NL

Business Context and Reporting Period

Company: NL Industries, Inc. (NYSE: NL)
Reporting Period: Fiscal year ended December 31, 2006
Structure: NL is primarily a holding company. It operates through two main segments:

• Component Products: Majority-owned subsidiary CompX International Inc. (70% owned), manufacturing security products, precision ball bearing slides, and marine components.
• Chemicals: Non-controlling interest in Kronos Worldwide, Inc. (36% owned), a global producer of titanium dioxide (TiO2) pigments. Kronos is accounted for using the equity method.

Ownership: Valhi, Inc. owns approximately 83% of NL's outstanding common stock. Valhi is majority-owned by Contran Corporation, which is controlled by Harold C. Simmons.

Key Financial Metrics (2006)

Metric	2006	2005
Net Sales	$190.1 million	$186.4 million
Net Income	$26.1 million	$33.0 million
Diluted EPS	$0.54	$0.68
Operating Cash Flow	$29.0 million	($5.3 million) used
Total Assets	$529.3 million	$485.6 million
Stockholders' Equity	$248.5 million	$220.3 million
Long-Term Debt	$0	$1.4 million
Cash & Equivalents	$52.7 million	$76.9 million

Note: NL's consolidated debt is minimal; however, its equity investee Kronos carries approximately $536 million in debt.

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased 21% to $26.1 million from $33.0 million in 2005. This was driven by higher environmental and legal defense costs and the absence of significant securities transaction gains recorded in 2005.
• Component Products Growth: CompX net sales increased 2% to $190.1 million, driven by acquisitions of marine component businesses and improved demand for security products. Segment profit rose 6% to $20.5 million.
• Equity in Earnings of Kronos: NL's share of Kronos earnings increased to $29.3 million from $25.7 million. However, Kronos reported a 17% decline in its own segment profit due to higher energy and raw material costs that could not be fully offset by pricing.
• Cash Flow Improvement: Operating cash flow turned positive at $29.0 million, a $34.3 million improvement over 2005, primarily due to lower cash paid for income taxes and environmental remediation.
• Dividend Reduction: The quarterly cash dividend was reduced to $0.125 per share in 2006 from $0.25 per share in 2005.

Guidance, Outlook, and Risks

Outlook for 2007: Management expects net income in 2007 to be lower than 2006. This projection is based on anticipated lower equity earnings from Kronos and higher legal expenses.

Key Risks and Contingencies:

• Lead Pigment Litigation: NL faces numerous lawsuits regarding former lead pigment operations. A significant adverse verdict was reached in the State of Rhode Island case in 2006, though the company intends to appeal. The company has not accrued for these liabilities as they are not currently estimable, but a future accrual could materially impact financial results.
• Environmental Remediation: The company has accrued approximately $51 million for environmental costs, with a reasonably possible upper range of $75 million. Approximately 20 sites remain where costs cannot currently be estimated.
• Raw Material Costs: Both CompX and Kronos face pressure from volatile raw material costs (steel, zinc, energy). Kronos specifically noted a 15% increase in utility costs in 2006.
• Competition: CompX faces price pressure from lower-cost Asian manufacturers, particularly in the furniture components sector.

Investor Verification Checklist

• Lead Litigation Status: Monitor the appeal process and potential abatement cost rulings in the Rhode Island lead pigment case, as this represents a significant unquantified liability.
• Kronos Debt Service: Verify Kronos' ability to service its $536 million debt load, as NL's cash flow is heavily dependent on dividends from Kronos.
• Environmental Accruals: Review future updates on the 20 sites where environmental remediation costs are currently unestimable.
• Raw Material Hedging: Assess the effectiveness of CompX's strategies to mitigate steel and zinc price volatility.
• Dividend Sustainability: Evaluate the impact of the reduced dividend rate on shareholder returns given the projected lower 2007 earnings.