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, 2004 Commission file number 1-31763
KRONOS WORLDWIDE, INC.
_______________________________________________________________________________
(Exact name of Registrant as specified in its charter)
Delaware 76-0294959
(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 an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes No X
--- ---
Number of shares of the Registrant's common stock outstanding on October 29,
2004: 48,946,049.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 2003 and September 30, 2004 3
Consolidated Statements of Income -
Three months and nine months ended September 30,
2003 and 2004 5
Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2003 and 2004 6
Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2004 7
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2003 and 2004 8
Notes to Consolidated Financial Statements 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 18
Item 4. Controls and Procedures 29
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 6. Exhibits and Reports on Form 8-K 31
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2003 2004
------------ -------------
Current assets:
Cash and cash equivalents $ 55,876 $ 118,504
Restricted cash and cash equivalents 1,313 916
Accounts and other receivables 156,212 203,976
Refundable income taxes 35,336 1,729
Receivables from affiliates 1,209 7
Inventories 266,020 203,171
Prepaid expenses 4,456 9,551
Deferred income taxes 2,755 3,089
---------- ----------
Total current assets 523,177 540,943
---------- ----------
Other assets:
Investment in TiO2 manufacturing joint venture 129,011 119,911
Deferred income taxes 6,682 180,036
Other 28,040 29,410
---------- ----------
Total other assets 163,733 329,357
---------- ----------
Property and equipment:
Land 32,339 31,957
Buildings 179,472 178,554
Equipment 765,231 766,836
Mining properties 63,701 62,764
Construction in progress 9,666 20,468
---------- ----------
1,050,409 1,060,579
Less accumulated depreciation and amortization 615,442 641,027
---------- ----------
Net property and equipment 434,967 419,552
---------- ----------
$1,121,877 $1,289,852
========== ==========
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2003 2004
------------ -------------
Current liabilities:
Current maturities of long-term debt $ 288 $ 148
Accounts payable 97,446 70,476
Accrued liabilities 69,218 92,442
Payable to affiliates 8,919 9,040
Income taxes 12,354 12,338
Deferred income taxes 3,436 -
---------- ----------
Total current liabilities 191,661 184,444
---------- ----------
Noncurrent liabilities:
Long-term debt 356,451 350,380
Notes payable to affiliates 200,000 200,000
Accrued pension costs 68,161 65,662
Accrued postretirement benefits costs 11,176 10,768
Deferred income taxes 119,825 51,843
Other 14,727 13,681
---------- ----------
Total noncurrent liabilities 770,340 692,334
---------- ----------
Minority interest 525 528
---------- ----------
Stockholders' equity:
Common stock 489 489
Additional paid-in capital 1,060,157 1,060,247
Retained deficit (729,260) (478,631)
Accumulated other comprehensive loss:
Currency translation (133,009) (130,533)
Pension liabilities (39,026) (39,026)
---------- ----------
Total stockholders' equity 159,351 412,546
---------- ----------
$1,121,877 $1,289,852
========== ==========
Commitments and contingencies (Notes 9 and 12)
See accompanying notes to consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
-------------------- ---------------------
2003 2004 2003 2004
---- ---- ---- ----
Net sales $ 242,931 $ 286,058 $ 762,535 $ 845,114
Cost of sales 177,432 219,382 563,498 649,118
--------- --------- --------- ---------
Gross margin 65,499 66,676 199,037 195,996
Selling, general and administrative expense 29,705 35,777 90,059 105,991
Other operating income (expense):
Currency transaction losses, net (458) (1,414) (4,299) (858)
Disposition of property and equipment (227) (197) (271) (199)
Other income 115 234 227 6,514
Corporate expense (930) (589) (2,614) (1,868)
--------- --------- --------- ---------
Income from operations 34,294 28,933 102,021 93,594
Other income (expense):
Trade interest income 200 287 561 699
Interest income from affiliates - - 723 -
Other interest income 54 284 128 657
Interest expense to affiliates - (4,529) (703) (13,480)
Interest expense (8,338) (8,720) (24,688) (26,529)
--------- --------- --------- ---------
Income before income taxes and
minority interest 26,210 16,255 78,042 54,941
Income tax expense (benefit) 10,241 6,189 3,567 (232,436)
Minority interest in after-tax earnings 18 18 61 38
--------- --------- --------- ---------
Net income $ 15,951 $ 10,048 $ 74,414 $ 287,339
========= ========= ========= =========
Basic and diluted net income per share $ .33 $ .21 $ 1.52 $ 5.87
========= ========= ========= =========
Basic and diluted weighted-average shares used in
the calculation of net income per share 48,943 48,946 48,943 48,945
========= ========= ========= =========
See accompanying notes to consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2003 and 2004
(In thousands)
2003 2004
---- ----
Net income $ 74,414 $ 287,339
Other comprehensive income, net of tax - currency translation
adjustment 14,291 2,476
--------- ---------
Comprehensive income $ 88,705 $ 289,815
========= =========
See accompanying notes to consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2004
(In thousands)
Accumulated other
comprehensive loss
Additional ----------------------------- Total
Common paid-in Retained Currency Pension stockholders'
stock capital deficit translation liabilities equity
-------- ------------ ----------- ------------ ------------ -------------
Balance at December 31, 2003 $ 489 $1,060,157 $(729,260) $(133,009) $(39,026) $159,351
Net income - - 287,339 - - 287,339
Dividends - - (36,710) - - (36,710)
Issuance of common stock - 90 - - - 90
Other comprehensive income - - - 2,476 - 2,476
------ ---------- --------- --------- -------- --------
Balance at September 30, 2004 $ 489 $1,060,247 $(478,631) $(130,533) $(39,026) $412,546
====== ========== ========= ========= ======== ========
See accompanying notes to consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2003 and 2004
(In thousands)
2003 2004
---- ----
Cash flows from operating activities:
Net income $ 74,414 $287,339
Depreciation and amortization 29,127 32,588
Noncash interest expense 1,628 1,852
Deferred income taxes 6,040 (243,922)
Minority interest 61 38
Net loss from disposition of property and equipment 271 199
Pension cost, net (3,646) 461
Distributions from TiO2 manufacturing joint venture, net 2,175 9,100
Other postretirement benefits, net (870) (506)
Other, net 1,070 1,942
Change in assets and liabilities:
Accounts and other receivables (30,802) (49,582)
Inventories 22,993 61,122
Prepaid expenses (888) (4,729)
Accounts payable and accrued liabilities (28,332) (6,351)
Income taxes 2,333 33,290
Accounts with affiliates 7,852 1,297
Other, net 20 (4,310)
-------- --------
Net cash provided by operating activities 83,446 119,828
-------- --------
Cash flows from investing activities:
Capital expenditures (23,735) (21,417)
Change in restricted cash equivalents (911) 409
Other, net 81 83
-------- --------
Net cash used in investing activities (24,565) (20,925)
-------- --------
Cash flows from financing activities:
Indebtedness:
Borrowings 16,106 99,968
Principal payments (45,868) (100,030)
Loans to affiliates 8,000 -
Repayment of loans from affiliates (52,600) -
Dividends paid (7,000) (36,710)
Other capital transactions with affiliates, net 19,700 -
Other, net (14) -
-------- --------
Net cash used in financing activities (61,676) (36,772)
-------- --------
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2003 and 2004
(In thousands)
2003 2004
---- ----
Cash and cash equivalents - net change from:
Operating, investing and financing activities $ (2,795) $ 62,131
Currency translation 1,544 497
Cash and cash equivalents at beginning of period 40,685 55,876
-------- --------
Cash and cash equivalents at end of period $ 39,434 $118,504
======== ========
Supplemental disclosures - cash paid (received) for:
Interest, net of amounts capitalized $ 17,048 $ 30,369
Income taxes, net (11,524) (22,433)
See accompanying notes to consolidated financial statements.
