Tronox Holdings plc - Quarter Report: 2019 September (Form 10-Q)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Item 1.

Financial Statements (Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(Millions of U.S. dollars, except for shares)

For the three months and nine months ended September 30, 2019

TRONOX HOLDINGS PLC

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Continued)

(Unaudited)

(Millions of U.S. dollars, except for shares)

For the three months and nine months ended September 30, 2018

1.	The Company

Prior to March 27, 2019, Tronox Limited,a public limited company registered under the laws of the State of Western Australia, was the ultimate parent company of the Tronox group of companies. Effective March 27, 2019, Tronox Limited effected a redomiciliation transaction (the “Re-domicile Transaction”), effectively changing its jurisdiction of incorporation from Western Australia to England and Wales, by “top-hatting” the Tronox group of companies with Tronox Holdings plc (referred to herein as “Tronox,” “we,” “us,” or “our”), a public limited company registered under the laws of England and Wales. As a result of the Re-domicile Transaction, Tronox Limited became a wholly-owned subsidiary of Tronox Holdings plc.  The Re-domicile Transaction was implemented by two schemes of arrangement, pursuant to which Tronox Limited’s Class A and Class B ordinary shares were exchanged on a one-for-one basis for ordinary shares in Tronox Holdings plc, par value US $0.01 per share. As a result, the Class A ordinary shares of Tronox Limited were delisted from the New York Stock Exchange (“NYSE”) and the ordinary shares of Tronox Holdings plc were listed on the NYSE in its place. The Re-domicile Transaction had an impact on capital gains tax for our ordinary shares held by Exxaro Resources Limited (“Exxaro”). See “Exxaro Mineral Sands Transaction Completion Agreement” below for a discussion of our agreement with Exxaro associated with South African capital gains tax.

On April 10, 2019, we completed the acquisition from Tasnee of the TiO₂ business of The National Titanium Dioxide Company Ltd., a limited company organized under the laws of the Kingdom of Saudi Arabia (“Cristal”) (the “Cristal Transaction”). Including the Cristal operations, we now operate titanium-bearing mineral sand mines and beneficiation and smelting operations in Australia, South Africa and Brazil to produce feedstock materials that can be processed into TiO₂ for pigment, high purity titanium chemicals, including titanium tetrachloride, and Ultrafine© titanium dioxide used in certain specialty applications where nano-particulate TiO₂ is required. It is our long-term strategic goal to be fully vertically integrated and consume all of our feedstock materials in our own TiO₂ pigment facilities in the United States, Australia, Brazil, UK, France, Netherlands, China and the Kingdom of Saudi Arabia (“KSA”). We believe that full vertical integration is the best way to achieve our ultimate goal of delivering low cost, high-quality pigment to our coatings and other TiO₂ customers throughout the world. The mining, beneficiation and smelting of titanium bearing mineral sands creates meaningful quantities of zircon, which we also supply to customers around the world. See Note 2 below for further details on the Cristal Transaction.

In order to obtain regulatory approval for the Cristal Transaction, the Federal Trade Commission (“FTC”) required us to divest Cristal’s North American TiO2 business, which we sold to INEOS on May 1, 2019, for cash proceeds, net of transaction costs, of approximately $708 million, inclusive of an amount for an estimated working capital adjustment. The working capital adjustment was finalized subsequent to September 30, 2019, resulting in a reimbursement to INEOS of approximately $7 million in October 2019. The operating results of Cristal’s North American TiO₂ business, from the acquisition date to the date of divestiture, are included in a single caption entitled “Loss from discontinued operations, net of tax” in our unaudited Condensed Consolidated Statements of Operations.

