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KRONOS WORLDWIDE INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) RESULTS OF OPERATIONS: Business 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 coatings, plastics, paper and other industrial and specialty products. For the nine months ended September 30, 2014, approximately one-half of our sales volumes were into European markets. Our production facilities are located in Europe and North America. We consider TiO2 to be a "quality of life" product, with demand affected by gross domestic product, or GDP, and overall economic conditions in our markets located in various regions of the world. Over the long-term, we expect 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 influenced in part by their expectations for future changes in TiO2 market selling prices as well as their expectations for future availability of product. Although certain of our TiO2 grades are considered specialty pigments, the majority of our grades and substantially all of our production are considered commodity pigment products, with price and availability being the most significant competitive factors along with quality and customer service. The factors having the most impact on our reported operating results are: - our TiO2 sales and production volumes, - TiO2 selling prices, - manufacturing costs, particularly raw materials, maintenance and energy-related expenses and - currency exchange rates (particularly the exchange rate for the U.S. dollar relative to the euro, Norwegian krone and the Canadian dollar). Our key performance indicators are our TiO2 average selling prices, our level of TiO2 sales and production volumes and the cost of our third-party feedstock ore. TiO2 selling prices generally follow industry trends and prices will increase or decrease generally as a result of competitive market pressures. Executive summary We reported net income of $31.9 million, or $.28 per share, in the third quarter of 2014 as compared to a net loss of $29.9 million, or $.26 per share, in the third quarter of 2013. For the first nine months of 2014, we reported net income of $79.3 million, or $.68 per share, compared to a net loss of $104.9 million, or $.91 per share, in the first nine months of 2013. We reported net income in the third quarter of 2014 compared to a loss in the third quarter of 2013 principally due to improved results from operations resulting primarily from lower raw material costs and higher production and sales volumes, partially offset by lower average selling prices as well as a third quarter 2013 litigation settlement charge. We reported net income in the first nine months of 2014 compared to a loss in the first nine months of 2013 principally due to improved results from operations resulting primarily from lower raw material costs and higher production volumes, partially offset by lower average selling prices and lower sales volumes in 2014 as well as the third quarter 2013 litigation settlement charge. Our results in the first nine months of 2014 include a second quarter aggregate non-cash income tax benefit of $5.7 million ($.05 per share) related to a net reduction in our reserve for uncertain tax positions. Our results in the first nine months of 2013 include a first quarter non-cash pre-tax charge of $6.6 million ($4.3 million, or $.04 per share, net of income tax benefit) and a third quarter charge of $2.3 million ($1.5 million, or $.01 per share, net of income tax benefit) related to the voluntary prepayment of $290 million and $100 million principal amount, respectively, of our term loan, consisting of the write-off of original issue discount costs and deferred financing costs associated with such prepayments. Our results in the third quarter of 2013 also include a pre-tax litigation settlement expense of $35 million ($22.5 million, or $.19 per share, net of income tax benefit). Forward-looking information This report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Statements in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking in nature and represent management's beliefs and assumptions based on currently available information. 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 - 19 - -------------------------------------------------------------------------------- forward-looking statements that represent our management's beliefs and assumptions based on currently available information. In some cases you can identify forward-looking statements 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 we believe the expectations reflected in forward-looking statements are reasonable, we do not know if these expectations will be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly impact expected results. Actual future results could differ materially from those predicted. 