SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2006 Commission file number 333-100047
KRONOS INTERNATIONAL, INC.
- --------------------------------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 22-2949593
- ------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
--------------
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 October 31,
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
Condensed Consolidated Balance Sheets -
December 31, 2005; September 30, 2006 (unaudited) 3
Condensed Consolidated Statements of Income - Three and nine
months ended September 30, 2005 and 2006 (unaudited) 5
Condensed Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2005 and 2006 (unaudited) 6
Condensed Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2006 (unaudited) 7
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2005 and 2006 (unaudited) 8
Notes to Condensed Consolidated Financial Statements
(unaudited) 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosure About
Market Risk 25
Item 4. Controls and Procedures 25
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 1A. Risk Factors 26
Item 6. Exhibits 26
Items 2, 3, 4, and 5 of Part II are omitted because there is no information to
report
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2005 2006
-------------- --------------
(unaudited)
Current assets:
Cash and cash equivalents $ 63,284 $ 76,986
Restricted cash 1,355 933
Accounts and other receivables, net 120,182 169,119
Receivables from affiliates 1,952 7,740
Refundable income taxes 1,053 44
Inventories, net 185,348 172,179
Prepaid expenses and other 2,680 5,494
-------- ----------
Total current assets 375,854 432,495
-------- ----------
Other assets:
Deferred financing costs 7,722 8,861
Restricted marketable debt securities 2,572 2,692
Unrecognized net pension obligation 6,108 6,477
Deferred income taxes 213,275 226,914
Other 960 1,024
-------- ----------
Total other assets 230,637 245,968
-------- ----------
Property and equipment:
Land 30,288 32,723
Buildings 138,925 150,133
Equipment 644,271 698,498
Mining properties 68,163 70,456
Construction in progress 12,112 18,535
-------- ----------
893,759 970,345
Less accumulated depreciation and amortization 544,984 602,374
-------- ----------
Net property and equipment 348,775 367,971
-------- ----------
Total assets $955,266 $1,046,434
======== ==========
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2005 2006
-------------- --------------
(unaudited)
Current liabilities:
Current maturities of long-term debt $ 958 $ 933
Accounts payable and accrued liabilities 118,285 143,884
Payable to affiliates 14,882 6,269
Income taxes 21,799 18,279
Deferred income taxes 4,136 1,100
---------- ----------
Total current liabilities 160,060 170,465
---------- ----------
Noncurrent liabilities:
Long-term debt 452,865 508,921
Deferred income taxes 19,265 19,126
Accrued pension costs 125,766 127,889
Other 15,434 14,606
---------- ----------
Total noncurrent liabilities 613,330 670,542
---------- ----------
Minority interest 75 41
---------- ----------
Stockholder's equity:
Common stock 297 297
Additional paid-in capital 1,944,185 1,944,185
Retained deficit (1,339,332) (1,333,486)
Notes receivable from affiliates (209,526) (209,526)
Accumulated other comprehensive loss:
Currency translation (130,178) (112,439)
Pension liabilities (83,645) (83,645)
---------- ----------
Total stockholder's equity 181,801 205,386
---------- ----------
Total liabilities, minority interest and stockholders equity $ 955,266 $1,046,434
========== ==========
Commitments and contingencies (Notes 6 and 10)
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2005 2006 2005 2006
---- ---- ---- ----
(unaudited)
Net sales $ 205,979 $ 233,722 $ 643,087 $ 690,867
Cost of sales 150,772 181,650 454,983 527,640
--------- ---------- --------- ----------
Gross margin 55,207 52,072 188,104 163,227
Selling, general and administrative expense 26,504 29,346 82,514 87,265
Other operating income (expense):
Currency transaction gains (losses), net 159 220 2,356 (2,913)
Disposition of property and equipment (282) (599) (429) (1,677)
Royalty income 1,730 1,755 5,145 5,807
Other income, net 328 206 440 263
--------- ---------- --------- ----------
Income from operations 30,638 24,308 113,102 77,442
Other income (expense):
Trade interest income 214 563 406 1,394
Other interest income - - - 830
Securities transaction gain - - 5,439 -
Interest income from affiliates 4,640 4,827 14,396 13,954
Loss on prepayment of debt - - - (22,311)
Interest expense (10,604) (9,026) (33,463) (31,801)
--------- ---------- --------- ----------
Income before income taxes and minority interest 24,888 20,672 99,880 39,508
Provision for income taxes 18,461 11,671 46,680 7,524
Minority interest in after-tax earnings 1 2 9 7
--------- ---------- --------- ----------
Net income $ 6,426 $ 8,999 $ 53,191 $ 31,977
========= ========== ========= ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Net income $ 53,191 $ 31,977
Other comprehensive income (loss), net of tax -
currency translation adjustment (26,887) 17,739
--------- ---------
Comprehensive income $ 26,304 $ 49,716
========= =========
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY
Nine months ended September 30, 2006
(In thousands)
Accumulated other
Notes comprehensive loss
Additional receivable -------------------------- Total
Common paid-in Retained from Currency Pension stockholder's
stock capital deficit affiliates translation liabilities equity
------ --------- -------- ----------- ----------- ----------- ----------
(unaudited)
Balance at December 31, 2005 $ 297 $1,944,185 $(1,339,332) $ (209,526) $(130,178) $(83,645) $181,801
Net income - - 31,977 - - - 31,977
Other comprehensive income - - - - 17,739 - 17,739
Dividends - - (26,131) - - - (26,131)
------ ---------- ----------- ----------- --------- -------- --------
Balance at September 30, 2006 $ 297 $1,944,185 $(1,333,486) $ (209,526) $(112,439) $(83,645) $205,386
====== ========== =========== =========== ========= ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from operating activities:
Net income $ 53,191 $ 31,977
Depreciation and amortization 27,608 27,268
Loss on prepayment of debt - 22,311
Call premium paid on prepayment of debt - (20,898)
Noncash interest expense 1,990 1,455
Deferred income taxes 32,558 (6,358)
Minority interest 9 7
Net loss from disposition of property and equipment 429 1,678
Securities transaction gain (5,439) -
Defined benefit pension plan expense greater
(less) than cash funding (1,082) 2,883
Other, net (1,252) (787)
Change in assets and liabilities:
Accounts and other receivables, net (17,636) (37,693)
Inventories, net (25,457) 26,809
Prepaid expenses and other (2,918) (2,520)
Accounts with affiliates (3,795) (15,925)
Accounts payable and accrued liabilities 16,595 18,892
Income taxes (1,904) (3,433)
Other, net (5,999) (3,216)
-------- --------
Net cash provided by operating activities 66,898 42,450
-------- --------
Cash flows from investing activities:
Capital expenditures (18,933) (24,687)
Change in restricted cash, net 592 487
Proceeds from disposal of interest
in Norwegian smelting operation 3,542 -
Other, net 37 40
-------- --------
Net cash used in investing activities (14,762) (24,160)
-------- --------
Cash flows from financing activities:
Indebtedness -
Borrowings - 498,530
Principal payments (13,055) (470,636)
Deferred financing costs paid - (8,863)
Dividends paid - (26,131)
-------- --------
Net cash used in financing activities (13,055) (7,100)
-------- --------
Cash and cash equivalents - net change from:
Operating, investing and financing activities 39,081 11,190
Currency translation (1,898) 2,512
Cash and cash equivalents at beginning of period 17,505 63,284
-------- --------
Cash and cash equivalents at end of period $ 54,688 $ 76,986
======== ========
Supplemental disclosures:
Cash paid for:
Interest, net of amounts capitalized $ 21,591 $ 14,912
Income taxes, net 16,672 17,795
Noncash investing activity - inventory received as
partial consideration for disposal of interest
in Norwegian smelting operation $ 1,897 $ -
See accompanying Notes to Condensed Consolidated Financial Statements.
