - 4,797 - 4,797
------ ---------- ----------- ----------- --------- -------- --------
Balance at March 31, 2006 $ 297 $1,944,185 $(1,326,184) $ (209,526) $(125,381) $(83,645) $199,746
====== ========== =========== =========== ========= ======== ========
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31, 2005 and 2006
(In thousands)
(Unaudited)
2005 2006
---- ----
Cash flows from operating activities:
Net income $ 18,238 $ 13,148
Depreciation and amortization 9,488 8,788
Noncash interest expense 696 576
Deferred income taxes 5,435 1,993
Minority interest 4 2
Net loss from disposition of property and equipment 34 433
Defined benefit pension plan expense less than cash funding (997) (672)
Other, net (52) (259)
Change in assets and liabilities:
Accounts and other receivables (29,733) (27,931)
Inventories (13,624) 5,148
Prepaid expenses (1,650) (1,885)
Accounts with affiliates 2,031 (16,690)
Accounts payable and accrued liabilities 14,953 10,328
Income taxes 3,034 2,085
Other, net (4,494) (116)
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Net cash provided by (used in) operating activities 3,363 (5,052)
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Cash flows from investing activities:
Capital expenditures (4,800) (3,696)
Change in restricted cash, net 529 411
Other, net 21 29
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Net cash used in investing activities (4,250) (3,256)
---------- ----------
Cash flows from financing activities:
Indebtedness -
principal payments (41) (39)
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Net cash used in financing activities (41) (39)
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Cash and cash equivalents - net change from:
Operating, investing and financing activities (928) (8,347)
Currency translation (477) 814
Cash and cash equivalents at beginning of period 17,505 63,284
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Cash and cash equivalents at end of period $ 16,100 $ 55,751
========== ==========
Supplemental disclosures:
Cash paid for:
Interest, net of amounts capitalized $ 171 $ 66
Income taxes, net 3,242 3,181
See accompanying notes to consolidated financial statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Organization and basis of presentation:
Kronos International, Inc. ("KII") is incorporated in the state of
Delaware, U.S.A., with its seat of management in Leverkusen, Germany. KII is a
wholly-owned subsidiary of Kronos Worldwide, Inc. ("Kronos") (NYSE:KRO). At
March 31, 2006, (i) Valhi held approximately 59% of Kronos' outstanding common
stock and NL Industries, Inc. (NYSE:NL) held an additional 36% of Kronos' common
stock, (ii) Valhi owned approximately 83% of NL's outstanding common stock and
(iii) Contran Corporation and its subsidiaries held approximately 92% of Valhi's
outstanding common stock. Substantially all of Contran's outstanding voting
stock is held by trusts established for the benefit of certain children and
grandchildren of Harold C. Simmons, of which Mr. Simmons is sole trustee, or is
held by Mr. Simmons or persons or other entities related to Mr. Simmons.
Consequently, Mr. Simmons may be deemed to control each of Contran, Valhi, NL,
Kronos and the Company.
The consolidated balance sheet of KII at December 31, 2005 has been
condensed from the Company's audited consolidated financial statements at that
date. The consolidated balance sheet data as of December 31, 2005 was derived
from the Company's audited consolidated financial statements at that date, but
does not include all disclosures required by GAAP, as permitted by regulations
of the SEC. The consolidated balance sheet at March 31, 2006, and the
consolidated statements of income, comprehensive income, stockholder's equity
and cash flows for the interim periods ended March 31, 2005 and 2006, have been
prepared by the Company, without audit, in accordance with accounting principles
generally accepted in the United States of America ("GAAP"). In the opinion of
management, all adjustments, consisting only of normal recurring adjustments,
necessary to state fairly the consolidated financial position, results of
operations and cash flows have been made.
The results of operations for the interim periods are not necessarily
indicative of the operating results for a full year or of future operations.
Certain information normally included in financial statements prepared in
accordance with GAAP has been condensed or omitted. The accompanying
consolidated financial statements should be read in conjunction with the
Company's Annual Report on Form 10-K for the year ended December 31, 2005 (the
"2005 Annual Report").