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 are not limited to, the following: - Future supply and demand for our products - The extent of the dependence of certain of our businesses on certain market sectors - The cyclicality of our business - Customer and producer inventory levels - Unexpected or earlier-than-expected industry capacity expansion - Changes in raw material and other operating costs (such as ore and energy costs) - Changes in the availability of raw materials (such as ore) - 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) - Competitive products and substitute products - Customer and competitor strategies - Potential consolidation of our competitors - Potential consolidation of our customers - The impact of pricing and production decisions - Competitive technology positions - The introduction of trade barriers - Possible disruption of our business, or increases in our cost of doing business, resulting from terrorist activities or global conflicts - Fluctuations in currency exchange rates (such as changes in the exchange rate between the U.S. dollar and each of the euro, the Norwegian krone and the Canadian dollar), or possible disruptions to our business resulting from potential instability resulting from uncertainties associated with the euro - Operating interruptions (including, but not limited to, labor disputes, leaks, natural disasters, fires, explosions, unscheduled or unplanned downtime, transportation interruptions and cyber attacks) - Our ability to renew or refinance credit facilities - Our ability to maintain sufficient liquidity - The ultimate outcome of income tax audits, tax settlement initiatives or other tax matters - Our ability to utilize income tax attributes, the benefits of which have been recognized under the more-likely-than-not recognition criteria - Environmental matters (such as those requiring compliance with emission and discharge standards for existing and new facilities) - Government laws and regulations and possible changes therein - The ultimate resolution of pending litigation - 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. - 20 - -------------------------------------------------------------------------------- Results of operations Current industry conditions As previously discussed, after about a year of decreasing selling prices within the TiO2 industry, our TiO2 selling prices were generally stable during the second half of 2013. Our average selling prices at the end of the third quarter of 2014 were 7% lower than at the end of 2013, with most of the decline occurring in the first half of the year, and with lower prices in all major markets, most notably in certain export markets. We experienced significantly lower sales to our generally lower-margin export markets in the first half of 2014 compared to the same period of 2013, however we experienced higher sales in most major markets, including the export markets, in the third quarter of 2014 as compared to the third quarter of 2013. Demand for TiO2 products has generally been stable in 2014 in most European and North American markets. We operated our production facilities at reduced capacity rates in 2013 (approximately 92%, 90%, 82% and 81% of practical capacity in the first through fourth quarter periods, respectively). While our production capacity utilization rates in the second half of 2013 were impacted by the union labor lockout at our Canadian production facility that ended in December 2013, our utilization rates were also impacted by such lockout in the first quarter of 2014, as restart of production at the facility did not begin until February 2014. We operated our production facilities at overall average capacity utilization rates of 96% in the third quarter of 2014, compared to 90% in the first quarter and 97% in the second quarter of 2014. Our cost of sales per metric ton of TiO2 sold in 2013 (particularly in the first quarter) was significantly higher than TiO2 sold in the first nine months of 2014, as a substantial portion of the TiO2 products we sold in the first quarter (and to a lesser-extent the second quarter) of 2013 was produced with the higher-cost feedstock ore procured in 2012. We have seen moderation in the cost of TiO2 feedstock ore procured from third parties in 2013 and continuing into 2014, but such reductions did not begin to be significantly reflected in our cost of sales until the third quarter of 2013. Quarter ended September 30, 2014 compared to the quarter ended September 30, 2013 Three months ended September 30, 2013 2014 (Dollars in millions) Net sales $ 419.1 100 % $ 414.8 100 % Cost of sales 371.9 89 319.1 77 Gross margin 47.2 11 95.7 23 Other operating income and expense, net 84.2 20 47.8 11 Income (loss) from operations $ (37.0 ) (9 )% $ 47.9 12 % % Change TiO2 operating statistics: Sales volumes* 121 125 4 % Production volumes* 113 134 18 % Percentage change in net sales: TiO2 product pricing (6 )% TiO2 sales volumes 4 TiO2 product mix - Changes in currency exchange rates 1 Total (1 )% * Thousands of metric tons Net sales - Net sales in the third quarter of 2014 decreased 1%, or $4.3 million, compared to the third quarter of 2013 primarily due to the net effects of a 6% decrease in average TiO2 selling prices (which decreased net sales by approximately $25 million) and a 4% increase in sales volumes (which increased net sales by approximately $17 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs. Our sales volumes increased 4% in the third quarter of 2014 as compared to the third quarter of 2013 due to higher sales primarily in certain export and U.S. markets. We estimate that changes in currency exchange rates increased our net sales by approximately $3 million as compared to the third quarter of 2013. - 21 - -------------------------------------------------------------------------------- Cost of sales - Cost of sales decreased $52.8 million or 14% in the third quarter of 2014 compared to 2013 due to the net impact of lower raw materials and other production costs of approximately $50 million (primarily caused by the lower third-party feedstock ore costs, as discussed above), a 4% increase in sales volumes, an 18% increase in TiO2 production volumes and currency fluctuations (primarily the euro). In addition, in the third quarter of 2013 we recognized approximately $7 million in unabsorbed fixed production costs related to a union labor lockout at our Canadian production facility. Our cost of sales as a percentage of net sales decreased to 77% in the third quarter of 2014 compared to 89% in the same period of 2013, primarily due to lower raw material costs and lower unabsorbed fixed costs as discussed above. Other operating expense, net - Other operating expense in the third quarter of 2013 includes a $35 million litigation settlement charge. Gross margin and income (loss) from operations - Income from operations increased by $84.9 million from a loss of $37.0 million in the third quarter of 2013 to income of $47.9 million in the third quarter of 2014. Income (loss) from operations as a percentage of net sales increased to 12% in the third quarter of 2014 from (9)% in the same period of 2013. This increase was driven by the increase in gross margin, which increased to 23% for the third quarter of 2014 compared to 11% for the third quarter of 2013 and by the third quarter 2013 litigation settlement charge as discussed above. As discussed and quantified above, our gross margin increased primarily due to the net effect of lower manufacturing costs (primarily raw materials), higher production volumes, higher sales volumes and lower selling prices. Additionally, changes in currency exchange rates have positively affected our gross margin and income from operations. We estimate that changes in currency exchange rates increased income from operations by approximately $8 million in the third quarter of 2014 as compared to the same period in 2013. Other non-operating income (expense) - We recognized an aggregate $2.3 million pre-tax charge, consisting of the write-off of unamortized original issue discount costs and deferred financing costs, in the third quarter of 2013 related to the voluntary prepayment of the remaining $100 million principal amount of our prior term loan. See Note 7 to our Condensed Consolidated Financial Statements. Interest expense decreased $.6 million from $4.5 million in the third quarter of 2013 to $3.9 million in the third quarter of 2014 primarily due to lower average interest rates on our outstanding borrowings in the third quarter of 2014, partially offset by slightly higher average debt levels. We currently expect our interest expense for all of 2014 will be lower than 2013, as the favorable impact of lower average interest rates on outstanding borrowings will offset the impact of higher overall average debt levels resulting from the new term loan we issued in February 2014. Income tax expense (benefit) - We recognized income tax expense of $12.3 million in the third quarter of 2014 compared to a benefit of $13.6 million in the same period last year. This difference is primarily due to our increased earnings. See Note 8 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax provision to our actual tax provision. We have substantial net operating loss carryforwards in Germany (the equivalent of $842 million and $127 million for German corporate and trade tax purposes, respectively, at December 31, 2013) and in Belgium (the equivalent of $102 million for Belgian corporate tax purposes at December 31, 2013). At September 30, 2014, we have concluded that no deferred income tax asset valuation allowance is required to be recognized with respect to such carryforwards, principally because (i) such carryforwards have an indefinite carryforward period, (ii) we have utilized a portion of such German carryforwards during the most recent three-year period and (iii) we currently expect to utilize the remainder of such carryforwards over the long term. However, prior to the complete utilization of such carryforwards, particularly if we were to generate losses in our German and Belgian operations for an extended period of time, it is possible that we might conclude the benefit of such carryforwards would no longer meet the more-likely-than-not recognition criteria, at which point we would be required to recognize a valuation allowance against some or all of the then-remaining tax benefit associated with the carryforwards. - 22 - -------------------------------------------------------------------------------- Nine months ended September 30, 2014 compared to the nine months ended September 30, 2013 Nine months ended September 30, 2013 2014 (Dollars in millions) Net sales $ 1,363.8 100 % $ 1,278.4 100 % Cost of sales 1,303.1 96 1,008.4 79 Gross margin 60.7 4 270.0 21 Other operating income and expense, net 192.3 14 151.8 12 Income (loss) from operations $ (131.6 ) (10 )% $ 118.2 9 % % Change TiO2 operating statistics: Sales volumes* 397 380 (4 )% Production volumes* 359 388 8 % Percentage change in net sales: TiO2 product pricing (5 )% TiO2 sales volumes (4 ) TiO2 product mix 1 Changes in currency exchange rates 2 Total (6 )% * Thousands of metric tons Net sales - Net sales in the nine months ended September 30, 2014 decreased 6%, or $85.4 million, compared to the nine months ended September 30, 2013 primarily due to the effects of a 4% decrease in sales volumes (which decreased net sales by approximately $55 million) and a 5% decrease in average TiO2 selling prices (which decreased net sales by approximately $68 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs. Our sales volumes decreased 4% in the first nine months of 2014 as compared to the first nine months of 2013 primarily due to lower sales in certain export markets. We estimate that changes in currency exchange rates increased our net sales by approximately $23 million as compared to the first nine months of 2013. Cost of sales - Cost of sales decreased $294.7 million or 23% in the nine months ended September 30, 2014 compared to the same period in 2013 primarily due to the net impact of lower raw materials and other production costs of approximately $235 million (primarily caused by lower third-party feedstock ore costs), an 8% increase in TiO2 production volumes, a 4% decrease in sales volumes and currency fluctuations (primarily the euro). Our cost of sales as a percentage of net sales decreased to 79% in the first nine months of 2014 compared to 96% in the same period of 2013, primarily due to lower raw material costs and the approximately $7 million in unabsorbed fixed production costs related to the union labor lockout at our Canadian production facility, as discussed above. Other operating expense, net - Other operating expense in the first nine months of 2013 includes a third quarter litigation settlement charge of $35 million. Gross margin and income (loss) from operations - Income from operations increased by $249.8 million from a loss of $131.6 million in the first nine months of 2013 to income of $118.2 million in the first nine months of 2014. Income (loss) from operations as a percentage of net sales increased to 9% in the first nine months of 2014 from (10)% in the same period of 2013. This increase was driven by the increase in gross margin, which increased to 21% for the first nine months of 2014 compared to 4% for the first nine months of 2013 and by the 2013 litigation settlement charge as discussed above. As discussed and quantified above, our gross margin increased primarily due to the net effect of lower manufacturing costs (primarily raw materials), higher production volumes, lower selling prices and lower sales volumes. Additionally, changes in currency exchange rates have positively affected our gross margin and income from operations. We estimate that changes in currency exchange rates increased income from operations by approximately $28 million in the first nine months of 2014 as compared to the same period in 2013. Other non-operating expense - We recognized an aggregate $8.9 million pre-tax charge, consisting of the write-off of unamortized original issue discount costs and deferred financing costs, in the first and third quarters of 2013 related to the voluntary prepayment of our prior term loan by $290 million in the first quarter of 2013 and the remaining $100 million in the third quarter of 2013. See Note 7 to our Condensed Consolidated Financial Statements. - 23 - -------------------------------------------------------------------------------- Interest expense decreased $4.0 million from $16.6 million in the nine months ended September 30, 2013 to $12.6 million in the nine months ended September 30, 2014 primarily due to lower average interest rates on outstanding borrowings in the first nine months of 2014 partially offset by slightly higher average debt levels. Income tax expense (benefit) - We recognized income tax expense of $27.0 million in the first nine months of 2014 compared to an income tax benefit of $51.3 million in the same period last year. This difference is primarily due to our increased earnings. In addition, our income tax expense in the first nine months of 2014 was favorably impacted by an aggregate non-cash income tax benefit of $5.1 million related to a net reduction in our reserve for uncertain tax positions. See Note 8 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax provision to our actual tax provision. Effects of Currency Exchange Rates We have substantial operations and assets located outside the United States (primarily in Germany, Belgium, Norway and Canada). The majority of our sales from non-U.S. operations are denominated in currencies other than the U.S. dollar, principally the euro, other major European currencies and the Canadian dollar. A portion of our sales generated from our non-U.S. operations is 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 non-U.S. sales and operating results are subject to currency exchange rate fluctuations which may favorably or unfavorably impact reported earnings and may affect the comparability of period-to-period operating results. In addition to the impact of the translation of sales and expenses over time, our