KRONOS INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Note 1 - Organization and basis of presentation:
Organization - We are a wholly-owned subsidiary of Kronos Worldwide, Inc.
("Kronos") (NYSE: KRO). We are incorporated in the state of Delaware, U.S.A.,
with our seat of management in Leverkusen, Germany. At September 30, 2006,
Valhi, Inc. (NYSE: VHI) held approximately 59% of Kronos' outstanding common
stock and NL Industries, Inc. (NYSE:NL) held an additional 36% of Kronos' common
stock. Valhi owned approximately 83% of NL's outstanding common stock at
September 30, 2006. Approximately 92% of Valhi's outstanding common stock is
held by Contran Corporation and its subsidiaries. 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 us.
Basis of presentation - The unaudited Condensed Consolidated Financial
Statements contained in this Quarterly Report have been prepared on the same
basis as the audited Consolidated Financial Statements in our Annual Report on
Form 10-K for the year ended December 31, 2005 that we filed with the Securities
and Exchange Commission ("SEC") on March 16, 2006 (the "2005 Annual Report"). In
our opinion, we have made all necessary adjustments (which include only normal
recurring adjustments) in order to state fairly, in all material respects, our
consolidated financial position, results of operations and cash flows as of the
dates and for the periods presented. We have condensed the Consolidated Balance
Sheet at December 31, 2005 contained in this Quarterly Report as compared to our
audited Consolidated Financial Statements at that date, and we have omitted
certain information and footnote disclosures (including those related to the
Consolidated Balance Sheet at December 31, 2005) normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America ("GAAP"). Our results of operations for the
interim periods ended September 30, 2006 may not be indicative of our operating
results for the full year. The Condensed Consolidated Financial Statements
contained in this Quarterly Report should be read in conjunction with our 2005
Consolidated Financial Statements contained in our 2005 Annual Report.
Unless otherwise indicated, references in this report to "we", "us" or
"our" refer to Kronos International, Inc. and its subsidiaries taken as a whole.
Note 2 - Accounts and other receivables, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Trade receivables $110,268 $152,054
Recoverable VAT and other receivables 11,343 18,809
Allowance for doubtful accounts (1,429) (1,744)
-------- --------
Total $120,182 $169,119
======== ========
Note 3 - Inventories, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Raw materials $ 42,807 $ 37,493
Work in process 13,654 15,442
Finished products 98,004 82,874
Supplies 30,883 36,370
-------- --------
Total $185,348 $172,179
======== ========
Note 4 - Accounts payable and accrued liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Accounts payable $ 63,382 $ 59,827
Employee benefits 27,147 29,102
Interest 117 15,655
Other 27,639 39,300
-------- --------
Total $118,285 $143,884
======== ========
Note 5 - Long-term debt:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
6.5% Senior Secured Notes $ - $505,241
8.875% Senior Secured Notes 449,298 -
Other 4,525 4,613
-------- --------
Total debt 453,823 509,854
Less current maturities 958 933
-------- --------
Total long-term debt $452,865 $508,921
======== ========
Senior Secured Notes - On April 11, 2006, we issued an aggregate of euro
400 million principal amount of new 6.5% Senior Secured Notes due April 2013, at
99.306% of their principal amount ($498.5 million when issued). These 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. On May 11, 2006,
we redeemed all of our 8.875% Senior Secured Notes at 104.437% of the aggregate
principal amount of euro 375 million for an aggregate of $491.4 million,
including the $20.9 million call premium. We used the proceeds from the 6.5%
Senior Secured Notes issued in April 2006 to fund the redemption. We recognized
a $22.3 million pre-tax interest charge in the second quarter of 2006 related to
the prepayment of the 8.875% Senior Secured Notes, consisting of the call
premium on the notes and the write-off of deferred financing costs and
unamortized premium related to the notes.
Note 6 - Income taxes:
Nine months ended
September 30,
------------------------
2005 2006
---- ----
(In millions)
Expected tax expense $35.0 $13.8
Non-U.S. tax rates .4 (.9)
Loss of German tax attribute 17.5 -
Nondeductible expenses 2.6 2.3
Resolutions of prior year income tax issues, net (.2) -
Contingency reserve adjustment, net (8.7) (8.1)
Other, net .1 .4
----- -----
Total $46.7 $ 7.5
===== =====
Due to the favorable resolution of certain income tax audits related to our
German and Belgian operations during the first six months of 2006, we recognized
a $2.0 million income tax benefit related to adjustments of prior year taxes.
