SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2006 Commission file number 1-640
--------------------- -----
NL INDUSTRIES, INC.
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(Exact name of Registrant as specified in its charter)
New Jersey 13-5267260
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(State or other jurisdiction of (IRS Employer
Incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (972) 233-1700
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
--- ---
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Securities Exchange Act of 1934). Large accelerated filer Accelerated filer
X Non-accelerated filer
--- ---
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes No X
--- ---
Number of shares of the Registrant's common stock outstanding on October 31,
2006: 48,569,034.
NL INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
Page
Part I. FINANCIAL INFORMATION Number
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -
December 31, 2005; September 30, 2006 (unaudited) 1
Condensed Consolidated Statements of Income -
Three and nine months ended September 30, 2005 and
2006 (unaudited) 3
Condensed Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2005 and
2006 (unaudited) 4
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2005 and 2006
(unaudited) 5
Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2006 (unaudited) 7
Notes to Condensed Consolidated Financial Statements
(unaudited) 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosure About Market Risk 35
Item 4. Controls and Procedures 36
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 1A. Risk Factors 39
Item 6. Exhibits 39
Items 2, 3, 4 and 5 of Part II are omitted because there is no information to
report
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2005 2006
-------------- --------------
(unaudited)
Current assets:
Cash and cash equivalents $ 76,912 $ 48,133
Marketable securities 9,265 9,255
Restricted cash and cash equivalents 4,327 6,061
Accounts and other receivables, net 23,392 24,537
Refundable income taxes 424 643
Receivable from affiliates 3,291 6,923
Inventories, net 22,538 23,631
Prepaid expenses 1,718 1,141
Deferred income taxes 7,295 7,074
---------- ----------
Total current assets 149,162 127,398
---------- ----------
Other assets:
Marketable equity securities 87,120 109,488
Investment in Kronos Worldwide, Inc. 146,774 155,984
Goodwill 27,240 32,541
Deferred income taxes 4 -
Other, net 5,499 8,979
---------- ----------
Total other assets 266,637 306,992
---------- ----------
Property and equipment:
Land 8,511 9,485
Buildings 28,001 29,090
Equipment 110,917 116,692
Construction in progress 2,015 8,637
---------- ----------
149,444 163,904
Less accumulated depreciation and amortization 80,540 90,972
---------- ----------
Net property and equipment 68,904 72,932
---------- ----------
Total assets $ 484,703 $ 507,322
========== ==========
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2005 2006
-------------- --------------
(unaudited)
Current liabilities:
Current maturities of long-term debt $ 171 $ 37
Accounts payable 11,079 10,344
Accrued liabilities 29,859 30,130
Accrued environmental costs 13,302 9,229
Payable to affiliates 982 382
Income taxes 599 271
---------- ----------
Total current liabilities 55,992 50,393
---------- ----------
Noncurrent liabilities:
Long-term debt 1,425 17
Accrued pension costs 942 -
Accrued postretirement benefits costs 10,141 8,911
Accrued environmental costs 41,645 42,250
Deferred income taxes 107,000 123,966
Other 2,246 2,336
---------- ----------
Total noncurrent liabilities 163,399 177,480
---------- ----------
Minority interest 45,630 45,723
---------- ----------
Stockholders' equity:
Common stock 6,070 6,070
Additional paid-in capital 363,233 357,633
Retained earnings - -
Accumulated other comprehensive income (loss):
Marketable securities 34,084 48,562
Currency translation (141,018) (135,852)
Pension liabilities (42,687) (42,687)
---------- ----------
Total stockholders' equity 219,682 233,726
---------- ----------
Total liabilities and stockholders' equity $ 484,703 $ 507,322
========== ==========
Commitments and contingencies (Note 12)
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
---------------------- ---------------------
2005 2006 2005 2006
---- ---- ---- ----
(unaudited)
Net sales $ 47,134 $ 48,812 $ 139,707 $ 145,984
Cost of goods sold 36,153 35,955 107,916 109,150
--------- --------- --------- ---------
Gross margin 10,981 12,857 31,791 36,834
Selling, general and administrative expense 6,049 6,673 17,979 19,832
Other operating income (expense):
Currency transaction gains (losses), net (43) 31 (58) (80)
Insurance recoveries 1,231 48 2,431 2,864
Other income - 124 207 128
Corporate expense (3,900) (7,686) (13,928) (18,275)
--------- --------- --------- ---------
Income (loss) from operations 2,220 (1,299) 2,464 1,639
Equity in earnings of Kronos Worldwide, Inc. 2,847 4,154 22,403 14,393
Other income (expense):
Trade interest income 32 115 76 252
Interest and dividend income from affiliates 619 471 1,858 1,413
Other interest income 785 743 2,445 2,369
Securities transactions, net (93) 82 14,603 146
Interest expense (90) (50) (287) (162)
--------- --------- --------- ---------
Income from continuing operations before
income taxes and minority interest 6,320 4,216 43,562 20,050
Provision for income taxes (benefit) 5,460 (52) 16,485 4,379
Minority interest in after-tax earnings (1,929) 1,126 (413) 2,999
--------- --------- --------- ---------
Income from continuing operations 2,789 3,142 27,490 12,672
Discontinued operations, net of tax - - (326) (177)
--------- --------- --------- ---------
Net income $ 2,789 $ 3,142 $ 27,164 $ 12,495
========= ========= ========= =========
Basic and diluted net income per share $ .06 $ .06 $ .56 $ .26
========= ========= ========= =========
Weighted-average shares outstanding:
Basic 48,558 48,569 48,534 48,566
Dilutive impact of stock options 36 15 49 18
--------- --------- --------- ---------
Diluted 48,594 48,584 48,583 48,584
========= ========= ========= =========
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Net income $ 27,164 $ 12,495
--------- ---------
Other comprehensive income, net of tax:
Marketable securities adjustment 5,728 14,478
Currency translation adjustment (4,718) 5,166
--------- ---------
Total other comprehensive income 1,010 19,644
--------- ---------
Comprehensive income $ 28,174 $ 32,139
========= =========
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from operating activities:
Net income $ 27,164 $ 12,495
Depreciation and amortization 8,420 8,644
Deferred income taxes:
Continuing operations (11,411) 5,546
Discontinued operations (187) -
Minority interest:
Continuing operations (413) 2,999
Discontinued operations (151) (148)
Equity in earnings of Kronos Worldwide, Inc. (22,403) (14,393)
Dividends from Kronos Worldwide, Inc. 13,214 13,137
Securities transactions, net (14,603) (146)
Benefit plan expense less than cash funding:
Defined benefit pension plans (660) (1,552)
Other postretirement benefit plans (991) (1,230)
Other, net 1,195 971
Change in assets and liabilities:
Accounts and other receivables (1,994) (1,557)
Inventories (763) 536
Prepaid expenses (1,279) 549
Accrued environmental costs (8,685) (3,468)
Accounts payable and accrued liabilities 19 (1,173)
Income taxes (1,370) (422)
Accounts with affiliates (1,407) (4,250)
Other, net (404) (2,552)
-------- --------
Net cash provided by (used in)
operating activities (16,709) 13,986
-------- --------
Cash flows from investing activities:
Capital expenditures (8,828) (9,117)
Acquisition, net of cash acquired (7,342) (9,832)
Collection of note receivable - 1,306
Collection of loans to affiliates 2,000 -
Change in restricted cash equivalents
and marketable debt securities, net 4,278 (1,537)
Proceeds from disposal of:
Business unit 18,094 -
Kronos common stock 19,176 -
Marketable securities 5,614 9,209
Property and equipment 19 45
Purchase of:
CompX common stock (707) (2,278)
Marketable securities (4,758) (9,357)
Cash of disposed business unit (4,006) -
-------- --------
Net cash provided by (used in) investing activities 23,540 (21,561)
-------- --------
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from financing activities:
Indebtedness:
Principal payments $ (48) $ (1,516)
Deferred financing costs paid (28) (105)
Cash dividends paid (24,279) (18,213)
Distributions to minority interest (1,805) (1,708)
Proceeds from issuance of common stock:
NL common stock 2,488 9
CompX common stock 639 104
-------- --------
Net cash used in financing activities (23,033) (21,429)
-------- --------
Cash and cash equivalents - net change from:
Operating, investing and financing activities (16,202) (29,004)
Currency translation 120 225
Cash and cash equivalents at beginning of period 99,185 76,912
-------- --------
Cash and cash equivalents at end of period $ 83,103 $ 48,133
======== ========
Supplemental disclosures - cash paid for:
Interest, net of amounts capitalized $ 105 $ 105
Income taxes, net 32,117 3,330
Noncash investing activity - note receivable
received upon disposal of business unit $ 4,179 $ -
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2006
(In thousands)
Accumulated other
comprehensive income (loss)
Additional ---------------------------------------------
Common paid-in Retained Marketable Currency Pension
stock capital earnings securities translation liabilities Total
------ --------- -------- ------------ ----------- ------------- -------
(unaudited)
Balance at December 31, 2005 $6,070 $363,233 $ - $ 34,084 $(141,018) $ (42,687) $219,682
Net income - - 12,495 - - - 12,495
Issuance of common stock - 80 - - - - 80
Dividends - (5,718) (12,495) - - - (18,213)
Other comprehensive income, net - - - 14,478 5,166 - 19,644
Other - 38 - - - - 38
------ -------- ------- -------- --------- --------- --------
Balance at September 30, 2006 $6,070 $357,633 $ - $ 48,562 $(135,852) $ (42,687) $233,726
====== ======== ======= ======== ========= ========= ========
See accompanying Notes to Condensed Consolidated Financial Statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(unaudited)
Note 1 - Organization and basis of presentation:
Organization - We are majority-owned by Valhi, Inc. (NYSE: VHI), which owns
approximately 83% of our outstanding common stock at September 30, 2006. Valhi
is majority-owned by Contran Corporation. Substantially all of Contran's
outstanding voting stock is held by trusts established for the benefit of
certain children and grandchildren of Harold C. Simmons (for which Mr. Simmons
is the sole trustee) or is held directly by Mr. Simmons or persons or companies
related to Mr. Simmons. Consequently, Mr. Simmons may be deemed to control
Contran, Valhi and us.
Basis of presentation - Consolidated in this Quarterly Report are the
results of our majority-owned subsidiary, CompX International, Inc. We also own
36% of Kronos Worldwide, Inc. which we account for by the equity method. CompX
(NYSE: CIX) and Kronos (NYSE: KRO) each file periodic reports with the
Securities and Exchange Commission ("SEC").