Note 2 - Accounts and other receivables, net:
December 31, March 31,
2005 2006
------------ ----------
(In thousands)
Trade receivables $110,268 $135,459
Recoverable VAT and other receivables 11,343 14,564
Allowance for doubtful accounts (1,429) (1,381)
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$120,182 $148,642
======== ========
Note 3 - Inventories, net:
December 31, March 31,
2005 2006
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(In thousands)
Raw materials $ 42,807 $ 30,006
Work in process 13,654 15,873
Finished products 98,004 102,976
Supplies 30,883 33,927
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$185,348 $182,782
======== ========
Note 4 - Accounts payable and accrued liabilities:
December 31, March 31,
2005 2006
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(In thousands)
Accounts payable $ 63,382 $ 61,301
Employee benefits 27,147 26,221
Interest 117 10,123
Other 27,639 30,152
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$118,285 $127,797
======== ========
Note 5 - Long-term debt:
December 31, March 31,
2005 2006
------------ ----------
(In thousands)
8.875% Senior Secured Notes $449,298 $455,609
Other 4,525 4,595
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453,823 460,204
Less current maturities 958 959
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$452,865 $459,245
======== ========
In April 2006, the Company called all of its 8.875% Senior Secured Notes
for redemption on May 11, 2006 at 104.437% of their aggregate principal amount
of euro 375 million (including such call premium, an aggregate of $470.2 million
at March 31, 2006 exchange rates). Funds for such redemption were provided by
the Company's issuance of an aggregate of euro 400 million principal amount of
new 6.5% Senior Secured Notes due April 2013, issued on April 11, 2006 at
99.306% of their principal amount. The new Senior Secured Notes were issued
pursuant to an indenture that contains covenants, restrictions and collateral
substantially identical to the covenants, restrictions and collateral of the
8.875% Senior Secured Notes. The Company expects to recognize a $21 million
pre-tax charge in the second quarter related to the early extinguishment of the
8.875% Senior Secured Notes, consisting of the call premium on such Notes and
the net write-off of deferred financing costs and existing unamortized premium
related to such Notes.
Note 6 - Other noncurrent liabilities:
December 31, March 31,
2005 2006
------------ ----------
(In thousands)
Employee benefits $ 4,735 $ 5,960
Insurance claims and expenses 1,255 1,585
Asset retirement obligations 934 968
Other 8,510 8,514
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$ 15,434 $ 17,027
======== ========
Note 7 - Accounts with affiliates:
December 31, March 31,
2005 2006
------------ ----------
(In thousands)
Current receivables from affiliates:
Kronos Canada, Inc. $ 1,948 $ 2,679
Kronos (US), Inc. ("KUS") - 1,538
Other 4 -
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$ 1,952 $ 4,217
======== ========
Current payables to affiliates:
KUS $ 14,882 -
Kronos - 84
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$ 14,882 $ 84
======== ========
Note 8 - Provision for income taxes:
Three months ended
March 31,
----------------------
2005 2006
---- ----
(In millions)
Expected tax expense $ 10.5 $ 7.2
Non-U.S. tax rates .2 (.3)
Nondeductible expenses 1.0 1.2
Adjustment of prior year income taxes, net - (.9)
Other, net - .2
-------- --------
$ 11.7 $ 7.4
======== ========
Certain of the Company's tax returns are being examined and tax authorities
have or may propose tax deficiencies, including penalties and interest. For
example:
o Kronos 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 March 31, 2006).
Kronos filed a protest to this assessment, and believes that a significant
portion of the assessment is without merit. The Belgian tax authorities
have filed a lien on the fixed assets of Kronos' Belgian TiO2 operations in
connection with this assessment.
o The Norwegian tax authorities have notified Kronos of their intent to
assess tax deficiencies of approximately kroner 12 million ($2 million)
relating to the years 1998 through 2000. Kronos 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, 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 9 - Employee benefit plans:
The components of net periodic defined benefit pension cost are presented
in the table below.
Three months ended
March 31,
----------------------
2005 2006
---- ----
(In thousands)
Service cost $ 1,616 $ 1,317
Interest cost 3,692 3,592
Expected return on plan assets (3,204) (2,661)
Amortization of prior service cost 126 81
Amortization of net transition obligations 81 58
Recognized actuarial losses 794 1,838
-------- --------
$ 3,105 $ 4,225
======== ========
Note 10 - Commitments and contingencies:
The Company and its affiliates are from time to time involved in various
environmental, contractual, product liability, patent (or intellectual
property), employment and other claims and disputes incidental to its past and
current operations. In certain cases, the Company has insurance coverage for
such items. The Company currently believes that the disposition of all claims
and disputes, individually or in the aggregate, should not have a material
adverse effect on its consolidated financial position, results of operations or
liquidity.
Reference is made to the 2005 Annual Report for a discussion of certain
other legal proceedings to which the Company is a party.