Due to an unfavorable resolution of certain income tax audit issues related to
our German operations during the third quarter of 2006, we recognized a $2.0
million provision for income taxes related to prior year income taxes, which
offset the $2.0 million benefit recognized in the first half of the year.
Tax authorities are examining certain of our non-U.S. tax returns and have
or may propose tax deficiencies, including penalties and interest. For example:
o We previously received a preliminary tax assessment related to 1993
from the Belgian tax authorities proposing tax deficiencies, including
related interest, of approximately euro 6 million. The Belgian tax
authorities filed a lien on the fixed assets of our Belgian TiO2
operations in connection with their assessment. This lien did not
interfere with on-going operations at the facility. We filed a protest
to this assessment, and in July 2006 the Belgian tax authorities
withdrew the assessment. The lien was subsequently released.
o The Norwegian tax authorities previously notified us of their intent
to assess tax deficiencies of approximately kroner 12 million relating
to the years 1998 through 2000. We objected to this proposed
assessment, and in May 2006 the Norwegian tax authorities withdrew the
assessment.
Principally as a result of the withdrawal of the Belgian and Norwegian
assessments discussed above, we recognized a $9.5 million income tax benefit in
the first six months of 2006 related to the total reduction in our income tax
contingency reserve. Principally as a result of our ongoing income tax audits in
Germany, we recognized a $1.4 million increase in our income tax contingency
reserve in the third quarter of 2006. Other income tax examinations related to
our operations continue, and we cannot guarantee that these tax matters will be
resolved in our favor due to the inherent uncertainties involved in settlement
initiatives and court and tax proceedings. We believe we have adequate accruals
for additional taxes and related interest expense which could ultimately result
from tax examinations. We believe the ultimate disposition of tax examinations
should not have a material adverse effect on our consolidated financial
position, results of operations or liquidity.
Note 7 - Employee benefit plans:
The components of net periodic defined benefit pension cost are presented
in the table below.
Three months ended Nine months ended
September 30, September 30,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands) (In thousands)
Service cost $1,562 $1,402 $ 4,701 $ 4,147
Interest cost 3,416 3,820 10,678 11,163
Expected return on plan assets (2,968) (2,831) (9,272) (8,275)
Amortization of prior service cost 117 86 365 251
Amortization of net transition obligations (77) 62 81 180
Recognized actuarial losses 741 1,953 2,305 5,708
------ ------ ------- -------
Total $2,791 $4,492 $ 8,858 $13,174
====== ====== ======= =======
Contributions - We expect our 2006 contributions for our pension plans to
be consistent with the amount we disclosed in our 2005 Annual Report.
Note 8 - Other noncurrent liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Employee benefits $ 4,735 $ 6,371
Insurance claims and expenses 1,255 995
Asset retirement obligations 934 1,050
Other 8,510 6,190
------- --------
Total $15,434 $ 14,606
======= ========
Note 9 - Accounts with affiliates:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Current receivables from affiliates:
Kronos Canada Inc. $ 1,948 $ 2,905
Kronos - 4,835
Other 4 -
------- ----
Total $ 1,952 $ 7,740
======= =======
Current payables to affiliates:
Kronos (US), Inc. $14,882 6,269
------- -------
Total $14,882 $ 6,269
======= =======
Note 10 - Commitments and contingencies:
Litigation matters - As reflected in our 2005 Annual Report, Kronos'
Belgian subsidiary and certain of its employees were the subject of civil and
criminal proceeding relating to an accident that resulted in two fatalities at
our Belgian facility in 2000. In June 2006, the appellate court upheld a finding
of civil responsibility against the subsidiary, reduced by approximately 50% the
fine that had been imposed against the subsidiary by the lower court, and
reversed the finding of responsibility as it related to the individual Kronos
employees. No appeal was taken of the appellate court's decision.
We and our affiliates are also involved in various environmental,
contractual, product liability, patent (or intellectual property), employment
and other claims and disputes incidental to our present and former businesses.
In certain cases, we have insurance coverage for these items. We currently
believe the disposition of all claims and disputes, individually or in the
aggregate, should not have a material adverse effect on our consolidated
financial position, results of operations or liquidity beyond the accruals
already provided for.
Please refer to our 2005 Annual Report for a discussion of certain other
legal proceedings to which we are a party.
Note 11 - Recent accounting pronouncements:
Inventory costs - Statement of Financial Accounting Standards ("SFAS") No.
151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, became effective
for us for inventory costs incurred on or after January 1, 2006. SFAS No. 151
requires that the allocation of fixed production overhead costs to inventory be
based on normal capacity of the production facilities, as defined by SFAS No.
151. SFAS No. 151 also clarifies the accounting for abnormal amounts of idle
facility expense, freight handling costs and wasted material, requiring those
items be recognized as current-period charges. Our existing production cost
policies complied with the requirements of SFAS No. 151, therefore the adoption
of SFAS No. 151 did not affect our Consolidated Financial Statements.
Stock options - We adopted the fair value provisions of SFAS No. 123R,
"Share-Based Payment," on January 1, 2006, using the modified prospective
application method. SFAS No. 123R, among other things, requires the cost of
employee compensation paid with equity instruments to be measured based on the
grant-date fair value. That cost is then recognized over the vesting period.
Using the modified prospective method, we will apply the provisions of the
standard to all new equity compensation granted after January 1, 2006 and any
existing awards vesting after January 1, 2006. We have not issued any stock
options to purchase Kronos common stock. However, certain of our employees have
been granted options by NL to purchase NL common stock. The number of non-vested
equity awards issued by NL as of December 31, 2005 is not material. Prior to the
adoption of SFAS No. 123R we accounted for equity compensation in accordance
with APBO No. 25, Accounting for Stock Issued to Employees. Our NL affiliate
accounted for their equity awards under the variable accounting method whereby
the equity awards were revalued based on the current trading price at each
balance sheet date. We now account for these awards using the liability method
under SFAS No. 123R, which is substantially identical to the variable accounting
method we previously used. We recorded approximately $300,000 of compensation
expense in the quarter ended September 30, 2005 for stock-based employee
compensation and no material income or compensation expense was recorded in the
quarter ended September 30, 2006. We recorded income for stock-based employee
compensation of approximately $200,000 in each of the nine month periods ended
September 30, 2005 and 2006. If we grant a significant number of equity awards
or modify, repurchase or cancel existing equity awards in the future, the amount
of equity compensation expense in our Consolidated Financial Statements could be
material.
