Forward Looking Information

This Quarterly Report on Form 10-Q (the “Report”), including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 2, contains forward-looking statements about the business, financial condition and prospects of TOR Minerals International, Inc. (the “Company”).  The actual results of the Company could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties including, without limitation, changes in demand for the Company’s products, changes in competition, economic conditions, fluctuations in exchange rates, changes in the cost of energy, fluctuations in market price for titanium dioxide (“TiO₂”) pigments, interest rate fluctuations, changes in the capital markets, changes in tax and other laws and governmental rules and regulations applicable to the Company’s business, and other risks indicated in the Company’s filing with the Securities and Exchange Commission, including those set forth in the Company’s Annual Report on Form 10-K under Item 1A. Risk Factors.  These risks and uncertainties are beyond the ability of the Company to control, and, in many cases, the Company cannot predict all of the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements.  When used in this report, the words “believes,” “estimates,” “plans,” “expects,” “anticipates,” “foresees,” “intends,” “may,” “likely,” “should” and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements.

Basis of Presentation and Use of Estimates

The accompanying interim consolidated financial statements (the “financial statements”) have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”).  The financial statements include the consolidated accounts of TOR Minerals International, Inc. (“TOR”, “we”, “us”, “our” or the “Company”) and its wholly-owned subsidiaries, TOR Processing and Trade, BV (“TPT”) and TOR Minerals Malaysia, Sdn. Bhd. (“TMM”).  All significant intercompany transactions have been eliminated.  All adjustments (consisting only of normal recurring adjustments) necessary for a fair statement of the consolidated financial position, results of operations and cash flows for the interim periods presented have been made.  Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to SEC rules and regulations.  These financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2015, in our Annual Report on Form 10-K filed with the SEC on March 7, 2016.  Operating results for the three month period ended March 31, 2016, are not necessarily indicative of the results for the year ending December 31, 2016.

Income Taxes

The Company records income taxes using the liability method.  Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

Income taxes consisted of federal income tax benefit of approximately $81,000, state income tax expense of approximately $5,000 and foreign tax expense of approximately $151,000 for the three month period ended March 31, 2016, as compared to a federal and state tax benefit of approximately $55,000 and $2,000, respectively, and foreign tax benefit of approximately $24,000 for the same three month period in 2015.

When accounting for uncertainties in income taxes, we evaluate all tax years still subject to potential audit under the applicable state, federal and foreign income tax laws.  We are subject to taxation in the United States, Malaysia and The Netherlands.  Our federal income tax returns in the United States are subject to examination for the tax years ended December 31, 2012 through December 31, 2015.  Our state tax return, which is filed in Texas, is subject to examination for the tax years ended December 31, 2011 through December 31, 2015.  Our tax returns in various non-U.S. jurisdictions are subject to examination for various tax years dating back to December 31, 2011.

As of January 1, 2016, we did not have any unrecognized tax benefits and there was no change during the three month period ended March 31, 2016.  In addition, we did not recognize any interest and penalties in our financial statements during the three month period ended March 31, 2016.  If any interest or penalties related to any income tax liabilities are imposed in future reporting periods, we expect to record both of these items as components of income tax expense.

Long-term Debt – Financial Institutions

Following is a summary of our long-term debt to financial institutions as of March 31, 2016 and December 31, 2015, in thousands:

Short-term Debt

U.S. Operations

On December 31, 2010, the Company entered into a credit agreement (the “Agreement”) with American Bank, N.A. (the “Lender”) which established a $1,000,000 line of credit (the “Line”), and on March 1, 2012, the Line was increased from $1,000,000 to $2,000,000.  On May 15, 2013, the Company and the Lender entered into the Second Amendment to the Agreement which reduced the minimum interest rate floor from 5.5% to 4.5%.  On May 15, 2015, the Company and the Lender entered into the Fifth Amendment to the Agreement which extended the Line from October 15, 2015 to October 15, 2016.  On December 30, 2015, the Company and the Lender entered into the Sixth Amendment to the Agreement.  Under the terms of the Sixth Amendment, the Company is required to maintain positive net earnings before taxes, interest, depreciation, amortization and all other non-cash charges on a rolling four-quarter basis.  The Company was in compliance with all covenants at March 31, 2016.