The unaudited Condensed Consolidated Financial Statements contained in this
Quarterly Report have been prepared on the same basis as the audited
Consolidated Financial Statements in our Annual Report on Form 10-K for the year
ended December 31, 2005 that we filed with the SEC on March 16, 2006 (the "2005
Annual Report"). In our opinion, we have made all necessary adjustments (which
include only normal recurring adjustments) in order to state fairly, in all
material respects, our consolidated financial position, results of operations
and cash flows as of the dates and for the periods presented. We have condensed
the Consolidated Balance Sheet at December 31, 2005 contained in this Quarterly
Report as compared to our audited Consolidated Financial Statements at that
date, and we have omitted certain information and footnote disclosures
(including those related to the Consolidated Balance Sheet at December 31, 2005)
normally included in financial statements prepared in accordance with accounting
principals generally accepted in the United States of America ("GAAP"). Our
results of operations for the interim periods ended September 30, 2006 may not
be indicative of our operating results for the full year. The Condensed
Consolidated Financial Statements contained in this Quarterly Report should be
read in conjunction with our 2005 Consolidated Financial Statements contained in
our 2005 Annual Report. Certain reclassifications have been made to prior year
balances to conform to the current year presentation.
Unless otherwise indicated, references in this report to "we," "us" or
"our" refer to NL Industries and its subsidiaries and affiliates, including
Kronos, taken as a whole.
Stock purchases - Our ownership of CompX is primarily through CompX Group,
Inc., our majority-owned subsidiary. CompX Group's sole asset consists of 83% of
the outstanding common stock of CompX. We also own an additional 2% of CompX
directly. During the first nine months of 2006, we purchased approximately
145,000 shares of CompX common stock in market transactions for an aggregate
purchase price of $2.3 million. We accounted for this purchase as a step
acquisition under the purchase method of accounting.
Acquisitions - In April 2006, CompX completed an acquisition of a marine
component products business for aggregate cash consideration of $9.8 million,
net of cash acquired. We completed this acquisition to expand the marine
component products business unit of CompX. We have included the results of
operations and cash flows of the acquired business in our Condensed Consolidated
Financial Statements starting in April 2006. The purchase price has been
allocated among the tangible and intangible net assets acquired based upon an
estimate of the fair value of such net assets. The pro forma effect to us,
assuming this acquisition had been completed as of January 1, 2005, is not
material.
Note 2 - Accounts and other receivables, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Trade receivables $ 20,921 $ 23,461
Other receivables 2,783 1,506
Allowance for doubtful accounts (312) (430)
-------- --------
Total $ 23,392 $ 24,537
======== ========
Note 3 - Inventories, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Raw materials $ 6,801 $ 6,268
In process products 9,116 9,260
Finished products 6,621 8,103
-------- --------
Total $ 22,538 $ 23,631
======== ========
Note 4 - Noncurrent marketable equity securities:
At December 31, 2005 and September 30, 2006, we owned approximately 4.7
million shares of Valhi common stock. At September 30, 2006 the quoted market
price was $23.25 per share, or an aggregate market value of $109.5 million, and
at December 31, 2005 the quoted market price was $18.50 per share, or an
aggregate market value of $87.1 million.
Note 5 - Investment in Kronos:
At December 31, 2005 and September 30, 2006, we owned approximately 17.5
million shares of Kronos common stock. At September 30, 2006 the quoted market
price was $28.79 per share, or an aggregate market value of $504.3 million, and
at December 31, 2005 the quoted market price was $29.01, or an aggregate market
value of $508.1 million.
Selected financial information of Kronos is summarized below:
December 31, September 30,
2005 2006
------------ -------------
(In millions)
Current assets $ 525.3 $ 586.6
Property and equipment, net 418.9 437.4
Investment in TiO2 joint venture 115.3 114.8
Other noncurrent assets 239.4 252.9
--------- ---------
Total assets $ 1,298.9 $ 1,391.7
========= =========
Current liabilities $ 205.1 $ 211.7
Long-term debt 464.4 528.3
Accrued pension and post retirement benefits 150.0 149.3
Other noncurrent liabilities 69.4 66.7
Stockholders' equity 410.0 435.7
--------- ---------
Total liabilities and stockholders' equity $ 1,298.9 $ 1,391.7
========= =========
Three months ended Nine months ended
September 30, September 30,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions) (In millions)
Net sales $292.1 $ 331.7 $ 895.7 $ 981.0
Cost of sales 216.2 256.2 640.9 748.8
Income from operations 38.2 34.3 142.3 105.4
Net income 8.0 11.6 62.2 40.2
Note 6 - Other noncurrent assets, net:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Intangible assets, net $ 3,432 $ 4,160
Prepaid pension cost - 638
Other 2,067 4,181
-------- --------
Total $ 5,499 $ 8,979
======== ========
Note 7 - Current accrued liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Employee benefits $ 10,933 $ 12,387
Professional fees 5,269 3,238
Other 13,657 14,505
-------- --------
Total $ 29,859 $ 30,130
======== ========
Note 8 - Other noncurrent liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Insurance claims and expenses $ 2,224 $ 2,336
Other 22 -
-------- --------
Total $ 2,246 $ 2,336
======== ========
We recorded a $745,000 charge in the third quarter of 2006 in connection
with our self-insurance obligations. This charge resulted from an understatement
of our accrual and originated over several years. The effect of this adjustment
on our expected results for the full year 2006 is not expected to be material.
Note 9 - Provision for income taxes:
Nine months ended
September 30,
----------------------
2005 2006
---- ----
(In millions)
Expected tax expense $ 15.2 $ 7.0
Non-U.S. tax rates (.1) (.3)
Incremental U.S. tax and rate differences on
equity in earnings 3.5 (2.7)
Nondeductible expenses .2 .2
U.S. state income taxes, net .3 .5
Excess of book basis over tax basis of Kronos common
stock sold or distributed 2.7 -
Tax contingency reserve adjustment, net (4.1) .2
Reduction in Canadian income tax rate - (.2)
Other, net (1.2) (.3)
------ -----
Total $ 16.5 $ 4.4
====== =====
Comprehensive provision (benefit) for income
taxes allocable to:
Income from continuing operations $ 16.5 $ 4.4
Discontinued operations .4 (.2)
Other comprehensive income:
Marketable securities 3.2 7.8
Currency translation (2.9) 3.3
------ -----
Total $ 17.2 $15.3
====== =====
In June 2006, Canada enacted a 2% reduction in the Canadian federal income
tax rate and eliminated the federal surtax. The 2% reduction will be phased in
from 2008 through 2010, and the federal surtax will be eliminated in 2008. As a
result, during the second quarter of 2006 we recognized a $0.2 million income
tax benefit related to the effect of such reduction on our previously recorded
net deferred income tax liability.
Note 10 - Employee benefit plans:
Defined benefit plans - The components of net periodic defined benefit
pension cost (income) are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Interest cost $ 753 $ 751 $ 2,271 $ 2,234
Expected return on plan assets (1,010) (1,352) (3,041) (4,045)
Amortization of net transition obligations (16) (17) (51) (50)
Recognized actuarial losses 93 107 291 308
------- ------- ------- -------
Total $ (180) $ (511) $ (530) $(1,553)
======= ======= =======- =======
Postretirement benefits - The components of net periodic postretirement
benefits cost are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
--------------------- --------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Interest cost $ 211 $ 184 $ 633 $ 551
Amortization of prior service credit (72) (28) (215) (84)
------- ------- ------- -------
Total $ 139 $ 156 $ 418 $ 467
======= ======= ======= =======
Contributions - We expect our 2006 contributions for our pension and
postretirement benefit plans to be consistent with the amount disclosed in our
2005 Annual Report.
Note 11 - Accounts with affiliates:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Current receivables from affiliates:
Valhi - federal income taxes $3,146 $ 6,791
Kronos - trade items 145 132
------ -------
Total $3,291 $ 6,923
====== =======
Current payables to affiliates:
Valhi - state income taxes $ 771 $ 161
Tremont Corporation - trade items 211 221
------ -------
Total $ 982 $ 382
====== =======
Note 12 - Commitments and contingencies:
Lead pigment litigation
Our former operations included the manufacture of lead pigments for use in
paint and lead-based paint. We, other former manufacturers of lead pigments for
use in paint and lead-based paint (together, the "former pigment
manufacturers"), and the Lead Industries Association ("LIA") (which discontinued
business operations prior to 2005) have been named as defendants in various
legal proceedings seeking damages for personal injury, property damage and
governmental expenditures allegedly caused by the use of lead-based paints.
Certain of these actions have been filed by or on behalf of states, large U.S.
cities or their public housing authorities and school districts, and certain
others have been asserted as class actions. These lawsuits seek recovery under a
variety of theories, including public and private nuisance, negligent product
design, negligent failure to warn, strict liability, breach of warranty,
conspiracy/concert of action, aiding and abetting, enterprise liability, market
share or risk contribution liability, intentional tort, fraud and
misrepresentation, violations of state consumer protection statutes, supplier
negligence and similar claims.
The plaintiffs in these actions generally seek to impose on the defendants
responsibility for lead paint abatement and health concerns associated with the
use of lead-based paints, including damages for personal injury, contribution
and/or indemnification for medical expenses, medical monitoring expenses and
costs for educational programs. A number of cases are inactive or have been
dismissed or withdrawn. Most of the remaining cases are in various pre-trial
stages. Some are on appeal following dismissal or summary judgment rulings in
favor of either the defendants or plaintiffs. In addition, various other cases
are pending (in which we are not a defendant) seeking recovery for injuries
allegedly caused by lead pigment and lead-based paint. Although we are not a
defendant in these cases, the outcome of these cases may have an impact on
pending cases and cases that might be filed against us in the future.
We believe these actions are without merit, and intend to continue to deny
all allegations of wrongdoing and liability and to defend against all actions
vigorously. We have never settled any of these cases, nor have any final adverse
judgments been entered against us. We have not accrued any amounts for pending
lead pigment and lead-based paint litigation. We cannot reasonably estimate
liability, if any, that may result. We cannot assure you that NL will not incur
liability in the future as a result of pending litigation due to the inherent
uncertainties involved in court and jury rulings in pending and possible future
cases. If future liabilities are incurred, it could have a material adverse
effect on our Consolidated Financial Statements, results of operations and
liquidity.
In one of these lead pigment cases (State of Rhode Island v. Lead
Industries Association), a trial before a Rhode Island state court jury began in
September 2002 on the question of whether lead pigment in paint on Rhode Island
buildings is a public nuisance. In October 2002, the trial judge declared a
mistrial in the case when the jury was unable to reach a verdict on the
question, with the jury reportedly deadlocked 4-2 in defendants' favor. In
November 2005, the State of Rhode Island began a retrial of the case on the
State's claims of public nuisance, indemnity and unjust enrichment. Following
the State's presentation of its case, the trial court dismissed the State's
claims of indemnity and unjust enrichment. The public nuisance claim was sent to
the jury in February 2006, and the jury found that we and two other defendants
substantially contributed to the creation of a public nuisance as a result of
the collective presence of lead pigments in paints and coatings on buildings in
Rhode Island. The jury also found that we and the two other defendants should be
ordered to abate the public nuisance. Following the jury verdict, the trial
court dismissed the State's claim for punitive damages. The scope of the
abatement remedy will be determined by the judge. The extent, nature and cost of
such remedy are not currently known and will be determined only following
additional proceedings before the trial court. Various matters remain pending
before the trial court, including our motion to dismiss and other post-trial
motions which were argued in August 2006. We intend to appeal any adverse
judgment which the trial court may enter against us.
