NLI HOLDINGS, INC. annual report, FY2018

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Business context and reporting period

NL Industries, Inc. filed this Form 10-K for the fiscal year ended December 31, 2018. NL is primarily a holding company: it owns approximately 87% of CompX International, a component-products manufacturer, and approximately 30% of Kronos Worldwide, a titanium dioxide (TiO2) producer accounted for under the equity method. NL also owns insurance and other investments. Valhi owned approximately 83% of NL at year-end.

Financial performance and liquidity

  • Revenue: NL reported net sales of $118.2 million, up 5.5% from $112.0 million in 2017. These sales principally reflect CompX; Kronos sales are not consolidated into NL’s net sales.
  • CompX profitability: Gross margin was $38.3 million (32.4% of sales), versus $34.8 million (31.1%) in 2017. Operating income increased 17% to $17.8 million, or 15.1% of sales. Marine Components sales rose 29%, while Security Products sales rose 2%.
  • Net income: NL recorded a $41.0 million net loss attributable to NL stockholders, or $0.84 per share, compared with net income of $116.1 million, or $2.38 per share, in 2017. Operating loss was $60.7 million, including a $62.0 million litigation-settlement charge. Equity in Kronos earnings was $62.3 million, down from $107.8 million.
  • Unusual investment loss: NL recorded a $60.9 million loss on marketable equity securities after adopting a new accounting standard requiring unrealized fair-value changes to be recognized in earnings. NL’s Valhi shares had a year-end market value of $27.7 million, down from $88.7 million a year earlier.
  • Cash flow: Operating cash flow was $17.1 million, compared with $18.6 million in 2017. Investing activities provided $1.3 million, versus $13.6 million used in 2017; financing activities used $0.3 million. Capital expenditures were $3.1 million.
  • Balance sheet and liquidity: Total assets were $547.2 million and total equity was $303.6 million. Cash, cash equivalents and restricted cash totaled approximately $121.0 million, although cash held by subsidiaries and affiliates is not necessarily available to NL. NL had $0.5 million of debt and $49.5 million available under its $50 million Valhi revolving facility. CompX had no debt outstanding. NL reported compliance with its debt covenants.
  • Other key balances: Environmental remediation liabilities totaled $98.2 million. NL’s investment in Kronos was carried at $255.6 million, versus a quoted market value of $405.7 million. NL paid no common-stock dividend in 2018.

Material changes versus 2017

  • NL’s results swung from substantial profit to loss, primarily due to the California lead-pigment litigation charge, the marketable-securities loss, and lower equity earnings from Kronos. The 2017 comparison benefited from a $37.5 million noncash tax benefit at NL and significant tax benefits recognized by Kronos.
  • CompX revenue and operating income improved, with higher marine demand and better fixed-cost absorption supporting margins.
  • Kronos net sales declined 4% to $1.662 billion. A 13% increase in average TiO2 selling prices was outweighed by a 16% fall in sales volume. Production declined 7% to 536,000 metric tons; capacity utilization was 95%, versus full practical capacity in 2017. Kronos net income fell to $205.0 million from $354.5 million.
  • NL’s cash balance increased, while operating cash flow declined modestly. Environmental remediation payments increased, including payment related to a settled site.

Outlook, risks and contingencies

  • NL outlook: Management expected 2019 net income attributable to NL stockholders to exceed 2018, mainly because 2018 included the $62 million litigation expense and litigation costs were expected to be lower; lower expected Kronos equity earnings were a partial offset. NL expected slightly lower general corporate expenses and approximately $4.8 million of 2019 capital expenditures.
  • Subsidiary outlook: CompX aimed to sustain sales and profitability momentum. Kronos expected higher 2019 sales volumes but lower average selling prices and higher feedstock costs; it consequently expected lower operating income than in 2018. Kronos planned to operate near full practical capacity.
  • California lead-pigment case: NL recorded a $62 million pretax charge based on a proposed settlement under which NL would pay $65 million and a former insurer would fund $15 million, for $80 million in total. The settlement remained subject to court approval; the trial court denied approval in September 2018, and NL appealed. The trial court set the recalculated abatement fund at $409 million. If the settlement is not approved, NL’s share of that fund is undetermined, and additional material liability remains possible.
  • Other litigation and remediation: NL faces other lead-pigment claims, including two Pennsylvania county suits, and environmental proceedings involving former operations. The company accrued approximately $98 million for about 35 reasonably estimable environmental sites; the estimated upper end of reasonably possible costs for those sites was approximately $117 million. Costs at about five other sites could not be reasonably estimated.
  • Key operating and financial risks: NL depends substantially on distributions from CompX and Kronos to meet parent-level obligations. Risks include TiO2 market cyclicality, pricing and capacity changes, raw-material and energy costs, feedstock supply, foreign exchange, environmental regulation, litigation outcomes, and the ability of affiliates to pay dividends. Kronos reported approximately $456.6 million of consolidated debt and substantial contractual commitments.

Important facts for investors to verify

  1. Check subsequent court decisions on the Santa Clara settlement appeal, the $409 million abatement fund, and any resulting NL payment or additional accrual.
  2. Review the status and potential cost range of environmental matters, particularly sites for which NL cannot currently estimate a range.
  3. Track Kronos selling prices, sales volumes, feedstock costs, production utilization, debt, and dividend capacity against management’s 2019 outlook.
  4. Assess how much of the reported $121.0 million cash balance is held at NL versus subsidiaries, and confirm the terms and availability of affiliate credit and distributions.
  5. Evaluate the effect of marketable-security fair-value movements and the accounting change on earnings comparability; NL’s 2018 results included a $60.9 million securities loss.
  6. Confirm the sustainability of CompX’s marine demand and margin improvement, and monitor customer concentration: its largest customer represented 13% of 2018 sales.