Effective January 1, 2006, SFAS No. 123R requires the cash income tax
benefit resulting from the exercise of stock options in excess of the cumulative
income tax benefit previously recognized for GAAP financial reporting purposes
to be reflected as a component of cash flows from financing activities in our
Consolidated Financial Statements. Because we account for these options to
purchase NL common stock under the liability method of SFAS No. 123R, the cash
income tax benefit resulting from the exercise of such stock options will always
be equal to the cumulative income tax benefit we would have previously
recognized for GAAP financial reporting purposes. SFAS No. 123R also requires
certain expanded disclosures regarding equity compensation, and we provided
these expanded disclosures in our 2005 Annual Report
Uncertain tax positions - In the second quarter of 2006 the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. ("FIN") 48,
Accounting for Uncertain Tax Positions, which will become effective for us on
January 1, 2007. FIN 48 clarifies when and how much of a benefit we can
recognize in our Consolidated Financial Statements for certain positions taken
in our income tax returns under SFAS No. 109, Accounting for Income Taxes, and
enhances the disclosure requirements for our income tax policies and reserves.
Among other things, FIN 48 will prohibit us from recognizing the benefits of a
tax position unless we believe it is more-likely-than-not our position will
prevail with the applicable tax authorities and limits the amount of the benefit
to the largest amount for which we believe the likelihood of realization is
greater than 50%. FIN 48 also requires companies to accrue penalties and
interest on the difference between tax positions taken on their tax returns and
the amount of benefit recognized for financial reporting purposes under the new
Standard. Our current income tax accounting policies comply with this aspect of
the new Standard. We will also be required to reclassify any reserves we have
for uncertain tax positions from deferred income tax liabilities, where they are
currently recognized, to a separate current or noncurrent liability, depending
on the nature of the tax position. We are currently evaluating the impact of FIN
48 on our Consolidated Financial Statements, we expect to complete our analysis
in the fourth quarter of 2006.
Planned Major Maintenance Activities - In September 2006 FASB issued FASB
Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major Maintenance
Activities, which will become effective for us on January 1, 2007, although
early adoption is permitted. Under FSP No. AUG AIR-1, accruing in advance for
major maintenance is no longer permitted. Companies that previously accrued in
advance for major maintenance activities will be required to restate
retroactively their financial statements to reflect a permitted method of
expense for all periods presented. In the past we accrued in advance for our
planned major maintenance; we will restate retroactively our financial
statements in the fourth quarter of 2006 to reflect the direct expense method of
accounting. The adoption of the FSP will have the following effect on our
previously reported net income for the periods indicated:
Increase (decrease) in net income
---------------------------------
2005 2006
---- ----
Quarter Ended: (In millions)
March 31 $ 1.2 $ .4
June 30 (.5) .3
September 30 (.6) (.3)
December 31 (.1) Na
----- -----
Total $ - $ .4
===== =====
Quantifying Financial Statement Misstatements - In September 2006 the SEC
issued Staff Accounting Bulletin ("SAB") No. 108 expressing their views
regarding the process of quantifying financial statement misstatements. The SAB
is effective for us no later than the fourth quarter of 2006. According to SAB
No. 108 both the "rollover" and "iron curtain" approaches must be considered
when evaluating a misstatement for materiality. We do not expect the adoption of
SAB No. 108 to have a material effect on our previously-reported consolidated
financial position or results of operations at the date of adoption.
Fair Value Measurements - In September 2006 the FASB issued SFAS No. 157,
Fair Value Measurements, which will become effective for us on January 1, 2007.
SFAS No. 157 generally provides a consistent, single fair value definition and
measurement techniques for GAAP pronouncements. SFAS No. 157 also establishes a
fair value hierarchy for different measurement techniques based on the objective
nature of the inputs in various valuation methods. We will be required to ensure
all of our fair value measurements are in compliance with SFAS No. 157 on a
prospective basis beginning in the first quarter of 2007. In addition, we will
be required to expand our disclosures regarding the valuation methods and level
of inputs we utilize in the first quarter of 2007. The adoption of this standard
will not have a material effect on our Consolidated Financial Statements.
Pension and Other Postretirement Plans - In September 2006 FASB issued SFAS
No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans. SFAS No. 158 requires us to recognize an asset or
liability for the over or under funded status of each of our individual defined
benefit pension plans on our Consolidated Balance Sheets. We will recognize
through other comprehensive income prior unrecognized gains and losses and prior
service costs or credits, net of tax, as of December 31, 2006 that we currently
amortize through net periodic benefit cost. All future changes in the funded
status of these plans will be recognized through comprehensive income, net of
tax (either net income or other comprehensive income). We will also provide
certain new disclosures related to these plans. In addition, we currently use
September 30 as a measurement date for our pension plans, but under this
standard we will be required to use December 31 as the measurement date for all
of our plans. The measurement date requirement of SFAF No. 158 will become
effective for us by the end of 2008 and provides two alternate transition
methods; we have not yet determined which transition method we will select. This
standard does not change the existing recognition and measurement requirements
that determine the amount of periodic benefit cost recognized in net income.
The asset and liability recognition and disclosure requirements of this
standard will become effective for us as of December 31, 2006 and will be
adopted prospectively. We will not complete the 2006 assessment of the funded
status of our pension and postretirement benefit plans until after December 31,
2006. At December 31, 2005, our pension plans were under funded by $175.7
million in the aggregate, and we had a net $136.1 million liability recognized
on our Consolidated Balance Sheet related to these plans. Our 2006 funded status
will be based in part on certain actuarial assumptions that we cannot yet
determine and differences between the actual and expected return on plan assets
during the year. Therefore, we are not able to determine the impact this
standard will have on our Consolidated Financial Statements; however we believe
the net effect of adopting SFAS No. 158 will reduce our stockholders' equity at
December 31, 2006. The full disclosure of the funded status of our defined
benefit pension and postretirement benefit plans at December 31, 2005 can be
found in Note 11 to our 2005 Annual Report.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
Business and results of operations overview
We are a leading global producer and marketer of value-added titanium
dioxide pigments ("TiO2"). TiO2 is used for a variety of manufacturing
applications, including plastics, paints, paper and other industrial products.