Note 11 - Accounting principles newly adopted in 2006:
Inventory costs. The Company adopted SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," as of January 1, 2006 for inventory costs
incurred on or after such date. Statement of Financial Accounting Standards
("SFAS") No. 151 requires that the allocation of fixed production overhead costs
to inventory shall be based on normal capacity. Normal capacity is not defined
as a fixed amount; rather, normal capacity refers to a range of production
levels expected to be achieved over a number of periods under normal
circumstances, taking into account the loss of capacity resulting from planned
maintenance shutdowns. The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of idle plant or production levels
below the low end of normal capacity, but instead a portion of fixed overhead
costs is charged to expense as incurred. Alternatively, in periods of production
above the high end of normal capacity, the amount of fixed overhead costs
allocated to each unit of production is decreased so that inventories are not
measured above cost. SFAS No. 151 also clarifies existing GAAP to require that
abnormal freight and wasted materials (spoilage) are to be expensed as incurred.
The Company's production cost accounting had already complied with the
requirements of SFAS No. 151, and therefore adoption of SFAS No. 151 did not
have a material effect on its consolidated financial statements.
Stock options. As permitted by regulations of the Securities and Exchange
Commission ("SEC") the Company adopted SFAS No. 123R, "Share-Based Payment," as
of January 1, 2006. SFAS No. 123R, among other things, eliminates the
alternative in existing GAAP to use the intrinsic value method of accounting for
stock-based employee compensation under Accounting Principles Board Opinion
("APBO") No. 25, "Accounting for Stock Issues to Employees,". The Company is now
generally required to recognize the cost of employee services received in
exchange for an award of equity instruments based on the grant-date fair value
of the award, with the cost recognized over the period during which an employee
is required to provide services in exchange for the award (generally, the
vesting period of the award). No compensation cost will be recognized in the
aggregate for equity instruments for which the employee does not render the
requisite service (generally, if the instrument is forfeited before it has
vested). The grant-date fair value will be estimated using option-pricing models
(e.g. Black-Scholes or a lattice model). Under the transition alternatives
permitted under SFAS No. 123R, the Company will apply the new standard to all
new awards granted on or after January 1, 2006, and to all awards existing as of
December 31, 2005 which are subsequently modified, repurchased or cancelled
(referred to as the modified prospective method in SFAS No. 123R). Additionally,
as of January 1, 2006, the Company recognizes compensation cost for the portion
of any non-vested award existing as of December 31, 2005 over the remaining
vesting period. Because the number of non-vested awards as of December 31, 2005
with respect to options granted by NL to employees of the Company was not
material, the effect of adopting SFAS No. 123R in so far as it relates to
existing stock options, did not have a material effect on the Company's
consolidated financial statements. Should the Company or its subsidiaries and
affiliates, however, either grant a significant number of options to employees
of the Company or modify, repurchase or cancel existing options in the future,
the effect on the Company's consolidated financial statements could be material.
Under the requirements of SFAS No. 123R, the 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,
is 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 reflects the effect of cash paid for income taxes exclusive
of such cash income tax benefit. The aggregate amount of such income tax
benefits recognized as a component of cash flows from financing activities was
nil in the first quarter of 2006.
SFAS No. 123R also requires certain expanded disclosures regarding the
Company's stock options, and such expanded disclosures were provided in the 2005
Annual Report.
The Company has not issued any stock options to purchase KII common stock.
However, certain employees of the Company have been granted options by NL to
purchase NL common stock. Prior to January 1, 2006, the Company accounted for
stock-based employee compensation in accordance with APBO No. 25, and its
various interpretations. Under APBO No. 25, no compensation cost is generally
recognized for fixed stock options in which the exercise price is greater than
or equal to the market price on the grant date. Prior to 2005, and following the
cash settlement of certain stock options held by employees of NL and the
Company, the Company commenced accounting for its stock options using the
variable accounting method of APBO No. 25 because the Company could not overcome
the presumption that it would not similarly cash settle the remaining stock
options. Under the variable accounting method, the intrinsic value of all
unexercised stock options (including stock options with an exercise price at
least equal to the market price on the date of grant) is accrued as an expense,
with subsequent increases (decreases) in the Company's market price resulting in
the recognition of additional compensation expense (income). Following adoption
of SFAS No. 123R effective January 1, 2006, the Company will continue to account
for NL's remaining stock options in a manner similar to the variable accounting
method of APBO No. 25, as required by the guidance of SFAS No. 123R.