The Rhode Island case is unique in that this is the first time that an
adverse verdict in the lead pigment litigation has been entered against us. We
believe there are a number of meritorious issues which can be appealed in this
case; therefore we currently believe it is not probable that we will ultimately
be found liable in this matter. In addition, we cannot reasonably estimate
potential liability, if any, with respect to this and the other lead pigment
litigation. However, legal proceedings are subject to inherent uncertainties,
and we cannot assure you that any appeal would be successful. Therefore it is
reasonably possible we could in the near term conclude that it is probable we
have incurred some liability in this Rhode Island matter that would result in
recognizing a loss contingency accrual. The potential liability could have a
material adverse impact on net income for the interim or annual period during
which such liability is recognized, and a material adverse impact on our
financial condition and liquidity. Various other cases in which we are a
defendant are also pending in other jurisdictions, and new cases could be filed
against us, the resolution of which could also result in recognition of a loss
contingency accrual that could have a material adverse impact on our net income
for the interim or annual period during which such liability is recognized, and
a material adverse impact on our financial condition and liquidity. We cannot
reasonably estimate the potential impact on our results of operations, financial
condition or liquidity related to these matters.
Environmental matters and litigation
Our operations are governed by various environmental laws and regulations.
Certain of our businesses are and have been engaged in the handling, manufacture
or use of substances or compounds that may be considered toxic or hazardous
within the meaning of applicable environmental laws. As with other companies
engaged in similar businesses, certain of our past and current operations and
products have the potential to cause environmental or other damage. We have
implemented and continue to implement various policies and programs in an effort
to minimize these risks. Our policy is to maintain compliance with applicable
environmental laws and regulations at all of our plants and to strive to improve
our environmental performance. From time to time, we may be subject to
environmental regulatory enforcement under U.S. and foreign statutes, the
resolution of which typically involves the establishment of compliance programs.
Future developments, such as stricter requirements of environmental laws and
enforcement policies, could adversely affect our production, handling, use,
storage, transportation, sale or disposal of such substances. We believe all of
our plants are in substantial compliance with applicable environmental laws.
Certain properties and facilities used in our former businesses, including
divested primary and secondary lead smelters and former mining locations, are
the subject of civil litigation, administrative proceedings or investigations
arising under federal and state environmental laws. Additionally, in connection
with past disposal practices, we have been named as a defendant, potentially
responsible party ("PRP") or both, pursuant to the Comprehensive Environmental
Response, Compensation and Liability Act, as amended by the Superfund Amendments
and Reauthorization Act ("CERCLA"), and similar state laws in various
governmental and private actions associated with waste disposal sites, mining
locations, and facilities we or our subsidiaries or their predecessors currently
or previously owned, operated or used, certain of which are on the U.S. EPA's
Superfund National Priorities List or similar state lists. These proceedings
seek cleanup costs, damages for personal injury or property damage and/or
damages for injury to natural resources. Certain of these proceedings involve
claims for substantial amounts. Although we may be jointly and severally liable
for such costs, in most cases we are only one of a number of PRPs who may also
be jointly and severally liable.
Environmental obligations are difficult to assess and estimate for numerous
reasons including:
o complexity and differing interpretations of governmental regulations,
o number of PRPs and their ability or willingness to fund such
allocation of costs,
o financial capabilities of the PRPs and the allocation of costs among
them,
o multiplicity of possible solutions; and
o number of years of investigatory, remedial and monitoring activity
required.
In addition, the imposition of more stringent standards or requirements
under environmental laws or regulations, new developments or changes respecting
site cleanup costs or allocation of such costs among PRPs, solvency of other
PRPs, the results of future testing and analysis undertaken with respect to
certain sites or a determination that we are potentially responsible for the
release of hazardous substances at other sites, could cause our expenditures to
exceed our current estimates. Because we may be jointly and severally liable for
the total remediation cost at certain sites, the amount we are ultimately liable
for may exceed our accruals due to, among other things, reallocation of costs
among PRPs or the insolvency of one or more PRPs. We cannot assure you that
actual costs will not exceed accrued amounts or the upper end of the range for
sites for which estimates have been made, and no assurance can be given that
costs will not be incurred with respect to sites as to which no estimate
presently can be made, and we cannot assure you that costs will not be incurred
for sites where no estimate presently can be made. Further, additional
environmental matters may arise in the future. If we were to incur any future
liability, this could have a material adverse effect on our consolidated
financial position, results of operations and liquidity.
We record liabilities related to environmental remediation obligations when
estimated future expenditures are probable and reasonably estimable. We adjust
environmental accruals as further information becomes available or circumstances
change. We generally do not discount estimated future expenditures to their
present value due to the uncertainty of the timing of the pay out. We recognize
recoveries of remediation costs from other parties, if any, as assets when their
receipt is deemed probable. At September 30, 2006, there were no receivables for
recoveries.
We do not know and cannot estimate the exact time frame over which we will
make payments for our accrued environmental costs. The timing of payments
depends upon a number of factors including the timing of the actual remediation
process; this in turn depends on factors outside our control. At each balance
sheet date, we estimate the amount of our accrued environmental costs that we
expect to pay within the next 12 months. We classify this estimate as a current
liability, and we classify the remaining accrued environmental costs as a
noncurrent liability on our consolidated balance sheet.
Changes in the accrued environmental costs during the first nine months of
2006 are as follows:
Amount
--------------
(In thousands)
Balance at the beginning of the period $ 54,947
Additions charged to expense, net 2,454
Payments, net (5,922)
--------
Balance at the end of the period $ 51,479
========
Amounts recognized in the balance sheet at the end of the period:
Current liability $ 9,229
Noncurrent liability 42,250
--------
Total $ 51,479
========
On a quarterly basis, we evaluate the potential range of liability at sites
where we have been named as a PRP or defendant. At September 30, 2006, we had
accrued $51.5 million for those environmental matters which we believe are
reasonably estimable. We believe that it is not possible to estimate the range
of costs for certain sites. The upper end of the range of reasonably possible
costs to us for sites for which we believe it is possible to estimate costs is
approximately $78 million, including the amount we have accrued.
At September 30, 2006, there are approximately 20 sites for which we are
unable to estimate a range of costs. For these sites, generally the
investigation is in the early stages, and it is either unknown as to whether we
actually had any association with the site, or if we did have an association
with the site, the nature of our responsibility, if any, for the contamination
at the site and the extent of contamination. We cannot estimate when enough
information will become available to allow us to estimate a range of loss. The
timing and availability of information on these sites is dependent on events
outside our control, such as when the party alleging liability provides
information to us. On certain previously inactive sites, we have received
general and special notices of liability from the EPA alleging that we, along
with other PRPs, are liable for past and future costs of remediating
environmental contamination allegedly caused by former operations conducted at
such sites. These notifications may assert that we, along with other PRPs, are
liable for past clean-up costs. These costs could be material to us if we were
ultimately found liable.
Other litigation
We have been named as a defendant in various lawsuits in several
jurisdictions, alleging personal injuries as a result of occupational exposure
primarily to products manufactured by our former operations containing asbestos,
silica and/or mixed dust. Approximately 500 of these types of cases remain
pending, involving a total of approximately 10,700 plaintiffs and their spouses.
We have not accrued any amounts for this litigation because of the uncertainty
of liability and inability to reasonably estimate the liability, if any. To
date, we have not been adjudicated liable in any of these matters. Based on
information available to us, including facts concerning historical operations,
the rate of new claims, the number of claims from which we have been dismissed,
and our prior experience in the defense of these matters, we believe that the
range of reasonably possible outcomes of these matters will be consistent with
our historical costs (which are not material). Furthermore, we do not expect any
reasonably possible outcome would involve amounts material to our consolidated
financial position, results of operations or liquidity. We have and will
continue to vigorously seek dismissal and/or a finding of no liability from each
claim. In addition, from time to time, we have received notices regarding
asbestos or silica claims purporting to be brought against former subsidiaries,
including notices provided to insurers with which we have entered into
settlements extinguishing certain insurance policies. These insurers may seek
indemnification from us.
For a discussion of other legal proceedings to which we are a party, refer
to the financial statements included in our 2005 Annual Report and our Quarterly
Reports on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006.
In addition to the litigation described above, we and our affiliates are
also involved in various other environmental, contractual, product liability,
patent (or intellectual property), employment and other claims and disputes
incidental to present and former businesses. In certain cases, we have insurance
coverage for these items, although we do not expect additional material
insurance coverage for environmental claims.
We currently believe that the disposition of all claims and disputes,
individually or in the aggregate, should not have a material adverse effect on
our consolidated financial position, results of operations or liquidity beyond
the accruals already provided.
Insurance coverage claims
For a complete discussion of certain litigation involving us and certain of
our former insurance carriers, refer to our 2005 Annual Report and our Quarterly
Report on Form 10-Q for the quarters ended March 31, 2006 and June 30, 2006.
Additional information regarding such litigation, or new litigation, is below.
Certain Underwriters at Lloyds, London v. Millennium Holdings LLC et. al.
(Supreme Court of the State of New York, County of New York, Index No.
06/60026). In August 2006, the trial court denied our motion to dismiss, and we
have appealed that decision.
NL Industries, Inc. v. American Re Insurance Company, et al. (Dallas County
Court at Law, Texas, Case No. CC-06-04523-E). In September 2006, the court
stayed this proceeding pending outcome of the appeal in the two New York
actions.
In September 2006, we filed a declaratory judgment action against OneBeacon
and certain other former insurance companies, captioned NL Industries, Inc. v.
OneBeacon America Insurance Company, et al. (Dallas County Court at Law, Texas,
Case No. CC-06-13934-A) seeking interpretation of a Stand-Still Agreement, which
is governed by Texas law. The defendants have filed a motion to consolidate this
case with the NL Industries, Inc. v. American Re Insurance Company, et al. case
which we filed in April 2006. We intend to oppose consolidation of the cases.
The issue of whether insurance coverage for defense costs or indemnity or
both will be found to exist for our lead pigment litigation depends upon a
variety of factors, and there can be no assurance that insurance coverage will
be available. We have not considered any potential insurance recoveries for lead
pigment or environmental litigation matters in determining related accruals.
Income tax matters
Tax authorities are examining certain of our U.S. and non-U.S. tax returns
and have or may propose tax deficiencies, including penalties and interest. For
example:
o Kronos received a preliminary tax assessment related to 1993 from the
Belgian tax authorities proposing tax deficiencies, including related
interest, of approximately euro 6 million. The Belgian tax authorities
filed a lien on Kronos' Belgian TiO2 operation's fixed assets in
connection with their assessment. Kronos filed a protest to this
assessment and in July 2006, the Belgian tax authorities withdrew the
assessment. The lien was subsequently released.
o The Norwegian tax authorities have notified Kronos of their intent to
assess tax deficiencies of approximately kroner 12 million relating to
the years 1998 through 2000. Kronos objected to this proposed
assessment and in May 2006 the Norwegian tax authorities withdrew the
assessment.
