Valhi, Inc. — Q3 2012 Form 10-Q
Business context and period. Valhi is a holding company with chemicals (Kronos), component products (CompX) and waste management (WCS) businesses. This unaudited report covers the quarter and nine months ended September 30, 2012; amounts are in millions of dollars except per-share data.
Financial results and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $524.5 | $584.1 | $1,706.2 | $1,612.9 |
| Income before taxes | $29.7 | $148.5 | $305.0 | $346.9 |
| Net income | $31.8 | $93.1 | $212.9 | $219.2 |
| Net income attributable to Valhi stockholders | $22.9 | $71.5 | $156.2 | $161.9 |
| Basic and diluted EPS | $0.07 | $0.21 | $0.46 | $0.47 |
| Operating cash flow | Not separately reported by quarter | $46.2 | $220.5 |
Third-quarter sales declined about 10% year over year and attributable earnings fell about 68%; nine-month sales increased about 6%, while attributable earnings declined about 4%. Consolidated gross margin was approximately 19% in Q3 2012 versus 36% in Q3 2011, and approximately 31% for the 2012 nine-month period versus 35% in 2011. The filing reports interest expense of $14.6 in Q3 and $42.5 for nine months, compared with $15.2 and $48.3, respectively, in 2011.
- Segment performance: Chemicals operating income was $40.4 in Q3 (down from $158.4) and $364.1 for nine months (down from $407.8). Component Products operating income was $4.4 in Q3 (up from $1.5) and $11.2 for nine months (down from $13.4). WCS operating losses narrowed to $1.0 in Q3 and $21.9 for nine months, compared with $9.7 and $27.9.
- Cash, liquidity and debt: At September 30, cash and cash equivalents were $123.5, restricted cash equivalents $6.8, and current assets $1,141.8; current liabilities were $393.7. Total debt was $803.4, including $34.7 current maturities, versus $736.4 at year-end 2011. Management reported $231.5 of restricted and unrestricted cash, cash equivalents and marketable securities and approximately $363 of available credit facilities. Operating cash flow declined substantially, with inventory and receivables/payables changes using $188.3 of cash; inventory rose to $624.3 from $464.5 at year-end.
- Investment and spending: Nine-month capital expenditures were $66.0. Valhi paid $48.0 in dividends during the period; dividends per share were $0.142 versus $0.117 in 2011. Total equity was $1,143.1, compared with $993.0 at December 31, 2011.
Material changes and management commentary
- The Chemicals business drove the profit decline. Q3 TiO2 sales volume fell 15% and production volume fell 27%; average selling prices were 5% higher year over year, but lower utilization, higher input costs and currency effects compressed margins. Nine-month TiO2 sales volume fell 9% while average prices rose 20%.
- Management attributed weaker Chemicals results to higher feedstock ore and petroleum coke costs, reduced production and unabsorbed fixed costs. Q3 reduced production created about $25 of unabsorbed fixed costs. Currency movements reduced Chemicals sales by about $34 in Q3 and $70 for nine months versus 2011.
- Kronos replaced its remaining 6.5% Senior Secured Notes with a June 2012 $400 term loan, issued at 98.5% of principal; it recorded a $7.2 debt-extinguishment charge. The loan carries a floating rate, averaging 5.75% at quarter-end, and matures in 2018. Kronos also established a $125 North American revolving facility, with no borrowings outstanding and approximately $125 available at September 30. The European facility was expanded and its maturity extended to 2017.
- Nonrecurring and unusual items included a $14.7 real-estate litigation settlement gain recognized in Q2 2012, a $7.2 debt-prepayment loss, a $0.8 reversal of contingent consideration in Q3, and a $11.1 tax benefit in Q3 from a partial reversal of previously accrued tax on expected foreign dividends. Insurance recoveries were materially higher in 2011.
- Management expects lower full-year 2012 net income attributable to Valhi stockholders than in 2011, primarily from lower Chemicals and Component Products operating income, partly offset by reduced WCS losses. It expects Q4 TiO2 prices below Q4 2011 levels, Chemicals operating income significantly lower year over year in Q4, and 2012 TiO2 production cost per metric ton 45%–55% above 2011. Chemicals production was expected at 80%–85% of practical capacity for 2012.
- WCS’s Compact low-level radioactive waste facility became operational in April 2012 and its Federal facility in September 2012. WCS had begun accepting shipments at the Compact facility but had not received Federal-site waste by quarter-end. Management expects continued WCS operating losses until volumes cover its high fixed costs.
Risks, contingencies and other disclosures
- Environmental remediation liabilities totaled $51.1 at September 30, including $49 accrued by NL for approximately 50 sites. The estimated upper end of reasonably possible NL costs for sites where a range can be estimated was approximately $79, including amounts accrued; costs for five sites could not then be estimated.
- Valhi has not accrued for pending lead-pigment litigation, stating that liability is not considered probable or reasonably estimable. The filing cautions that a future adverse outcome could materially affect earnings, financial condition and liquidity.
- WCS disposal licenses remained in effect while appeals and challenges by the Sierra Club proceeded. NL also faces asbestos/silica litigation and disputes with former insurers over coverage and defense-cost reimbursements.
- Tax authorities are examining returns. A Canadian reassessment dispute could result in approximately Cdn. $15.9 of cash tax liability if fully assessed; the company says it believes its accruals are adequate. It also discloses $18.1 of undistributed French earnings potentially subject to a 3% dividend surtax if distributed.
- Management said it was in compliance with debt covenants and expected sufficient liquidity for near- and long-term obligations, but warned that results materially below expectations could affect covenant compliance and liquidity. Key business risks include TiO2 demand, prices and raw-material costs, global economic conditions, currency rates, environmental obligations, litigation, and the ability to sustain subsidiary dividends. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether TiO2 demand, prices, production rates and raw-material costs developed as forecast, especially the expected Q4 margin and earnings pressure.
- How the sharp decline in operating cash flow and the increase in inventory affected working capital and liquidity after quarter-end.
- The terms, covenants, borrowing capacity and repayment profile of Kronos’s new term loan and revolving facilities, and the resulting consolidated debt burden.
- Progress toward WCS revenue growth and profitability, including operating volumes at the Federal facility and outcomes of license litigation.
- Updates to environmental accruals, lead-pigment and asbestos litigation, insurance recoveries, and tax disputes or potential tax liabilities.
- Whether unusual gains, tax benefits and debt-extinguishment charges materially affect comparisons of recurring earnings.