Under the terms of the Agreement, as amended, the amount the Company is entitled to borrow under the Line is subject to a borrowing base, which is based on the loan value of the collateral pledged to the Lender to secure the indebtedness owing to the Lender by the Company.  Amounts advanced under the Line bear interest at a variable rate equal to one percent per annum point above the Wall Street Journal Prime Rate as such prime rate changes from time to time, with a minimum floor rate of 4.5%.  At March 31, 2016, no funds were outstanding on the Line.

European Operations

On July 13, 2015, TPT amended the short-term banking facility (the “Amended Agreement”) with Rabobank.  Under the terms of the Amended Agreement, the line of credit was reduced from €1,100,000 to €500,000 ($1,253,000 to $569,000 at 3/31/2016) and interest was changed from a variable interest rate of bank prime plus 2.8% to the average 1-month EURIBOR plus the bank margin of 3.3%, which was 3.03% at March 31, 2016.  No funds were outstanding on the TPT line of credit at March 31, 2016.

Asian Operations

On August 24, 2015, TMM amended its short-term banking facility with HSBC to extend the maturity date from June 30, 2015 to June 30, 2016.  The HSBC facility includes the following in RM:  (1) overdraft of RM 500,000 ($129,000 at 3/31/2016); (2) an import/export line (“ECR”) of RM 10,460,000 ($2,697,000 at 3/31/2016); and (3) a foreign exchange contract limit of RM 5,000,000 ($1,289,000 at 3/31/2016).  At March 31, 2016, the outstanding balance on the ECR was RM 3,578,000 ($923,000 at 3/31/2016) and at a current interest rate of 4.47%.

On August 15, 2014, TMM amended its short term banking facility with RHB Bank Berhad (“RHB”) to extend the maturity date from March 24, 2014 to April 1, 2015.  TMM is currently negotiating with RHB to extend the maturity date to April 21, 2017.  The RHB facility includes the following:  (1) an overdraft line of credit up to RM 1,000,000 ($258,000 at 3/31/2016); (2) an ECR of RM 7,300,000 ($1,882,000 at 3/31/2016); (3) a bank guarantee of RM 1,200,000 ($309,000 at 3/31/2016); and (4) a foreign exchange contract limit of RM 25,000,000 ($6,446,000 at 3/31/2016).  At March 31, 2016, no funds were outstanding on the RHB facility.

The banking facilities with both HSBC and RHB bear an interest rate on the respective overdraft facilities at 1.25% over bank prime, and the respective ECR facilities bear interest at 1.0% above the funding rate stipulated by the Export-Import Bank of Malaysia Berhad.  The ECR facilities, which are a government supported financing arrangement specifically for exporters, are used by TMM for short-term financing of up to 180 days against customers’ and inter-company shipments.

The borrowings under both the HSBC and the RHB short term credit facilities are subject to certain subjective acceleration covenants based on the judgment of the banks and a demand provision that provides that the banks may demand repayment at any time.  A demand provision is customary in Malaysia for such facilities.  The loan agreements are secured by TMM’s property, plant and equipment.  However, if demand is made by HSBC or RHB, we may be unable to refinance the demanded indebtedness, in which case, the lenders could foreclose on the assets of TMM.  While repatriation is allowed in the form of dividends, the credit facilities prohibit TMM from paying dividends, and the HSBC facility further prohibits loans to related parties without the prior consent of HSBC.

The following table summarizes the valuation of our financial instruments recorded on a fair value basis as of March 31, 2016 and December 31, 2015.  The Company did not hold any non-financial assets and/or non-financial liabilities subject to fair value measurements at March 31, 2016 or at December 31, 2015.

Our foreign currency derivative financial instruments mitigate foreign currency exchange risks and include forward contracts.  The forward contracts are marked-to-market at each balance sheet date with any resulting gain or loss recognized in income as part of the gain or loss on foreign currency exchange rates included under “Other Expense” on the Company’s consolidated statement of operations.  The fair value of the currency forward contracts is determined using Level 2 inputs based on the currency rate in effect at the end of the reporting period.