KRONOS WORLDWIDE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 - Organization and basis of presentation:
At September 30, 2004, (i) NL Industries, Inc. (NYSE:NL) held approximately
49% of Kronos common stock, (ii) Valhi, Inc. (NYSE:VHI) and a wholly-owned
subsidiary of Valhi held approximately 83% of NL's outstanding common stock,
(iii) Valhi and such wholly-owned subsidiary of Valhi held an additional 45% of
Kronos' outstanding common stock and (iv) Contran Corporation and its
subsidiaries held approximately 90% 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. Mr. Simmons, the Chairman of
the Board of Valhi, Contran, NL and the Company, may be deemed to control each
of such companies.
The consolidated balance sheet of Kronos at December 31, 2003 has been
condensed from the Company's audited consolidated financial statements at that
date. The consolidated balance sheet at September 30, 2004, and the consolidated
statements of income, comprehensive income, stockholders' equity and cash flows
for the interim periods ended September 30, 2003 and 2004, 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
present 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, and certain prior year
amounts have been reclassified to conform to the current year presentation. 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,
2003 (the "2003 Annual Report").
The Company has complied with the consolidation requirements of FASB
Interpretation ("FIN") No. 46R, "Consolidation of Variable Interest Entities, an
interpretation of ARB No. 51," as amended, as of March 31, 2004. See Note 13.
The Company has not issued any stock options to purchase Kronos common
stock. However, certain employees of the Company have been granted options by NL
to purchase NL common stock. As disclosed in the 2003 Annual Report, the Company
accounts for stock-based employee compensation in accordance with Accounting
Principles Board Opinion ("APBO") No. 25, "Accounting for Stock Issued to
Employees," and its various interpretations. 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 2003,
the Company commenced accounting for its stock options using the variable
accounting method of APBO No. 25, which requires 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) to be accrued as an
expense, with subsequent increases (decreases) in the Company's market price
resulting in recognition of additional compensation expense (income). Aggregate
compensation income related to NL stock options held by employees of the Company
was approximately $300,000 in each of the third quarter and first nine months of
2003 and aggregate compensation expense was approximately $1 million and $1.9
million in the third quarter and first nine months of 2004, respectively.
The following table presents what the Company's consolidated net income,
and related per share amounts, would have been in the 2003 and 2004 periods
presented if the Company and its subsidiaries and affiliates 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
Statements of Financial Accounting Standards ("SFAS") SFAS No. 123, "Accounting
for Stock-Based Compensation," for all awards granted subsequent to January 1,
1995.
Three months ended Nine months ended
September 30, September 30,
-------------------- ---------------------
2003 2004 2003 2004
---- ---- ---- ----
(In millions, except per share amounts)
Net income as reported $16.0 $10.0 $74.4 $287.3
Adjustments, net of applicable income tax
effects and minority interest, of
stock-based employee compensation
determined under:
APBO No. 25 (.2) .6 (.2) 1.2
SFAS No. 123 (.1) - (.2) -
----- ----- ----- ------
Pro forma net income $15.7 $10.6 $74.0 $288.5
===== ===== ===== ======
Basic and diluted net income per share:
As reported $ .33 $ .21 $1.52 $ 5.87
Pro forma .32 .22 1.51 5.89
Note 2 - Accounts and other receivables:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Trade receivables $147,029 $193,634
Recoverable VAT and other receivables 12,103 13,191
Allowance for doubtful accounts (2,920) (2,849)
-------- --------
$156,212 $203,976
======== ========
Note 3 - Inventories:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Raw materials $ 61,959 $ 36,363
Work in process 19,855 16,762
Finished products 147,270 113,128
Supplies 36,936 36,918
-------- --------
$266,020 $203,171
======== ========
Note 4 - Other noncurrent assets:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Deferred financing costs, net $ 10,417 $ 8,613
Restricted marketable debt securities 2,586 2,556
Unrecognized net pension obligations 13,747 13,810
Other 1,290 4,431
-------- --------
$ 28,040 $ 29,410
======== ========
Note 5 - Accrued liabilities:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Employee benefits $ 31,732 $ 33,702
Interest 207 7,992
Other 37,279 50,748
-------- --------
$ 69,218 $ 92,442
======== ========
Note 6 - Long-term debt:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Kronos International, Inc. and subsidiaries:
Senior Secured Notes $356,136 $350,180
Other 603 348
-------- --------
356,739 350,528
Less current maturities 288 148
-------- --------
$356,451 $350,380
======== ========
During the first quarter of 2004, certain of Kronos' operating subsidiaries
in Europe borrowed a net Euro 26 million ($32 million when borrowed) under the
European revolving credit facility at an interest rate of 3.8%. Such amounts
were repaid in the second quarter of 2004. In October 2004 one of Kronos'
operating subsidiaries in Europe borrowed Euro 10 million ($12 million when
borrowed) under the European revolving credit facility at an interest rate of
3.83%.
Note 7 - Other noncurrent liabilities:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Employee benefits $ 4,849 $ 4,611
Insurance 1,673 1,385
Other 8,205 7,685
-------- --------
$ 14,727 $ 13,681
======== ========
Note 8 - Other income:
Nine months ended
September 30,
-------------------------
2003 2004
---- ----
(In thousands)
Contract dispute settlement $ - $ 6,289
Other income 227 225
-------- --------
$ 227 $ 6,514
======== ========
The contract dispute settlement relates to the Company's settlement with a
customer. As part of the settlement, the customer agreed to make payments to the
Company through 2007 aggregating $7.3 million. The $6.3 million gain recognized
represents the present value of the future payments to be paid by the customer
to the Company. Of such $7.3 million, $1.5 million was paid to Kronos in the
second quarter of 2004, $1.75 million is due in each of the second quarter of
2005 and 2006 and $2.25 million is due in the second quarter of 2007. At
September 30, 2004, the present value of the remaining amounts due to be paid to
Kronos aggregated approximately $5.0 million, of which $1.7 million is included
in accounts receivable and $3.3 million is included in other noncurrent assets.
