NL

Business Context and Reporting Period

Company: NL Industries, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2009
Business Overview: NL Industries operates primarily as a holding company. Its main operating subsidiary is CompX International Inc., a manufacturer of component products for office furniture, transportation, and marine industries. NL also holds a 36% non-controlling interest in Kronos Worldwide, Inc., a global producer of titanium dioxide pigments, accounted for using the equity method. The company is majority-owned by Valhi, Inc.

Key Financial Metrics

Note: Net sales and gross margin figures represent consolidated results including CompX operations. Kronos results are reflected via equity in net income/loss.

Material Changes vs. Prior Period

• Revenue Decline: Net sales decreased 33% in the third quarter and 32% in the first nine months of 2009 compared to 2008. This was primarily driven by lower order rates from CompX customers due to unfavorable economic conditions in North America.
• Profitability Shift: The company reported a net income of $3.1 million for the third quarter of 2009, a significant improvement from a net loss of $6.7 million in the same period of 2008. However, for the nine-month period, the net loss widened to $10.9 million from $3.1 million in 2008.
• Equity in Kronos: Equity in net income from Kronos turned positive in the third quarter ($3.1 million) compared to a loss in 2008, but contributed a significant loss of $14.4 million for the nine-month period due to production curtailments and lower sales volumes in the first half of 2009.
• One-Time Items:
  • 2009: Included a $11.3 million pre-tax litigation settlement gain related to a real estate condemnation proceeding and a $0.7 million write-down of assets held for sale.
  • 2008: Included a $10.1 million non-cash goodwill impairment charge related to CompX's marine business line.
• Working Capital: Accounts receivable decreased by approximately $13.7 million and inventories decreased by $5.4 million compared to December 31, 2008, reflecting reduced sales volumes and inventory management.

Guidance, Outlook, and Risks

Management Commentary and Outlook:

• CompX: Demand remains slow and unstable. Management is focusing on lean manufacturing and cost improvements. Raw material costs are expected to remain volatile. CompX expects to maintain compliance with its credit facility covenants, though a loss in the third quarter effectively restricted borrowing capacity under the interest coverage ratio covenant.
• Kronos: Sales volumes are expected to be lower in 2009 than 2008 due to the economic downturn. However, Kronos expects to gain market share following competitor capacity reductions. Price increases announced in late 2009 are expected to improve average selling prices in the fourth quarter and into 2010. Kronos expects to operate at 90-95% capacity in Q4 2009.

Risks and Contingencies:

• Lead Pigment Litigation: NL is a defendant in numerous lawsuits regarding lead-based paint. While no liability has been accrued, the company notes that resolution could have a material adverse impact on financial condition.
• Environmental Remediation: Accrued environmental costs totaled $45.6 million. The upper end of the range of reasonably possible costs for estimable sites is approximately $82 million. Costs for 20 sites remain unestimable.
• Patent Litigation: CompX is involved in patent infringement disputes with Humanscale and Accuride. While management believes an out-of-court resolution is likely for Accuride, defense costs are expected to be material in the short term.
• Liquidity: CompX's ability to borrow under its credit facility is restricted by financial covenants tied to earnings before interest and taxes. Kronos has also amended its European credit facility with new covenants and interest rate adjustments.

Investor Verification Checklist

• Credit Covenant Compliance: Verify CompX's ability to maintain the interest coverage ratio covenant given recent operating losses, and Kronos's compliance with its amended European facility covenants.
• Environmental Accruals: Review the $45.6 million accrued environmental liability and the potential exposure of up to $82 million for estimable sites, plus the unestimable liability for 20 other sites.
• Legal Exposure: Monitor the status of the lead pigment litigation and the recent jury verdict in the EMS minority shareholder dispute (approx. $217 million in damages awarded, though NL intends to appeal and believes the judgment will be set aside).
• Kronos Dividend Status: Confirm the suspension of Kronos dividends and its impact on NL's cash flow, as NL relies on subsidiary dividends for parent-level liquidity.
• Asset Valuation: Assess the fair value of the $122.8 million investment in Kronos and the $71.9 million in marketable equity securities (Valhi and TIMET) given market volatility.