The fair value of the Company’s debt is based on estimates using standard pricing models and Level 2 inputs, including the Company’s estimated borrowing rate, that take into account the present value of future cash flows as of the consolidated balance sheet date.  The computation of the fair value of these instruments is performed by the Company.  The carrying amounts and estimated fair values of the Company’s long-term debt, including current maturities, are summarized below:

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, trade receivables, payables and accrued liabilities, accrued income taxes and short-term borrowings approximate fair values due to the short term nature of these instruments, accordingly, these items have been excluded from the above table.

Following is a summary of inventory at March 31, 2016 and December 31, 2015, in thousands:

The following table sets forth the computation of basic and diluted earnings per share:

For the three month period ended March 31, 2015, approximately 528,000 detachable warrants were excluded from the calculation of diluted earnings per share as the effect would be anti-dilutive.  The warrants, issued in May 2009 with our six percent (6%) convertible subordinated debentures, have an exercise price of $2.65 and a maturity date of May 4, 2016.

For the three month period ended March 31, 2016, approximately 359,000 employee stock options were excluded from the calculation of diluted earnings per share as the exercise price was greater than the market price of the common shares and, therefore, the effect would be anti-dilutive.

For the three month period ended March 31, 2015, approximately 147,000 employee stock options were excluded from the calculation of diluted earnings per share as the effect would be anti-dilutive.

The Company and its subsidiaries operate in the business of pigment manufacturing and related products in three geographic segments – United States, European and Asian.

Product sales of inventory between the U.S., European and Asian operations are based on inter-company pricing, which includes an inter-company profit margin.  The segment profit (loss) included in the table below, from each location is reflective of these inter-company prices, as is inventory at the Corpus Christi location prior to elimination adjustments.  Such presentation is consistent with the internal reporting reviewed by the Company’s chief operating decision maker.  The elimination entries include an adjustment to the cost of sales resulting from the adjustment to ending inventory to eliminate inter-company profit, and the reversal of a similar adjustment from a prior period.  To the extent there are net increases/declines period over period in Corpus Christi inventories that include an inter-company component, the net effect of these adjustments can decrease/increase location profit.

Sales from the subsidiary to the parent company are based upon profit margins which represent competitive pricing of similar products.  Intercompany sales consist primarily of ALUPREM®, Synthetic Rutile, HITOX® and TIOPREM®.

A summary of the Company’s manufacturing operations by geographic segment is presented below:

Our chief operating decision maker, or CODM, regularly reviews financial information about our segments in order to allocate resources and evaluate performance.  Our CODM assesses segment performance based on Segment sales and Segment Adjusted EBITDA.

Following is a summary of adjusted EBITDA by segment and consolidated for the three month periods ended March 31, 2016 and 2015.

For the three month periods ended March 31, 2016 and 2015, the Company recorded stock-based employee compensation expense of $49,000 and $29,000, respectively.  This compensation expense is included in “selling, general and administrative expenses” in the accompanying consolidated statements of operations.

The Company granted 215,000 stock options during the three month period ended March 31, 2016.  No options were granted during the same three month period of 2015.

As of March 31, 2016, there was approximately $602,000 of compensation expense related to non-vested awards.  This expense is expected to be recognized over a weighted average period of 4.22 years.

The Company has exposure to certain risks relating to its ongoing business operations, including financial, market, political and economic risks.  The following discussion provides information regarding our exposure to the risks of changing foreign currency exchange rates.  The Company has not entered into these contracts for trading or speculative purposes in the past, nor do we currently anticipate entering into such contracts for trading or speculative purposes in the future.  The foreign exchange contracts are used to mitigate uncertainty and volatility and to cover underlying exposures.

Foreign Currency Forward Contracts

We manage the risk of changes in foreign currency exchange rates, primarily at our Malaysian operation, through the use of foreign currency contracts.  Foreign currency exchange contracts are used to protect the Company from the risk that the eventual cash flows resulting from transactions in foreign currencies, including sales and purchases transacted in a currency other than the functional currency, will be adversely affected by changes in exchange rates.  We report the fair value of the derivatives on our consolidated balance sheets and changes in the fair value are recognized in earnings in the period of the change.