On November 26, 2018, we, certain of our subsidiaries and Exxaro entered into the Exxaro Mineral Sands Transaction Completion Agreement (the “Completion Agreement”). The Completion Agreement (i) provides for the orderly sale of Exxaro’s remaining ownership interest in us, subject to market conditions, (ii) helped to facilitate the Re-domicile Transaction, and (iii) addressed several legacy issues related to our 2012 acquisition of Exxaro’s mineral sands business. Pursuant to the terms of the Completion Agreement, Tronox has covenanted to pay Exxaro an amount equal to any South African capital gains tax assessed on Exxaro in respect of any profit arising to it on a disposal of any of its ordinary shares subsequent to the Re-domicile Transaction where such tax would not have been assessed but for the Re-domicile Transaction.  Similarly, Exxaro has covenanted to pay Tronox an amount equal to any South African tax savings Exxaro may realize in certain situations from any tax relief that would not have arisen but for the Re-domicile Transaction.

Pursuant to the terms of the Completion Agreement, on May 9, 2019, we repurchased 14 million shares from Exxaro for an aggregate purchase price of approximately $200 million or $14.3185 per share plus fees of approximately $1 million. The share price was based upon a 5% discount to the 10 day volume weighted average price as of the day that Exxaro exercised their sale notice to us. Upon repurchase of the shares by the Company, the shares were cancelled. As a result of the sale of the 14 million shares on May 9, 2019, we have recorded a liability of approximately $6 million  which is included in “Accrued liabilities” in our unaudited Condensed Consolidated Balance Sheets as of September 30, 2019.

At  September 30, 2019, Exxaro continues to own approximately 14.7 million shares of Tronox, or a 10.4% ownership interest, as well as their 26% ownership interest in our South African operating subsidiaries. Under the terms of the Completion Agreement, Exxaro has the right to sell its ownership in Tronox at any time. At the present time we are unable to reasonably determine when and if Exxaro will sell its remaining shares in the foreseeable future, and as a result, we are not able to estimate what the capital gains tax impacts would be should Exxaro sell its remaining shares. See Note 23 for additional information.

Furthermore, pursuant to the Completion Agreement, the parties agreed to accelerate our purchase of Exxaro’s 26% membership interest in Tronox Sands LLP, a U.K. limited liability partnership (“Tronox Sands”). On February 15, 2019, we completed the redemption of Exxaro’s ownership interest in Tronox Sands for consideration of approximately ZAR 2.06 billion (or approximately $148 million) in cash, which represented Exxaro’s indirect share of the loan accounts in our South African subsidiaries.

The acquisition of Cristal has impacted the comparability of our financial statements. As the Cristal Transaction was completed on April 10, 2019, in accordance with ASC 805, the three and nine month periods ended September 30, 2019, only include the results of the Cristal business since the date of the acquisition, while the three and nine month periods ended September 30, 2018 do not include any results of Cristal. Likewise, the balance sheet at September 30, 2019 includes the impacts of the acquisition of Cristal while the balance sheet at December 31, 2018 does not.

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases (“ASU 2016-02”) which includes a lessee accounting model that recognizes two types of leases - finance leases and operating leases. The new standard requires a lessee to recognize on the balance sheet, for all leases of more than 12 months, a lease liability, which corresponds to the discounted obligation of future lease payments arising from a lease, and a right-of-use (“ROU”) asset, which represents the lessee’s right to use, or control the use of, the underlying asset over the lease term.

2.	Cristal Acquisition and Related Divestitures

On April 10, 2019, we completed the acquisition of the TiO₂ business of Cristal for $1.675 billion of cash, subject to a working capital and noncurrent liability adjustment, plus 37,580,000 ordinary shares. The total acquisition price, including the value of the ordinary shares at $14 per share on the closing date of the Cristal Transaction, was approximately $2.2 billion, subject to a working capital and noncurrent liability adjustment. With the acquisition of our shares, an affiliate of Cristal became our largest shareholder. At September 30, 2019, Cristal International Holdings B.V. (formerly known as Cristal Inorganic Chemical Netherlands Cooperatief W.A.), a wholly-owned subsidiary of Tasnee, continues to own 37,580,000 shares of Tronox, or a 26% ownership interest.

