Kronos(KRO) - 2018 Q4 - Annual Report

Part I Business The company is a leading global producer of TiO2 pigments, serving diverse markets with complementary mining and chemical operations - Kronos is a leading global producer and marketer of TiO2, selling to approximately 4,000 customers in 100 countries[11] - At December 31, 2018, a concentrated ownership structure exists, with approximately 50% of common stock owned by Valhi, Inc., and 30% by a subsidiary of NL Industries, Inc[15] Products and End-Use Markets The company's sales are dominated by over 40 grades of TiO2 pigments, with complementary businesses contributing a smaller portion 2018 Sales Volume Percentages | By Geographic Region | % | By End-Use | % | | :--- | :--- | :--- | :--- | | Europe | 44% | Coatings | 56% | | North America | 37% | Plastics | 27% | | Asia Pacific | 10% | Paper | 7% | | Rest of World | 9% | Other | 10% | - Sales of core TiO2 pigments represented approximately 94% of net sales in 2018, with the company offering over 40 different pigment grades under the KRONOS® trademark[19] - The company's TiO2 business is supported by three complementary businesses which comprised about 6% of net sales in 2018: ilmenite mining, iron-based chemicals, and specialty titanium chemicals[26][27] Manufacturing, Operations, and Properties The company operates TiO2 plants globally using both chloride and sulfate processes, supported by its own ilmenite mining operations - The company produces TiO2 using both chloride (74% of capacity) and sulfate (26% of capacity) processes, with 2018 production at 536,000 metric tons and an average capacity utilization rate of approximately 95%[29][31] - Kronos operates TiO2 plants in Germany, Belgium, Norway, and Canada, and has a 50% interest in a joint venture plant in Lake Charles, Louisiana[30] - The company owns and operates two ilmenite mines in Norway under an unlimited governmental concession, securing feedstock for its European plants[27][42] Raw Materials The company relies on titanium-containing feedstock, chlorine, coke, and sulfuric acid sourced from a limited number of suppliers - Primary raw materials are titanium-containing feedstock (rutile ore, slag, ilmenite), chlorine, coke, and sulfuric acid, sourced from a limited number of suppliers under long-term contracts[40][42] Raw Materials Procured or Mined in 2018 (in thousands of metric tons) | Production Process/Raw Material | Amount | | :--- | :--- | | Chloride process plants: | | | Purchased slag or rutile ore | 430 | | Sulfate process plants: | | | Ilmenite ore mined and used internally | 328 | | Purchased slag | 24 | Competition The TiO2 industry is highly concentrated and competitive, with significant barriers to entry due to high capital costs and technology - The TiO2 industry is highly competitive, with the top six producers accounting for approximately 58% of world production capacity[53][80] Estimated Worldwide Production Capacity - 2018 | Company | Capacity Share | | :--- | :--- | | Chemours | 16% | | Cristal | 11% | | Venator | 9% | | Lomon Billions | 9% | | Kronos | 7% | | Tronox | 6% | | Other | 42% | - Competition is based on price, product quality, technical service, and availability, with high barriers to entry due to capital costs and proprietary technology[52][58] Employees The company's workforce is primarily based in Europe, with a high percentage of employees covered by collective bargaining agreements - As of December 31, 2018, the company employed 2,195 people, with the majority (1,805) in Europe[64] - Approximately 86% of the worldwide workforce is organized under collective bargaining agreements[66] Risk Factors The company faces significant risks from industry cyclicality, competition, raw material costs, high leverage, and global operations - The company's profitability is highly dependent on the cyclical TiO2 industry, which accounted for 94% of 2018 sales[78][79] - The company has significant leverage, with total consolidated debt of approximately $456.6 million as of December 31, 2018, which could limit operational flexibility[84] - Higher costs or limited availability of raw materials pose a risk, with minimum purchase commitments of approximately $594 million for feedstock subsequent to December 31, 2018[82][83] - As a global business with 44% of 2018 sales volumes in Europe, the company is subject to risks from currency fluctuations and trade barriers[88][89] Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - None[99] Properties Information regarding the company's properties is incorporated by reference from the Business section of this report - Information on properties is incorporated by reference to Item 1: Manufacturing, Operations and Properties[99] Legal Proceedings Details concerning legal proceedings are incorporated by reference from the notes to the Consolidated Financial Statements - Information is incorporated by reference to Note 16 to the Consolidated Financial Statements[100] Mine Safety Disclosures This section is not applicable to the company - Not applicable[101] Part II Market for Common Equity and Related Stockholder Matters The company's stock (NYSE: KRO) has an active repurchase plan and has underperformed the S&P 500 over the last five years - The company's common stock is listed on the New York Stock Exchange (symbol: KRO)[102] - A stock repurchase plan was