Valhi, Inc. — Second-Quarter 2012 Form 10-Q
Business context and period: This unaudited report covers the quarter and six months ended June 30, 2012. Valhi is a holding company with chemicals (Kronos), component products (CompX), and waste management (WCS) operations. Unless noted, amounts are in millions of dollars; per-share data reflects the May 2012 three-for-one stock split.
Financial performance
| Metric | Q2 2011 | Q2 2012 | Six months 2011 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $573.1 | $583.8 | $1,028.8 | $1,181.7 |
| Income before taxes | $114.5 | $96.2 | $198.4 | $275.3 |
| Net income | $72.9 | $61.6 | $126.1 | $181.1 |
| Net income attributable to Valhi stockholders | $52.4 | $44.4 | $90.4 | $133.3 |
| Basic and diluted EPS | $0.15 | $0.13 | $0.26 | $0.39 |
| Operating cash flow | Not stated by quarter | Not stated by quarter | $61.1 | $(76.4) |
Margins: Consolidated gross margin was approximately 28.3% in Q2 2012 versus 35.0% a year earlier, and 36.3% for the first half versus 34.0%. Q2 cost of sales rose to $418.3 million from $372.4 million. Interest expense declined to $14.4 million for Q2 and $27.9 million for the half, from $15.9 million and $33.1 million, respectively.
Liquidity and debt: At June 30, cash and cash equivalents were $103.2 million; restricted cash equivalents were $5.5 million. The company reported $200.1 million of restricted and unrestricted cash, cash equivalents and marketable securities in aggregate. Total debt was $863.8 million, including $34.9 million of current maturities. Total current assets were $1,263.1 million and current liabilities $480.9 million. Available credit was approximately $253 million, including a $125 million Kronos revolving facility with no borrowings outstanding. Management said it expected sufficient liquidity for near- and long-term obligations and reported compliance with debt covenants.
Material changes and operating trends
- Quarter: Net sales increased 2%, but Valhi-attributable income fell 15%. Chemicals operating income declined 23% to $112.4 million, as lower volumes and higher costs more than offset higher TiO₂ prices. WCS operating loss widened to $11.3 million. Component Products operating income improved to $3.9 million.
- First half: Net sales increased 15% and Valhi-attributable income rose 47%. Chemicals operating income increased 30% to $323.7 million, while Component Products operating income fell to $6.8 million from $11.9 million, partly because the prior-year period included a $7.5 million patent settlement gain. WCS operating loss widened to $20.9 million.
- Six-month operating cash flow fell from $61.1 million provided to $76.4 million used, mainly reflecting working-capital use of $293.0 million, including higher receivables and inventories, and increased cash contributions to the TiO₂ joint venture and taxes.
- Working-capital balances increased materially: receivables rose to $457.2 million from $316.0 million and inventory to $661.2 million from $464.5 million at year-end 2011.
Outlook, unusual items and risks
- Management expected lower Valhi-attributable net income in the second half of 2012 versus the comparable 2011 period, primarily due to lower expected Chemicals operating income; higher Component Products income and lower WCS losses were expected to partly offset this.
- Kronos reported softer global TiO₂ demand in Q2 and operated at about 86% of practical capacity. It expected full-year 2012 production at 90%–95% of attainable practical capacity, lower full-year sales volumes than 2011, and average selling prices for the rest of 2012 above comparable 2011 levels. Management forecast TiO₂ production cost per metric ton to rise approximately 50%–60% versus 2011, principally due to feedstock ore costs, and expected lower Chemicals operating income in the second half.
- WCS’s Compact low-level radioactive waste facility became operational in April 2012; the Federal facility was expected to be certified and operational in Q3. WCS anticipated continuing operating losses until sales volumes and utilization improve.
- Unusual Q2 items included a $14.7 million real-estate litigation settlement gain and a $7.2 million pre-tax charge on early extinguishment of Kronos debt. The gain contributed approximately $0.02 per diluted share and the debt charge approximately $0.01 per diluted share.
- Kronos refinanced its 6.5% Senior Secured Notes with a $400 million term loan, issued at 98.5% of principal, and borrowed €80 million under its European revolving facility. Consolidated debt increased from $736.4 million at year-end 2011 to $863.8 million.
- Key risks include cyclical TiO₂ demand and pricing, higher raw-material and energy costs, foreign-exchange movements, working-capital and liquidity needs, environmental remediation, tax examinations, and litigation. NL had accrued $54 million for approximately 50 environmental sites; the estimated upper end of reasonably possible costs for estimable matters was approximately $83 million. No liability was accrued for pending lead-pigment litigation because the company said loss was not probable or reasonably estimable. WCS licenses remained subject to litigation and appeal.
- Management stated that disclosure controls were effective as of June 30, 2012, and that there had been no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether TiO₂ price gains can offset lower volumes and sharply higher feedstock, energy and production costs.
- Whether the substantial receivables and inventory build converts to cash and operating cash flow improves.
- The terms, covenant headroom, repayment schedule and interest-rate exposure of Kronos’s new debt and revolving facilities.
- Progress, certification and customer demand at WCS’s Federal disposal facility, and the impact of license-related litigation.
- Potential changes in environmental remediation estimates, tax exposures and litigation outcomes, including matters for which no loss accrual was recorded.
- Whether the $73.7 million carrying value of TIMET shares remains recoverable; the filing said the decline below cost was considered temporary at June 30, 2012.