At March 31, 2016, we marked these contracts to market, recording $2,000 as a current asset on the consolidated balance sheets. 

The following table summarizes the gross fair market value of all derivative instruments, which are not designated as hedging instruments and their location in our consolidated balance sheets at March 31, 2016 and December 31, 2015, in thousands:

For the three month period ended March 31, 2016, we did not incur a gain or loss on these contracts; however, during the three month period ended March 31, 2015, we recorded a net gain of $11,000, as a component of our net loss.

The following table summarizes, in thousands, the impact of the Company’s derivatives on the consolidated financial statements of operations for the three month periods ended March 31, 2016 and 2015:

As reported in the Company’s filing on Form 8-K filed with the Securities and Exchange Commission on May 2, 2016, three holders, two of whom are directors of the Company and another of whom is a greater than 5% shareholder, exercised 377,360 warrants which were issued in August 2009 on April 29, 2016.  In addition, several other holders exercised 128,304 warrants on April 27, 2016.  Upon exercise and receipt of the aggregate exercise price of $1,340,010, the Company will issue 505,664 shares of common stock to the investors.  The Company will use the proceeds for working capital purposes.

No underwriters were involved in the foregoing sale of securities.  The common stock to be issued upon exercise of the warrants was issued in reliance upon the exemption from registration provided by Section 4(2) under the Securities Act of 1933, as amended, based on the private sale of securities.  The sale of the common stock issued upon exercise of these warrants was registered with the Securities and Exchange Commission (the “SEC”) on Form S-3 (Registration No. 333-175054), filed with the SEC on June 30, 2011.

Company Overview

We are a global producer of high performance, specialty mineral products focused on product innovation and technical support.  Our specialty mineral products, which include flame retardant and smoke suppressant fillers, engineered fillers, and TiO2-color hybrid pigments, are designed for use in plastics, coating and paint applications, as well as a wide range of other industrial applications. With operations in the United States, Europe and Asia, our mission is to bring high value products and superior levels of service to our customers to help ensure their success.

Our U.S. operation, located in Corpus Christi, Texas, is also the global headquarters for the Company.  The U.S. operation manufactures HITOX, BARTEX, HALTEX/OPTILOAD and TIOPREM.  TPT, our European operation, located in Hattem, The Netherlands, manufactures ALUPREM alumina based products and BARYPREM and our Asian operation, located in Ipoh, Malaysia, manufactures HITOX and TIOPREM.

Operating expenses in the foreign locations are primarily in local currencies.  Accordingly, we have exposure to fluctuation in foreign currency exchange rates.  These fluctuations impact the translation of sales, earnings, assets and liabilities from local currency to the U.S. Dollar.

Our business is closely correlated with the construction industry and its demand for materials that use pigments, such as paints and plastics.  This has generally led to higher sales in our second and third quarters due to increases in construction and maintenance during warmer weather.  Also, pigment consumption is closely correlated with general economic conditions.  When the economy is in an expansionary state, there is typically an increase in pigment consumption while a slowdown in the economy typically results in decreased pigment consumption.  When the construction industry or the economy is in a period of decline, TOR's sales and profits are likely to be adversely affected.

We manage our business in three geographical segments – United States, European and Asia (See Note 6 to our consolidated financial statements).  Product sales of inventory between the U.S., European and Asian operations are based on inter-company pricing, which includes an inter-company profit margin.  Our chief operating decision maker, or CODM, regularly reviews financial information about our segments in order to allocate resources and evaluate performance.  Our CODM assesses segment performance based on Segment sales and Segment Adjusted EBITDA which we define as net income (loss) before depreciation and amortization, interest expense, bad debt expense, foreign currency gains and losses, income taxes, and other items which management does not believe reflect the underlying performance of the segment.

A summary of the Adjusted EBITDA by segment and consolidated for the three months ended March 31, 2016 and 2015, is included in Note 6 to the consolidated financial statements on page 13.

