NL Industries, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. The filing is by NL Industries, Inc. (not “NLI Holdings, Inc.”). NL is primarily a holding company, consolidating majority-owned CompX and accounting for its approximately 30% interest in Kronos Worldwide under the equity method. Dollar amounts below are U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Key financial results
| Metric | Q1 2016 | Q1 2017 | Change / context |
|---|---|---|---|
| Net sales | $27.1 | $29.9 | Up 11%; primarily CompX sales |
| Gross margin | $8.2 | $9.7 | Gross margin rate rose to about 32% from 30% |
| Operating income (loss) | $(2.2) | $(0.9) | Improved; CompX operating income rose to $4.5 million |
| Equity earnings (losses) of Kronos | $(1.2) | $11.2 | Major contributor to year-over-year earnings improvement |
| Net income (loss) attributable to NL stockholders | $(2.5) | $8.4 | EPS changed from $(0.05) to $0.17 |
| Operating cash flow | $0.5 | $2.0 | Improved by $1.5 million |
- CompX: Sales increased 11% to $29.9 million, and operating income grew 35% to $4.5 million. Higher Security Products volumes and manufacturing efficiencies lifted margins; Marine Components sales also increased.
- Kronos: Its Q1 sales rose 16% to $369.8 million and net income was $36.8 million, versus a $3.8 million loss. Higher TiO2 selling prices, lower production costs and higher volumes supported results; NL recognized $11.2 million of equity earnings.
- Cash and liquidity: Cash, cash equivalents and restricted cash totaled $97.9 million at March 31, compared with $98.2 million at year-end. Current assets were $126.2 million and current liabilities $27.1 million.
- Debt and facilities: NL had $0.5 million outstanding under its $50 million Valhi revolving facility, with $49.5 million available; NL reported covenant compliance. CompX had no outstanding debt. Kronos also reported compliance with its debt covenants.
- Other assets and liabilities: NL’s Kronos investment was carried at $130.0 million, while its quoted market value was $578.7 million. Environmental remediation accruals totaled $119.3 million, of which $13.1 million was current.
Material changes versus prior period
- NL moved from a net loss to net income, mainly reflecting Kronos’ turnaround from an equity loss to substantial equity earnings, alongside improved CompX operating results.
- CompX sales rose 11%, with Security Products sales up 11% and Marine Components sales up 8%. CompX’s gross margin rate improved to 32% from 30%.
- Kronos benefited from a 17% increase in average TiO2 selling prices and 3% higher sales volumes; its cost of sales fell 4%. Currency movements reduced its sales by an estimated $7 million and operating income by $8 million compared with Q1 2016.
- Environmental accruals increased from $116.7 million at year-end to $119.3 million, including $3.0 million of additions charged to expense, net of payments.
Outlook, risks and unusual items
- CompX outlook: Management expected government security sales to moderate by midyear and full-year 2017 government security volumes to be below 2016. Transportation-market sales were expected to remain soft; sales to other Security Products markets were expected to be at least comparable to the prior year. NL expected 2017 general corporate expenses to be comparable to 2016.
- Kronos outlook: Kronos expected 2017 operating income to exceed 2016, chiefly due to higher average selling prices. It anticipated sales volumes comparable to 2016 and cost per metric ton comparable to slightly higher. Higher-cost feedstock purchased in Q1 was expected to affect results beginning in Q2. These expectations depend on market demand, pricing, costs, currency rates and industry capacity.
- Tax item: Kronos recognized a $5.0 million non-cash tax benefit from a decrease in its German and Belgian deferred-tax valuation allowance. NL stated this contributed approximately $0.02 per share to Q1 2017 earnings. A further material non-cash benefit from a possible German valuation-allowance reversal was described as possible, not assured.
- Lead-pigment litigation: NL continued to appeal the California Santa Clara judgment finding it and two other defendants jointly and severally liable for $1.15 billion in lead-paint abatement costs. NL recorded no accrual, stating loss was not probable and could not be reasonably estimated. The filing cautions that an adverse outcome could materially affect earnings, financial position and liquidity.
- Environmental and other contingencies: NL estimated the upper end of reasonably possible remediation and related costs at approximately $160 million, including the $119 million accrued; costs for five sites could not be reasonably estimated. The company also disclosed asbestos-related cases and other claims, generally without accrual where liability or loss could not be estimated.
- Management said it expected sufficient liquidity for short-term obligations. The filing also identifies risks including cyclicality and pricing in TiO2, raw-material costs, currency movements, litigation, environmental obligations, tax matters and reliance on dividends from subsidiaries and affiliates.
Important facts for investors to verify
- Progress and potential financial exposure in the Santa Clara lead-pigment appeal, and whether any new facts change NL’s no-accrual assessment.
- Changes in environmental remediation estimates, particularly the $160 million possible-cost ceiling and sites for which costs remain unestimable.
- Whether CompX government-security and transportation sales track management’s 2017 expectations.
- Whether Kronos sustains higher TiO2 pricing and margins as feedstock costs rise, and whether currency effects or market capacity alter its outlook.
- NL’s access to cash generated by CompX and Kronos, ongoing affiliate lending arrangements, and the sustainability of expected affiliate dividends.
- Potential effects of Kronos tax-valuation-allowance changes on reported equity earnings and future periods.