Note 9 - Income tax expense (benefit):
Nine months ended
September 30,
-------------------------
2003 2004
---- ----
(In thousands)
Expected tax expense $ 27.3 $ 19.2
Change in deferred income tax valuation
allowance, net (.7) (254.3)
Refund of prior year income taxes (24.6) (3.1)
Incremental U.S. tax and rate differences on
equity in earnings of non-tax group companies .1 (.1)
Non-U.S. tax rates .2 -
Nondeductible expenses 1.9 2.3
Other, net (.6) 3.6
-------- --------
$ 3.6 $ (232.4)
======== ========
Certain of the Company's U.S. and non-U.S. tax returns are being examined
and tax authorities have or may propose tax deficiencies, including penalties
and interest. For example:
o Kronos has received a preliminary tax assessment related to 1993 from the
Belgian tax authorities proposing tax deficiencies, including related
interest, of approximately Euro 6 million ($7 million at September 30,
2004). Kronos has 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
titanium dioxide pigments ("TiO2") operations in connection with this
assessment. In April 2003, Kronos received a notification from the Belgian
tax authorities of their intent to assess a tax deficiency related to 1999
that, including interest, is expected to be approximately Euro 13 million
($16 million). Kronos believes the proposed assessment is substantially
without merit, and Kronos has filed a written response.
o The Norwegian tax authorities have notified Kronos of their intent to
assess tax deficiencies of approximately kroner 12 million ($2 million at
September 30, 2004) relating to the years 1998 to 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.
At December 31, 2003, Kronos had a significant amount of net operating loss
carryforwards for German corporate and trade tax purposes, all of which have no
expiration date. These net operating loss carryforwards were generated by Kronos
International, Inc. ("KII") principally during the 1990's when KII had a
significantly higher level of outstanding indebtedness than is currently
outstanding. For financial reporting purposes, however, the benefit of such net
operating loss carryforwards had not previously been recognized because Kronos
did not believe they met the "more-likely-than-not" recognition criteria, and
accordingly Kronos had a deferred income tax asset valuation allowance
offsetting the benefit of such net operating loss carryforwards and Kronos'
other tax attributes in Germany. KII had generated taxable income in Germany for
both German corporate and trade tax purposes since 2000, and starting with the
quarter ended December 31, 2002 and for each quarter thereafter, KII had
cumulative taxable income in Germany for the most recent twelve quarters.
However, offsetting this positive evidence was the fact that prior to the end of
2003, Kronos believed there was significant uncertainty regarding its ability to
utilize such net operating loss carryforwards under German tax law and,
principally because of the uncertainty caused by this negative evidence, Kronos
had concluded the benefit of the net operating loss carryforwards did not meet
the "more-likely-than-not" criteria. By the end of 2003, and primarily as a
result of a favorable German court ruling in 2003 and the procedures Kronos had
completed during 2003 with respect to the filing of certain amended German tax
returns (as discussed below), Kronos had concluded that the significant
uncertainty regarding its ability to utilize such net operating loss
carryforwards under German tax law had been eliminated. However, at the end of
2003, Kronos believed at that time that it would generate a taxable loss in
Germany during 2004. Such expectation was based primarily upon then current
levels of prices for TiO2, and the fact that Kronos was experiencing a downward
trend in its TiO2 selling prices and Kronos did not have any positive evidence
to indicate that the downward trend would improve. If the price trend continued
downward throughout all of 2004 (which was a possibility given Kronos' prior
experience), Kronos would likely have a taxable loss in Germany for 2004. If the
downward trend in prices had abated, ceased, or reversed at some point during
2004, then Kronos would likely have taxable income in Germany during 2004.
Accordingly, Kronos continued to conclude at the end of 2003 that the benefit of
the German net operating loss carryforwards did not meet the
"more-likely-than-not" criteria and that it would not be appropriate to reverse
the deferred income tax asset valuation allowance, given the likelihood that
Kronos would generate a taxable loss in Germany during 2004. The expectation for
a taxable loss in Germany continued through the end of the first quarter of
2004. By the end of the second quarter of 2004, however, Kronos' TiO2 selling
prices had started to increase, and Kronos believes its selling prices will
continue to increase during the remainder of 2004 after Kronos and its major
competitors announced an additional round of price increases. The fact that
Kronos' selling prices started to increase during the second quarter of 2004,
combined with the fact that Kronos and its competitors had announced additional
price increases (which based on past experience indicated to Kronos that some
portion of the additional price increases would be realized in the marketplace),
provided additional positive evidence that was not present at December 31, 2003.
Consequently, Kronos' revised projections now reflect taxable income for Germany
in 2004 as well as 2005. Accordingly, based on all available evidence, including
the fact that (i) Kronos had generated positive taxable income in Germany since
2000, and starting with the quarter ended December 31, 2002 and for each quarter
thereafter, KII had cumulative taxable income in Germany for the most recent
twelve quarters, (ii) Kronos was now projecting positive taxable income in
Germany for 2004 and 2005 and (iii) the German net operating loss carryforwards
have no expiration date, Kronos concluded that the benefit of the net operating
loss carryforwards and other German tax attributes met the
"more-likely-than-not" recognition criteria, and Kronos reversed the deferred
income tax asset valuation allowance related to Germany. Given the magnitude of
the German net operating loss carryforwards and the fact that current provisions
of German law limit the annual utilization of net operations loss carryforwards
to 60% of taxable income after the first euro 1 million of taxable income,
Kronos believes it will take several years to fully utilize the benefit of such
operating loss carryforwards. However, given the number of years for which
Kronos has now generated positive taxable income in Germany, combined with the
fact that the net operating loss carryforwards were generated during a time when
KII had a significantly higher level of outstanding indebtedness than it
currently has outstanding, and the fact that the net operating loss
carryforwards have no expiration date, Kronos concluded it was appropriate to
reverse all of the valuation allowance related to the net operating loss
carryforwards. Accordingly, in the first six months of 2004, Kronos recognized a
$254.3 million income tax benefit related to the reversal of such deferred
income tax asset valuation allowance attributable to Kronos' income tax
attributes in Germany (principally the net operating loss carryforwards). Of
such $254.3 million, $8.7 million relates primarily to the utilization of the
German net operating loss carryforwards during the first six months of 2004, the
benefit of which had previously not met the "more-likely-than-not" recognition
criteria, and $245.6 million relates to the German deferred income tax asset
valuation allowance attributable to the remaining German net operating loss
carryforwards and other tax attributes as of June 30, 2004, the benefit of which
Kronos has concluded now meet the "more-likely-than-not" recognition criteria.
At September 30, 2004, the net operating loss carryforwards for German corporate
and trade tax purposes aggregated the equivalent of $602 million and $244
million, respectively, all of which have no expiration date.
