NLI HOLDINGS, INC. annual report, FY2016

Business context and reporting period

This is NL Industries, Inc.’s Form 10-K for the fiscal year ended December 31, 2016, filed March 10, 2017. The request metadata names “NLI Holdings, Inc.”; the filing identifies the registrant as NL Industries, Inc. (NYSE: NL). NL is primarily a holding company: it consolidates its 87%-owned component-products subsidiary CompX and accounts for its 30% interest in titanium-dioxide producer Kronos Worldwide using the equity method.

Financial performance and position

NL’s reported net sales principally reflect CompX; Kronos’s sales are not consolidated. CompX sales were essentially flat, while gross margin rose to 32% of sales and operating income increased 11% to $15.6 million (about 14% of sales), supported by favorable product and customer mix and Marine Components growth. NL’s consolidated operating result was a $1.0 million loss, including corporate costs and sharply lower insurance recoveries.

Kronos reported 2016 sales of $1.364 billion, operating income of $81.1 million and net income of $43.3 million, versus an operating loss of $1.1 million and net loss of $173.6 million in 2015. NL’s share of Kronos earnings improved to $13.2 million from a $52.8 million loss. Kronos’s 2015 loss included a substantial noncash deferred-tax valuation allowance.

NL’s current assets were $123.5 million and current liabilities $30.7 million. Its $98.2 million cash total includes restricted cash. NL also held $49.7 million of Valhi securities and reported a $27.4 million receivable from Valhi, a related party. NL’s investment in Kronos had a $120.3 million carrying value versus a $420.5 million quoted market value at year-end. Cash from investing activities was a $30.6 million outflow, mainly due to net affiliate lending; capital expenditures were $3.2 million.

Material changes versus the prior year

• NL returned to profitability, primarily because its equity-method results from Kronos moved from a large loss to earnings.
• CompX’s revenue was nearly unchanged, but gross margin improved and operating income rose from $14.0 million to $15.6 million.
• Kronos sales increased 1% as sales volumes rose 7%, partly offset by a 3% decline in average TiO₂ prices. Lower feedstock and production costs improved margins; year-end selling prices were 10% above year-end 2015.
• NL insurance recoveries fell to $0.4 million from $3.7 million. Corporate environmental costs rose to $5.2 million from $4.4 million, while litigation costs declined to $3.5 million from $4.8 million.
• NL’s environmental accrual increased to approximately $116.7 million from $113.1 million. Cash and restricted cash decreased by $2.7 million.

Outlook, risks and unusual items

Management expected 2017 net income attributable to NL stockholders to exceed 2016, mainly on higher Kronos equity earnings and lower environmental costs, partly offset by lower CompX operating income. CompX expected continued strong demand overall but did not expect government-security demand to match 2016. Kronos expected sales volumes comparable to 2016, slightly higher production, and higher operating income, principally from anticipated higher average selling prices. NL estimated 2017 capital expenditures of about $3.6 million and expected adequate liquidity for near-term obligations; Valhi made up to $49.5 million available under NL’s revolving facility at year-end.

Key risks include cyclical TiO₂ prices and demand, competition and capacity changes, feedstock and energy costs, foreign-exchange movements, Kronos’s debt and covenant requirements, and NL’s reliance on distributions from affiliates. NL’s $117 million environmental accrual covers about 41 estimable sites; the upper end of the estimated range is approximately $160 million, and costs for five additional sites could not be estimated. NL also faces a California lead-pigment judgment imposing aggregate $1.15 billion liability on NL and two co-defendants; NL appealed, considered loss less than probable, and recorded no accrual. A future adverse outcome could materially affect results, financial position and liquidity. NL’s regular quarterly dividend has been suspended since 2014; future dividends are discretionary.

Important facts for investors to verify

• Confirm the registrant identity: the filing is for NL Industries, Inc., not “NLI Holdings, Inc.”
• Review Kronos’s separate audited statements, debt, credit facilities and 2017 pricing assumptions; NL’s equity-method earnings are a major driver of parent results.
• Track the California lead-pigment appeal and environmental-site developments against the recorded accruals and unestimable exposures.
• Assess the credit terms, collateral and collectability of the $27.4 million Valhi receivable, as well as the broader related-party arrangements.
• Distinguish unrestricted cash from restricted cash and note that the parent depends substantially on subsidiary and affiliate distributions.