In order to obtain regulatory approval for the Cristal Transaction, the FTC required us to divest Cristal's North American TiO2 business, which we sold to INEOS on May 1, 2019, for cash proceeds, net of transaction costs, of $708 million, inclusive of an amount for an estimated working capital adjustment. The working capital adjustment was finalized subsequent to September 30, 2019, resulting in a reimbursement to INEOS of approximately $7 million in October 2019. The operating results of Cristal’s North American TiO₂ business from the acquisition date to the date of divestiture are included in a single caption entitled “Loss from discontinued operations, net of tax” in our unaudited Condensed Consolidated Statements of Operations. Additionally, “Loss from discontinued operations, net of tax” also includes the operating results of Cristal Metals which encompasses a production facility in Ottawa, IL that produced titanium metal and alloy powders. The assets and liabilities of Cristal Metals continue to be included in assets and liabilities held for sale. We are in the process of exiting the business. See Note 5 for additional information on discontinued operations.

In conjunction with the Cristal Transaction, we entered into a transition services agreement with Tasnee and certain of its affiliates under which we and the Tasnee entities will provide certain transition services to one another. See Note 23 for further details of the transition services agreement. In conjunction with the divestiture of Cristal's North American TiO₂ business to INEOS, we entered into a transition services agreement with INEOS. Under the terms of the transition services agreement, INEOS will provide services to Tronox for manufacturing, technology and innovation, information technology, finance, warehousing and human resources. Similarly, Tronox will provide services to INEOS for information technology, finance, product stewardship, warehousing and human resources.

In addition, the previously announced divestiture of the 8120 paper laminate grade to Venator Materials PLC (“Venator”), which we were required to undertake by the European Commission in order to consummate the Cristal Transaction, was completed on April 26, 2019.  Under the terms of the agreement, we will supply the 8120 grade product to Venator under a supply agreement for an initial term of 2 years, and extendable up to 3 years, to allow for the transfer of the manufacturing of the 8120 grade to Venator. Total cash consideration is 8 million Euros, of which 1 million Euros was paid at the closing and the remaining 7 million Euros will be paid in equal installments during the second quarters of 2020 and 2021. We recorded a charge of approximately $19 million during the second quarter of 2019, in “Contract loss” in the unaudited Condensed Consolidated Statements of Operations, reflecting both the proceeds on sale and the estimated losses we expect to incur under the supply agreement with Venator.

We funded the cash portion of the Cristal Transaction through existing cash, borrowings from our Wells Fargo Revolver, and restricted cash which had been borrowed under the Blocked Term Loan and which became available to us for the purpose of consummating the Cristal Transaction. See Note 13 for further details of the Cristal Transaction financing.

For the Cristal acquisition, we have applied the acquisition method of accounting in accordance with the ASC 805, "Business Combinations", with respect to the identifiable assets and liabilities of Cristal, which have been measured at estimated fair value as of the date of the business combination.

The aggregate purchase price noted above was allocated to the identifiable assets acquired and liabilities assumed based upon their estimated fair values at the acquisition date using primarily Level 2 and Level 3 inputs (see Note 15 for an explanation of Level 2 and Level 3 inputs).  These Level 2 and Level 3 valuation inputs include management's best estimate of future cash flows (including sales, cost of sales and contributory asset charges), discount rates, competitive trends, market comparables and other factors. Inputs used were generally determined from historical data supplemented by current and anticipated market conditions and growth rates.

The allocation of the purchase price to the assets acquired and liabilities assumed is based upon preliminary information and subject to change. The primary areas of the preliminary purchase price allocation that are not yet finalized relate to the fair value of inventories, property, plant and equipment, mineral rights, intangible assets, leases, legal reserves, contingent liabilities, including uncertain tax positions, deferred tax assets and liabilities other assets and liabilities and noncontrolling interest. Further adjustments may result before the end of the measurement period, which ends one year from the date of the acquisition. During the measurement period, if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in revised estimated values of those assets or liabilities as of that date, we will revise the preliminary purchase price allocation. The effect of measurement period adjustments to the estimated fair values will be calculated as if the adjustments had been completed on the acquisition date. The impact of all changes that do not qualify as measurement period adjustments will be included in current period earnings.