For the nine months ended September 30, 2006, approximately three-fourths of our
sales volumes were into European markets in Europe. We believe we are the second
largest producer of TiO2 in Europe with an estimated 20% share of European TiO2
sales volumes. Our production facilities are located throughout Europe.
We reported net income of $9.0 million, in the third quarter of 2006 as
compared to net income of $6.4 million, in the third quarter of 2005. For the
first nine months of 2006, we reported net income of $32.0 million, compared to
net income of $53.2 million, in the first nine months of 2005. Our increased net
income for the third quarter 2006 compared to the third quarter of 2005 is due
to the favorable effects of lower interest expense and lower income taxes in
2006, offset somewhat by the effects of lower income from operations. Our net
income for the first nine months of 2006 declined from the first nine months of
2005 due primarily to the net effect of (i) lower income from operations in
2006, (ii) a gain from the sale of our passive interest in a Norwegian smelting
operation in 2005, (iii) a charge from the 2006 redemption of our 8.875% Senior
Secured Notes, and (iv) the favorable effect of certain net income tax benefits
recognized in 2006.
Our net income in the first nine months of 2005 includes a net third
quarter non-cash income tax charge of $8.8 million for developments with respect
to ongoing non-U.S. income tax audits primarily in Germany and Belgium and a
second quarter gain of $5.4 million related to the sale of our passive interest
in a Norwegian smelting operation. Our net income in the first nine months of
2006 includes a second quarter charge related to the redemption of our 8.875%
Senior Secured Notes of $22.3 million and a net income tax benefit of $8.1
million (expense of $3.4 million in the third quarter) related to the net effect
of the withdrawal of certain income tax assessments previously made by the
Belgian and Norwegian tax authorities, the resolution of certain income tax
issues related to our German and Belgian operations.
Forward-looking information
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Statements in this Quarterly
Report on Form 10-Q that are not historical in nature are forward-looking in
nature about our future that are not statements of historical fact. Statements
in this report including, but not limited to, statements found in Item 2 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," are forward-looking statements that represent our beliefs and
assumptions based on currently available information. In some cases you can
identify these forward-looking statements 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 we
believe the expectations reflected in forward-looking statements are reasonable,
we do not know if these expectations will be correct. Forward-looking statements
by their nature involve substantial risks and uncertainties that could
significantly impact expected results. Actual future results could differ
materially from those predicted. While it is not possible to identify all
factors, we continue to face many risks and uncertainties. Among the factors
that could cause our actual future results to differ materially from those
described herein are the risks and uncertainties discussed in this Quarterly
Report and those described from time to time in our other filings with the SEC
including, but not limited to, the following:
o Future supply and demand for our products,
o The extent of our dependence on certain market sectors,
o The cyclicality of our businesses,
o Customer inventory levels (such as the extent to which our 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 Our ability 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 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 forecasted or expected. We
disclaim any intention or obligation to update or revise any forward-looking
statement whether as a result of changes in information, future events or
otherwise.
Results of operations
We consider TiO2 to be a "quality of life" product, with demand affected by
gross domestic product (or "GDP") in various regions of the world. Over the
long-term, we expect that demand for TiO2 will grow by 2% to 3% per year,
consistent with our expectations for the long-term growth in GDP. However, even
if we and our competitors maintain consistent shares of the worldwide market,
demand for TiO2 in any interim or annual period may not change in the same
proportion as the change in GDP, in part due to relative changes in the TiO2
inventory levels of our customers. We believe that our customers' inventory
levels are partly influenced by their expectation for future changes in market
TiO2 selling prices.
The factors having the most impact on our reported operating results are:
o Our TiO2 selling prices,
o Foreign currency exchange rates (particularly the exchange rate for
the U.S. dollar relative to the euro),
o Our TiO2 sales and production volumes, and
o Manufacturing costs particularly maintenance and energy-related
expenses.
Our key performance indicators are our TiO2 average selling prices, and our
level of TiO2 sales and production volumes.
Quarter ended September 30, 2005 compared to the
Quarter ended September 30, 2006 -
Three months ended
September 30,
---------------------------------------------
2005 2006
-------------------- -------------------
(Dollars in millions)
Net sales $206.0 100 % $233.7 100 %
Cost of sales 150.8 73 % 181.6 78 %
------ --- ------ ---
Gross margin 55.2 27 % 52.1 22 %
Other operating income and expenses, net 24.6 12 % 27.8 12 %
------ --- ------ ---
Income from operations $ 30.6 15 % $ 24.3 10 %
====== === ====== ===
%
Change
TiO2 operating statistics:
Sales volumes* 82 89 9 %
Production volumes* 83 84 1 %
Percent change in net sales:
TiO2 product pricing (1)%
TiO2 sales volumes 9 %
TiO2 product mix 1 %
Changes in currency exchange rates 4 %
---
Total 13 %
===
* Thousands of metric tons
Net sales - Net sales increased 13% or $27.7 million compared to the third
quarter of 2005 primarily due to a 9% increase in TiO2 sales volumes and the
impact of currency exchange rates. The benefit of higher sales volumes was
offset somewhat by a 1% decrease in average TiO2 selling prices. We estimate the
favorable effect of changes in currency exchange rates increased our net sales
by approximately $8 million, compared to the same period in 2005. We expect
average selling prices in the fourth quarter of 2006 to increase slightly from
the third quarter of 2006.
Our 9% increase in sales volumes in the third quarter of 2006 is primarily
due to higher sales volumes in Europe and export markets. We expect overall
demand will continue to remain high for the remainder of the year.