Below are our results for the three months ended March 31, 2016 and 2015.

Results of Operations

The Company and its subsidiaries operate in three geographic segments.  Product sales between the U.S., Asian and European operations are based on inter-company pricing which includes an inter-company profit margin.  The inter-company sales are excluded from our consolidated sales and from the sales of each of our three geographic segments.

Net Sales:  Consolidated net sales decreased approximately 5% for the three month period ended March 31, 2016, as compared to the same three month period of 2015.  The decrease was primarily due to a decrease in volume, selling price and the impact of the change in foreign currency exchange rates as both the Euro and the Malaysian Ringgit weakened against the U.S. Dollar.

Below is a summary of our consolidated products sales for the three month periods ended March 31, 2016 and 2015 (in thousands).

ALUPREM sales increased 9% for the three month period ended March 31, 2016, primarily related to an increase in volume of 13%, which was partially offset by a decrease in selling price of 3% and the impact of the change in the foreign currency exchange rates of 1% as the Euro weakened against the U.S. Dollar.  ALUPREM volume increased in both the U.S. and European markets, and the decrease in selling price relates to a U.S. customer and the pricing from this customer will continue to be below last year’s price.  The order pattern of our largest ALUPREM customers can vary significantly from quarter to quarter and does not necessarily follow a normal seasonal pattern, and while we anticipate a slight increase in annual volume from this customer, the second quarter volume may be impacted by plant maintenance scheduled at one of the customer’s locations. 

HITOX sales decreased 29% for the three month period ended March 31, 2016, primarily due to a reduction in volume of 19%, selling price of 7% and the impact of the change in the foreign currency exchange rates of 3% as both the Euro and the Malaysian Ringgit weakened against the U.S. Dollar.  The decrease in sales volume of HITOX was primarily due to the continued weakness in the global TiO2 market, as well as aggressive pricing pressure from producers of white TiO2 in China.  We expect this pressure to continue to affect both volume and pricing in our TiO2 product sales for the balance of the year, and we expect conditions in the TiO2 market to remain difficult for the next several years.

BARTEX®/BARYPREM® sales decreased 4% during the three month period ended March 31, 2016, primarily due to a decrease in volume and a change in product mix of 3% and 1%, respectively.  The decrease in volume in the U.S. was partially offset by an increase in volume in Europe.

HALTEX®/OPTILOAD® sales increased 19% for the three month period ended March 31, 2016, due to an increase in volume of 21%, which was partially offset by a change in product mix of 2%.  The increase in volume was primarily due to an increase in our customer base, as well as an increase in requirements for existing customers.

TIOPREM sales decreased 2% for the three month period ended March 31, 2016, primarily due to a reduction in selling price and the impact of the change in the foreign currency exchange rates as the Malaysian Ringgit weakened against the U.S. Dollar of 13% and 2%, respectively, which were partially offset by an increase in volume of 13%.

Synthetic Rutile (“SR”) – For the three month period ended March 31, 2016, there were no sales of SR to third parties.  For the three month period ended March 31, 2015, our SR sales revenue from third party customers was approximately $14,000.  While producers of white TiO2 in China have contributed to the overall weakness in the global TiO2 market, we typically only produce SR for our own internal consumption.  Separately, in 2015, we made a strategic decision to take our SR production capacity out of service.  We are currently supplementing our existing SR inventory with product produced by alternate sources.  By making this strategic move, we expect cost savings as well as a reduction in our SR inventory levels over the next 12 months.

Other Product sales decreased 29% for the three month period ended March 31, 2016, primarily due to a decrease in volume and selling price in the U.S. and at TMM.

U.S. Operations

Below is a summary of net sales for our U.S. operation for the three month periods ended March 31, 2016 and 2015 (in thousands).  All inter-company sales have been eliminated.

ALUPREM sales increased 10% for the three month period ended March 31, 2016, primarily related to an increase in volume of 24%, which was partially offset by a decrease in selling price of 14%.  The change in volume and selling price primarily relate to a significant U.S. customer, and the pricing from this customer will continue to be below last year’s price.