non-U.S. operations also generate currency transaction gains and losses which primarily relate to the difference between the currency exchange rates in effect when non-local currency sales or operating costs are initially accrued and when such amounts are settled with the non-local currency. Overall, we estimate that fluctuations in currency exchange rates had the following effects on our sales and income from operations for the periods indicated. Impact of changes in currency exchange rates three months ended September 30, 2014 vs September 30, 2013 Translation Transaction gains recognized gain/loss - Total currency impact of impact 2013 2014 Change rate changes 2014 vs 2013 (In millions) Impact on: Net sales $ - $ - $ - $ 3 $ 3 Income from operations - 3 3 5 8 Impact of changes in currency exchange rates nine months ended September 30, 2014 vs September 30, 2013 Translation Transaction gains recognized gain/loss - Total currency impact of impact 2013 2014 Change rate changes 2014 vs 2013 (In millions) Impact on:: Net sales $ - $ - $ - $ 23 $ 23 Income from operations come from operations (1 ) 3 4 24 28 - 24 - -------------------------------------------------------------------------------- Outlook During the first nine months of 2014 we operated our production facilities at 94% of practical capacity. This reflects an increased plant utilization rate as compared to the same period of 2013. While our production capacity utilization rates in the second half of 2013 were impacted by the lockout at our Canadian production facility that ended in December 2013, our utilization rates continued to be impacted by such lockout in the first quarter of 2014, as restart of production at the facility did not begin until February 2014. While we expect our production volumes to be higher in 2014 as compared to 2013, we expect to continue to operate below full production capacity in 2014. The less-than-full production utilization is principally due to the ramp-up of operations at our Canadian facility following the end of the lockout as well as the implementation of certain productivity-enhancing capital improvement projects at other facilities which will result in longer-than-normal maintenance shutdowns in certain instances. We will continue to monitor current and anticipated near-term customer demand levels and align our production and inventories accordingly. We experienced moderation in the cost of TiO2 feedstock ore procured in 2013 and continuing into 2014, and consequently our cost of sales per metric ton of TiO2 sold in the first nine months of 2014 was significantly lower than our cost of sales per metric ton of TiO2 sold in the first nine months of 2013. Given the time lag between when we procure third-party feedstock ore and when the TiO2 product produced with such third-party feedstock is sold and recognized in our cost of sales, we expect our cost of sales per metric ton of TiO2 sold in calendar 2014 will be lower than the cost of sales per metric ton of TiO2 sold in calendar 2013, and our cost of sales per metric ton of TiO2 sold in the fourth quarter of 2014 will be lower than the cost of sales per metric ton of TiO2 sold in the first nine months of 2014. Although the cost of feedstock ore has and continues to moderate, as discussed below our average TiO2 selling prices have declined during 2014. We started 2014 with selling prices 6% lower than the beginning of 2013, and prices declined by an additional 7% in the first nine months of 2014. Industry data indicates that overall TiO2 inventory held by producers has been significantly decreased. In addition, we believe most customers hold very low inventories of TiO2 with many operating on a just-in-time basis. As a result, lead times for delivery are increasing. With the strong sales volumes experienced in 2013 and in certain established markets during the first nine months of 2014, we continue to see evidence of improvement in demand for our TiO2 products in certain of our primary markets. The extent to which we will be able to achieve any price increases in the near term will depend on market conditions. Overall, we expect that income from operations in 2014 will be higher as compared to 2013, as a result of: - the favorable effect of lower third-party feedstock ore costs, - the favorable effects of anticipated higher production volumes in 2014 (in part from the resumption of production at our Canadian TiO2 production facility), and - the litigation settlement charge recognized in third quarter 2013. Due to the constraints of high capital costs and extended lead time associated with adding significant new TiO2 production capacity, especially for premium grades of TiO2 products produced from the chloride process, we believe increased and sustained profit margins will be necessary to financially justify major expansions of TiO2 production capacity required to meet expected future growth in demand. As a result of customer decisions over the last year and the resulting adverse effect on global TiO2 pricing, some industry projects to increase TiO2 production capacity have been cancelled or deferred indefinitely. Given the lead time required for such production capacity expansions, a shortage of TiO2 products could occur if economic conditions