Cost of sales - Cost of sales increased $30.9 million or 20% in the third
quarter of 2006 compared to 2005 primarily due to the impact of increased sales
volumes, a 33% increase in utility costs (primarily energy costs), and a 5%
increase in raw material costs. The cost of sales as a percentage of net sales
increased to 78% in the third quarter of 2006 compared to 73% in the third
quarter of 2005 primarily due to increases in operating costs.
The negative impact of the increase in other operating costs and raw
materials was somewhat offset by increased production levels. TiO2 production
volumes increased 1% in the third quarter of 2006 compared to the same period in
2005, which favorably impacted our operating income comparisons. We continued to
gain operational efficiencies at our existing TiO2 facilities by enhancing our
processes and debottlenecking production to meet long-term demand. Our operating
rates were near full capacity in both periods.
Through our debottlenecking program, we added finishing capacity in the
German chloride-process facility which along with equipment upgrades and
enhancements in several locations, have allowed us to reduce downtime for
maintenance activities. Our production capacity has increased by approximately
25% over the past ten years with only moderate capital expenditures. We believe
our annual attainable TiO2 production capacity for 2006 is approximately 350,000
metric tons, with some additional capacity expected to be available in 2007
through our continued debottlenecking efforts.
Income from operations - Income from operations for the third quarter of
2006 declined by 21% to $24.3 million compared to the same period in 2005;
income from operations as a percentage of net sales declined to 10% in the third
quarter of 2006 from 15% in the same period for 2005. This decrease is driven by
the decline in gross margin, which fell to 22% in 2006 compared to 27% in 2005.
While our sales volumes are higher in 2006, our gross margin has decreased as
pricing has not improved to offset the negative impact of our increased
operating costs (primarily energy costs and raw materials). Changes in currency
exchange rates, have also negatively affected our gross margin. We estimate the
negative effect of changes in foreign currency exchange rates decreased income
from operations by approximately $1 million. We expect income from operations
for the fourth quarter of 2006 will continue to be lower than the fourth quarter
of 2005.
Other non-operating income (expense) - Interest expense decreased $1.6
million from $10.6 million in the third quarter of 2005 to $9.0 million in the
third quarter of 2006 due primarily to redemption of the 8.875% Senior Secured
Notes and issuance of the 6.5% Senior Secured Notes in the second quarter of
2006, which is partially offset by unfavorable changes in currency exchange
rates in 2006 compared to 2005. Excluding the effect of currency exchange rates,
we expect interest expense will be lower in the fourth quarter of 2006 as
compared to the fourth quarter of 2005.
We have a significant amount of indebtedness denominated in the euro,
primarily the Senior Secured Notes. The interest expense we recognize will vary
with fluctuations in the euro exchange rate.
Provision for income taxes - Our provision for income taxes was $11.7
million in the third quarter of 2006 compared to $18.5 million in the same
period last year. Our income tax expense for the third quarter 2006 includes an
aggregate provision for income taxes of $3.4 million, principally for
unfavorable developments with respect to ongoing income tax audits in Germany.
Our income tax expense in the third quarter of 2005 includes an income tax
benefit of $8.7 million for the effect of favorable developments with respect to
income tax audits in Belgium offset by a charge of $17.5 million for the
unfavorable effect related to the loss of certain of our German income tax
attributes. See Note 6 to the Condensed Consolidated Financial Statements.
Nine months ended September 30, 2005 compared to the
Nine months ended September 30, 2006 -
Nine months ended
September 30,
---------------------------------------------
2005 2006
-------------------- -------------------
(Dollars in millions)
Net sales $643.1 100 % $690.8 100 %
Cost of sales 455.0 71 % 527.6 76 %
------ --- ------ ---
Gross margin 188.1 29 % 163.2 24 %
Other operating income and expense, net 75.0 12 % 85.8 12 %
------ --- ------ ---
Income from operations $113.1 17 % $ 77.4 12 %
====== === ====== ===
%
Change
TiO2 operating statistics:
Sales volumes* 244 270 11 %
Production volumes* 250 258 3 %
Percent change in net sales:
TiO2 product pricing (1)%
TiO2 sales volumes 11 %
TiO2 product mix (1)%
Changes in currency exchange rates (2)%
---
Total 7 %
===
* Thousands of metric tons
Net sales - Net sales increased 7% or $47.8 million compared to the nine
months ended September 30, 2005, primarily due to an 11% increase in TiO2 sales
volumes, offset somewhat by the impact of currency exchange rates. We estimate
the unfavorable effect of changes in currency exchange rates decreased our net
sales by approximately $14 million, compared to the same period in 2005.
Our 11% increase in sales volumes in the nine months ended September 30,
2006 is primarily due to higher sales volumes in Europe and export markets. Our
sales volumes in the first nine months of 2006 was a new record for us.
Cost of sales - Cost of sales increased $72.7 million or 16% in the nine
months ended September 30, 2006, compared to the same period in 2005, primarily
due to the impact of increased sales volumes, a 27% increase in utility costs
(primarily energy costs) and a 5% increase in raw materials costs. The cost of
sales percentage of net sales increased to 76% in the nine months ended
September 30, 2006, compared to 71% in the same period of 2005 primarily due to
increases in higher raw material and other operating costs (including energy
costs).
The negative impact of the increase in energy costs and raw materials was
somewhat offset by record production levels. TiO2 production volumes increased
3% in the nine months ended September 30, 2006 compared to the same period in
2005, which favorably impacted our income from operations comparisons. Our
operating rates were near full capacity in both periods. Production volume was a
record aided by enhancing our process and continuing debottlenecking efforts.
Income from operations - Income from operations for the nine months ended
September 30, 2006 declined by 32% to $77.4 million compared to the same period
in 2005, the income from operations as a percentage of net sales declined to 12%
in the nine months ended September 30, 2006 from 18% in the same period for
2005. This decrease is driven by the decline in gross margin which fell to 24%
in 2006 compared to 29% in 2005. While our sales volumes are higher in 2006, our
gross margin, has decreased as pricing has not improved to offset the negative
impact of our increased operating costs (primarily energy and raw materials). We
estimate the negative effect of changes in foreign currency exchange rates
decreased income from operations by approximately $10 million.