HITOX sales decreased 37% for the three month period ended March 31, 2016, primarily due to a reduction in volume of 29% and selling price of 8%.  The decrease in sales volume and selling price primarily relates to the continued weakness in the global TiO2 market, as well as the entry into the TiO2 market by producers of white TiO2 in China.  We expect this pressure to continue to affect both volume and pricing in our TiO2 product sales for the balance of the year, and we expect conditions in the TiO2 market to remain difficult for the next several years.

BARTEX sales decreased 5% for the three month period ended March 31, 2016, primarily due to a decrease in volume.

HALTEX/OPTILOAD sales increased 19% for the three month period ended March 31, 2016, due to an increase in volume of 21%, primarily due to an increase in our customer base, as well as an increase in requirements for existing customers, which was partially offset by a change in product mix of 2%.

TIOPREM sales increased 10% for the three month period ended March 31, 2016, primarily due to an increase in volume of 26%, which was offset by a reduction in selling price of 16%.

Other Product sales decreased 14% for the three month period ended March 31, 2016, due to a decrease in volume and selling price of 6% and 8%, respectively. 

European Operations

TPT manufactures and sells ALUPREM to third party customers, as well as to our U.S. operations for distribution to our North American customers.  TPT purchases HITOX from our Asian operation and TIOPREM from our U.S. operation for distribution in Europe.  The following table represents TPT’s sales (in thousands) for the three month periods ended March 31, 2016 and 2015 to third-party customers.  All inter-company sales have been eliminated.

ALUPREM sales in Europe increased 9% for the three month period ended March 31, 2016, primarily due to a change in product mix and sales volume of 8% and 3%, respectively, which was partially offset by the impact of the change in foreign currency which reduced sales 2% as the Euro weakened against the U.S. Dollar.

BARYPREM sales in Europe increased 8% for the three month period ended March 31, 2016, due to an increase in volume primarily related to an increase demand by a customer in Europe.

HITOX sales in Europe decreased 19% during the three month period ended March 31, 2016, primarily due to a decrease in volume, selling price and the impact of the change in foreign currency of 10%, 6% and 3%, respectively.  The European HITOX sales continue to be impacted by the overall weakness in the global TiO2 market.

TIOPREM sales in Europe decreased 59% during the three month period ended March 31, 2016, due to a decrease in volume. 

Asian Operations

TMM manufactures and sells SR and HITOX to third party customers, as well as to our U.S. and European operations.  The following table represents TMM’s sales (in thousands) for the three month periods ended March 31, 2016 and 2015 to third-party customers.  All inter-company sales have been eliminated.

HITOX sales in Asia decreased 5% for the three month period ended March 31, 2016, primarily due to the impact of the change in foreign currency and a decrease in selling price of 14% and 2%, respectively, which was partially offset by an increase in volume of 11%.  The HITOX market in Asia continues to decline due to the weakness in the TiO2 market, as well as the entry into the TiO2 market by producers of white TiO2 in China.  We expect this pressure to continue to affect both volume and pricing in our TiO2 product sales for the balance of the year, and we expect conditions in the TiO2 market to remain difficult for the next several years.

TIOPREM sales in Asia decreased in volume 50% for the three month period ended March 31, 2016, primarily due to a decrease in volume and the impact of the change in foreign currency of 33% and 17%, respectively.

Synthetic Rutile (“SR”) For the three month period ended March 31, 2016, there were no sales of SR to third parties.  For the three month period ended March 31, 2015, our SR sales revenue from third party customers was approximately $14,000.  While producers of white TiO2 in China have contributed to the overall weakness in the global TiO2 market, we typically only produce SR for our own internal consumption.  Separately, in 2015, we made a strategic decision to take our SR production capacity out of service.  We are currently supplementing our existing SR inventory with product produced by alternate sources.  By making this strategic move, we expect cost savings as well as a reduction in our SR inventory levels over the next 12 months.

Other Product sales volume decreased 100% for the three month period ended March 31, 2016, due to a decrease in the sale of TMM’s by-products.