In the first quarter of 2003, KII was notified by the German Federal Fiscal
Court that the Court had ruled in KII's favor concerning a claim for refund suit
in which KII sought refunds of prior taxes paid during the periods 1990 through
1997. KII and KII's German operating subsidiary were required to file amended
tax returns with the German tax authorities to receive refunds for such years,
and all of such amended returns were filed during 2003. Such amended returns
reflected an aggregate net refund of taxes and related interest to KII and its
German operating subsidiary of Euro 26.9 million ($32.1 million), and the
Company recognized the benefit for these net refunds in its 2003 results of
operations. During the first nine months of 2004, the Company recognized a
benefit of Euro 2.5 million ($3.1 million) related to additional net interest
which has accrued on the outstanding refund amounts. Assessments and refunds
will be processed by year as the respective returns are reviewed by the tax
authorities. Certain interest components may also be refunded separately. The
German tax authorities have reviewed and accepted the amended returns with
respect to the 1990 through 1994 tax years. Through September 2004, KII's German
operating subsidiary had received net refunds of Euro 27.2 million ($33.6
million when received). KII believes it will receive the remainder of the net
refunds of taxes and related interest for the remaining years during the
remainder of 2004. In addition to the refunds for the 1990 to 1997 periods, the
court ruling also resulted in a refund of 1999 income taxes and interest for
which KII received Euro 21.5 million ($24.6 million) in 2003, and the Company
recognized the benefit of this refund in the second quarter of 2003.
Note 10 - Employee benefit plans:
The components of net periodic defined benefit pension cost are presented
in the table below.
Three months ended Nine months ended
September 30, September 30,
-------------------- ---------------------
2003 2004 2003 2004
---- ---- ---- ----
(In thousands)
Service cost benefits $ 1,272 $ 1,772 $ 3,790 $ 4,829
Interest cost on projected benefit obligations 3,847 4,267 11,375 12,882
Expected return on plan assets (3,556) (3,776) (11,411) (11,396)
Amortization of prior service cost 88 140 263 421
Amortization of net transition obligations 202 159 586 482
Recognized actuarial losses 306 739 925 2,227
------- ------- ------- -------
$ 2,159 $ 3,301 $ 5,528 $ 9,445
======= ======= ======= =======
The components of net periodic postretirement benefits other than pensions
("OPEB") cost (credit) are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
-------------------- ---------------------
2003 2004 2003 2004
---- ---- ---- ----
(In thousands)
Service cost $ 39 $ 57 $ 112 $ 170
Interest cost 173 180 509 540
Amortization of prior service credit (263) (182) (791) (548)
Recognized actuarial losses 22 38 64 116
------- ------- ------- -------
$ (29) $ 93 $ (106) $ 278
======= ======= ======= =======
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the "Medicare 2003 Act") introduced a prescription drug benefit under Medicare
(Medicare Part D) as well as a federal subsidy to sponsors of retiree health
care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D. During the third quarter of 2004, the Company
determined that benefits provided by its plan are actuarially equivalent to the
Medicare Part D benefit and therefore the Company is eligible for the federal
subsidy provided for by the Medicare 2003 Act. The effect of such subsidy, which
is accounted for prospectively from the date actuarial equivalence was
determined, as permitted by and in accordance with FASB Staff Position No.
106-2, did not have a material impact on the accumulated postretirement benefit
obligation, and will not have a material impact on the net periodic OPEB cost
going forward. At September 30, 2004, approximately 55% of the Company's
consolidated accrued OPEB costs relates to the Company's U.S. plan, and the
remainder relates to the Company's Canadian plan.
Note 11 - Accounts with affiliates:
December 31, September 30,
2003 2004
------------ -------------
(In thousands)
Current receivables from affiliates -
NL - income taxes and other $ 1,209 $ 7
======== ========
Current payables to affiliates:
NL $ 359 $ 105
Income taxes payable to Valhi - 121
Louisiana Pigment Company 8,560 8,814
-------- --------
$ 8,919 $ 9,040
======== ========
Notes payable to affiliates:
NL $200,000 $ 31,423
Valhi - 6,077
Valcor, Inc. - 162,500
-------- --------
$200,000 $200,000
======== ========
On September 24, 2004, NL completed the acquisition of the shares of common
stock of CompX International, Inc. previously held by Valhi and Valcor, Inc., a
wholly-owned subsidiary of Valhi. The purchase price for these shares was paid
by NL's transfer to Valhi and Valcor of an aggregate $168.6 million of NL's $200
million long-term note receivable from Kronos. In October 2004, Valcor
distributed its note receivable from Kronos to Valhi, and subsequently Kronos
prepaid $100.0 million on the note payable to Valhi (including accrued interest)
principally using available cash on hand.
Note 12 - Commitments and contingencies:
The Company is from time to time involved in various environmental,
contractual, product liability, patent (or intellectual property), employment
and other claims and disputes incidental to its present and former businesses.
In certain cases, the Company has insurance coverage for such items. The Company
currently believes the disposition of all of these claims and disputes
individually or in the aggregate, should not have a material adverse effect on
the Company's consolidated financial condition, results of operations or
liquidity.
Note 13 - Accounting principle newly adopted in 2004:
The Company complied with the consolidation requirements of FIN No. 46R,
"Consolidation of Variable Interest Entities, an interpretation of ARB No. 51,"
as amended, as of March 31, 2004. The Company does not have any involvement with
any variable interest entity (as that term is defined in FIN No. 46R) covered by
the scope of FIN No. 46R which had not already been consolidated under prior
applicable GAAP, and therefore the impact to the Company of adopting the
consolidation requirements of FIN No. 46R was not material.
Note 14 - Subsequent event:
On October 8, 2004, the Company filed a registration statement with the
Securities and Exchange Commission ("SEC") for a proposed offering of up to 8.25
million shares of its common stock. The registration statement has not yet been
declared effective by the SEC. There can be no assurance that the registration
statement will be declared effective, or if declared effective, that the
offering would be completed.
Note 15 - Stockholders' equity:
Kronos has a long-term incentive compensation plan that provides for the
discretionary grant of, among other things, qualified incentive stock options,
nonqualified stock options, restricted common stock, stock awards and stock
appreciation rights. Up to 150,000 shares of Kronos common stock may be issued
pursuant to this plan. As of September 30, 2004, no options had been granted
pursuant to this plan, and 147,000 shares were available for future grants.
During the first nine months of 2004, an aggregate of 3,000 shares of Kronos
common stock were awarded pursuant to this plan to members of the Company's
board of directors.
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 third quarter and the first nine months of 2003 and 2004 are
primarily due to (i) relative changes in average TiO2 selling prices, (ii)
relative changes in TiO2 sales volumes and (iii) relative changes in foreign
currency exchange rates. Selling prices were generally: increasing during the
first quarter of 2003, flat during the second quarter of 2003, decreasing during
the third and fourth quarters of 2003 and the first quarter of 2004, flat during
the second quarter of 2004 and increasing during the third quarter of 2004.