Other non-operating income (expense) - In the second quarter of 2006, we
issued our euro 400 million principal amount of 6.5% Senior Secured Notes, and
used the proceeds to redeem our euro 375 million principal amount of 8.875%
Senior Secured Notes, we recognized a $22.3 million pre-tax interest charge
($14.8 million net of income tax benefit) in the second quarter of 2006 for the
prepayment of the notes, representing (1) the call premium on the notes, (2) the
write-off of deferred financing costs and (3) write off of the existing
unamortized premium on the notes. See Note 5 to the Condensed Consolidated
Financial Statements. Annual interest expense on the 6.5% Senior Secured Notes
will be approximately euro 6 million less than on the 8.875% Senior Secured
Notes.
Interest expense decreased $1.7 million to $31.8 million for the nine
months ended September 30, 2006 from $33.5 million in the same period in 2005.
The decrease in interest expense is due to the redemption of the 8.875% Senior
Secured Notes and the issuance of the 6.5% Senior Secured Notes.
Provision for income taxes (benefit) - Our provision for income taxes was
$7.5 million in the first nine months of 2006 compared to $46.7 million in the
same period last year. Our income tax expense in 2006 includes (i) an income tax
benefit of $2.0 million related to the favorable resolution of certain income
tax audits issues in Germany and Belgium, (ii) a $2.0 million provision for
income taxes related to the unfavorable resolution of certain income tax audit
issues in Germany, (iii) an income tax benefit of $9.5 million resulting from
the reduction in our income tax contingency reserves related to favorable
developments with income tax audits in Belgium and Norway and (iv) a $1.4
million provision for income taxes resulting from the increase in our income tax
contingency reserve related to our ongoing income tax audits, principally in
Germany. Our income tax expense in the first nine months of 2005 includes an
income tax benefit of $8.7 million for the aggregate effect of favorable
developments with respect to income tax audits in Belgium and a charge of $17.5
million for the unfavorable effect related to the loss of certain of our German
income tax attributes. See Note 6 to the Condensed Consolidated Financial
Statements for a tabular reconciliation of the statutory tax expense to our
actual tax benefit.
Currency exchange
All of our operations and assets are located outside the United States (in
Germany, Belgium and Norway). The majority of our sales are denominated in
foreign currencies, principally the euro and other major European currencies. A
portion of our sales generated from our operations are denominated in the U.S.
dollar. Certain raw materials used worldwide, primarily titanium-containing
feedstocks, are purchased in U.S. dollars, while labor and other production
costs are purchased primarily in local currencies. Consequently, the translated
U.S. dollar value of our 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 foreign currency exchange rates had the following
effects on our sales and income from operations in 2006 as compared to 2005.
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
------------------ ------------------
Increase (decrease), in millions
-----------------------------------------------
Impact on:
Net sales $ 8 $ (14)
Income from operations (1) (10)
Outlook
We expect income from operations for the fourth quarter of 2006 will be
lower than the fourth quarter of 2005 due primarily to continued downward
pricing pressure and increased energy costs and raw materials costs. Our
expectations as to the future of the TiO2 industry are based upon a number of
factors beyond our control, including worldwide growth of gross domestic
product, competition in the marketplace, unexpected or earlier than expected
capacity additions and technological advances. If actual developments differ
from our expectations, our results of operations could be unfavorably affected.
LIQUIDITY AND CAPITAL RESOURCES
Consolidated cash flows
Operating activities
Trends in cash flows as a result of our operating activities (excluding the
impact of significant asset dispositions and relative changes in assets and
liabilities) are generally similar to trends in our earnings.
Our cash flows from operating activities provided $42.4 million in the
first nine months of 2006, compared to $66.9 million the first nine months of
2005. This decrease was due primarily to the net effects of the following items:
o Lower income from operations in 2006 of $35.7 million;
o Payment of the $20.9 million call premium as a result of the May 2006
prepayment of our 8.875% Senior Secured Notes, which is required to be
included in cash flows from operating activities;
o A lower amount of net cash used from relative changes in our
inventories, receivables, payables and accruals of $17.3 million in
2006 due primarily to relative changes in our inventory levels, as
discussed below;
o Lower cash paid for interest in 2006 of $6.7 million, primarily as a
result of the May 2006 redemption of our 8.875% Senior Secured Notes
(which paid interest semiannually in June and December) and the April
2006 issuance of our 6.5% Senior Secured Notes (which will pay
interest semiannually in April and October); and
o Higher cash paid for income taxes in 2006 of $1.1 million, in part due
to the net payment of $4.3 million in 2006 associated with the
settlement of prior year income tax audits.
Changes in working capital were affected by accounts receivable and
inventory changes. Our average day's sales outstanding ("DSO") increased from 52
days at December 31, 2005 to 65 days at September 30, 2006 due to the timing of
collection on higher accounts receivable balances at the end of September. For
comparative purposes, our average DSO remained constant at 57 days, from
December 31, 2004 to September 30, 2005. Our average days sales in inventory
("DSI") decreased from 105 days at December 31, 2005 to 85 days at September 30,
2006, as our record TiO2 sales volumes in the first nine months of 2006 exceeded
our record TiO2 production volumes during such period. For comparative purposes,
our TiO2 production volumes were higher than our TiO2 sales volumes in the first
nine months of 2005, and our average DSI increased from 99 days at December 31,
2004 to 105 days at September 30, 2005.
Investing activities
Capital expenditures were $18.9 million and $24.7 million in the nine
months ended September 30, 2005 and 2006, respectively. Capital expenditures are
primarily for improvements and upgrades to existing facilities.
Financing activities
In the second quarter of 2006 we redeemed our euro 375 million principal
amount of 8.875% Senior Secured Notes ($470.5 million when redeemed) and issued
euro 400 million principal amount of 6.5% Senior Secured Notes at 99.306%
($498.5 million when issued). See Note 5 to the Condensed Consolidated Financial
Statements.
We paid dividends of $26.1 million in the first nine months of 2006.
