NL

Business Context and Reporting Period

Company: NL Industries, Inc. (NYSE: NL)
Reporting Period: Fiscal year ended December 31, 2003
Primary Operations: The Company operates primarily through its majority-owned subsidiary, Kronos Worldwide, Inc. (51% owned), the world's fifth-largest producer of titanium dioxide (TiO2) pigments. Approximately 50% of sales volume is in Europe, 40% in North America, and the remainder in export markets. The Company also mines ilmenite ore in Norway and produces iron-based water treatment chemicals.

Key Financial Metrics (Year Ended Dec 31, 2003)

Note: The decrease in Stockholders' Equity is primarily due to the December 2003 distribution of 48.8% of Kronos Worldwide, Inc. common stock to NL stockholders, which reduced retained earnings by approximately $111 million (including the net carrying value of shares and associated tax liability).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 15% driven by a 13% increase in average TiO2 selling prices (in U.S. dollars) and a 2% increase in sales volumes. The price increase was largely due to favorable currency translation effects (weaker U.S. dollar vs. Euro and Canadian dollar) and higher prices in European and export markets.
• Production Records: The Company produced a record 476,000 metric tons of TiO2 in 2003, operating at near full capacity, compared to 442,000 tons in 2002.
• Cost Structure: Cost of sales increased 10% due to higher volumes. However, cost of sales as a percentage of net sales decreased from 77% in 2002 to 73% in 2003 due to cost reduction efforts and higher production efficiency.
• Corporate Expenses: Corporate expenses increased 51% to $57.4 million, primarily due to higher environmental remediation expense accruals.
• Currency Impact: While currency fluctuations increased sales by $93 million, they resulted in a net decrease in operating income of approximately $6 million due to higher translated operating costs and $7.7 million in currency transaction losses.

Guidance, Outlook, and Risks

Outlook for 2004

• Volume: Production volumes expected to approximate 2003 levels; sales volumes expected to be slightly higher.
• Pricing: Average TiO2 selling prices are expected to decline in Q1 2004. Management hopes prices will stabilize in the first half of 2004 and rise thereafter, but expects 2004 average prices (in billing currencies) to be lower than 2003.
• Operating Income: Expected to be lower in 2004 compared to 2003.

Material Risks and Contingencies

• Lead Pigment Litigation: The Company is a defendant in numerous lawsuits regarding former lead pigment operations. No liability has been accrued as it cannot be reasonably estimated. The Company intends to defend vigorously.
• Environmental Liabilities: The Company has accrued $77 million for reasonably estimable environmental costs. The upper end of the range of reasonably possible costs is estimated at $110 million. Approximately 20 sites remain where costs cannot be estimated.
• Tax Matters: Significant German income tax loss carryforwards ($438 million) exist but are subject to a valuation allowance. New German tax laws enacted in January 2004 may limit the utilization of these carryforwards. The Company is also involved in tax examinations in the U.S., Belgium, and Norway.
• Market Risks: Exposure to fluctuations in foreign currency exchange rates (Euro, Canadian Dollar, Norwegian Krone) and interest rates. The Company holds $356.1 million in fixed-rate euro-denominated debt.

Key Facts for Investor Verification

• Kronos Distribution Impact: Verify the long-term financial impact of the December 2003 spin-off of Kronos Worldwide, Inc., including the reduction in NL's retained earnings and the shift to minority interest reporting for Kronos earnings in 2004.
• Environmental Accrual Adequacy: Assess the sufficiency of the $77 million environmental accrual against the disclosed upper range of $110 million and the 20 sites with unestimable costs.
• German Tax Carryforwards: Monitor the impact of new German tax legislation on the utilization of the $438 million in tax loss carryforwards and the potential reversal of the associated valuation allowance.
• Lead Litigation Exposure: Track developments in lead pigment litigation, as the Company has not accrued for these liabilities and outcomes could be material.
• 2004 Pricing Trends: Verify if the anticipated decline in TiO2 selling prices in early 2004 materializes and impacts the projected lower operating income for the year.