Other income tax examinations related to our operations continue, and we
cannot guarantee that these tax matters will be resolved in our favor due to the
inherent uncertainties involved in settlement initiatives and court and tax
proceedings. We believe we have adequate accruals for additional taxes and
related interest expense which could ultimately result from tax examinations. We
believe the ultimate disposition of tax examinations should not have a material
adverse effect on our consolidated financial position, results of operations or
liquidity.
Note 13 - Discontinued operations, net of tax:
Discontinued operations relates to CompX's former Thomas Regout operations
in the Netherlands. Prior to December 2004, the Thomas Regout European
operations were classified as held for use. A formal plan of disposal adopted by
CompX's board of directors in December 2004 resulted in the reclassification of
the operations to held for sale. Based upon the estimated realizable value (or
fair value less costs to sell) of the net assets disposed, we determined that
the goodwill associated with the assets held for sale was partially impaired. In
determining the estimated realizable value of the Thomas Regout operations as of
December 31, 2004, when we classified it as held for sale, we used the sales
price inherent in the definitive agreement reached with the purchaser in January
2005 and our estimate of the related transaction costs (or costs to sell). In
January 2005, we completed the sale of Thomas Regout for net proceeds that were
approximately $864,000 less than previously estimated (primarily due to higher
expenses associated with the sale). These additional expenses reflect a
refinement of our previous estimate of the realizable value of the Thomas Regout
operations and accordingly we recognized a further impairment of goodwill. As a
result, discontinued operations for the first nine months of 2005 includes a
first quarter charge for the additional expenses ($326,000, net of income tax
benefit and minority interest). Discontinued operations in the first nine months
of 2006 includes a second quarter expense of $500,000 ($177,000, net of income
tax benefit and minority interest) for a change in estimate of certain
indemnification obligations we had to the purchaser of the Thomas Regout
operations.
Note 14 - Recent accounting pronouncements:
Quantifying financial statement misstatements - In September 2006 the SEC
issued Staff Accounting Bulletin ("SAB") No. 108 expressing their views
regarding the process of quantifying financial statement misstatements. The SAB
is effective for us no later than the fourth quarter of 2006. According to SAB
No. 108, both the "rollover" and "iron curtain" approaches must be considered
when evaluating a misstatement for materiality. We do not expect the adoption of
the SAB to have a material effect on our previously-reported consolidated
financial position or results of operations at the date of adoption.
Fair value measurements - In September 2006 the Financial Accounting
Standards Board ("FASB") issued Statement of Financial Accounting Standards
("SFAS") No. 157, Fair Value Measurements, which will become effective for us on
January 1, 2008. SFAS No. 157 generally provides a consistent fair value
definition and measurement framework for GAAP pronouncements. SFAS No. 157 also
establishes a fair value hierarchy for different measurement techniques based on
the objective nature of the inputs in various valuation methods. We will be
required to ensure all of our fair value measurements are in compliance with
SFAS No. 157 on a prospective basis beginning in the first quarter of 2008. In
addition, we will be required to expand our disclosures regarding the valuation
methods and level of inputs we utilize in the first quarter of 2008. The
adoption of this standard will not have a material effect on our Consolidated
Financial Statements.
Pension and other postretirement plans - Also in September 2006 the FASB
issued SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans. SFAS No. 158 requires us to recognize an asset or
liability for the over or under funded status of each of our individual defined
benefit pension and postretirement benefit plans on our Consolidated Balance
Sheets. We will recognize through other comprehensive income prior unrecognized
gains and losses and prior service costs or credits, net of tax, at December 31,
2006 that we currently amortize through net periodic benefit cost. All future
changes in the funded status of these plans will be recognized through
comprehensive income, net of tax (either in net income or in other comprehensive
income). We will also provide certain new disclosures related to these plans. In
addition, we currently use September 30 as a measurement date for our defined
benefit pension plans, but under this standard we will be required to use
December 31 as the measurement date for all of our plans. The measurement date
requirement of SFAF No. 158 will become effective for us by the end of 2008 and
provides two alternate transition methods; we have not yet determined which
transition method we will select. This standard does not change the existing
recognition and measurement requirements that determine the amount of periodic
benefit cost recognized in net income.
The asset and liability recognition and disclosure requirements of this
standard will become effective for us as of December 31, 2006 and will be
adopted prospectively. We will not complete the 2006 assessment of the funded
status of our pension and postretirement benefit plans until after December 31,
2006. At December 31, 2005, our pension plans were over-funded by a net $2.6
million, and we had a net $1.2 million liability recognized on our Consolidated
Balance Sheet related to these plans. At December 31, 2005, our post retirement
benefit plans were under-funded by a net $14.0 million, and we had a net $12.0
million liability recognized on our Consolidated Balance Sheet related to these
plans. Our 2006 funded status will be based in part on certain actuarial
assumptions that we cannot yet determine and differences between the actual and
expected return on plan assets during the year. Therefore, we are not able to
determine the impact this standard will have on our Consolidated Financial
Statements. Because the difference between the aggregate funded status of our
defined benefit and post retirement benefits plans and the net amounts
recognized with respect to these plans on our Consolidated Financial Statements
at December 31, 2005 is not materially significant, we cannot yet determine
whether the net effect of adopting SFAS No. 158 will increase or reduce our
stockholders' equity at December 31, 2006, in so far as it relates to our
benefit plans. However, our investment in Kronos and our stockholders' equity
will be affected by our pro-rata share of the effect to Kronos from adopting
this standard, and Kronos believes the net effect of adopting SFAS No. 158 will
reduce their stockholders' equity. The full disclosure of the funded status of
our defined benefit pension and postretirement benefit plans at December 31,
2005 can be found in Note 16 to our 2005 Annual Report.
Inventory costs - SFAS No. 151, Inventory Costs, an amendment of ARB No.
43, Chapter 4, became effective for inventory costs incurred on or after January
1, 2006. SFAS No. 151 requires that allocation of fixed production overhead
costs to inventory be based on normal capacity of the production facilities, as
defined by SFAS No. 151. SFAS No. 151 also clarifies the accounting for abnormal
amounts of idle facility expense, freight handling costs and wasted material,
requiring the recognition of those items as current period charges. Our existing
production cost policies complied with the requirements of SFAS No. 151,
therefore the adoption of SFAS No. 151 did not affect our Consolidated Financial
Statements.
Stock options - We adopted the fair value provisions of SFAS No. 123R,
Share-Based Payment, on January 1, 2006 using the modified prospective
application method. SFAS No. 123R, among other things, requires the cost of
employee compensation paid with equity instruments to be measured based on the
grant date fair value. That cost is then recognized over the vesting period.
Using the modified prospective method, we will apply the provisions of the
standard to all new equity compensation granted after January 1, 2006 and any
existing awards which are modified, repurchased or cancelled after January 1,
2006. The number of non-vested equity awards we or our subsidiaries had issued
as of December 31, 2005 was not material. Before adopting SFAS No. 123R we
accounted for our equity compensation under the variable accounting method
whereby the equity awards were revalued based on the current trading price at
each balance sheet date. We now account for these awards using the liability
method under SFAS No. 123R, which is substantially identical to the variable
accounting method we previously used. We recorded compensation income in the
nine months ended September 30, 2005 and 2006 of $53,000 and $25,000,
respectively. If we or our subsidiaries grant a significant number of equity
awards or modify, repurchase or cancel existing equity awards in the future, the
amount of equity compensation expense in our Consolidated Financial Statements
could be material.
Effective January 1, 2006, SFAS No. 123R requires the cash income tax
benefit resulting from the exercise of stock options in excess of the cumulative
income tax benefit previously recognized for GAAP financial reporting purposes
(which for us did not represent a significant amount in the first nine months of
2006) to be reflected as a component of cash flows from financing activities in
our Consolidated Financial Statements. SFAS No. 123R also requires certain
expanded disclosures regarding equity compensation, and we provided these
expanded disclosures in our 2005 Annual Report.
Uncertain tax positions - In the second quarter of 2006 the FASB issued
FASB Interpretation No. ("FIN") 48, Accounting for Uncertain Tax Positions,
which will become effective for us on January 1, 2007. FIN 48 clarifies when and
how much of a benefit we can recognize in our Consolidated Financial Statements
for certain positions taken in our income tax returns under SFAS No. 109,
Accounting for Income Taxes, and enhances the disclosure requirements for our
income tax policies and reserves. Among other things, FIN 48 will prohibit us
from recognizing the benefits of a tax position unless we believe it is
more-likely-than-not our position will prevail with the applicable tax
authorities and limits the amount of the benefit to the largest amount for which
we believe the likelihood of realization is greater than 50%. FIN 48 also
requires companies to accrue penalties and interest on the difference between
tax positions taken on their tax returns and the amount of benefit recognized
for financial reporting purposes under the new Standard. Our current income tax
accounting policies comply with this aspect of the new Standard. We will also be
required to reclassify any reserves we have for uncertain tax positions from
deferred income tax liabilities, where they are currently recognized, to a
separate current or noncurrent liability, depending on the nature of the tax
position. We are currently evaluating the impact of FIN 48 on our Consolidated
Financial Statements, and we expect to finalize our analysis in the fourth
quarter of 2006.
Planned Major Maintenance Activities - In September 2006, the FASB issued
FASB Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major
Maintenance Activities, which will become effective for Kronos in January 2007,
although early adoption is permitted. Under FSP No. AUG AIR-1 accruing in
advance for major maintenance is no longer permitted. Companies that previously
accrued in advance for major maintenance activities (such as Kronos) will be
required to retroactively restate their financial statements to reflect a
permitted method of expense for all periods presented. Concurrent with Kronos,
we will retroactively restate our financial statements in the fourth quarter of
2006 when Kronos adopts the direct expense method of accounting. The adoption of
the FSP will have the following effect on our previously reported net income for
the periods indicated:
Increase (decrease) in net income
---------------------------------
2005 2006
---- ----
Quarter Ended: (In millions)
March 31 $ .3 $ .2
June 30 (.2) (.1)
September 30 - -
December 31 (.1) na
---- ----
Total $ - $ .1
==== ====
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
--------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Business and results of operations overview
NL Industries is primarily a holding company. We operate in the
component products industry through our majority-owned subsidiary, CompX
International Inc. We also own a non-controlling interest in Kronos Worldwide,
Inc. Both CompX (NYSE: CIX) and Kronos (NYSE: KRO) file periodic reports with
the Securities and Exchange Commission ("SEC").
CompX is a leading manufacturer of precision ball bearing slides, security
products and ergonomic computer support systems used in office furniture,
transportation, tool storage and a variety of other industries. CompX has also
recently entered the performance marine components industry through the
acquisition of two performance marine manufacturers.