The purchase price consideration and preliminary estimated fair value of Cristal’s net assets acquired as of the acquisition date on April 10, 2019 are shown below.  The assets and liabilities of Cristal's North American TiO₂ business, that was subsequently divested on May 1, 2019, are shown as held for sale in the fair value of assets acquired and liabilities assumed. During the three months ended September 30, 2019,  we updated the preliminary purchase price allocation which resulted in increasing property, plant and equipment by $120 million, increasing accounts receivable by $16 million, decreasing inventory by $14 million, increasing mineral leaseholds by $12 million, decreasing prepaid and other assets by $27 million, increasing assets held for sale by $45 million, decreasing other long-term assets by $19 million, decreasing goodwill by $68 million, increasing environmental liabilities by $26 million, increasing noncontrolling interest by $14 million, as well as other minor adjustments. The adjustments to the unaudited Condensed Consolidated Statement of Operations that would have been recognized in the second quarter of 2019 if the measurement period adjustments had been completed as of the acquisition date would have increased the net loss by approximately $2 million.

We utilized the carrying values, net of allowances, to value accounts receivable and accounts payable as well as other current assets and liabilities as it was determined that carrying values represented the fair value of those items at the acquisition date.

For the three months ended September 30, 2019, the acquired Cristal business contributed $346 million in revenue and $13 million in operating losses. For the nine months ended September 30, 2019, the acquired Cristal business contributed $699 million in revenue and $61 million in operating losses.

Supplemental Pro forma financial information

The following unaudited pro forma information gives effect to the Cristal Transaction as if it had occurred on January 1, 2018. The unaudited pro forma financial information reflects certain adjustments related to the acquisition, such as:

The unaudited pro forma financial information should not be relied upon as being indicative of the historical results that would have been obtained if the Cristal Transaction had actually occurred on that date, nor the results of operations in the future.

For the three and nine months ended September 30, 2019, we incurred pre-tax charges of $40 million and $95 million, respectively, related to the recognition of the step up to fair value of inventories acquired and for the nine months ended September 30, 2019 we also incurred a pre-tax charge of $19 million in contract losses incurred on the 8120 supply agreement with Venator. The 2019 pro forma results were adjusted to exclude these charges as these costs were reflected within the results of operations in the pro forma results as if they were incurred on January 1, 2018. For the nine months ended September 30, 2018, we incurred pre-tax charges of $95 million, related to the recognition of the step up to fair value of inventories acquired. The pre-tax amounts for the three months ended September 30, 2018 were not material.

3.	Restructuring Initiatives

On April 10, 2019, we announced the completion of the Cristal Transaction. During the second quarter, as a result of the acquisition, we outlined a broad based synergy savings program that is expected to reduce costs, simplify processes and focus the organization’s structure and resources on key growth initiatives. During the three and nine months ended September 30, 2019, we recorded costs of $3 million and $13 million, respectively, in our unaudited Condensed Consolidated Statement of Operations. The costs consisted of charges for employee related costs, including severance.

 

4.

Revenue

We recognize revenue at a point in time when the customer obtains control of the promised products. For most transactions this occurs when products are shipped from our manufacturing facilities or at a later point when control of the products transfers to the customer at a specified destination or time.

Contract assets represent our rights to consideration in exchange for products that have transferred to a customer when the right is conditional on situations other than the passage of time. For products that we have transferred to our customers, our rights to the consideration are typically unconditional and only the passage of time is required before payments become due. These unconditional rights are recorded as accounts receivable. As of September 30, 2019, and December 31, 2018, we did not have material contract asset balances.

