NL

Business Context and Reporting Period

Company: NL Industries, Inc. (NYSE: NL)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Model: NL is primarily a holding company. Its operations are conducted through two main subsidiaries:

• CompX International Inc. (86% owned): A manufacturer of component products including security products, precision ball bearing slides, and marine components.
• Kronos Worldwide, Inc. (36% owned): A global producer of titanium dioxide (TiO2) pigments. NL accounts for this investment using the equity method.

Ownership Structure: NL is majority-owned by Valhi, Inc. (approx. 83%), which is controlled by Contran Corporation. Harold C. Simmons is deemed to control Contran, Valhi, and NL.

Key Financial Metrics (2007)

Material Changes vs. Prior Period

• Net Loss: The company reported a net loss of $1.7 million in 2007 compared to net income of $26.1 million in 2006. This reversal was driven primarily by a significant decline in equity earnings from Kronos and lower insurance recoveries.
• Kronos Performance: Equity in earnings from Kronos swung from a $29.3 million gain in 2006 to a $23.9 million loss in 2007. This was largely due to a non-cash charge of approximately $90.8 million at Kronos related to a reduction in German income tax rates and an adjustment of German income tax attributes.
• CompX Operations: CompX income from operations decreased 25% to $15.4 million. Sales declined 7% due to lower order rates from the office furniture industry and competition from lower-priced Asian manufacturers. However, gross margin percentage improved to 25% due to product mix changes and cost reductions.
• Facility Consolidation: CompX incurred $2.7 million in one-time costs related to consolidating three northern Illinois facilities into one, including a $600,000 write-down of assets held for sale.
• Debt Structure: In October 2007, CompX issued a $52.6 million promissory note to an affiliate (TIMET) to repurchase shares, resulting in $50.0 million of long-term debt on the balance sheet at year-end.
• Securities Transactions: NL recognized a $22.7 million pre-tax gain from the sale of 800,000 shares of TIMET common stock to Valhi in the fourth quarter of 2007.

Guidance, Outlook, and Risks

2008 Outlook:

• Management expects net income in 2008 to be comparable to 2007.
• Income from operations is expected to be slightly higher due to lower legal costs and improved CompX results.
• Equity in earnings from Kronos is expected to be higher in 2008, as the unfavorable tax rate change impact in 2007 will not recur, offsetting expected lower operating income at Kronos.
• Securities transaction gains are expected to be lower in 2008.

Key Risks and Contingencies:

• Lead Pigment Litigation: NL faces numerous lawsuits regarding lead-based paint. While no amounts are accrued, a jury verdict in the State of Rhode Island case found NL liable for a public nuisance. The company is appealing, but a loss could have a material adverse impact.
• Environmental Matters: NL has accrued approximately $50 million for environmental remediation. The upper end of the reasonably possible range is approximately $71 million. There are approximately 20 sites where costs cannot currently be estimated.
• Raw Material Costs: CompX faces pressure from rising costs of steel, zinc, and plastic resins. The company may not be able to fully pass these costs to customers due to competition.
• Kronos Leverage: Kronos carries approximately $606 million in debt. Its ability to service this debt depends on future cash flows, which are subject to cyclical demand for TiO2 and raw material costs.

Investor Verification Checklist

• Kronos Tax Impact: Verify the magnitude of the non-cash tax charge at Kronos and confirm the sustainability of future earnings given the German tax rate changes.
• Lead Litigation Status: Monitor the appeal process in the Rhode Island lead pigment case and any new filings in other jurisdictions, as liability remains unquantified.
• CompX Margin Pressure: Assess the ability of CompX to maintain gross margins amidst rising raw material costs and aggressive pricing from Asian competitors.
• Debt Service: Review Kronos' debt covenants and cash flow projections to ensure ability to service its $606 million debt load in a cyclical downturn.
• Environmental Accruals: Track updates on the 20 sites where remediation costs are currently unestimable, as these could exceed current accruals.