Aggregate compensation expense related to NL stock options held by
employees of the Company was approximately $100,000 in the first quarter of 2005
and aggregate compensation income was approximately $200,000 in the first
quarter of 2006. If the Company and its subsidiaries had each elected to account
for their respective stock-based employee compensation related to stock options
in accordance with the fair value-based recognition provisions of SFAS No. 123,
for all awards granted subsequent to January 1, 1995, the effect on the
Company's results of operations in the first quarter of 2005 would not have been
material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Executive summary
Relative changes in the Company's TiO2 sales and income from operations
during the 2005 and 2006 periods presented are primarily due to (i) relative
changes in TiO2 average selling prices (ii) relative changes in selling volumes,
and (iii) relative changes in foreign currency exchange rates. Selling prices
for TiO2 (in billing currencies) were generally: increasing in the first half of
2005, decreasing during the last half of 2005 and increasing during the first
quarter of 2006.
Forward-looking information
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that the statements in this
Quarterly Report on Form 10-Q relating to matters that are not historical facts
are forward-looking statements that represent management's beliefs and
assumptions based on currently available information. Forward-looking statements
can be identified by the use of words such as "believes," "intends," "may,"
"should," "could," "anticipates," "expected" or comparable terminology, or by
discussions of strategies or trends. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
cannot give any assurances that these expectations will prove to be correct.
Such statements by their nature involve substantial risks and uncertainties that
could significantly impact expected results, and actual future results could
differ materially from those described in such forward-looking statements. While
it is not possible to identify all factors, the Company continues to face many
risks and uncertainties. The factors that could cause actual future results to
differ materially are the risks and uncertainties discussed in this Quarterly
Report and those described from time to time in the Company's other filings with
the SEC include, but are not limited to, the following:
o Future supply and demand for the Company's products,
o The extent of the dependence of certain of the Company's businesses on
certain market sectors,
o The cyclicality of the Company's 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, natural disasters, fires, explosions, unscheduled or unplanned
downtime and transportation interruptions),
o The timing and amounts of insurance recoveries,
o The ability of the Company to renew or refinance credit facilities,
o The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of which
has been recognized under the "more-likely-than-not" recognition criteria,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
o Government laws and regulations and possible changes therein,
o The ultimate resolution of pending litigation, and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecasted or expected. The
Company disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of changes in information, future
events or otherwise.
Three months ended
March 31,
---------------------- %
2005 2006 Change
---- ---- ------
(In millions, except percentages and volumes)
Net sales $209.5 $208.6 **
Cost of sales 147.1 155.6 +6%
------ ------
Gross margin 62.4 53.0 -15%
Selling, general and administrative expense (28.1) (27.7) -1%
Currency transaction gains (losses), net .8 (1.2)
Royalty income 1.5 2.2
Other operating expense (net) - (.4)
------ ------
Income from operations $ 36.6 $ 25.9 -29%
====== ======
TiO2 operating statistics:
Percent change in average selling prices:
Using actual foreign currency exchange rates -7%
Impact of changes in foreign currency exchange rates +8%
---
In billing currencies +1%
===
Sales volumes* 77 83 +8%
Production volumes* 81 86 +6%
________________________________
* Thousands of metric tons
** Less than 1% decrease
The Company's sales decreased $900,000 (less than 1%) in the first quarter
of 2006 compared to the first quarter of 2005 due to the net effects of higher
average TiO2 selling prices (in billing currencies), higher TiO2 selling volumes
and the unfavorable effect of fluctuations in foreign currency exchange rates,
which decreased sales by approximately $16 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 in the first quarter of 2006 were 1% higher as compared to the first
quarter of 2005. When translated from billing currencies to U.S. dollars using
actual foreign currency exchange rates prevailing during the respective periods,
the Company's average TiO2 selling prices in the first quarter of 2006 decreased
7% compared to the first quarter of 2005.
The Company's sales are denominated in various currencies, including the
U.S. dollar, the euro, 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 7% decrease
in the Company's average TiO2 selling prices during the first quarter of 2006 as
compared to the first quarter of 2005 using actual foreign currency exchange
rates prevailing during the respective periods (the GAAP measure), and the 1%
increase in the Company's average TiO2 selling prices in billing currencies (the
non-GAAP measure) during such periods is due to the net effect of changes in
foreign currency exchange rates. The above table presents in a tabular format
(i) the percentage change in the Company's average TiO2 selling prices using
actual foreign currency exchange rates prevailing during the respective periods
(the GAAP measure), (ii) the percentage change in the Company's average TiO2
selling prices in billing currencies (the non-GAAP measure) and (iii) the
percentage change due to changes in foreign currency exchange rates (or the
reconciling item between the non-GAAP measure and the GAAP measure).
