Valhi, Inc. — Third-Quarter 2017 Form 10-Q
Business context and period. Valhi is a holding company with four principal segments: chemicals (Kronos titanium dioxide), component products (CompX), waste management (WCS), and real estate management and development (BMI and LandWell). This unaudited filing covers the quarter and nine months ended September 30, 2017, compared with the same 2016 periods. Contran owned approximately 93% of Valhi’s common stock.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2017 | Nine months 2016 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $406.8m | $514.9m | $1,158.9m | $1,444.0m |
| Income (loss) before tax | $11.6m | $79.1m | $(26.5)m | $6.6m |
| Income tax expense (benefit) | $2.6m | $15.2m | $(5.8)m | $(134.2)m |
| Net income (loss) attributable to Valhi | $3.0m | $45.9m | $(25.0)m | $67.4m |
| Basic and diluted EPS | $0.01 | $0.13 | $(0.07) | $0.20 |
| Gross margin | $85.3m | $168.6m | $189.5m | $431.3m |
Q3 gross margin was about 32.7% of sales, versus 21.0% a year earlier; the nine-month margin was about 29.9%, versus 16.3%. Q3 improvement primarily reflected stronger chemicals results. Nine-month earnings also reflect substantial, largely noncash tax benefits and a large WCS impairment, so reported net income does not solely reflect operating performance.
- Cash flow: Operating cash flow for the first nine months was $204.3m, up from $39.7m. Investing activities used $47.8m, including $45.9m of capital expenditures; financing activities provided $111.0m. Cash, cash equivalents and restricted cash ended at $475.3m, compared with $196.5m at year-end 2016.
- Balance sheet and liquidity: At September 30, cash and cash equivalents were $424.4m, restricted cash equivalents $13.9m, and marketable securities $257.5m. Current assets were $1,217.5m and current liabilities $354.1m. Total assets were $2,818.4m and equity $606.2m.
- Debt: Total debt was $1,106.7m, compared with $965.0m at December 31, 2016. Kronos issued €400m of 3.75% senior secured notes due 2025 and used proceeds to repay its term loan and revolving borrowings. Valhi reported $246.8m of borrowing availability across specified facilities. The company reported compliance with debt covenants.
- Dividends: Valhi paid $0.06 per share in the first nine months, unchanged from 2016. Future dividends remain discretionary.
Material changes and segment performance
- Chemicals: Q3 sales rose 30% to $464.5m and operating income rose to $93.9m from $30.1m. For nine months, sales increased 24% to $1,275.7m and operating income rose to $221.9m from $45.8m. Higher TiO₂ prices were the main driver: average prices were up 23% in Q3 and 20% year to date; sales volumes rose 5% in both comparisons. Higher feedstock costs began to affect Q3 results.
- Component products: Q3 sales declined 5% to $26.9m and operating income fell to $3.4m from $4.4m, reflecting a nonrecurring prior-year government order, product/customer mix and higher marine manufacturing costs. Nine-month sales increased 5% to $86.9m and operating income rose 8% to $12.5m.
- Waste management: Q3 sales rose to $18.4m from $13.6m; operating income before impairment was $4.0m, versus a $5.1m loss. Nine-month sales were $60.4m, and operating income before impairment was $3.6m, versus a $23.0m loss. The nine-month reported operating loss of $167.0m includes a $170.6m impairment recognized in Q2.
- Real estate: Nine-month sales rose to $21.0m from $15.8m and operating income was $3.1m, versus a $5.1m loss. Q3 sales fell to $5.1m from $8.7m, while operating income increased to $1.3m from $0.3m.
Outlook, unusual items and risks
- Management expected higher 2017 net income attributable to Valhi than in 2016, principally from stronger Chemicals operating income and the German and Belgian deferred-tax valuation-allowance reversal. This outlook also includes the WCS impairment and higher costs associated with the terminated WCS sale agreement.
- Management expected Chemicals sales volumes to be slightly higher in 2017 than 2016, production volumes to increase, and full-year cost of sales per metric ton to be comparable to 2016. It anticipated continued strong TiO₂ demand and expected the remaining $11.7m German and Belgian valuation allowance to be reversed in Q4.
- The $170.4m nine-month income tax benefit included a $149.9m Q2 reversal of valuation allowance, plus benefits from NOL utilization. These benefits are noncash. The Canada-Germany tax agreement generated an additional $11.3m Q3 tax benefit. Conversely, Valhi recorded a $49.3m noncash tax expense related to its direct Kronos investment.
- The planned $270m cash sale of WCS was blocked by a federal antitrust court order; Valhi terminated the agreement in June and received a $4m termination fee. WCS faces challenges obtaining recurring disposal volumes and positive cash flows. Valhi was pursuing other potential buyers but gave no assurance a transaction would occur.
- Material contingencies include NL’s appeal of the California lead-paint abatement judgment, which ordered defendants to fund $1.15bn in aggregate; Valhi said loss was not probable and could not be reasonably estimated, but an adverse outcome could materially affect results, financial position and liquidity. Environmental remediation accruals were $120.6m; NL’s accrued share was approximately $115m, with an estimated reasonably possible range up to $157m for estimable sites. WCS compliance costs for stored DOE waste were not currently estimable; DOE funding arrangements were in place as of October 2017.
- Key risks include cyclical TiO₂ demand and pricing, feedstock and energy costs, foreign exchange, WCS volumes and licensing, environmental obligations, tax examinations and litigation. Euro-denominated notes add currency exposure: a hypothetical 10% adverse exchange-rate move would increase their U.S.-dollar equivalent by about $47m.
- Management said disclosure controls were effective. A Chemicals ERP implementation was underway; the remaining system deployment was not expected before January 2018. Valhi expected approximately $84m of 2017 capital expenditures, excluding about $22m of LandWell development costs.
Important facts for investors to verify
- How much of earnings improvement is supported by recurring segment operations versus noncash tax benefits, the WCS impairment, and the WCS termination fee.
- Whether TiO₂ prices and volumes remain strong as feedstock costs rise, and whether the stated 2017 outlook is achieved.
- WCS’s disposal volumes, funding needs, prospects for a sale, and potential further impairment or operating losses.
- Developments in the California lead-paint appeal, environmental matters and DOE waste-compliance plan, including any change in the probability or estimability of losses.
- Debt and liquidity availability, including currency effects on euro-denominated notes and the extent to which cash held at subsidiaries is available to Valhi.
- Actual reversal of the remaining deferred-tax valuation allowance and any changes to tax positions, audits or related cash payments.