We account for our 36% non-controlling interest in Kronos by the equity
method. Kronos is a leading global producer and marketer of value-added titanium
dioxide pigments ("TiO2"). TiO2 is used for a variety of manufacturing
applications including plastics, paints, paper and other industrial products.
Forward-looking information
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Statements in this Quarterly
Report on Form 10-Q that are not historical facts are forward-looking in nature.
Statements found in this report including, but not limited to, the statements
found in Item 2 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations," are forward-looking statements that represent our
beliefs and assumptions based on currently available information. In some cases
you can identify these forward-looking statements by the use of words such as
"believes," "intends," "may," "should," "could," "anticipates," "expected" or
comparable terminology, or by discussions of strategies or trends. Although we
believe the expectations reflected in forward-looking statements are reasonable,
we do not know if these expectations will be correct. Forward-looking statements
by their nature involve substantial risks and uncertainties that could
significantly impact expected results. Actual future results could differ
materially from those predicted. While it is not possible to identify all
factors, we continue to face many risks and uncertainties. Among the factors
that could cause our actual future results to differ materially from those
described herein are the risks and uncertainties discussed in this Quarterly
Report and those described from time to time in our other filings with the SEC
including, but not limited to, the following:
o Future supply and demand for our products,
o The extent of the dependence of certain of our businesses on certain
market sectors,
o The cyclicality of our businesses (such as Kronos' TiO2 operations),
o The impact of certain long-term contracts on certain of our
businesses,
o Customer inventory levels (such as the extent to which Kronos'
customers may, from time to time, accelerate purchases of TiO2 in
advance of anticipated price increases or defer purchases of TiO2 in
advance of anticipated price decreases),
o Changes in raw material and other operating costs (such as energy
costs),
o The possibility of labor disruptions,
o General global economic and political conditions (such as changes in
the level of gross domestic product in various regions of the world
and the impact of such changes on demand for TiO2),
o Demand for office furniture,
o Competitive products and substitute products, including increased
competition from low-cost manufacturing sources (such as China),
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o Competitive technology positions,
o Service industry employment levels,
o Possible disruption of our business or increases in the cost of doing
business resulting from terrorist activities or global conflicts,
o The introduction of trade barriers,
o Fluctuations in currency exchange rates (such as changes in the
exchange rate between the U.S. dollar and each of the euro, the
Norwegian kroner and the Canadian dollar),
o Operating interruptions (including, but not limited to, labor
disputes, leaks, natural disasters, fires, explosions, unscheduled or
unplanned downtime and transportation interruptions),
o The timing and amounts of insurance recoveries,
o The ability to renew or refinance credit facilities,
o The extent to which our subsidiaries were to become unable to pay us
dividends,
o Uncertainties associated with new product development,
o The ultimate outcome of income tax audits, tax settlement initiatives
or other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of
which has been recognized under the "more likely than not" recognition
criteria (such as Kronos' ability to utilize its German net operating
loss carryforwards),
o Environmental matters (such as those requiring compliance with
emission and discharge standards for existing and new facilities, or
new developments regarding environmental remediation at sites related
to our former operations),
o Government laws and regulations and possible changes therein (such as
changes in government regulations which might impose various
obligations on present and former manufacturers, including us, of lead
pigment and lead-based paint, with respect to asserted health concerns
associated with the use of such products),
o The ultimate resolution of pending litigation (such as our lead
pigment and environmental litigation and litigation), and
o Possible future litigation.
Should one or more of these risks materialize or if the consequences of such a
development worsen, or should the underlying assumptions prove incorrect, actual
results could differ materially from those currently forecasted or expected. We
disclaim any intention or obligation to update or revise any forward-looking
statement whether as a result of changes in information, future events or
otherwise.
Results of Operations
Net Income Overview
Quarter Ended September 30, 2006 Compared to
Quarter Ended September 30, 2005
Our net income was $3.1 million, or $.06 per diluted share, in the third
quarter of 2006 compared to net income of $2.8 million, or $.06 per diluted
share, in the third quarter of 2005. Our diluted earnings per share remained
consistent from 2005 to 2006 due primarily to the net effects of:
o higher equity in earnings of Kronos in 2006, and
o higher component products income from operations of CompX in 2006,
offset by
o higher environmental and legal defense costs for NL in 2006.
Our income from continuing operations in 2005 includes (net of tax and
minority interest):
o a loss of $.13 per diluted share related to a change in CompX's
permanent reinvestment conclusion regarding certain of its non-U.S.
subsidiaries,
o income of $.08 per diluted share related to developments with respect
to certain income tax audits of NL,
o income of $.02 per diluted share related to certain insurance
recoveries we received, and
o a net expense included in our equity in earnings of Kronos of $.02 per
diluted share related to the aggregate effect of developments with
respect to certain non-U.S. income tax audits of Kronos, principally
in Germany, Belgium and Canada.
Our income from continuing operations in 2006 includes a net expense
included in our equity in earnings of Kronos of $.02 per diluted share related
to the unfavorable resolution of certain income tax issues related to Kronos'
operations in Germany and an increase in Kronos' income tax contingency reserve
principally related to ongoing income tax audits of Kronos in Germany.
Nine Months Ended September 30, 2006 Compared to
Nine Months Ended September 30, 2005 -
Our consolidated income from continuing operations was $12.7 million, or
$.26 per diluted share, in the first nine months of 2006 compared to income from
continuing operations of $27.5 million, or $.57 per diluted share, in the first
nine months of 2005.
The decrease in our diluted earnings per share from 2005 to 2006 is due
primarily to the net effects of:
o lower equity in earnings of Kronos in 2006, and
o higher environmental and legal defense costs for NL in 2006, offset by
o certain securities transactions gains in 2005, and
o higher component products income from operations at CompX in 2006.
We currently believe net income for the full year 2006 will be lower than
2005 primarily due to lower expected equity in earnings of Kronos in 2006,
securities transaction gains we recognized in 2005 and higher legal defense
costs in 2006.
Our income from continuing operations in 2005 includes (net of tax and
minority interest):
o gains from our sales of shares of Kronos common stock of $.17 per
diluted share, net of income tax,
o income of $.08 per diluted share related to developments with respect
to certain income tax audits of NL,
o income included in our equity in earnings of Kronos of $.02 per
diluted share related to Kronos' sale of its passive interest in a
Norwegian smelting operation,
o income of $.03 per diluted share related to certain insurance
recoveries we received,
o a loss of $.13 per diluted share related to a change in CompX's
permanent reinvestment conclusion regarding certain of its non-U.S.
subsidiaries, and
o a net expense included in our equity in earnings of Kronos of $.02 per
diluted share related to the aggregate effect of developments with
respect to certain non-U.S. income tax audits of Kronos, principally
in Germany, Belgium and Canada.
Our income from continuing operations in 2006 includes:
o a charge included in our equity in earnings of Kronos of $.07 per
diluted share, net of income tax benefit, related to Kronos'
redemption of its 8.875% Senior Secured Notes,
o income included in our equity in earnings of Kronos of $.04 per
diluted share related to Kronos' aggregate income tax benefit
associated with the withdrawal of certain income tax assessments
previously made by the Belgian and Norwegian tax authorities,
favorable developments with certain income tax issues related to
Kronos' German and Belgian operations and the enactment of a reduction
in the Canadian federal income tax rate offset by the unfavorable
resolution of certain other income tax issues related to Kronos'
German operations, and an increase in Kronos' income tax contingency
reserve principally related to ongoing income tax audits in Germany,
and
o income of $.04 per diluted share related to certain insurance
recoveries we received.
Income from Operations
The following table shows the components of our income from operations.
Three months ended Nine months ended
September 30, September 30,
------------------ % ------------------- %
2005 2006 Change 2005 2006 Change
---- ---- ------ ---- ---- ------
(In millions) (In millions)
CompX $ 4.8 $ 6.2 30% $13.6 $16.8 23%
Insurance recoveries 1.2 .1 -92% 2.4 2.9 21%
Corporate expense and other, net (3.8) (7.6) 100% (13.5) (18.1) 34%
----- ----- ----- -----
Income (loss) from operations $ 2.2 $(1.3) $ 2.5 $ 1.6
===== ===== ===== =====
Amounts attributable to CompX relate to its components products business,
while the other amounts generally relate to NL. Each of these items is more
fully discussed below.
CompX International Inc.
Three months ended Nine months ended
September 30, September 30,
------------------ % ------------------- %
2005 2006 Change 2005 2006 Change
---- ---- ------ ---- ---- ------
(In millions) (In millions)
Net sales $ 47.1 $ 48.8 4% $139.7 $146.0 4%
Cost of goods sold 36.1 35.9 -1% 107.9 109.2 1%
------ ------ ------ ------
Gross margin $ 11.0 $ 12.9 $ 31.8 $ 36.8
====== ====== ====== ======
Income from operations $ 4.8 $ 6.2 30% $ 13.6 $ 16.8 23%
====== ====== ====== ======
Percentage of net sales:
Cost of goods sold 77% 74% 77% 75%
Income from operations 10% 13% 10% 12%
Net sales - Our component products sales increased in the third quarter and
first nine months of 2006 as compared to the third quarter and first nine months
of 2005. The increases are due mainly to:
o sales volumes from the two marine component products businesses
acquired in April 2006 and August 2005, which increased sales by $2.1
million and $10.4 million in the third quarter and first nine months
of 2006, respectively, and
o sales volume increases in security products due to improved demand and
the favorable effect of currency exchange rates, offset by
o sales volume decreases in furniture components due to competition from
lower-priced Asian manufacturers.
Cost of goods sold and gross margin - Our component products cost of goods
sold percentage improved in the third quarter and first nine months of 2006
compared to the third quarter and first nine months of 2005. As a result of our
improvements in cost of goods sold, our gross margin percentage increased from
23% in the third quarter of 2005 to 26% in the third quarter of 2006 and
increased from 23% to 25% in the first nine months of 2006 as compared to the
first nine months of 2005. The improvements in gross margin percentages for the
comparable periods are primarily due to an improved product mix as the decline
in lower-margin furniture components sales were offset by increased sales of
higher-margin security products and marine components.
Operating income - Our component products income from operations increased
$1.4 million, or 30%, to $6.2 million in the third quarter of 2006 from $4.8
million in the third quarter of 2005. Income from operations in the first nine
months of 2006 increased $3.2 million, or 23%, to $16.8 million compared to
$13.6 million for the first nine months of 2005. As a percentage of net sales,
income from operations increased to 12% for the first nine months of 2006 from
10% for the first nine months of 2005 primarily due to the increase in net sales
and more favorable product mix as well as the favorable impact of a continuous
focus on reducing costs across all segments, partially offset by the negative
impact of currency exchange rates (as discussed below).
Currency - CompX has substantial operations and assets located outside the
United States (in Canada and Taiwan). The majority of sales generated from
CompX's non-U.S. operations are denominated in the U.S. dollar with the
remainder denominated in foreign currencies, principally the Canadian dollar and
the New Taiwan dollar. Most raw materials, labor and other production costs for
these non-U.S. operations are denominated primarily in local currencies.