The Company's TiO2 sales volumes in the first quarter of 2006 increased 8%
compared to the first quarter of 2005, due primarily to higher sales volumes in
North America. Demand for TiO2 has remained strong in the first quarter of 2006,
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 income from operations comparisons were also favorably impacted by
higher production levels, which increased 6% in the first quarter of 2006 as
compared to the same period in 2005. The Company's operating rates were near
full capacity in both periods, and the Company's production and sales volumes in
the first quarter of 2006 were new records for the Company for a first quarter.
The Company's cost of sales increased $8.5 million (6%) in the first
quarter of 2006 compared to the first quarter of 2005 largely due to higher
sales volumes. As a result of lower average TiO2 selling prices using actual
foreign currency exchange rates as well as the unfavorable effect of higher raw
material and other operating costs (including energy), the Company's cost of
sales, as a percentage of net sales, increased from 70% in the first quarter of
2005 to 75% in the first quarter of 2006.
The Company's gross margins for the first quarter of 2006 decreased $9.4
million (15%) from the first quarter of 2005 due to the net effects of the
aforementioned decrease in sales and increase in cost of sales as well as the
unfavorable effect of relative changes in foreign currency exchange rates, as
discussed below.
Selling, general and administrative expenses decreased $423,000 (1%) in the
first quarter of 2006 as compared to the corresponding period in 2005. This
decrease is largely attributable to the impact of translating foreign currencies
(primarily the euro) into U.S. dollars.
The Company's operations and assets are located outside the United States
(particularly in Germany, Belgium and Norway). A significant amount of the
Company's sales generated from its operations are denominated in currencies
other than the U.S. dollar, principally the euro and other major European
currencies. Certain raw materials, primarily titanium-containing feedstocks, are
purchased in U.S. dollars, while labor and other production costs are
denominated primarily in local currencies. Consequently, the translated U.S.
dollar value of the Company's foreign sales and operating results are subject to
currency exchange rate fluctuations which may favorably or adversely impact
reported earnings and may affect the comparability of period-to-period operating
results. Overall, fluctuations in the value of the U.S. dollar relative to other
currencies, primarily the euro, decreased TiO2 sales by a net $16 million in the
first quarter of 2006 as compared to the same period in 2005. Fluctuations in
the value of the U.S. dollar relative to other currencies similarly impacted the
Company's foreign currency-denominated operating expenses. The Company's
operating costs that are not denominated in the U.S. dollar, when translated
into U.S. dollars, were higher in the first quarter of 2006 compared to the
first quarter of 2005. Overall, the net impact of currency exchange rate
fluctuations on the Company's operating income comparisons resulted in a net $3
million decrease in the Company's income from operations in the first quarter of
2006 as compared to the first quarter of 2005.
Outlook
Kronos' 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 chloride
process facility and equipment upgrades and enhancements in several locations to
allow for reduced downtime for maintenance activities. Kronos' production
capacity has increased by approximately 25% over the past ten years due to
debottlenecking programs, with only moderate capital expenditures. Kronos
believes its annual attainable production capacity for 2006 is approximately
345,000 metric tons, with some additional capacity expected to be available in
2007 through its continued debottlenecking efforts.
Kronos expects its income from operations in 2006 will continue to be
somewhat lower than 2005. Kronos' expectations as to the future prospects of
Kronos and the TiO2 industry are based upon a number of factors beyond Kronos'
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 Kronos' expectations,
Kronos' results of operations could be unfavorably affected.
Other income (expense)
Three months ended
March 31,
----------------------
2005 2006 Difference
---- ---- ----------
(In millions)
Trade interest income $ .1 $ .5 $ .4
Interest income from affiliates 4.9 4.4 (.5)
Interest expense (11.6) (10.3) 1.3
------ ------ ------
$ (6.6) $ (5.4) $ 1.2
====== ====== ======
Interest income from affiliates decreased $490,000 in the first quarter of
2006 as compared to the first quarter of 2005 due primarily to relative changes
in foreign currency exchange rates. The Company expects interest income will be
comparable in 2006 as compared to 2005 as these notes receivable from Kronos are
expected to be outstanding during the full year.
The Company has a significant amount of outstanding indebtedness
denominated in the euro, including its euro 375 million Senior Secured Notes.
Accordingly, the reported amount of interest expense will vary depending on
relative changes in foreign currency exchange rates. Interest expense in the
first quarter of 2006 was $10.3 million, a decrease of $1.3 million from the
first quarter of 2005. The decrease was due primarily to relative changes in
foreign currency exchange rates, which increased the U.S. dollar equivalent of
interest expense on the Company's euro 375 million Senior Secured Notes
outstanding during both periods by approximately $1.1 million in the first
quarter of 2006 as compared to the first quarter of 2005.