Outstanding debt obligations
At September 30, 2006, our consolidated debt was comprised of:
o euro 400 million principal amount of 6.5% Senior Secured Notes ($505.2
million at September 30, 2006) due in 2013; and
o Approximately $4.6 million of other indebtedness
Certain of our credit agreements contain provisions which could result in
the acceleration of indebtedness prior to its stated maturity for reasons other
than defaults for failure to comply with applicable covenants. For example,
certain credit agreements allow the lender to accelerate the maturity of the
indebtedness upon a change of control (as defined in the agreement) 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. We are in compliance with all of our
debt covenants at September 30, 2006. See Note 5 to the Condensed Consolidated
Financial Statements.
Our assets consist primarily of investments in operating subsidiaries, and
our ability to service parent level obligations, including the Senior Secured
Notes, depends in large part upon the distribution of earnings of our
subsidiaries, whether in the form of dividends, advances or payments on account
of intercompany obligation or otherwise. None of our subsidiaries have
guaranteed the Senior Secured Notes, although we have pledged 65% of the common
stock or other ownership interests of certain of our first-tier operating
subsidiaries as collateral of the Senior Secured Notes.
Future cash requirements
Liquidity
Our primary source of liquidity on an ongoing basis is cash flows from
operating activities. From time-to-time we 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. We will also from time-to-time sell
assets outside the ordinary course of business, the proceeds of which are
generally used to (i) repay existing indebtedness, (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.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact earnings and operating cash flows.
Changes in TiO2 pricing, production volumes and customer demand, among other
things, could significantly affect our liquidity.
We routinely evaluate our liquidity requirements, alternative uses of
capital, capital needs and availability of resources in view of, among other
things, our dividend policy, our debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, we have in the past and may in the future seek to reduce, refinance,
repurchase or restructure indebtedness, raise additional capital, repurchase
shares of our common stock, modify our dividend policy, restructure ownership
interests, sell interests in our subsidiaries or other assets, or take a
combination of these steps or other steps to manage our liquidity and capital
resources. Such activities have in the past and may in the future involve
related companies. In the normal course of our business, we may investigate,
evaluate, discuss and engage in acquisition, joint venture, strategic
relationship and other business combination opportunities in the TiO2 industry.
In the event of any future acquisition or joint venture opportunity, we may
consider using then-available liquidity, issuing our equity securities or
incurring additional indebtedness.
At September 30, 2006, unused credit available under all of our existing
credit facilities was approximately $99 million. Based upon our expectation for
the TiO2 industry and anticipated demands on cash resources, we expect to have
sufficient liquidity to meet our future obligations including operations,
capital expenditures, debt service and current dividend policy. If actual
developments differ from our expectations, our liquidity could be adversely
affected.
Capital expenditures
We intend to spend approximately $40 million for major improvements and
upgrades to our existing facilities during 2006, including the $24.7 million we
spent though September 30, 2006.
Off-balance sheet financing
We do not have any off-balance sheet financing agreements other than the
operating leases discussed in our 2005 Annual Report.
Commitments and contingencies
See Notes 6 and 10 to the Condensed Consolidated Financial Statements for a
description of certain income tax examinations currently underway and legal
proceedings.
Recent accounting pronouncements
See Note 11 to the Condensed Consolidated Financial Statements.
Critical accounting policies
For a discussion of our critical accounting policies, refer to Part I, Item
7 "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our 2005 Annual Report. There have been no changes in our
critical accounting policies during the first nine months of 2006.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk, including foreign currency exchange rates,
interest rates and security prices. For a discussion of such market risk items,
refer to Part I, Item 7A, "Quantitative and Qualitative Disclosure About Market
Risk" in our 2005 Annual Report. There have been no material changes in these
market risks during the first nine months of 2006.
We have substantial operations located outside the United States for which
the functional currency is not the U.S. dollar. As a result, the reported
amounts of our assets and liabilities related to our non-U.S. operations, and
therefore our consolidated net assets, will fluctuate based upon changes in
currency exchange rates.
We periodically use currency forward contracts to manage a very nominal
portion of foreign exchange rate risk associated with trade receivables
denominated in a currency other than the holder's functional currency or similar
exchange rate risk associated with future sales. We had no forward contracts
outstanding at September 30, 2006. We have not entered into these contracts for
trading or speculative purposes in the past, nor do we currently anticipate
entering into such contracts for trading or speculative purposes in the future.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain 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
we are required to disclose in the reports we file or submit to the SEC under
the Act is accumulated and communicated to our management, including our
principal executive officer and our 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, our Chief
Executive Officer, and Gregory M. Swalwell, our Vice President, Finance and
Chief Financial Officer, have evaluated the design and effectiveness of our
disclosure controls and procedures as of September 30, 2006. Based upon their
evaluation, these executive officers have concluded that our disclosure controls
and procedures are effective as of September 30, 2006.
Internal Control over Financial Reporting
We also maintain 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, our principal
executive and principal financial officers, or persons performing similar
functions, and effected by our 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 our
assets,
o Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with GAAP, and that our receipts and expenditures are being made only
in accordance with authorizations of our management and directors, and
o Provide reasonable assurance regarding prevention or timely detection
of an unauthorized acquisition, use or disposition of our assets that
could have a material effect on our Condensed Consolidated Financial
Statements.
As permitted by the SEC, our assessment of internal control over financial
reporting excludes (i) internal control over financial reporting of its equity
method investees and (ii) internal control over the preparation of our financial
statement schedules required by Article 12 of Regulation S-X.
Changes in Internal Control over Financial Reporting
There has been no change to our internal control over financial reporting
during the quarter ended September 30, 2006 that has materially affected, or is
reasonably likely to materially affect, the internal control over financial
reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Note 10 of the Condensed Consolidated Financial Statements and to
the 2005 Annual Report for descriptions of certain legal proceedings.
Item 1A. Risk Factors
For a discussion of the risk factors related to our businesses, refer to
Part I, Item 1A., "Risk Factors," in our 2005 Annual report. There have been no
material changes to such risk factors during the nine months ended September 30,
2006.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
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.
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(Registrant)
Date November 6, 2006 By /s/ Gregory M. Swalwell
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Gregory M. Swalwell
Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
Date November 6, 2006 By /s/ Tim C. Hafer
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Tim C. Hafer
Vice President and Controller
(Principal Accounting Officer)