Contract liabilities represent our obligations to transfer products to a customer for which we have received consideration from the customer. Infrequently we may receive advance payment from our customers that is accounted for as deferred revenue. Deferred revenue is earned when control of the product transfers to the customer, which is typically within a short period of time from when we received the advanced payment. Contract liability balances as of September 30, 2019 and December 31, 2018 were approximately $3 million and less than $1 million, respectively. Contract liability balances were reported as “Accounts payable” in the unaudited Condensed Consolidated Balance Sheets.  All contract liabilities as of December 31, 2018 were recognized as revenue in “Net sales” in the unaudited Condensed Consolidated Statements of Operations during the first quarter of 2019.

Disaggregation of Revenue

We operate under one operating and reportable segment, TiO₂. See Note 24 for details. We disaggregate our revenue from contracts with customers by product type and geographic area. We believe this level of disaggregation appropriately depicts how the nature, amount, timing and uncertainty of our revenue and cash flows are affected by economic factors and reflects how our business is managed.

Net sales from external customers for each similar type of product were as follows:

TiO₂ includes pigment and ultrafine. Feedstock and other products mainly include pig iron rutile prime, ilmenite, Chloride (“CP”) slag, 8120 grade product and other mining products. Electrolytic products mainly include electrolytic manganese dioxide and boron. We sold our Electrolytic operations on September 1, 2018. The nature, amount, timing and uncertainty of revenue and cash flows typically do not differ significantly among different products.

5.	Dispositions

As discussed in Note 2, the Company divested Cristal's North American TiO2 business to INEOS on May 1, 2019, for cash proceeds, net of transaction costs, of $708 million, inclusive of an amount for an estimated working capital adjustment. The operating results of Cristal’s North American TiO₂ business from the acquisition date to the date of divestiture are included in a single caption entitled “Net income from discontinued operations, net of tax” in our unaudited Condensed Consolidated Statements of Operations. Additionally, “Net income from discontinued operations, net of tax” also includes the operating results of Cristal Metals. As of September 30, 2019, the assets and liabilities of Cristal Metals are included in assets and liabilities held for sale as is outlined below.

The following table presents the combined major classes of Cristal’s North American TiO2 business and Cristal Metals line items constituting the “Income from discontinued operations, net of tax” in our unaudited Condensed Consolidated Statements of Operations:

During the three months ended September 30, 2019, the Company determined that it had incorrectly calculated the tax effects of a transaction related to the Cristal acquisition within the Company’s net loss from discontinued operations, net of tax on the Company’s unaudited condensed consolidated statement of operations for both the three and  six months ended June 30, 2019.  During the three months ended September 30, 2019, the Company corrected the tax impact by recording a credit of approximately $7 million in “Net income from discontinued operations, net of tax” on the unaudited Condensed Consolidated Statement of Operations.  Management evaluated the materiality of the out of period adjustment from a quantitative and qualitative perspective and concluded that this adjustment was not material to the Company’s presentation and disclosures, and has no material impact on the Company’s financial position, results of continuing operations and cash flows.  After taking into effect this adjustment, for the three months ended June 30, 2019, net income from discontinued operations, net of tax would have been $7 million or $0.05 per share.  For the six months ended June 30, 2019, “Net income from discontinued operations, net of tax” would have been $7 million or $0.05 per share.  

The table below presents the carrying amounts of the assets and liabilities included in the Company’s unaudited Condensed Consolidated Balance Sheet:

On September 1, 2018, Tronox LLC, our indirect wholly owned subsidiary, sold to EMD Acquisition LLC certain of the assets and liabilities of our Henderson Electrolytic Operations based in Henderson, Nevada (the “Henderson Electrolytic Operations”), a component of our TiO₂ segment, for $1.3 million in cash and a Secured Promissory Note of $4.7 million. On December 27, 2018, we received the full settlement of the Promissory Note of $4.7 million from EMD Acquisition LLC. For the year ended December 31, 2018, a total pre-tax loss on the sale of $31 million was recorded in “Impairment loss” in the unaudited Condensed Consolidated Statements of Operations, of which $25 million had been recognized during the three months ended March 31, 2018. The remaining loss of $6 million was recognized during the third quarter of 2018, primarily due to an amendment to the original purchase agreement which reduced the initially agreed consideration from $13 million to $6 million.