In April 2006, the Company called all of its 8.875% Senior Secured Notes
for redemption on May 11, 2006 at 104.437% of their aggregate principal amount
of euro 375 million (an aggregate of $470.2 million at March 31, 2006 exchange
rates). Funds for such redemption were provided by the Company's issuance of an
aggregate of euro 400 million principal amount of new 6.5% Senior Secured Notes
due April 2013, issued on April 11, 2006 at 99.306% of their principal amount.
The Company expects to recognize a $21 million pre-tax charge in the second
quarter related to the early extinguishment of the 8.875% Senior Secured Notes,
consisting of the call premium on such Notes and the net write-off of deferred
financing costs and existing unamortized premium related to such Notes. See Note
5.
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 8 to the Consolidated Financial Statements.
At March 31, 2006, the Company has the equivalent of $597 million and $93
million of income tax loss carryforwards for German corporate and trade tax
purposes, respectively, all of which have no expiration date. As more fully
described in the 2005 Annual Report, during 2004 the Company concluded the
benefit of such net carryforwards met the "more-likely-than-not" recognition
criteria of GAAP, and accordingly in 2004 the Company reversed the deferred
income tax asset valuation allowance related to such German carryforwards and
other net deductible temporary differences related to Germany. Prior to the
complete utilization of such carryforwards, it is possible that the Company
might conclude in the future that the benefit of such carryforwards would no
longer meet the "more-likely-than-not" recognition criteria, at which point the
Company would be required to recognize a valuation allowance against the
then-remaining tax benefit associated with the carryforwards.
Accounting principles newly adopted in 2006
See Note 11 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES:
Consolidated cash flows
The Company's consolidated cash flows from operating, investing and
financing activities for the three months ended March 31, 2005 and 2006 are
presented below:
Three months ended
March 31,
----------------------
2005 2006
---- ----
(In millions)
Net cash provided by (used in):
Operating activities $ 3.4 $ (5.0)
Investing activities (4.3) (3.3)
Financing activities - -
------ ------
Net cash used in operating, investing
and financing activities $ (.9) $ (8.3)
====== ======
Summary
The Company's primary source of liquidity on an ongoing basis is its cash
flows from operating activities, which is generally used to (i) fund capital
expenditures, (ii) repay any short-term indebtedness incurred primarily for
working capital purposes and (iii) provide for the payment of dividends. In
addition, from time-to-time the Company will incur indebtedness, generally to
(i) fund short-term working capital needs, (ii) refinance existing indebtedness
or (iii) fund major capital expenditures or the acquisition of other assets
outside the ordinary course of business. Also, the Company will from
time-to-time sell assets outside the ordinary course of business, the proceeds
of which are generally used to (i) repay existing indebtedness (including
indebtedness which may have been collateralized by the assets sold), (ii) make
investments in marketable and other securities, (iii) fund major capital
expenditures or the acquisition of other assets outside the ordinary course of
business or (iv) pay dividends.
Operating activities
The TiO2 industry is cyclical and changes in economic conditions within the
industry significantly impact the earnings and operating cash flows of the
Company. Cash flow from operations is considered the primary source of liquidity
for the Company. Changes in TiO2 pricing, production volume and customer demand,
among other things, could significantly affect the liquidity of the Company.
Trends in cash flows from operating activities (excluding the impact of
significant asset dispositions and relative changes in assets and liabilities)
are generally similar to trends in the Company's earnings. However, certain
items included in the determination of net income are non-cash, and therefore
such items have no impact on cash flows from operating activities. Non-cash
items included in the determination of net income include depreciation and
amortization expense, deferred income taxes and non-cash interest expense.
Non-cash interest expense consists of amortization of deferred financing costs.
Certain other items included in the determination of net income may have an
impact on cash flows from operating activities, but the impact of such items on
cash flows from operating activities will differ from their impact on net
income. For example, the amount of periodic defined benefit pension plan expense
depends upon a number of factors, including certain actuarial assumptions, and
changes in such actuarial assumptions will result in a change in the reported
expense. In addition, the amount of such periodic expense generally differs from
the outflows of cash required to be currently paid for such benefits.
Relative changes in assets and liabilities generally result from the timing
of production, sales, purchases and income tax payments. Such relative changes
can significantly impact the comparability of cash flow from operations from
period to period, as the income statement impact of such items may occur in a
different period from when the underlying cash transaction occurs. For example,
raw materials may be purchased in one period, but the payment for such raw
materials may occur in a subsequent period. Similarly, inventory may be sold in
one period, but the cash collection of the receivable may occur in a subsequent
period.