The Company reported net income of $10.0 million, or $.21 per diluted
share, in the third quarter of 2004 compared to net income of $16.0 million, or
$.33 per diluted share, in the third quarter of 2003. For the first nine months
of 2004, the Company reported net income of $287.3 million, or $5.87 per diluted
share, compared to net income of $74.4 million, or $1.52 per diluted share, in
the first nine months of 2003. The increase in the Company's diluted earnings
per share from the first nine months of 2003 to the same period in 2004 is due
primarily to the net effects of (i) significantly higher tax benefit generated
from the reversal of the Company's German deferred income tax asset valuation
allowance, (ii) lower gross margins, (iii) higher selling, general and
administrative expense, (iv) income from a contract dispute settlement and (v)
higher interest expense to affiliates. Overall, the Company believes its net
income in 2004 will be higher than 2003 as the impact of the reversal of the
Company's deferred income tax asset valuation allowance is expected to more than
offset the effect of expected lower income from operations. Net income in the
first nine months of 2003 includes certain income tax benefits relating to
Germany aggregating $.50 per diluted share. Net income in the first nine months
of 2004 includes (a) certain income tax benefits related to Germany aggregating
$5.02 per diluted share and (b) income related to contract dispute settlement of
$.08 per diluted share. These items are more fully described below.
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," "expects" or comparable terminology, or by
discussions of strategies or trends. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
cannot give any assurances that these expectations will prove to be correct.
Such statements by their nature involve substantial risks and uncertainties that
could significantly impact expected results, and actual future results could
differ materially from those described in such forward-looking statements. While
it is not possible to identify all factors, the Company continues to face many
risks and uncertainties. Among the factors that could cause actual future
results to differ materially 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 Securities and Exchange Commission ("SEC") including, but not
limited to, the following:
o Future supply and demand for the Company's products,
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 The introduction of trade barriers,
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o Competitive technology positions,
o Fluctuations in currency exchange rates (such as changes in the exchange
rate between the U.S. dollar and each of the euro, the Norwegian kroner and
the Canadian dollar),
o Operating interruptions (including, but not limited to, labor disputes,
leaks, fires, explosions, unscheduled or unplanned downtime and
transportation interruptions),
o The ability of the Company to renew or refinance credit facilities,
o The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of which
has been recognized under the "more-likely-than-not" recognition criteria,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
o Government laws and regulations and possible changes therein,
o The ultimate resolution of pending litigation and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecast or expected. The
Company disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of new information, future events
or otherwise.
Net sales and income from operations
Three months ended Nine months ended
September 30, September 30,
---------------------------------- ----------------------------------
2003 2004 % Change 2003 2004 % Change
---- ---- -------- ---- ---- --------
(In millions, except percentages and volumes)
Net sales $ 242.9 $ 286.1 +18% $ 762.5 $ 845.1 +11%
Cost of sales 177.4 219.4 +24% 563.5 649.1 +15%
-------- -------- -------- --------
Gross margin 65.5 66.7 +2% 199.0 196.0 -2%
Selling, general and administrative
expense (29.7) (35.8) (90.1) (106.0)
Currency transaction gains (losses), net (.5) (1.4) (4.3) (.8)
Disposition of property and equipment (.2) (.2) (.2) (.2)
Contract dispute settlement - - - 6.3
Other income .1 .2 .2 .2
Corporate expense (.9) (.6) (2.6) (1.9)
-------- -------- -------- --------
Income from operations $ 34.3 $ 28.9 -16% $ 102.0 $ 93.6 -8%
======== ======== ======== ========
TiO2 data:
Percent change in average TiO2
selling prices:
Using actual foreign currency
exchange rates +3% +2%
Impact of changes in foreign
currency exchange rates -4% -5%
---- ----
In billing currencies -1% -3%
==== ====
Sales volumes* 111 128 +16% 350 383 +9%
Production volumes* 118 123 +5% 354 363 +3%
________________________________
* Thousands of metric tons
Kronos' sales increased $43.2 million (18%) in the third quarter of 2004
compared to the third quarter of 2003 and increased $82.6 million (11%) in the
first nine months of 2004 compared to the same period in 2003, as the favorable
effect of fluctuations in foreign currency exchange rates, which increased sales
and production by approximately $11 million and $46 million, respectively, (as
more fully discussed below) and increased sales volumes more than offset the
impact of lower average TiO2 selling prices. Excluding the effect of
fluctuations in the value of the U.S. dollar relative to other currencies, the
Company's average TiO2 selling prices in billing currencies were 1% lower in the
third quarter of 2004 as compared to the third quarter of 2003 and 3% lower in
the first nine months of 2004 as compared to the first nine months of 2003. When
translated from billing currencies into U.S. dollars using actual foreign
currency exchange rates prevailing during the respective periods, Kronos'
average TiO2 selling prices in the third quarter of 2004 were 3% higher than the
third quarter of 2003 and 2% higher for the first nine months of 2004 compared
to the first nine months of 2003. Kronos' TiO2 sales volumes in the third
quarter and first nine months of 2004 increased 16% and 9%, respectively,
compared to the same periods of 2003, as higher volumes in Europe, the United
States and export markets more than offset lower volumes in Canada. Kronos' TiO2
sales volumes in the first nine months of 2004 were a new record for Kronos.
The Company's sales are denominated in various currencies, including the
U.S. dollar, the euro, other major European currencies and the Canadian dollar.
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 3% and 2% increase in the Company's average TiO2 selling prices during the
third quarter and first nine months of 2004, as compared to the same periods in
2003 using actual foreign currency exchange rates prevailing during the
respective periods (the GAAP measure) and the 1% and 3% decreases in the
Company's average TiO2 selling price in billing currencies (the non-GAAP
measure) during the third quarter and first nine months of 2004 is due to the
effect of changes in foreign currency exchange rates. The above table presents
in a tabular format (i) the percentage change in the Company's average TiO2
selling prices using actual foreign currency exchange rates prevailing during
the respective periods (the GAAP measure), (ii) the percentage change in the
Company's average TiO2 selling prices in billing currencies (the non-GAAP
measure) and (iii) the percentage change due to changes in foreign currency
exchange rates (or the reconciling item between the non-GAAP measure and the
GAAP measure).
The Company's cost of sales increased $42.0 million (24%) in the third
quarter of 2004 compared to the third quarter of 2003, and increased $85.6
million (15%) in the year-to-date period largely due to the increased sales
volumes and the effects of translating foreign currencies (primarily the euro)
into U.S. dollars. As a result of the lower average TiO2 selling prices in
billing currencies, the Company's cost of sales, as a percentage of net sales
increased from 73% and 74% in each of the third quarter and first nine months of
2003, respectively, to 77% in the third quarter and first nine months of 2004.
