NL Industries, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The filing is by NL Industries, Inc., not a company identified as “NLI Holdings, Inc.” NL is primarily a holding company: it consolidates majority-owned CompX International, a components manufacturer, and accounts for its approximately 30% interest in titanium dioxide producer Kronos Worldwide under the equity method. Amounts below are in U.S. dollars; financial-statement amounts are generally in millions unless stated otherwise.
Financial results and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net sales | $28.4 | $26.5 | $82.6 | $83.3 |
| Gross margin | $9.4; 33.1% | $8.1; 30.6% | $26.1; 31.6% | $25.8; 31.0% |
| Income (loss) from operations | Approximately breakeven | $1.0 | $(1.6) | $2.9 |
| Equity in Kronos earnings (losses) | $6.8 | $(3.6) | $6.1 | $(46.6) |
| Net income (loss) attributable to NL stockholders | $7.4; $0.15 per share | $0.9; $0.02 per share | $5.7; $0.12 per share | $(18.3); $(0.38) per share |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $17.9 | $18.3 |
- Q3 sales increased 7% year over year; nine-month sales decreased 1%. CompX’s third-quarter gross profit improved on higher sales, manufacturing efficiencies, and fixed-cost leverage. Nine-month gross margin was broadly stable.
- Corporate and other costs resulted in a $1.6 million operating loss for the nine-month period, despite CompX operating income of $11.5 million. Q3 corporate expense was $4.6 million, including $2.1 million of environmental remediation costs.
- At September 30, cash and cash equivalents were $101.0 million, restricted cash was $4.6 million, and current assets were $133.1 million against current liabilities of $28.8 million. Total assets were $379.9 million and total equity was $186.2 million.
- NL and CompX reported no outstanding debt. NL had the full $40 million Valhi borrowing facility available, subject to Valhi’s discretion. Kronos, an equity-method affiliate, reported $336.0 million of long-term debt; it was in compliance with its covenants.
- Operating cash flow was $17.9 million and investing cash outflow was $13.1 million for the first nine months. Investing outflow included a net $10.7 million loan receivable from Valhi made by CompX. Capital expenditures were $2.4 million. Cash increased $4.5 million from year-end.
Material changes and management commentary
- NL’s earnings improvement primarily reflected the reversal from Kronos equity-method losses to earnings: Kronos reported Q3 net income of $22.2 million versus a loss of $11.8 million a year earlier, and nine-month net income of $20.1 million versus a loss of $153.2 million. The 2015 comparison included a large deferred-tax valuation allowance against German and Belgian tax assets.
- CompX’s Q3 sales rose 7% and operating income rose 30%. Nine-month sales were down 1%, largely because approximately $4.9 million of prior-year government project sales did not recur; a new project for the same customer began shipping in August and was expected to continue through year-end. Marine Components sales rose 8% year to date.
- Kronos Q3 sales increased 6%, with TiO2 volumes up 6% and pricing up 2% year over year. For the first nine months, sales declined 3% as a 7% price decrease outweighed 6% volume growth. Prices had risen 8% from year-end by the end of Q3.
- Management expected CompX full-year 2016 sales to approach 2015 levels absent a significant change in economic conditions. Kronos expected higher 2016 operating income than in 2015, citing anticipated higher volumes, lower feedstock costs, cost reductions, and price increases; results remain sensitive to demand, pricing, costs, and currency movements. These are expectations, not guarantees.
- NL recorded $14.3 million of other comprehensive income for the first nine months, largely reflecting gains in marketable securities and currency translation. Its Valhi share investment increased in market value to $33.1 million from $19.3 million at year-end; unrealized gains are reported in other comprehensive income under the then-applicable accounting treatment.
Risks, contingencies, and unusual items
- Environmental remediation: Accrued costs were $116.8 million at September 30, including $13.4 million current. NL estimated an upper end of approximately $160 million for costs at sites where it could estimate a range, including the amount accrued; costs at five additional sites could not be reasonably estimated. Actual costs may exceed accruals.
- Lead-pigment litigation: NL is appealing a California judgment holding it and two other defendants jointly and severally liable for $1.15 billion of lead-paint abatement. NL recorded no accrual, stating that a loss was not probable and could not be reasonably estimated. The filing warns that an adverse appeal outcome could materially affect results, financial position, and liquidity.
- Other claims: NL disclosed asbestos, silica, environmental, tax, and other litigation and proceedings. It had not accrued amounts for the described asbestos claims because liability and loss could not be reasonably estimated. Insurance coverage and recoveries for litigation costs remain uncertain.
- Tax matters: A U.S.-Canada advance pricing agreement finalized in Q3 led Kronos to recognize a $5.6 million current tax benefit; a Canadian tax payment of about $2.3 million was expected but covered by existing accruals. Kronos continued to carry a substantial valuation allowance against certain German and Belgian deferred-tax assets.
- Related-party exposure: CompX’s $10.7 million demand-note receivable from Valhi bears interest at prime plus 1% and is due on demand, but not before December 31, 2017. Loans are at CompX’s discretion; Valhi also controls NL through its majority ownership.
- Key business risks include cyclical TiO2 supply and demand, pricing and raw-material costs, customer concentration and project timing, currency and interest rates, environmental obligations, litigation outcomes, and reliance on dividends from subsidiaries and affiliates. NL stated its disclosure controls were effective and reported no material changes in internal control during the quarter.
Important facts for investors to verify
- Track the California lead-pigment appeal, potential accrual implications, and the timing and amount of environmental remediation spending.
- Assess whether CompX’s new government project continues through year-end and whether full-year sales approach 2015 levels as management expected.
- Monitor Kronos TiO2 pricing, volumes, feedstock costs, foreign-exchange effects, and the basis for its forecast of improved full-year operating income.
- Review the collectability, terms, and related-party governance of CompX’s Valhi loan, and distinguish cash held by CompX from cash available to NL’s parent operations.
- Confirm Kronos dividend capacity and debt-covenant compliance, given NL’s reliance on affiliate distributions and the difference between NL’s debt-free position and Kronos’s reported debt.
- Consider the effects of unusual prior-period tax charges, insurance recoveries, and valuation changes when comparing reported earnings across periods.