Cash flows used in operating activities increased from $3.4 million
provided by operating activities in the first three months of 2005 to $5.0
million of cash used in operating activities in the first three months of 2006.
This $8.4 million increase in cash used in operating activities was due
primarily to the net effects of (i) lower net income of $5.1 million, (ii) lower
deferred income taxes of $3.4 million and (iii) a higher amount of net cash used
from relative changes in the Company's inventories, receivables, payables and
accruals of $2.8 million in the first three months of 2006 as compared to the
first three months of 2005. Relative changes in accounts receivable are affected
by, among other things, the timing of sales and the collection of the resulting
receivables. Relative changes in inventories and accounts payable and accrued
liabilities are affected by, among other things, the timing of raw material
purchases and the payment for such purchases and the relative difference between
production volumes and sales volumes. The Company's average days sales
outstanding ("DSO") increased from 52 days at December 31, 2005 to 64 days at
March 31, 2006, due to the timing of collection on the higher accounts
receivable balance at the end of March. At March 31, 2006 and December 31, 2005,
the average number of days in inventory ("DII") remained consistent at 105 days.
Investing and financing activities
The Company's capital expenditures were $4.8 million and $3.7 million in
the first three months of 2005 and 2006,
respectively.
At March 31, 2006, unused credit available under the Company's existing
credit facilities approximated $97 million, including approximately $94 million
under its revolving credit facility. At March 31, 2006, KII had approximately
$101 million available for payment of dividends and other restrictive payments
as defined in the Senior Secured Notes indenture. In April 2006, the Company
paid a $10 million dividend to Kronos, as allowed under the terms of the
indenture. Based upon the Company's expectations for the TiO2 industry and
anticipated demands on the Company's cash resources as discussed herein, the
Company expects to have sufficient liquidity to meet its future obligations
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.
Provisions contained in certain of the Company's credit agreements could
result in the acceleration of the applicable indebtedness prior to its stated
maturity for reasons other than defaults from failing to comply with typical
financial covenants. For example, certain credit agreements allow the lender to
accelerate the maturity of the indebtedness upon a change of control (as
defined) of the borrower. In addition, certain credit agreements could result in
the acceleration of all or a portion of the indebtedness following a sale of
assets outside the ordinary course of business.
Off-balance sheet financing arrangements
Other than the operating leases discussed in the 2005 Annual Report, the
Company nor any of its subsidiaries or affiliates are parties to any off-balance
sheet financing arrangements.
Other
At March 31, 2006, the Company and its subsidiaries had (i) current cash
and cash equivalents aggregating $55.8 million, (ii) current restricted cash
equivalents of $951,000 and (iii) noncurrent restricted marketable debt
securities of $2.6 million.
At March 31, 2006, the Company's outstanding debt was comprised of (i)
$455.6 million related to KII's Senior Secured Notes and (ii) approximately $4.6
million of other indebtedness, principally related to capital lease obligations
at the Company's Norwegian operations.
The Company's assets consist primarily of investments in its operating
subsidiaries, and the Company's ability to service its parent level obligations,
including the Senior Secured Notes, depends in large part upon the distribution
of earnings of its subsidiaries, whether in the form of dividends, advances or
payments on account of intercompany obligations, or otherwise. None of the
Company's subsidiaries have guaranteed the Senior Secured Notes, although the
Company has pledged 65% of the common stock or other ownership interest of
certain of its first-tier operating subsidiaries as collateral of such Senior
Secured Notes.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact the Company's earnings and operating
cash flows. Cash flows from operations is considered the primary source of
liquidity for the Company. Changes in TiO2 pricing, production volumes and
customer demand, among other things, could significantly affect the liquidity of
the Company.
Based upon the Company's expectations for the TiO2 industry and anticipated
demand for the Company's cash resources as discussed herein, the Company expects
to have sufficient short-term (defined as the twelve-month period ending March
31, 2007) and long-term (defined as the five-year period ending December 31,
2010, the time period for which the Company generally does long-term budgeting)
liquidity to meet its obligations including operations, capital expenditures,
debt service and dividends. To the extent that actual developments differ from
the Company's expectations, the Company's liquidity could be adversely affected.
See Note 8 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of the Company's income
tax returns in various non-U.S. jurisdictions, and see Note 10 to the
Consolidated Financial Statements with respect to certain legal proceedings with
respect to the Company.