6.	Income Taxes

Our operations are conducted through various subsidiaries in a number of countries throughout the world. We have provided for income taxes based upon the tax laws and rates in the countries in which operations are conducted and income is earned.

Tronox Holdings plc, a U.K. public limited company, became the public parent during the three months ended March 31, 2019. During the three and nine months ended September 30, 2018, Tronox Limited was the public parent, registered under the laws of the State of Western Australia but managed and controlled in the U.K. The statutory tax rate in the U.K. at both September 30, 2019 and 2018 was 19%. The effective tax rate for the three and nine months ended September 30, 2019 and 2018 differs from the U.K. statutory rate of 19% primarily due to income and losses in jurisdictions with full valuation allowances, disallowable expenditures, net reversal of deferred charges, and our jurisdictional mix of income at tax rates different than the U.K. statutory rate.

Upon completion of the Cristal Transaction, we now have additional jurisdictions with operational income.  The statutory tax rates on income earned in Australia (30%), the United States (21%), South Africa (28%), France (32%), China (25%), Brazil (34%), (KSA) (20%), and the Netherlands (25%) are higher than the U.K. statutory rate of 19%. Tax rates will be reduced in the Netherlands and the U.K. to 20.5% and 17%, respectively, in future years.

During the second quarter of 2018, we determined that sufficient positive evidence existed to reverse the valuation allowance attributable to our operating subsidiary in the Netherlands. We continue to maintain full valuation allowances related to the total net deferred tax assets in Australia and the U.S., as we cannot objectively assert that these deferred tax assets are more likely than not to be realized. It is reasonably possible that a portion of these valuation allowances could be reversed within the next year due to increased profitability levels. For entities acquired in the Cristal Transaction, we have full valuation allowances in Australia, Brazil, Switzerland and the U.S. Until these valuation allowances are eliminated, future provisions for income taxes for these jurisdictions will include no tax benefits with respect to losses incurred and tax expense only to the extent of current tax payments. Additionally, we have valuation allowances against specific tax assets in the Netherlands, South Africa, and the U.K.

The Company’s ability to use certain loss and expense carryforwards could be substantially limited if the Company were to experience an ownership change as defined under IRC Section 382. In general, an ownership change would occur if the Company’s “5-percent shareholders,” as defined under IRC Section 382, including certain groups of persons treated as “5-percent shareholders,” collectively increased their ownership in the Company by more than 50 percentage points over a rolling three-year period. If an ownership change does occur during 2019, the resulting impact could be a limitation of up to $5.2 billion composed of both U.S. net operating losses and interest limitation carryforwards. We believe there would be minimal impact on the $2.5 billion future Grantor Trust deductions from an IRC Sections 382 change.

We currently have no uncertain tax positions recorded; however, we continue to evaluate the companies acquired in the Cristal Transaction, and it is reasonably possible that this could change in the next 12 months.

We believe that we have made adequate provision for income taxes that may be payable with respect to years open for examination; however, the ultimate outcome is not presently known and, accordingly, adjustments to our provisions may be necessary and/or reclassifications of noncurrent tax liabilities to current may occur in the future.

7.	Income (Loss) Per Share

Net income (loss) per ordinary share amounts were calculated from exact, not rounded net loss and share information.  Prior to January 2019, we had issued shares of restricted stock which were participating securities that did not have a contractual obligation to share in losses; therefore, when we had a net loss, none of the loss was allocated to participating securities. The restricted stock vested on January 29, 2019. For both the three and nine months ended September 30, 2019 and for the nine months ended September 30, 2018, the two-class method did not have an effect on our net loss per ordinary share calculation.

8.	Inventories, Net