Consequently, the translated U.S. dollar values of CompX's non-U.S. sales and
operating results are subject to currency exchange rate fluctuations which may
favorably or unfavorably impact reported earnings and may affect comparability
of period-to-period operating results. Overall, fluctuations in foreign currency
exchange rates had the following effects on net sales and income from operations
in 2006 as compared to 2005.
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
------------------ ------------------
(Increase (decrease), in thousands)
-----------------------------------------------
Impact on:
Net sales $ 265 $ 1,009
Income from operations $(226) $(1,178)
Outlook - The component product markets in which we operate are highly
competitive in terms of product pricing and features. Our strategy is to focus
on areas where we can provide products that have value-added, user-oriented
features that enable our customers to compete more effectively in their markets.
One of the focal points of this strategy is to replace low margin, commodity
type products with higher margin user-oriented feature products. While this
strategy is likely to result in lower volumes in the short term, management
expects the long term effect to increase both sales and profits. Additionally,
we believe that our focus on collaborating with customers to identify solutions
and our ability to provide a high level of customer service enable us to compete
effectively. In response to competitive pricing pressure, we continually focus
on reducing production cost through product reengineering, improvement in
manufacturing processes or moving production to lower-cost facilities.
Raw material prices, especially steel, zinc and copper continue to be
volatile, putting pressure on our margins. We actively seek to mitigate the
margin impact by entering into raw material supply agreements in order to
stabilize the cost for a period of time, execute larger volume tactical spot
purchases at prices that are expected to be favorable compared to future prices
and, if necessary, pass on the cost increases to our customers through
surcharges and price increases. To date we have been able to effectively
mitigate the impact of higher materials cost on our margins through raw material
supply agreements, tactical spot purchases, surcharges and price increases;
however, we may not be able to achieve these same results in future periods.
Equity in earnings of Kronos Worldwide, Inc.
Three months ended Nine months ended
September 30, September 30,
------------------ % ------------------- %
2005 2006 Change 2005 2006 Change
---- ---- ------ ---- ---- ------
(In millions) (In millions)
Kronos historical:
Net sales $292.1 $331.6 14 % $895.7 $981.0 10 %
Cost of sales 216.2 256.2 19 % 640.9 748.8 17 %
------ ------ ------ ------
Gross margin $ 75.9 $ 75.4 $254.8 $232.2
====== ====== ====== ======
Income from operations $ 38.2 $ 34.3 (10)% $142.3 $105.4 (26)%
Other general corporate, net .4 .8 6.7 2.7
Loss on prepayment of debt - - - (22.3)
Interest expense (10.6) (9.7) (34.0) (33.5)
------ ------ ------ ------
28.0 25.4 115.0 52.3
Income tax expense (20.0) (13.8) (52.8) (12.1)
------ ------ ------ ------
Net income $ 8.0 $ 11.6 $ 62.2 $ 40.2
====== ====== ====== ======
Percentage of net sales:
Cost of sales 74% 77% 72% 76%
Income from operations 13% 11% 16% 11%
Equity in earnings of Kronos
Worldwide, Inc. $ 2.8 $ 4.1 $ 22.4 $ 14.4
====== ====== ====== ======
TiO2 operating statistics:
Sales volumes* 119 132 11 % 356 396 11 %
Production volumes* 122 126 3 % 371 383 3 %
Change in Ti02 net sales:
Ti02 product pricing (1)% -
Ti02 sales volume 11 % 11 %
Ti02 product mix 1 % -
Changes in currency exchange rates 3 % (1)%
--- ---
Total 14 % 10 %
=== ===
-------------------------------
* Thousands of metric tons
The key performance indicators for Kronos are TiO2 average selling prices
and TiO2 sales and production volumes.
Net sales - Kronos' net sales increased 14% or $39.5 million compared to
the third quarter of 2005 primarily due to an 11% increase in TiO2 sales volumes
and the impact of currency exchange rates. The benefit of higher sales volumes
was offset somewhat by a 1% decrease in average TiO2 selling prices. Kronos
estimates the favorable effect of changes in currency exchange rates increased
net sales by approximately $9 million, or 3%, compared to the same period in
2005. Kronos expects selling prices to decline in the fourth quarter of 2006
compared to the third quarter of 2006.
Kronos' net sales increased 10% or $85.3 million compared to the nine
months ended September 30, 2005, primarily due to an 11% increase in TiO2 sales
volumes, offset somewhat by the impact of currency exchange rates. Kronos
estimates the unfavorable effect of changes in currency exchange rates decreased
net sales by approximately $11 million, or 1%, compared to the same period in
2005.
Kronos' 11% increase in TiO2 sales volumes in the third quarter and first
nine months of 2006 was due primarily to higher sales volumes in the United
States, Europe and in export markets, which were somewhat offset by lower sales
volumes in Canada. Kronos believes sales volumes in Canada have decreased as
customer demand has been impacted by decreased demand for TiO2 used in paper
products. Kronos' sales volumes in the first nine months of 2006 set a new
record for Kronos. Kronos expects demand will continue to remain high for the
remainder of the year.
Cost of sales and gross margin - Kronos' cost of sales increased in 2006 as
compared to the same periods in 2005 due primarily to the impact of higher sales
volumes and increased raw material and utility costs (primarily energy costs.)
Kronos' raw material and utility costs increased 4% and 24%, respectively, in
the third quarter of 2006 as compared to the third quarter of 2005 (with
year-to-date increases of 5% and 21%, respectively). Cost of sales as a
percentage of sales increased in 2006 as compared to the same periods in 2005
primarily due to increases in operating costs (including energy costs) and
higher raw materials costs. The negative impact of the increase in raw materials
and energy costs on Kronos' gross margin and income from operations comparisons
was somewhat offset by the 3% increase in TiO2 production volumes. Kronos'
operating rates were near full capacity in both 2005 and 2006, and Kronos'
production volumes in the first nine months of 2006 were a new record for
Kronos.
Kronos continued to gain operational efficiencies at its existing
production facilities by debottlenecking production to meet long-term demand.
Such debottlenecking efforts include, among other things, the addition of
finishing capacity in the German chloride process facility and equipment
upgrades and enhancements in several locations to allow for reduced downtime for
maintenance activities. Kronos' production capacity has increased by
approximately 30% over the past ten years with only moderate capital
expenditures. Kronos believes annual attainable production capacity for 2006 is
approximately 515,000 metric tons, with some additional capacity expected to be
available in 2007 through continued debottlenecking efforts.
Currency - Kronos has substantial operations and assets located outside the
United States (primarily in Germany, Belgium, Norway and Canada). The majority
of sales generated from non-U.S. operations are denominated in currencies other
than the U.S. dollar, principally the euro, other major European currencies and
the Canadian dollar. A portion of sales generated from non-U.S. operations are
denominated in the U.S. dollar. Certain raw materials, primarily
titanium-containing feedstocks, are purchased in U.S. dollars, while labor and
other production costs are denominated primarily in local currencies.
Consequently, the translated U.S. dollar value of foreign sales and operating
results are subject to currency exchange rate fluctuations which may favorably
or adversely impact reported earnings and may affect the comparability of
period-to-period operating results. Overall, fluctuations in foreign currency
exchange rates had the following effects on Kronos' net sales and income from
operations in 2006 as compared to 2005.
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
------------------ ------------------
(Increase (decrease), in millions)
-----------------------------------------------
Impact on:
Net sales $ 9 $ (11)
Income from operations $(3) $ (18)
Interest expense - In the second quarter of 2006, Kronos issued euro 400
million principal amount of 6.5% Senior Secured Notes, and used the proceeds to
redeem its euro 375 million principal amount of 8.875% Senior Secured Notes. As
a result of the prepayment of the 8.875% Senior Secured Notes, Kronos recognized
a $22.3 million pre-tax interest charge in the second quarter of 2006 for the
prepayment of the notes, representing (1) the call premium on the notes, (2) the
write-off of deferred financing costs and (3) write off of the existing
unamortized premium on the notes.
Kronos' interest expense in 2006 decreased as compared to the same periods
in 2005 due to the redemption of the 8.875% Senior Secured Notes and the
issuance of the 6.5% Senior Secured Notes, which is partially offset by changes
in currency exchange rates in 2006 compared to 2005. Excluding the effect of
currency exchange rates, Kronos expects interest expense will be lower in fourth
quarter of 2006 as compared to the fourth quarter of 2005.
Kronos has a significant amount of indebtedness, primarily the Senior
Secured Notes, denominated in the euro. The interest expense recognized will
vary with fluctuations in the euro exchange rate.
Income taxes - Kronos' income tax expense for the third quarter 2006
includes an aggregate provision for income taxes of $3.4 million, which includes
a $1.4 million provision resulting from the increase in the income tax
contingency reserves related to unfavorable developments with respect to ongoing
income tax audits in Germany, and a $2 million provision for income taxes
related to the unfavorable resolution of certain income tax audit issues in
Germany. Kronos' provision for income taxes in the first nine months of 2006
also includes a $9.5 million benefit related to the reduction in its tax
contingency reserves resulting from favorable developments with income tax
audits in Belgium and Norway, a $2 million benefit associated with favorable
developments with certain income tax issues related to the Belgian and German
operations and a $1.1 million benefit resulting from the enactment of a
reduction in Canadian income tax rates.
Kronos' income tax expense in the third quarter and first nine months of
2005 also includes an income tax benefit of $12.5 million for the aggregate
effect of favorable developments with respect to income tax audits in Belgium
and Canada offset by a charge of $17.5 million for the unfavorable effect
related to the loss of certain German income tax attributes.
Other - On September 22, 2005, the chloride-process TiO2 facility operated
by Kronos' 50%-owned joint venture, Louisiana Pigment Company ("LPC"),
temporarily halted production due to Hurricane Rita. Although there was minimal
storm damage to core processing facilities, a variety of factors, including loss
of utilities, limited access and availability of employees and raw materials,
prevented the resumption of partial operations until October 9, 2005 and full
operations until late 2005. LPC expects the majority of its property damage and
unabsorbed fixed costs for periods in which normal production levels were not
achieved will be covered by insurance, and we believe insurance will cover its
lost profits (subject to applicable deductibles) resulting from its share of the
lost production at LPC. Both Kronos and LPC have filed claims with their
insurers. Kronos expects to recover their losses through the insurer late in the
fourth quarter of 2006 or early in 2007, although the amount and timing of the
insurance recovery is not yet known. Accordingly, Kronos has not accrued a
receivable for the amount of the insurance claim and will not record the claim
until negotiations with their insurer are finalized. The effect on our financial
results will depend on the timing and amount of insurance recoveries.