Kronos' TiO2 production volumes in the third quarter of 2004 increased 5%
compared to the third quarter of 2003, and increased 3% in the first nine months
of 2004 as compared to the same period in 2003, with operating rates near full
capacity in those periods. Kronos' TiO2 production volumes in the first nine
months of 2004 were also a new record for Kronos.
The Company's gross margins for the third quarter of 2004 increased $1.2
million (2%) from the third quarter of 2003, as the higher sales volumes and the
favorable effect of relative changes in foreign currency exchange rates more
than offset the effect of lower average selling prices. However, gross margins
decreased $3.0 million (2%) from the first nine months of 2003 as compared to
the first nine months of 2004, as the unfavorable effect of lower average TiO2
selling prices more than offset the favorable effect of higher sales volumes and
relative changes in foreign currency exchange rates.
Selling, general and administrative expenses increased $6.1 million (20%)
and $15.9 million (18%), respectively, in the third quarter and first nine
months of 2004 as compared to the corresponding periods in 2003. These increases
are largely attributable to the higher sales volumes as well as the impact of
translating foreign currencies (primarily the euro) into U.S. dollars.
Kronos' income from operations in the first nine months of 2004 also
includes $6.3 million of income related to the settlement of a certain contract
dispute with a customer in the second quarter of 2004. As part of the
settlement, the customer agreed to make payments to Kronos through 2007
aggregating $7.3 million. The $6.3 million recognized gain represents the
present value of the future payments to be paid by the customer to Kronos. The
dispute with the customer concerned the customer's alleged past failure to
purchase the required amount of TiO2 from Kronos under the terms of Kronos'
contract with the customer. Under the settlement, the customer agreed to pay an
aggregate of $7.3 million to Kronos through 2007, to resolve such dispute.
The Company has substantial operations and assets located outside the
United States (particularly in Germany, Belgium, Norway and Canada). A
significant amount of the Company's sales generated from its non-U.S. operations
are denominated in currencies other than the U.S. dollar, primarily the euro,
other major European currencies and the Canadian dollar. In addition, a portion
of the Company's sales generated from its non-U.S. operations are denominated in
the U.S. dollar. Certain raw materials, primarily titanium-containing
feedstocks, are purchased in U.S. dollars, while labor and other production
costs are denominated primarily in local currencies. Consequently, the
translated U.S. dollar value of the Company's foreign sales and operating
results are subject to currency exchange rate fluctuations which may favorably
or adversely impact reported earnings and may affect the comparability of
period-to-period operating results. Overall, fluctuations in the value of the
U.S. dollar relative to other currencies, primarily the euro, increased TiO2
sales in the third quarter of 2004 by a net amount of approximately $11 million
compared to the same period in 2003 and increased TiO2 sales in the first nine
months of 2004 by approximately $46 million compared to the same period in 2003.
Fluctuations in the value of the U.S. dollar relative to other currencies
similarly impacted the Company's foreign currency-denominated operating
expenses. The Company's operating costs that are not denominated in the U.S.
dollar, when translated into U.S. dollars, were higher in the third quarter and
first nine months of 2004 compared to the third quarter and first nine months of
2003. Overall, currency exchange rate fluctuations resulted in a net increase in
the Company's income from operations of approximately $7 million in the first
nine months of 2004 as compared to the same period in 2003. Currency exchange
rate fluctuations did not have a material effect on the Company's income from
operations in the third quarter of 2004 as compared to the third quarter of
2003.
Outlook
Reflecting the impact of partial implementation of prior price increase
announcements, the Company's average TiO2 selling prices in billing currencies
in the third quarter of 2004 were 3% higher than the second quarter of 2004, the
first quarter with an upward trend in selling prices since the third quarter of
2003. In June 2004, the Company announced additional price increases of 4 cents
per pound in the U.S., Canadian 6 cents per pound in Canada and Euro 120 per
metric ton in Europe, all of which are targeted to be implemented in the fourth
quarter of 2004. In September 2004, the Company announced additional price
increases of 3 cents to 6 cents per pound in the U.S., Canadian 4 cents to
Canadian 8 cents per pound in Canada and Euro 110 per metric ton in Europe, all
of which are in addition to the July/August announced increases and are targeted
to be implemented in January 2005. The Company is also targeting to achieve
price increases in export markets in the fourth quarter of the year. The extent
to which all of such price increases will be realized will depend on, among
other things, economic factors.
The Company expects its TiO2 sales and production volumes in 2004 will be
higher than 2003. The Company's average TiO2 selling price, which declined
during the second half of 2003 and first quarter of 2004, commenced to begin to
rise during the second quarter of 2004, and was higher by 3% in the third
quarter of 2004 as compared to the second quarter of 2004, and should continue
to rise during the remainder of the year. Nevertheless, the Company expects its
average TiO2 selling prices, in billing currencies, will be lower in calendar
2004 as compared to 2003 and expects its gross margin in 2004 to be lower than
2003. The Company's expectations as to the future prospects of the Company and
the TiO2 industry are based upon a number of factors beyond its control,
including worldwide growth of gross domestic product, competition in the
marketplace, unexpected or earlier-than-expected capacity additions and
technological advances. If actual developments differ from the Company's
expectations, the Company's results of operations could be unfavorably affected.
Other income (expense)
Three months ended Nine months ended
September 30, September 30,
---------------------------------- ----------------------------------
2003 2004 Difference 2003 2004 Difference
---- ---- ---------- ---- ---- ----------
(In millions)
Trade interest income $ .2 $ .3 $ .1 $ .6 $ .7 $ .1
Interest income from affiliates - - - .7 - (.7)
Other interest income .1 .3 .2 .1 .6 .5
Interest expense to affiliates - (4.5) (4.5) (.7) (13.5) (12.8)
Other interest expense (8.4) (8.7) (.3) (24.7) (26.5) (1.8)
------- ------- ------- ------- ------- -------
$ (8.1) $ (12.6) $ (4.5) $ (24.0) $ (38.7) $ (14.7)
======= ======= ======= ======= ======= =======
Interest expense to affiliates increased $4.5 million from the third
quarter of 2003 to $4.5 million in the third quarter of 2004, and increased
$12.8 million in the first nine months of 2004 to $13.5 million due to the $200
million long-term notes payable to affiliates which the Company distributed to
NL in December 2003. See Note 11 to the Consolidated Financial Statements.
Because of this distribution, interest expense to affiliates is expected to
continue to be higher during the remainder of 2004 as compared to the same
periods in 2003.
Kronos has a significant amount of outstanding indebtedness denominated in
the euro, including KII's Euro 285 million Senior Secured Notes. Accordingly,
the reported amount of interest expense will vary depending on relative changes
in foreign currency exchange rates. Other interest expense in the third quarter
and first nine months of 2004 was $8.7 million and $26.5 million, respectively,
increases of $400,000 and $1.8 million, respectively, from the third quarter and
first nine months of 2003. The increases were due primarily to relative changes
in foreign currency exchange rates, which increased the U.S. dollar equivalent
of interest expense on the KII Senior Secured Notes by approximately $500,000 in
the third quarter and $2.2 million in the first nine months of 2004 as compared
to the third quarter and first nine months of 2003. Assuming no significant
change in interest rates or foreign currency exchange rates, other interest
expense for the full-year 2004 is expected to be slightly higher than amounts
for the same periods in 2003.