authorized in December 2010, with 1,951,000 shares remaining available for repurchase as of December 31, 2018[103] Comparison of 5-Year Cumulative Total Return | | 2013 | 2014 | 2015 | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Kronos common stock | $100 | $71 | $33 | $77 | $170 | $79 | | S&P 500 Composite Stock Index | $100 | $114 | $115 | $129 | $157 | $150 | | Peer Group | $100 | $108 | $19 | $76 | $141 | $68 | Selected Financial Data A five-year summary shows peak net sales and income in 2017, with a decline in 2018 Selected Financial Data (2014-2018, in millions, except per share data) | | 2014 | 2015 | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | :--- | :--- | | STATEMENTS OF OPERATIONS DATA: | | | | | | | Net sales | $1,651.9 | $1,348.8 | $1,364.3 | $1,729.0 | $1,661.9 | | Income from operations | $161.4 | $11.0 | $92.9 | $347.8 | $330.1 | | Net income (loss) | $99.2 | $(173.6) | $43.3 | $354.5 | $205.0 | | Net income (loss) per share | $0.86 | $(1.50) | $0.37 | $3.06 | $1.77 | | BALANCE SHEET DATA (at year end): | | | | | | | Total assets | $1,633.1 | $1,242.7 | $1,179.6 | $1,824.4 | $1,898.1 | | Notes payable and long-term debt | $343.6 | $341.0 | $339.0 | $474.5 | $456.6 | | OPERATING STATISTICS: TiO2 (k metric tons) | | | | | | | Sales volumes | 496 | 525 | 559 | 586 | 491 | | Production volumes | 511 | 528 | 546 | 576 | 536 | Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) Management discusses financial results, highlighting impacts from TiO2 pricing and volumes, and provides an outlook for 2019 Results of Operations Operating results declined in 2018 after a strong 2017, driven by changes in TiO2 sales volumes and selling prices Comparison of 2018 to 2017 Results (in millions) | | 2017 | 2018 | % Change | | :--- | :--- | :--- | :--- | | Net sales | $1,729.0 | $1,661.9 | (4)% | | Gross margin | $569.7 | $562.2 | (1)% | | Income from operations | $347.8 | $330.1 | (5)% | | TiO2 Sales volumes (k tons) | 586 | 491 | (16)% | | TiO2 Production volumes (k tons) | 576 | 536 | (7)% | - The 4% decrease in net sales in 2018 was due to a 16% decrease in sales volumes, partially offset by a 13% increase in average TiO2 selling prices[130][131] Comparison of 2017 to 2016 Results (in millions) | | 2016 | 2017 | % Change | | :--- | :--- | :--- | :--- | | Net sales | $1,364.3 | $1,729.0 | 27% | | Gross margin | $264.7 | $569.7 | 115% | | Income from operations | $92.9 | $347.8 | 274% | | TiO2 Sales volumes (k tons) | 559 | 586 | 5% | | TiO2 Production volumes (k tons) | 546 | 576 | 5% | - The 27% increase in net sales in 2017 was driven by a 22% increase in average TiO2 selling prices and a 5% increase in sales volumes[152] - Outlook for 2019: The company expects sales to be higher than 2018 due to higher sales volumes, but income from operations to be lower due to lower expected selling prices and higher raw material costs[171] Critical Accounting Policies and Estimates Key accounting estimates relate to asset recoverability, pension obligations, and the realization of deferred income tax assets - Key estimates involve the recoverability of long-lived assets, defined benefit pension plan obligations, and the realization of deferred income tax assets[119][121] - The company reversed its deferred income tax asset valuation allowance for German and Belgian operations in 2017, concluding that realization was more-likely-than-not[122] - Following the 2017 Tax Act, the company determined that undistributed earnings of its European subsidiaries are no longer permanently reinvested[123] Liquidity and Capital Resources The company maintains liquidity through operations and has significant debt, with planned capital expenditures of $85 million for 2019 Consolidated Cash Flows (in millions) | | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $89.6 | $276.1 | $188.5 | | Net cash used in investing activities | $(53.0) | $(77.9) | $(42.7) | | Net cash provided by (used in) financing activities | $(73.3) | $58.8 | $(80.4) | - Cash from operations decreased by $87.6 million in 2018 compared to 2017, primarily due to lower income from operations and higher cash taxes paid[195] - At Dec 31, 2018, the company had total debt of $456.6 million, primarily consisting of €400 million in 3.75% Senior Secured Notes due 2025[206][209] - The company had $373.3 million in cash and cash equivalents at Dec 31, 2018, with $118.5 million held by non-U.S. entities[213] - Capital expenditures for 2019 are planned to be approximately $85 million, including $25 million for environmental compliance programs[215] Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risks from currency exchange rates, commodity prices, and the value of its equity securities - The company's primary market risks are from changes in interest rates, currency exchange rates, and prices of equity securities and raw materials[224] - Currency exchange rate risk is significant; a hypothetical 10% adverse change in exchange rates would increase the U.S. dollar equivalent of its euro-denominated debt by approximately $46 million as of Dec 31, 2018[228][231] - The company is exposed to market risk from its marketable securities portfolio, which had a fair value of $3.4 million at Dec 31, 2018[232] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of year-end 2018 - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of December 