NL Industries, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. The filing is by NL Industries, Inc.; it describes a holding company with a majority-owned operating subsidiary, CompX, and a 30% equity-method investment in Kronos Worldwide. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $27.0 | $28.4 | $86.9 | $82.6 |
| Gross margin | $8.2 | $9.4 | $27.4 | $26.1 |
| Income (loss) from operations | $0.9 | Near break-even | $1.2 | $(1.6) |
| Equity in Kronos earnings | $22.4 | $6.8 | $93.4 | $6.1 |
| Net income attributable to NL stockholders | $17.5 | $7.4 | $67.0 | $5.7 |
| Basic and diluted EPS | $0.36 | $0.15 | $1.38 | $0.12 |
| Income tax expense (benefit) | $6.5 | $(0.6) | $28.9 | $(1.1) |
- Q3 sales fell about 5%, while nine-month sales rose about 5%. The Q3 gross margin was about 30% of sales, versus 33% a year earlier; the nine-month margin was about 32% in both periods.
- Earnings growth was principally attributable to the much higher contribution from Kronos, alongside lower environmental remediation costs. NL’s nine-month equity earnings include a substantial share of Kronos’s noncash tax benefits from releasing German and Belgian deferred-tax valuation allowances.
- NL’s share of Kronos’s Q3 and nine-month results also reflected a debt-prepayment loss at Kronos; NL estimated the effect at about $0.02 per share. Kronos’s German-Belgian valuation-allowance benefit and Canada-Germany tax agreement benefit contributed about $0.03 and $0.05 per share, respectively, in Q3.
Cash, debt, and balance sheet
- Operating cash flow was $15.2 million for the first nine months, down from $17.9 million. Investing used $11.4 million, including $2.2 million of capital expenditures and a net $9.3 million loan to Valhi. Financing distributions to CompX noncontrolling shareholders were $0.25 million. Cash and restricted cash increased $3.5 million to $101.8 million.
- At September 30, total current assets were $129.3 million and current liabilities $27.0 million. Total assets were $481.0 million and total equity $265.4 million. NL’s marketable Valhi shares were carried at $34.9 million; its Kronos investment was carried at $216.3 million, versus a quoted market value of $804.1 million.
- NL had $0.5 million outstanding on its $50 million affiliate revolving facility, with $49.5 million available, and reported covenant compliance. CompX had no debt. Kronos, an equity-method investee rather than a consolidated subsidiary, reported $467.5 million of long-term debt, up from $335.4 million at year-end 2016.
- Environmental remediation liabilities totaled $115.3 million: $11.4 million current and $103.9 million noncurrent. The filing estimates a reasonably possible cost range up to approximately $157 million, including the accrued amount.
Changes, outlook, and risks
- CompX: Q3 sales declined because approximately $1.9 million of prior-year sales to one government customer did not recur. Nine-month sales increased on higher government-customer volumes. Q3 operating income fell to $3.4 million from $4.5 million, reflecting lower Security Products sales and unfavorable mix and manufacturing costs. Management expected full-year 2017 sales in both Security Products and Marine Components to meet or exceed 2016 levels and expected margins to improve in Q4 after resolving temporary staffing-related production challenges.
- Kronos: Q3 sales increased 30% to $464.5 million and nine-month sales increased 24% to $1.276 billion, driven mainly by higher TiO2 prices and higher volumes. Kronos reported full practical-capacity utilization during the first nine months. Management expected 2017 operating income to exceed 2016, sales volumes to be slightly higher, and cost of sales per ton to be comparable. These expectations depend on market demand, pricing, capacity, input costs, currencies, and economic conditions.
- NL outlook: Management expected full-year corporate expenses to be lower than in 2016, but noted that litigation activity or environmental developments could increase costs. NL expected sufficient liquidity for obligations through September 30, 2018, subject to actual results and cash demands. No specific numerical earnings guidance for NL was provided.
- Material litigation: NL and two other defendants face a California trial judgment ordering aggregate payment of $1.15 billion for lead-paint abatement. NL’s appeal was argued in August 2017 and remained pending. NL had not accrued a liability, stating a loss was not probable and could not be reasonably estimated; the filing warns that an adverse outcome could materially affect earnings, financial position, and liquidity.
- Other contingencies: NL reported approximately 38 environmental sites with reasonably estimable remediation costs and five sites for which it could not estimate a range. It also faced asbestos-related claims involving 103 pending cases and approximately 587 plaintiffs, with additional claims administratively inactive; no amounts were accrued for this litigation. Management said other claims were not expected to have a material adverse effect beyond recorded accruals.
- Accounting changes: NL expected to adopt the new revenue standard in Q1 2018 using the modified retrospective approach and anticipated minimal revenue impact. Adoption of the new financial-instruments standard in 2018 will move changes in fair value of available-for-sale equity securities from other comprehensive income to net income.
Most important facts for investors to verify
- How much of reported earnings is recurring operating performance versus Kronos equity earnings and noncash tax benefits; confirm the timing and effect of the remaining Kronos valuation-allowance reversal.
- The outcome of the Santa Clara appeal and any developments in environmental remediation estimates, including the potential exposure above the $115.3 million accrued balance.
- Kronos’s debt, operating performance, and ability to sustain TiO2 prices, volumes, and capacity utilization, given NL’s reliance on its equity-method earnings and dividends.
- CompX’s customer concentration, government-order trends, recreational-transportation demand, and whether production and margins improved as management expected.
- Liquidity and cash availability by entity, including affiliate funding arrangements and the extent to which NL receives dividends from subsidiaries and affiliates.