As stated in Note 6 to the Consolidated Financial Statements, one of KII's
operating subsidiaries borrowed Euro 10 million in October 2004 under the
European revolving credit facility at an interest rate of 3.83%.
Income tax benefit
The principal reasons for the difference between the Company's effective
income tax rates and the U.S. federal statutory income tax rates are explained
in Note 9 to the Consolidated Financial Statements.
At September 30, 2004, Kronos had the equivalent of $602 million and $244
million, respectively, of net operating loss carryforwards for German corporate
and trade tax purposes, all of which have no expiration date. As more fully
described in Note 9 to the Consolidated Financial Statements, Kronos had
previously provided a deferred income tax asset valuation allowance against
substantially all of these tax loss carryforwards and other deductible temporary
differences in Germany because Kronos did not believe they met the
"more-likely-than-not" recognition criteria. During the first six months of
2004, Kronos reduced its deferred income tax asset valuation allowance by
approximately $8.7 million, primarily as a result of utilization of these German
net operating loss carryforwards, the benefit of which had not previously been
recognized. At June 30, 2004, after considering all available evidence, Kronos
concluded that these German tax loss carryforwards and other deductible
temporary differences met the "more-likely-than-not" recognition criteria.
Accordingly, as of June 30, 2004, Kronos reversed the remaining $245.6 million
valuation allowance related to such items. Because the benefit of such net
operating loss carryforwards and other deductible temporary differences in
Germany has now been recognized, the Company's effective income tax rate in the
third quarter of 2004 was higher than the effective income tax rate in the first
half of the year (exclusive of the reversal of the German deferred income tax
asset valuation allowance) and the Company's future effective income tax rate is
expected to continue to be higher than what it would have otherwise been,
although its future cash income tax rate would not be affected.
In January 2004, the German federal government enacted new tax law
amendments that limit the annual utilization of income tax loss carryforwards
effective January 1, 2004 to 60% of taxable income after the first Euro 1
million of taxable income. The new law will have a significant effect on Kronos'
cash tax payments in Germany going forward, the extent of which will be
dependent on the level of income earned in Germany.
In October 2004, the American Jobs Creation Act of 2004 was enacted into
law. The new law contains several provisions that could impact the Company.
These provisions provide for, among other things, a special deduction from U.S.
taxable income equal to a stipulated percentage of qualified income from
domestic activities (as defined) beginning in 2005, and a special 85% dividends
received deduction for certain dividends received from controlled foreign
corporations, which deduction is subject to a number of limitations. Both of
these provisions are complex and subject to numerous restrictions. The Company
is still studying the new law, including the technical provisions related to the
two complex provisions noted above. The effect on the Company of the new law, if
any, has not yet been determined, in part because the Company has not yet
determined whether its operations qualify for the special deduction or whether
it would benefit from the special dividends received deduction.
Recently adopted accounting principle
See Note 13 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES:
Consolidated cash flows
The Company's consolidated cash flows from operating, investing and
financing activities for the nine months ended September 30, 2003 and 2004 are
presented below:
Nine months ended
September 30,
-------------------------
2003 2004
---- ----
(In millions)
Net cash provided (used) by:
Operating activities $ 83.4 $ 119.8
Investing activities (24.5) (20.9)
Financing activities (61.7) (36.8)
-------- --------
Net cash provided (used) by operating, investing
and financing activities $ (2.8) $ 62.1
======== ========
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
and periodic OPEB 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 from operating activities increased from $83.4 million provided
in the first nine months of 2003 to $119.8 million of cash provided by operating
activities in the first nine months of 2004. This $36.4 million increase was due
primarily to the net effects of (i) higher net income of $212.9 million, (ii)
higher depreciation and amortization expense of $3.5 million, (iii) lower
deferred income taxes of $250.0 million, (iv) higher net distributions from the
TiO2 manufacturing joint venture of $9.1 million in the first nine months of
2004 compared to a $2.2 million distribution in the first nine months of 2003,
(v) a higher amount of net cash provided by relative changes in the Company's
inventories, receivables, payables and accruals and accounts with affiliates of
$34.8 million in the first nine months of 2004 as compared to the first nine
months of 2003 and (vi) lower net cash received for income taxes of $10.9
million. 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.
Investing and financing activities
The Company's capital expenditures were $23.7 million and $21.4 million in
the first nine months of 2003 and 2004, respectively.
In the first quarter of 2004 KII's operating subsidiaries in Germany,
Belgium and Norway borrowed a net Euro 26 million ($32 million when borrowed)
under the European revolving credit facility at an interest rate of 3.8%. Such
amounts were repaid in the second quarter of 2004. As stated in Note 6 to the
Consolidated Financial statements, one of KII's operating subsidiaries borrowed
Euro 10 million in October 2004 under the European revolving credit facility.
The Company currently expects to repay such Euro 10 million of borrowing by the
end of the year.
In October 2004, Valcor distributed its note receivable from Kronos to
Valhi, and subsequently Kronos prepaid $100.0 million on the note payable to
Valhi (including accrued interest) principally using available cash on hand.
In each of the first, second and third quarters of 2004, the Company paid a
regular quarterly dividend to stockholders of $.25 per share, aggregating $36.7
million.
At September 30, 2004, unused credit available under Kronos' existing
credit facilities approximated $144 million, which was comprised of: $95 million
under its European revolving credit facility, $8 million under its Canadian
credit facility, $38 million under its U.S. credit facility and $3 million under
other non-US facilities. At September 30, 2004, KII had approximately $220
million available for payment of dividends and other restrictive payments as
defined in the Senior Secured Notes indenture.
Provisions contained in certain of Kronos' credit agreements could result
in the acceleration of the applicable indebtedness prior to its stated maturity
for reasons other than defaults from failing to comply with typical financial
covenants. For example, certain credit agreements allow the lender to accelerate
the maturity of the indebtedness upon a change of control (as defined) of the
borrower. In addition, certain credit agreements could result in the
acceleration of all or a portion of the indebtedness following a sale of assets
outside the ordinary course of business. Other than operating leases discussed
in the 2003 Annual Report, neither Kronos nor any of its subsidiaries or
affiliates are parties to any off-balance sheet financing arrangements.
In October 2004, the Company filed a registration statement with the SEC
for a proposed offering of up to 8.25 million shares of its common stock. The
registration statement has not yet been declared effective by the SEC. There can
be no assurance that the registration statement will be declared effective, or
if declared effective, that the offering would be completed. The securities may
not be offered for sale or sold nor may offers to buy be accepted prior to the
time the registration statement becomes effective. If the offering is completed,
the Company would use a portion of the net proceeds from such offering to repay
the remaining balance of its long-term notes payable to affiliates, with the
balance of the net proceeds available for the Company's general corporate
purposes, including possible acquisitions.