31, 2018[238] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2018, based on the 2013 COSO framework[240] - PricewaterhouseCoopers LLP audited and issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of December 31, 2018[241] Part III Directors, Executive Officers and Corporate Governance Information concerning directors, executive officers, and corporate governance is incorporated by reference from the 2019 proxy statement - Information is incorporated by reference from the Registrant's definitive proxy statement to be filed within 120 days after the fiscal year end[248] Executive Compensation Information regarding executive compensation is incorporated by reference from the company's 2019 proxy statement - Information is incorporated by reference from the 2019 proxy statement[249] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Details on security ownership are incorporated by reference from the company's 2019 proxy statement - Information is incorporated by reference from the 2019 proxy statement[250] Certain Relationships and Related Transactions, and Director Independence Information on related party transactions and director independence is incorporated by reference from the 2019 proxy statement - Information is incorporated by reference from the 2019 proxy statement and Note 15 to the Consolidated Financial Statements[251] Principal Accounting Fees and Services Information regarding principal accounting fees and services is incorporated by reference from the 2019 proxy statement - Information is incorporated by reference from the 2019 proxy statement[252] Part IV Exhibits and Financial Statement Schedules This section lists the financial statements and exhibits filed as part of the Annual Report - The consolidated financial statements of the Registrant are filed as part of the Annual Report[254] - An index of exhibits is provided, including key agreements such as the Indenture for the Senior Secured Notes and intercompany service agreements[258][259] Financial Statements Report of Independent Registered Public Accounting Firm PricewaterhouseCoopers LLP issued unqualified opinions on the company's financial statements and internal controls over financial reporting - PricewaterhouseCoopers LLP expressed an unqualified opinion that the financial statements are fairly presented in accordance with U.S. GAAP[269] - The firm also opined that the Company maintained effective internal control over financial reporting as of December 31, 2018[269] Consolidated Financial Statements The statements show a financial position with $1.90 billion in assets and 2018 net income of $205.0 million Consolidated Balance Sheet Highlights (in millions) | | Dec 31, 2017 | Dec 31, 2018 | | :--- | :--- | :--- | | Total current assets | $1,062.5 | $1,201.4 | | Total assets | $1,824.4 | $1,898.1 | | Total current liabilities | $231.5 | $233.4 | | Long-term debt | $473.8 | $455.1 | | Total stockholders' equity | $754.3 | $839.8 | Consolidated Statement of Income Highlights (in millions) | | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Net sales | $1,364.3 | $1,729.0 | $1,661.9 | | Gross margin | $264.7 | $569.7 | $562.2 | | Income from operations | $92.9 | $347.8 | $330.1 | | Net income | $43.3 | $354.5 | $205.0 | Note 13 – Income Taxes Income tax expense in 2018 contrasts with a 2017 benefit, which was driven by valuation allowance reversals and the U.S. Tax Act Income Tax Expense (Benefit) Reconciliation (in millions) | | 2016 | 2017 | 2018 | | :--- | :--- | :--- | :--- | | Pre-tax income | $61.2 | $305.7 | $293.8 | | Expected tax expense at U.S. rate | $21.4 | $107.0 | $61.7 | | Valuation allowance | $(2.2) | $(205.4) | - | | Transition Tax | - | $76.2 | $(1.7) | | Income tax expense (benefit) | $17.9 | $(48.8) | $88.8 | - In 2017, the company recognized a net income tax benefit of $136.5 million, primarily from the reversal of valuation allowances offset by the provisional Transition Tax expense[137][139] - As of Dec 31, 2018, the company has substantial net operating loss (NOL) carryforwards in Germany ($541 million) and Belgium ($16 million), all with indefinite carryforward periods[386] Note 15 – Related Party Transactions The company engages in significant transactions with affiliated entities for services, supplies, and financing - Purchases of TiO2 from the 50%-owned joint venture, LPC, were $165.9 million in 2018, while sales of feedstock to LPC were $66.9 million[407] - The company is charged for management and administrative services by related parties, with net fees amounting to $21.1 million in 2018[411] - The company participates in a group insurance program with other Contran affiliates, with premiums and fees paid to related entities totaling $10.4 million in 2018[412] Note 16 – Commitments and Contingencies The company has substantial future commitments for raw material purchases and operating leases - The company has long-term supply contracts for TiO2 feedstock with minimum purchase commitments of approximately $594 million for years subsequent to December 31, 2018[420] - Future minimum payments under non-cancellable operating leases total $42.5 million at December 31, 2018[423] - The company's largest customer concentration risk was one customer accounting for approximately 10% of net sales in 2016, with no single customer reaching that threshold in 2017 or 2018[418]