NL

Business Context and Reporting Period

Company: NL Industries, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2010
Business Overview: NL Industries operates primarily as a holding company. Its main operating subsidiary is CompX International Inc., a manufacturer of security products, precision ball bearing slides, and marine components. NL also holds a 36% noncontrolling interest in Kronos Worldwide, Inc., a global producer of titanium dioxide pigments, accounted for using the equity method.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Turnaround: Net income attributable to NL stockholders for the nine months ended September 30, 2010, was $13.5 million, a significant improvement from a net loss of $10.9 million in the same period of 2009.
• CompX Performance: CompX net sales increased 18% year-over-year for the nine-month period. Operating income improved from a loss of $2.0 million in 2009 to income of $7.8 million in 2010, driven by higher sales volumes and improved gross margins.
• Kronos Equity Income: Equity in net income from Kronos Worldwide, Inc. was $33.9 million for the nine months of 2010, compared to an equity loss of $14.4 million in 2009. This was driven by higher TiO2 sales volumes and prices.
• Litigation and Settlements: The 2010 results included a $32.2 million litigation settlement expense related to a settlement with Contran Corporation, partially offset by $18.6 million in insurance recoveries. Conversely, a $5.3 million litigation settlement gain was recognized in Q3 2010 related to an environmental matter.
• Debt Structure: Total debt increased from $42.5 million at year-end 2009 to $74.4 million at September 30, 2010. This increase includes a new $18.0 million promissory note issued for the litigation settlement and $9.2 million borrowed from Valhi.

Guidance, Outlook, and Risks

• Outlook: Management expects demand for CompX products to remain uncertain but is focused on lean manufacturing and cost improvements. Kronos expects to operate at near full capacity for the remainder of 2010 with continued price increases for TiO2, anticipating higher operating income for the full year 2010 compared to 2009.
• Liquidity: The company expects sufficient liquidity to meet short-term obligations. It has a $40 million revolving promissory note with Valhi (with $9.2 million outstanding) and CompX has a $37.5 million credit facility (with $5.0 million outstanding).
• Risks and Contingencies:
  • Lead Pigment Litigation: NL faces ongoing litigation regarding lead-based paint. While no liability is currently accrued, the company notes that resolution could have a material adverse impact.
  • Environmental Remediation: Accrued environmental costs are $40.5 million. The company notes that actual costs could exceed accruals due to the complexity of site remediation and potential insolvency of other responsible parties.
  • Patent Litigation: CompX won a patent infringement case against Humanscale with a $20 million award, but the outcome is subject to appeal, and no receivable has been accrued.
• Unusual Items: A $1.9 million deferred income tax provision was recognized in Q1 2010 due to a change in the permanent reinvestment status of earnings from CompX's Taiwanese subsidiary.

Investor Verification Checklist

• Litigation Settlement Terms: Verify the specific terms and future cash flow implications of the $32.2 million settlement with Contran Corporation and the $18.0 million promissory note.
• Environmental Accrual Adequacy: Assess the sufficiency of the $40.5 million environmental accrual given the company's disclosure that costs for certain sites cannot be estimated and actual costs may exceed accruals.
• Kronos Ownership Dilution: Monitor the impact of Kronos' October 2010 public offering of 7.8 million shares, which will reduce NL's ownership stake from 36% to approximately 31%.
• Insurance Recoveries: Evaluate the certainty of future insurance recoveries related to lead pigment and asbestos litigation defense costs, as the company states these amounts are not fully determinable.
• CompX Patent Award: Track the status of the $20 million patent infringement award against Humanscale, noting that it has not been accrued due to the pending appeal.