Cash, cash equivalents, restricted cash and restricted marketable debt
securities
At September 30, 2004, the Company and its subsidiaries had (i) current
cash and cash equivalents aggregating $118.5 million ($81.8 million held by
non-U.S. subsidiaries), (ii) current restricted cash equivalents of $900,000 and
(iii) noncurrent restricted marketable debt securities of $2.6 million.
At September 30, 2004, Kronos' outstanding debt was comprised of (i) $350.2
million related to KII's Senior Secured Notes and (ii) approximately $300,000 of
other indebtedness. In addition, Kronos had $200 million long-term notes payable
to affiliates due in 2010.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact Kronos' earnings and operating cash
flows. Cash flows from operations is considered the primary source of liquidity
for Kronos. Changes in TiO2 pricing, production volumes and customer demand,
among other things, could significantly affect the liquidity of Kronos.
See Note 9 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of Kronos' income tax
returns in various U.S. and non-U.S. jurisdictions, and see Note 12 to the
Consolidated Financial Statements with respect to certain legal proceedings with
respect to Kronos.
Kronos 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, Kronos has in the past and may in the future seek to reduce, refinance,
repurchase or restructure indebtedness, raise additional capital, repurchase
shares of its common stock, 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, Kronos 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, Kronos may
consider using its available cash, issuing its equity securities or increasing
its indebtedness to the extent permitted by the agreements governing Kronos'
existing debt.
Kronos has 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 Kronos' assets and liabilities related to its non-U.S. operations,
and therefore Kronos' 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 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 4. 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, 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 September 30, 2004. Based upon their evaluation, these
executive officers have concluded that the Company's disclosure controls and
procedures are effective as of the date of such evaluation.
The Company also maintains a system of internal controls over financial
reporting. The term "internal control over financial reporting," as defined by
regulations of the SEC, means a process designed by, or under the supervision
of, the Company's principal executive and principal financial officers, or
persons performing similar functions, and effected by the Company's board of
directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with GAAP, and includes
those policies and procedures that:
o Pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the
assets of the Company,
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with GAAP, and
that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company,
and
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the Company's consolidated financial
statements.
There has been no change to the Company's system of internal controls over
financial reporting during the quarter ended September 30, 2004 that has
materially affected, or is reasonably likely to materially affect, the Company's
system of internal controls over financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 will require the Company to
annually include a management report on internal control over financial
reporting starting in the Company's Annual Report on Form 10-K for the year
ended December 31, 2004. The Company's independent auditors will also be
required to annually attest to the Company's internal control over financial
reporting. In order to achieve compliance with Section 404, the Company has been
documenting, testing and evaluating its internal control over financial
reporting since 2003, using a combination of internal and external resources.
The process of documenting, testing and evaluating the Company's internal
control over financial reporting under the applicable guidelines is complex and
time consuming, and available internal and external resources necessary to
assist the Company in the documentation and testing required to comply with
Section 404 are limited. While the Company currently believes it has dedicated
the appropriate resources and that it will be able to fully comply with Section
404 in its Annual Report on Form 10-K for the year ended December 31, 2004 and
be in a position to conclude that the Company's internal control over financial
reporting is effective as of December 31, 2004, because the applicable
requirements are complex and time consuming, and because currently unforeseen
events or circumstances beyond the Company's control could arise, there can be
no assurance that the Company will ultimately be able to fully comply with
Section 404 in its Annual Report on Form 10-K for the year ended December 31,
2004 or whether it will be able to conclude the Company's internal control over
financial reporting is effective as of December 31, 2004.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 12 of the Consolidated Financial Statements, the
2003 Annual Report and the Company's Quarterly Reports on Forms 10-Q for the
quarters ended March 31, 2004 and June 30, 2004 for descriptions of certain
legal proceedings.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
The Company has retained a signed original of any exhibit listed below
that contains signatures, and the Company will provide any such
exhibit to the SEC or its staff upon request. The Company will also
furnish, without charge, a copy of its Code of Business Conduct and
Ethics, its Audit Committee Charter and its Corporate Governance
Guidelines, each as approved by the Company's board of directors and
each of which are also available at the Company's website at
www.kronosww.com, upon request. Such requests should be directed to
the attention of the Company's corporate secretary at the Company's
corporate offices located at 5430 LBJ Freeway, Suite 1700, Dallas,
Texas 75240.
10.1 - First Amendment Agreement, dated September 3, 2004, Relating to
a Facility Agreement dated June 25, 2002 among Kronos Titan GmbH,
Kronos Europe S.A./N.V., Kronos Titan AS and Titania A/S, as
borrowers, Kronos Titan GmbH, Kronos Europe S.A./N.V. and Kronos
Norge AS, as guarantors, Kronos Denmark ApS, as security
provider, with Deutsche Bank Luxembourg S.A., acting as agent -
incorporated by reference to Exhibit 10.8 to the Registration
Statement on Form S-1 of the Registrant (File No. 333-119639).
10.2 - Promissory Note dated September 24, 2004 in the original
principal amount of $31,422,500.00 payable to the order of NL
Industries, Inc. and executed by the Registrant - incorporated by
reference to Exhibit 10.2 to the Current Report on Form 8-K of NL
Industries, Inc. (File No. 1-640) dated September 24, 2004.
10.3 - Promissory Note dated September 24, 2004 in the original
principal amount of $162,500,000.00 payable to the order of
Valcor, Inc. and executed by the Registrant - incorporated by
reference to Exhibit 99.1 to the Current Report on Form 8-K of NL
Industries, Inc. (File No. 1-640) dated September 24, 2004.
10.4 - Promissory Note dated September 24, 2004 in the original
principal amount of $6,077,500.00 payable to the order of Valhi,
Inc. and executed by the Registrant - incorporated by reference
to Exhibit 99.2 to the Current Report on Form 8-K of NL
Industries, Inc. (File No. 1-640) dated September 24, 2004.
31.1 - Certification
31.2 - Certification
32.1 - Certification
(b) Reports on Form 8-K
Reports on Form 8-K for the quarter ended September 30, 2004.
August 6, 2004 - Reported Item 9 and Item 12.
September 1, 2004 - Reported Item 7.01 and Item 9.
September 7, 2004 - Reported Item 2.03
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 Worldwide, Inc.
---------------------------------
(Registrant)
Date November 8, 2004 By /s/ Gregory M. Swalwell
---------------- -------------------------
Gregory M. Swalwell
Vice President, Finance and
Chief Financial Officer
(Principal Financial Officer)
Date November 8, 2004 By /s/ James W. Brown
---------------- -------------------------
James W. Brown
Vice President and Controller
(Principal Accounting Officer)