improve and global demand levels for TiO2 increase sufficiently. Our expectations for our future operating results are based upon a number of factors beyond our control, including worldwide growth of GDP, competition in the marketplace, continued operation of competitors, unexpected or earlier-than-expected capacity additions or reductions 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. Cash provided by operating activities was $26.5 million in the first nine months of 2014 compared to $60.8 million in the first nine months of 2013. This $34.3 million decrease in the amount of cash provided was primarily due to the net effects of the following: - higher income from operations in 2014 of $249.8 million, - 25 - --------------------------------------------------------------------------------- net cash used in 2014 of $122.4 million associated with relative changes in our inventories, receivables, payables and accruals as compared to net cash provided by such relative changes in 2013 of $178.0 million, primarily due to a significant amount of cash provided by relative changes in our inventories in 2013 resulting principally from lower inventory costs, - lower net cash paid for income taxes in 2014 of $13.9 million resulting from prior year decreased profitability and timing of tax payments, - higher net distributions from our TiO2 manufacturing joint venture in 2014 of $9.2 million, primarily due to the timing of the joint venture's working capital needs, and - lower cash paid for interest in 2014 of $4.8 million, primarily due to lower average interest rates on borrowings. Changes in working capital were affected by accounts receivable and inventory changes. As shown below: - Our average days sales outstanding, or DSO, increased from December 31, 2013 to September 30, 2014, due to higher average daily net sales resulting from higher sales volumes in the third quarter of 2014 as compared to the fourth quarter of 2013, partially offset by lower selling prices in the third quarter of 2014, and - Our average days sales in inventory, or DSI, decreased from December 31, 2013 to September 30, 2014 principally due to higher sales volumes in the third quarter of 2014 as compared to the fourth quarter of 2013, as well as higher inventory volumes offset by lower inventory raw material costs in 2014. For comparative purposes, we have also provided comparable prior year numbers below. December 31, September 30, December 31, September 30, 2012 2013 2013 2014 DSO 61 days 67 days 62 days 68 days DSI 102 days 57 days 75 days 68 days Investing activities Our capital expenditures of $49.9 million and $39.9 million in the nine months ended September 30, 2013 and 2014, respectively, were primarily to maintain and improve the cost effectiveness of our existing manufacturing facilities. In addition, we had a net reduction in restricted cash of $7.5 million in the nine months ended September 30, 2014, principally related to the release of certain restricted cash deposits upon the cancellation of certain letters of credit issued in connection with the appeal of a Canadian income tax assessment which was completed in our favor. See Notes 7 and 8 to our Condensed Consolidated Financial Statements. Financing activities During the nine months ended September 30, 2014, we: - borrowed $348.3 million on our new term loan and subsequently repaid $1.7 million, - repaid $170.0 million under our note payable with Contran, - borrowed $81.0 million on our revolving North American credit facility and subsequently repaid $92.1 million, and - paid quarterly dividends to stockholders aggregating $.45 per share ($52.1 million). Outstanding debt obligations At September 30, 2014, our consolidated debt comprised: - $348.2 million aggregate borrowing under our term loan ($346.7 million carrying amount, net of unamortized original issue discount) due in February 2020, and - approximately $2.9 million of other indebtedness. Our North American and European revolvers and our new term loan contain a number of covenants and restrictions which, among other things, restrict our ability to incur additional debt, incur liens, pay dividends or merge or consolidate with, or sell or transfer substantially all of our assets to, another entity, and contains other provisions and restrictive covenants customary in lending transactions of this type. Certain of our credit agreements contain provisions which could result in the acceleration of indebtedness prior to their stated maturity for reasons other than defaults for failure to comply with typical financial or payment 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 - 26 - -------------------------------------------------------------------------------- indebtedness following a sale of assets outside the ordinary course of business. Our European revolving credit facility also requires the maintenance of certain financial ratios, and one of such requirements is based on the ratio of net debt to the last twelve months EBITDA of the borrowers. In December 2013, the lenders under our European revolving credit facility granted a waiver through June 30, 2014 with respect to the financial test, but our ability to borrow any amounts under the facility was subject to the requirement that the borrowers