Outlook - Kronos expects its income from operations for the fourth quarter
2006 will be lower than the fourth quarter 2005. Expectations for future
prospects of Kronos and the TiO2 industry are based upon a number of factors
beyond Kronos' control, including worldwide growth of gross domestic product,
competition in the marketplace, unexpected or earlier-than-expected capacity
additions and technological advances. If actual developments differ from Kronos'
expectations, Kronos' results of operations could be unfavorably affected.
Insurance Recoveries, Corporate Expense, Interest Expense, Provision for Income
Taxes, Minority Interest and Discontinued Operations - 2006 Compared to 2005
Insurance recoveries - We have reached an agreement with a former insurance
carrier in which the carrier will reimburse us for a portion of our past and
future lead pigment litigation defense costs. We received approximately $1.1
million during the first nine months of 2006 under the agreement. We received
$1.2 million in the third quarter of 2005 under this agreement. We are not able
to determine how much we will ultimately recover from the carrier for the past
defense costs we incurred because the carrier has certain discretion regarding
which past defense costs qualify for reimbursement.
We also received $1.8 million in insurance recoveries in the first nine
months of 2006 in settlements with certain of our former insurance carriers.
These settlements, as well as similar settlements we reached in the past few
years (including $1.2 million in the first nine months of 2005), resolved court
proceedings in which we sought reimbursement from carriers for legal defense
costs and indemnity coverage for certain of our environmental remediation
expenditures. We do not expect to receive any further material insurance
settlements relating to litigation concerning environmental remediation
coverages.
While we continue to seek additional insurance recoveries, we do not know
if we will be successful in obtaining reimbursement for either defense costs or
indemnity. We have not considered any additional potential insurance recoveries
in determining accruals for lead pigment litigation matters. Any additional
insurance recoveries would be recognized when the receipt is probable and the
amount is determinable.
Corporate expense - Corporate expenses were $7.7 million in the third
quarter of 2006, $3.8 million or 97% higher than in the third quarter of 2005
primarily due to higher litigation and related expenses and to higher
environmental remediation expenses. Corporate expenses were $18.3 million in the
first nine months of 2006, 31% higher compared to the first nine months of 2005
due mainly to the higher litigation and related expenses and higher
environmental remediation expenses. We expect corporate expenses in 2006 to be
higher than in 2005, in part due to higher expected litigation and related
expenses.
Obligations for environmental remediation costs are difficult to assess and
estimate, and it is possible that actual costs for environmental remediation
will exceed accrued amounts or that costs will be incurred in the future for
sites in which we cannot currently estimate our liability. If these events were
to occur in the fourth quarter of 2006, our corporate expenses would be higher
than we currently estimate. See Note 12 to the Condensed Consolidated Financial
Statements.
Interest expense - Substantially all of our interest expense relates to
CompX. Interest expense declined in the third quarter and the first nine months
of 2006 compared to 2005 due primarily to lower average debt levels.
Provision for income taxes - See Note 9 to the Condensed Consolidated
Financial Statements for a tabular reconciliation of our statutory tax expense
to our actual tax benefit.
In accordance with GAAP, we recognize deferred income taxes on our
undistributed equity in earnings of Kronos. We do not recognize, and we are not
required to pay, income taxes to the extent we receive dividends from Kronos.
Because we and Kronos are part of the same U.S. federal income tax group, we are
entitled to a 100% dividends received deduction on the dividends we receive from
Kronos. Therefore, our effective income tax rate will generally be lower than
the U.S. federal statutory income tax rate.
Our provision for income taxes in 2006 includes a second quarter benefit of
$159,000 related to the effect of the reduction in the Canadian federal income
tax rate on our previously recorded net deferred income tax liability related to
our operations in Canada.
Our provision for income taxes in the third quarter of 2005 includes the
net effects of (i) the favorable effect of recent developments with respect to
certain income tax items of $4.1 million and (ii) the unfavorable effect with
respect to a change in CompX's permanent reinvestment conclusion regarding its
foreign subsidiaries of $9.0 million.
Minority interest - Minority interest in earnings increased $3.4 million in
the first nine months of 2006 as compared to the first nine months of 2005. This
increase is due to higher earnings of CompX in 2006, partially offset by the
increase in our ownership of CompX.
Discontinued operations - See Note 13 to the Condensed Consolidated
Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Consolidated cash flows
Operating activities
Trends in cash flows from operating activities (excluding the impact of
significant securities transactions, deferred taxes and relative changes in
assets and liabilities) are generally similar to trends in our earnings.
Cash flows from operating activities increased from $16.7 million used in
operating activities in the first nine months of 2005 to $14.0 million of cash
provided by operating activities in the first nine months of 2006. This $30.7
million increase is primarily due to a lower amount of cash paid for income
taxes in 2006 as compared to 2005. Cash paid for income taxes was $28.8 million
lower in 2006, primarily due to a $21 million tax payment we made in 2005 to
settle a previously-reported income tax audit in the U.S.
Relative changes in working capital (primarily in accounts receivable,
payables, and inventories) can have a significant effect on our cash flows from
operating activities. Our average days sales outstanding ("DSO") related to
continuing operations increased from 40 days at December 31, 2005 to 43 days at
September 30, 2006, due to the timing of collections on our higher accounts
receivable balance at the end of September. For comparative purposes, our
average DSO increased from 38 days at December 31, 2004 to 43 days at September
30, 2005. Our average number of days in inventory ("DII") was 59 days at
December 31, 2005 and 60 days at September 30, 2006. The increase in DII is
primarily due to the higher cost of commodity raw materials balance at September
30, 2006. For comparative purposes, our average DII was 52 days and 57 days at
December 31, 2004 and September 30, 2005, respectively, primarily as a result of
lower commodity raw materials costs in the first nine months of 2005 compared to
2006.
We do not have complete access to CompX's cash flows in part because we do
not own 100% of CompX. A detail of our consolidated cash flows from operating
activities is presented in the table below. Intercompany dividends have been
eliminated.
Nine months ended
September 30,
-----------------------
2005 2006
---- ----
(In millions)
Cash provided (used) by operating activities:
CompX $ 14.2 $ 19.7
NL Parent and wholly-owned subsidiaries (27.0) (1.7)
Eliminations (3.9) (4.0)
------ -------
Total $(16.7) $ 14.0
====== ======
Investing and financing activities
Substantially all of our consolidated capital expenditures relate to CompX.
During the first nine months of 2006:
o We paid aggregate cash dividends of $18.2 million ($.125 per share in
each of the first, second and third quarters),
o CompX completed an acquisition of a marine component products company
for $9.8 million, net of cash acquired,
o We purchased approximately 145,000 shares of CompX common stock in
market transactions for $2.3 million, and
o CompX prepaid $1.5 million of indebtedness assumed in prior business
acquisitions.
Investing activities in 2005 included CompX's net proceeds from the sale of
the Thomas Regout operations in Europe offset by cash paid for a marine
component product business.
Distributions to minority interests consist of CompX dividends paid to
shareholders other than us. Other cash flows from financing activities relate
primarily to proceeds from the issuance of NL and CompX common stock upon
exercise of stock options.
At September 30, 2006, there were no amounts outstanding under CompX's $50
million revolving credit facility that matures in January 2009.
Provisions contained in certain of CompX's and Kronos' credit agreements
could result in the acceleration of the applicable indebtedness prior to its
stated maturity for reasons other than defaults from failing to comply with
typical financial covenants. For example, certain credit agreements allow the
lender to accelerate the maturity of the indebtedness upon a change of control
(as defined) of the borrower. In addition, certain credit agreements could
result in the acceleration of all or a portion of the indebtedness following a
sale of assets outside the ordinary course of business.
Future cash requirements
Liquidity
Our primary source of liquidity on an ongoing basis is our cash flow from
operating activities, including the dividends Kronos pays to us. We generally
use these amounts to (i) fund capital expenditures, (ii) pay ongoing
environmental remediation and legal expenses and (iii) provide for the payment
of dividends.
At September 30, 2006, we had an aggregate of $63.4 million of restricted
and unrestricted cash, cash equivalents and debt securities. A detail by entity
is presented in the table below.
CompX $25.8
NL Parent and wholly-owned subsidiaries 37.6
-----
Total $63.4
=====
We routinely compare our liquidity requirements and alternative uses of
capital against the estimated future cash flows we expect to receive from our
subsidiaries and affiliates. As a result of this process, we have in the past
and may in the future seek to raise additional capital, incur debt, repurchase
indebtedness in the market or otherwise, modify our dividend policies, consider
the sale of our interests in our subsidiaries, affiliates, business units,
marketable securities or other assets, or take a combination of these and other
steps, to increase liquidity, reduce indebtedness and fund future activities.
Such activities have in the past and may in the future involve related
companies.
We periodically evaluate acquisitions of interests in or combinations with
companies (including related companies) perceived by management to be
undervalued in the marketplace. These companies may or may not be engaged in
businesses related to our current businesses. We intend to consider such
acquisition activities in the future and, in connection with this activity, may
consider issuing additional equity securities and increasing indebtedness. From
time to time, we also evaluate the restructuring of ownership interests among
our respective subsidiaries and related companies.
Based upon our expectations of our operating performance, and the
anticipated demands on our cash resources we expect to have sufficient liquidity
to meet our short-term obligations (defined as the twelve-month period ending
September 30, 2007) and our long-term obligations (defined as the five-year
period ending December 31, 2010, our time period for long-term budgeting). If
actual developments differ from our expectations, our liquidity could be
adversely affected.
Capital Expenditures
Firm purchase commitments for capital projects in process at September 30,
2006 approximated $2.9 million.
Dividends
Because our operations are conducted primarily through subsidiaries and
affiliates, our long-term ability to meet parent company-level corporate
obligations is largely dependent on the receipt of dividends or other
distributions from our subsidiaries and affiliates. Kronos currently pays a
regular quarterly cash dividend of $.25 per share. At that rate, and based on
the 17.5 million shares of Kronos we held at September 30, 2006, we would
receive annual dividends from Kronos of $17.5 million. CompX currently pays a
regular quarterly dividend of $.125 per share rate. At that rate, and based on
the 10.7 million shares of CompX we held directly or indirectly at September 30,
2006, we would receive annual dividends from CompX of $5.4 million. Our ability
to service our liabilities and pay dividends on common stock could be adversely
affected if our subsidiaries and affiliates were to become unable to make
sufficient cash dividends or other distributions. In addition, a significant
portion of our assets consists of ownership interests in our subsidiaries and
affiliates. If we were required to liquidate securities in order to generate
funds to satisfy our liabilities, we may be required to sell such securities on
the open market and may not be able to realize the book value of the assets.
Investments in our Subsidiaries and Affiliates and other Acquisitions
We have in the past, and may in the future, purchase the securities of our
subsidiaries and affiliates or third-parties in market or privately-negotiated
transactions. We base our purchase decisions on a variety of factors, including
an analysis of the optimal use of our capital, taking into account the market
value of the securities and the relative value of expected returns on
alternative investments. In connection with these activities, we may consider
issuing additional equity securities or increasing our indebtedness. We may also
evaluate the restructuring of ownership interests of our businesses among our
subsidiaries and related companies.