The Company periodically evaluates its liquidity requirements, alternative
uses of capital, capital needs and availability of resources in view of, among
other things, its dividend policy, its debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, the Company has in the past and may in the future seek to reduce,
refinance, repurchase or restructure indebtedness, raise additional capital,
modify its dividend policy, restructure ownership interests, sell interests in
subsidiaries or other assets, or take a combination of such steps or other steps
to manage its liquidity and capital resources. In the normal course of its
business, the Company may review opportunities for acquisitions, divestitures,
joint ventures or other business combinations in the chemicals or other
industries, as well as the acquisition of interests in, and loans to, related
entities. In the event of any such transaction, the Company may consider using
its available cash, issuing its equity securities or increasing its indebtedness
to the extent permitted by the agreements governing the Company's existing debt.
The Company's operations are located outside the United States where the
functional currency is not the U.S. dollar. As a result, the reported amounts of
the Company's assets and liabilities related to its non-U.S. operations, and
therefore the Company's consolidated net assets, will fluctuate based upon
changes in currency exchange rates.
Non-GAAP financial measures
In an effort to provide investors with additional information regarding the
Company's results of operations as determined by GAAP, the Company has disclosed
certain non-GAAP information which the Company believes provides useful
information to investors.
o The Company discloses percentage changes in its average TiO2 selling prices
in billing currencies, which excludes the effects of foreign currency
translation. The Company believes disclosure of such percentage changes
allows investors to analyze such changes without the impact of changes in
foreign currency exchange rates, thereby facilitating period-to-period
comparisons of the relative changes in average TiO2 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 TiO2 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Reference is made to the 2005 Annual Report for a discussion of the market
risks associated with changes in foreign currency exchange rates, interest rates
and security prices that affect the Company. There have been no material changes
in such market risks since the Company filed the 2005 Annual Report.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. The Company maintains a
system of disclosure controls and procedures. The term "disclosure controls and
procedures," as defined by regulations of the SEC, means controls and other
procedures that are designed to ensure that information required to be disclosed
in the reports that the Company files or submits to the SEC under the Securities
Exchange Act of 1934, as amended (the "Act"), is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that it files or submits to the SEC under the Act is
accumulated and communicated to the Company's management, including its
principal executive officer and its principal financial officer, or persons
performing similar functions, as appropriate to allow timely decisions to be
made regarding required disclosure. Each of Harold C. Simmons, the Company's
Chief Executive Officer, and Gregory M. Swalwell, the Company's Vice President,
Finance and Chief Financial Officer, have evaluated the Company's disclosure
controls and procedures as of March 31, 2006. Based upon their evaluation, these
executive officers have concluded that the Company's disclosure controls and
procedures are effective as of March 31, 2006.
Internal Control Over Financial Reporting. The Company also maintains
internal control over financial reporting. The term "internal control over
financial reporting," as defined by regulations of the SEC, means a process
designed by, or under the supervision of, the Company's principal executive and
principal financial officers, or persons performing similar functions, and
effected by the Company's board of directors, management and other personnel, to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with GAAP, and includes those policies and procedures that:
o Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the assets of the
Company,
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and
that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company,
and
o Provide reasonable assurance regarding prevention or timely detection of an
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the Company's Consolidated Financial
Statements.
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 March 31, 2006 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
Reference is made to the 2005 Annual Report and Note 10 to the Consolidated
Financial Statements for descriptions of certain legal proceedings.
Item 1A. Risk Factors.
Reference is made to the 2005 Annual Report for a discussion of risk
factors related to the Company's businesses. There have been no material changes
in such risk factors since the Company filed the 2005 Annual Report.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
The Company has retained a signed original of any of the above exhibits
that contains signatures, and the Company will provide such exhibit to the
Commission or its staff upon request. The Company will also furnish,
without charge, a copy of Kronos' Code of Business Conduct and Ethics, its
Audit Committee Charter and its Corporate Governance Guidelines, each as
adopted by Kronos' board of directors, upon request. Such requests should
be directed to the attention of Kronos' Corporate Secretary at Kronos'
corporate offices located at 5430 LBJ Freeway, Suite 1700, Dallas, Texas
75240.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KRONOS INTERNATIONAL, INC.
-----------------------------
(Registrant)
Date May 5, 2006 By /s/ Gregory M. Swalwell
------------- -------------------------------
Gregory M. Swalwell
Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
Date May 5, 2006 By /s/ James W. Brown
------------- -------------------------------
James W. Brown
Vice President and Controller
(Principal Accounting Officer)