maintain a specified level of EBITDA. We met the specified minimum level of EBITDA during the waiver period that ended June 30, 2014. We are in compliance with all of our debt covenants at September 30, 2014. We believe that we will be able to continue to comply with the financial covenants contained in our credit facilities through their maturity; however if future operating results differ materially from our expectations we may be unable to maintain compliance. We believe we have alternate sources of liquidity, including cash on hand and borrowings under our North American revolver, in order to adequately address any compliance issues which might arise. Neither our new term loan nor our North American revolving credit facility contains a financial maintenance covenant. Our assets consist primarily of investments in operating subsidiaries, and our ability to service parent-level obligations, including our term loan, depends in part upon the distribution of earnings of our subsidiaries, whether in the form of dividends, advances or payments on account of intercompany obligations or otherwise. The term loan is collateralized by, among other things, a first priority lien on (i) 100% of the common stock of certain of our U.S. wholly-owned subsidiaries, (ii) 65% of the common stock or other ownership interest of our Canadian subsidiary (Kronos Canada, Inc.) and certain first-tier European subsidiaries (Kronos Titan GmbH and Kronos Denmark ApS) and (iii) a $395.7 million unsecured promissory note issued by our wholly-owned subsidiary, Kronos International, Inc. (KII). The term loan is also collateralized by a second priority lien on our U.S. assets which collateralize our North American revolving credit facility. Our North American revolving credit facility is collateralized by, among other things, a first priority lien on the borrower's trade receivables and inventories. Our European revolving credit facility is collateralized by, among other things, the accounts receivable and inventories of the borrowers plus a limited pledge of all the other assets of the Belgian borrower. See Note 7 to our Condensed Consolidated Financial Statements. Future cash requirements Liquidity Our primary source of liquidity on an ongoing basis is cash flows from operating activities which is generally used to (i) fund working capital expenditures, (ii) repay any short-term indebtedness incurred for working capital purposes and (iii) provide for the payment of dividends. 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 and use the proceeds 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. 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, 2014, we had aggregate cash, cash equivalents and restricted cash on hand of $153.5 million, of which $71.1 million was held by non-U.S. subsidiaries. At September 30, 2014, we had approximately $97 million available for borrowing under our North American revolving credit facility. Based on the terms of our European credit facility (including the net debt to EBITDA financial test discussed above), and the borrowers' EBITDA over the last twelve months ending September 30, 2014, our borrowing availability at September 30, 2014 under this facility is approximately 53% of the credit facility, or €64 million ($81 million). We could borrow all available amounts under each of our credit facilities without violating our existing debt covenants. Based upon our expectation for the TiO2 industry and anticipated demands on cash resources, we expect to have sufficient liquidity to meet our short term obligations (defined as the twelve-month period ending September 30, 2015) and our long-term obligations (defined as the five- - 27 - --------------------------------------------------------------------------------year period ending September 30, 2019, our time period for long-term budgeting). If actual developments differ from our expectations, our liquidity could be adversely affected. Capital expenditures We currently estimate that we will invest approximately $68 million in capital expenditures to maintain and improve our existing facilities during 2014, including the $39.9 million we have spent through September 30, 2014. Stock repurchase program In December 2010 our board of directors authorized the repurchase of up to 2.0 million shares of our common stock in open market transactions, including block purchases, or in privately-negotiated transactions at unspecified prices and over an unspecified period of time. In 2013, we repurchased 49,000 shares under the plan and 1,951,000 shares are available for repurchase. Off-balance sheet financing We do not have any off-balance sheet financing agreements other than the operating leases discussed in our 2013 Annual Report. Commitments and contingencies See Notes 8 and 12 to the Condensed Consolidated Financial Statements for a description of certain income tax examinations currently underway and legal proceedings. Recent accounting pronouncements See Note 14 to our 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 2013 Annual Report. There have been no changes in our critical accounting policies during the first nine months of 2014. - 28 - -------------------------------------------------------------------------------- |