Off-balance sheet financing arrangements
We do not have any off-balance sheet financing agreements other than the
operating leases discussed in our 2005 Annual Report.
Commitments and contingencies
There have been no material changes in our contractual obligations since we
filed our 2005 Annual Report, and we refer you to the report for a complete
description of these commitments.
We are subject to certain commitments and contingencies, as more fully
described in Note 12 to the Condensed Consolidated Financial Statements or in
Part II, Item 1 of this report. In addition to those legal proceedings described
in Note 12 to the Condensed Consolidated Financial Statements, various
legislation and administrative regulations have, from time to time, been
proposed that seek to (i) impose various obligations on present and former
manufacturers of lead pigment and lead-based paint (including NL) with respect
to asserted health concerns associated with the use of such products and (ii)
effectively overturn court decisions in which we and other pigment manufacturers
have been successful. Examples of such proposed legislation include bills which
would permit civil liability for damages on the basis of market share, rather
than requiring plaintiffs to prove that the defendant's product caused the
alleged damage, and bills which would revive actions barred by the statute of
limitations. While no legislation or regulations have been enacted to date that
are expected to have a material adverse effect on our consolidated financial
position, results of operations or liquidity, enactment of such legislation
could have such an effect.
Recent accounting pronouncements
See Note 14 to the Condensed Consolidated Financial Statements.
Critical accounting policies and estimates
For a discussion of our critical accounting policies, refer to Part I, Item
7 - "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in our 2005 Annual Report. There have been no changes in our
critical accounting policies during the first nine months of 2006.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk, including foreign currency exchange rates,
interest rates and security prices. For a discussion of such market risk items,
refer to Part I, Item 7A. - "Quantitative and Qualitative Disclosure About
Market Risk" in our 2005 Annual Report. There have been no material changes in
these market risks during the first nine months of 2006.
Certain of our sales generated by CompX's non-U.S. operations are
denominated in U.S. dollars. CompX periodically uses currency forward contracts
to manage a portion of currency exchange rate market risk associated with
receivables, or similar exchange rate risk associated with future sales,
denominated in a currency other than the holder's functional currency. CompX has
not entered into these contracts for trading or speculative purposes in the
past, nor do they anticipate entering into such contracts for trading or
speculative purposes in the future. A majority of the currency forward contracts
CompX enters into meet the criteria for hedge accounting under GAAP and are
designated as cash flow hedges. For these currency forward contracts, gains and
losses representing the effective portion of the hedges are deferred as a
component of accumulated other comprehensive income, and are subsequently
recognized in earnings at the time the hedged item affects earnings.
Occasionally, CompX enters into currency forward contracts for specific
transactions which do not meet the criteria for hedge accounting. CompX
marks-to-market the estimated fair value of such contracts at each balance sheet
date, with any resulting gain or loss recognized in income currently as part of
net currency transactions. At September 30, 2006, we had no outstanding currency
contracts.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures - We maintain a system of
disclosure controls and procedures. The term "disclosure controls and
procedures," as defined by regulations of the SEC, means controls and other
procedures that are designed to ensure that information required to be disclosed
in the reports we file or submit to the SEC under the Securities Exchange Act of
1934, as amended (the "Act"), is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information we are required to disclose in the reports
we file or submit to the SEC under the Act is accumulated and communicated to
our management, including our principal executive officer and our principal
financial officer, or persons performing similar functions, as appropriate to
allow timely decisions to be made regarding required disclosure. Each of Harold
C. Simmons, our Chief Executive Officer, and Gregory M. Swalwell, our Vice
President, Finance and Chief Financial Officer, have evaluated the Company's
disclosure controls and procedures as of September 30, 2006. Based upon their
evaluation, these executive officers have concluded that the Company's
disclosure controls and procedures are effective as of September 30, 2006.
Internal Control over Financial Reporting - We also maintain internal
control over financial reporting. The term "internal control over financial
reporting," as defined by SEC regulations, means a process designed by, or under
the supervision of, our principal executive and principal financial officers, or
persons performing similar functions, and effected by our board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with GAAP, and includes those policies and
procedures that:
o Pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect our transactions and dispositions of our
assets,
o Provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with GAAP, and that our receipts and expenditures are made only in
accordance with authorizations of our management and directors, and
o Provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of our assets that
could have a material effect on our Condensed Consolidated Financial
Statements.
As permitted by the SEC, our assessment of internal control over financial
reporting excludes (i) internal control over financial reporting of our equity
method investees and (ii) internal control over the preparation of our financial
statement schedules required by Article 12 of Regulation S-X. However, our
assessment of internal control over financial reporting with respect to our
equity method investees did include our controls over the recording of amounts
related to our investment that are recorded in our Condensed Consolidated
Financial Statements, including controls over the selection of accounting
methods for our investments, the recognition of equity method earnings and
losses and the determination, valuation and recording of our investment account
balances.
Changes in Internal Control over Financial Reporting - There has been
no change to our internal control over financial reporting during the quarter
ended September 30, 2006 that has materially affected, or is reasonably likely
to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal proceedings
In addition to the matters discussed below, refer to Note 12 to the
Condensed Consolidated Financial Statements and to our 2005 Annual Report and
our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006 and
June 30, 2006.
Thomas v. Lead Industries Association, et al. (Circuit Court, Milwaukee,
Wisconsin, Case No. 99-CV-6411). In August 2006, the trial court rejected any
claim by the plaintiff other than a failure to warn claim.
Smith, et al. v. Lead Industries Association, et al. (Circuit Court for
Baltimore City, Maryland, Case No. 24-C-99-004490). In September 2006, the
plaintiffs filed a certiorari petition with the Maryland Court of Appeals, and
we opposed the petition in October.
City of Milwaukee v. NL Industries, Inc. and Mautz Paint (Circuit Court,
Civil Division, Milwaukee County, Wisconsin, Case No. 01CV003066). In September
2006, the court removed the case from the January 2007 trial calendar and in
October 2006, the court set a trial date of May 23, 2007.
Jones v. NL Industries, Inc., et al. (Circuit Court of LeFlore County,
Mississippi, Civil Action No. 2002-0241-CICI). In August 2006, the plaintiffs
filed a motion for a new trial, which was denied by the district court in
October 2006.
Terry, et al. v. NL Industries, Inc., et al. (United States District Court,
Southern District of Mississippi, Case No. 4:04 CV 269 PB). In September 2006,
we informed the court of the result in the Jones case.
In October 2006, we were served with a complaint in Davis v. Millennium
Holding LLC, et al. (District Court, Douglas County, Nebraska, Case No.
1061-619). Plaintiff alleges injuries purportedly caused by lead on the surfaces
of various homes in which he has resided. Plaintiff seeks punitive and
compensatory damages. We intend to deny all liability and to defend against all
of the claims vigorously. In October 2006, we filed a motion to dismiss the
complaint.
In October 2006, we were served with a complaint in Tyler v. Sherwin
Williams Company et al. (District Court, Douglas County, Nebraska, Case No.
1058-174). Plaintiff alleges injuries purportedly caused by lead on the surfaces
of various homes in which he has resided. Plaintiff seeks punitive and
compensatory damages, as well as equitable relief to move the plaintiff's family
from a home alleged to contain lead paint. We intend to deny all liability and
to defend against all of the claims vigorously. In October 2006, we filed a
motion to dismiss the complaint.
In October 2006, we were served with a complaint in City of Akron, Ohio v.
Sherwin-Williams Company et al.(Court of Common Pleas, Summit County, Ohio, Case
No. CV-2006-106309). The City seeks compensatory and punitive damages, detection
and abatement in residences, schools, hospitals and public and private buildings
within the City accessible to children and damages for funding of a public
education campaign and health screening programs. Plaintiff seeks judgments of
joint and several liability against the former pigment manufacturers and the
Lead Industries Association ("LIA"). We intend to deny all liability and to
defend against all of the claims vigorously.
In October 2006, we were served with a complaint in City of E. Cleveland,
Ohio v. Sherwin-Williams Company et al.(Court of Common Pleas, Cuyahoga County,
Ohio, Case No. CV06602785). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
In October 2006, we were served with a complaint in City of Lancaster, Ohio
v. Sherwin-Williams Company et al.(Court of Common Pleas, Fairfield County,
Ohio, Case No. 2006 CV 01055). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
In October 2006, we were served with a complaint in City of Toledo, Ohio v.
Sherwin-Williams Company et al.(Court of Common Pleas, Lucas County, Ohio, Case
No. G-4801-CI-200606040-000). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
Brown et. al. v. NL Industries, Inc. et. al. (Circuit Court Wayne County,
Michigan, Case No. 06-602096 CZ). In August 2006, the plaintiffs amended their
complaint to drop the class action allegations, and are now seeking recovery
solely on their individual claims.
Park Hills, Mo. Site. In August 2006, Doe Run ceased to negotiate with us
regarding allocation. We intend to pursue Doe Run for its share of the costs
associated with complying with the Order.
Donnelly and Donnelley v. NL Industries, Inc. (United States District
Court, Northern District of New York, Case No. 1:06-CV-0851). In July 2006, we
removed this case to Federal Court. In August 2006, we answered the complaint
and denied all of the plaintiffs' allegations.
In July 2006, we were served with a complaint in Norampac Industries, Inc.
v. NL Industries, Inc. (United States District Court, Western District of New
York, Case No. 06-CV-0479). The plaintiff sued under CERCLA and New York's
Navigation Law for contribution for costs that have been, or will be, expended
by the plaintiff to clean up a former Magnus Metals facility. The complaint also
alleges common-law claims for negligence, public nuisance, private nuisance,
indemnification, natural resource damages and declaratory relief. In September
2006, we denied all liability for, and we intend to defend vigorously against,
all of the claims raised in the complaint. In October 2006, the matter was
referred to mediation by the court.
In October 2006, we entered into a consent decree in the United States
District Court for the District of Kansas, in which we agreed to perform
remedial design and remedial actions in OU-6, Waco Subsite, of the Cherokee
County Superfund Site. We conducted milling activities on the portion of the
site which we have agreed to remediate. We are also sharing responsibility with
other potentially-responsible parties for remediating a tributary that drains
the portions of the site in which the potentially-responsible parties operated.
We will also reimburse EPA for a portion of its past and future response costs
related to the site.
Item 1A. Risk Factors
For a discussion of the risk factors related to our businesses, refer
to Part I, Item 1A., "Risk Factors," in our 2005 Annual report. There have been
no material changes to such risk factors during the nine months ended September
30, 2006.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NL INDUSTRIES, INC.
-------------------------------
(Registrant)
Date November 6, 2006 By /s/ Gregory M. Swalwell
------------------------------
Gregory M. Swalwell
Vice President, Finance and Chief
Financial Officer (Principal
Financial Officer)
Date November 6, 2006 By /s/ Tim C. Hafer
------------------------------
Tim C. Hafer
Vice President and Controller
(Principal Accounting Officer)