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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, 2005 Commission file number 1-640
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NL INDUSTRIES, INC.
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(Exact name of Registrant as specified in its charter)
New Jersey 13-5267260
- ------------------------------- -------------------
(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 No X
--- ---
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No
--- ---
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
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Number of shares of the Registrant's common stock outstanding on October 31,
2005: 48,561,234.
- 3 -
NL INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets -
December 31, 2004 (Restated);
September 30, 2005 (Unaudited) 3
Consolidated Statements of Income -
Three months and nine months ended
September 30, 2004 (Unaudited and Restated)
Three months and nine months ended
September 30, 2005 (Unaudited) 5
Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2004 (Unaudited and Restated);
Nine months ended September 30, 2005 (Unaudited) 6
Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2005 (Unaudited) 7
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2004 (Unaudited and Restated);
Nine months ended September 30, 2005 (Unaudited) 8
Notes to Consolidated Financial Statements (Unaudited) 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 30
Item 4. Controls and Procedures 45
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 48
Item 6. Exhibits 49
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands)
ASSETS December 31, September 30,
2004 2005
------------ ------------
(Restated)
Current assets:
Cash and cash equivalents $ 99,185 $ 83,103
Restricted cash and cash equivalents 7,810 2,675
Restricted marketable debt securities 9,446 9,428
Accounts and other receivables 24,302 24,264
Refundable income taxes 32 473
Receivable from affiliates 1,681 335
Inventories 28,781 22,711
Prepaid expenses 1,332 2,964
Deferred income taxes 13,604 7,110
---------- ----------
Total current assets 186,173 153,063
---------- ----------
Other assets:
Marketable equity securities 75,793 84,671
Restricted marketable debt securities 3,848 -
Investment in Kronos Worldwide, Inc. 175,578 169,382
Receivable from affiliate 10,000 8,000
Deferred income taxes 545 -
Goodwill 20,772 26,192
Other 3,715 6,941
---------- ----------
Total other assets 290,251 295,186
---------- ----------
Property and equipment:
Land 5,356 8,489
Buildings 26,877 27,917
Equipment 127,044 111,677
Construction in progress 2,431 2,355
---------- ----------
161,708 150,438
Less accumulated depreciation and amortization 86,490 80,448
---------- ----------
Net property and equipment 75,218 69,990
---------- ----------
$ 551,642 $ 518,239
========== ==========
See accompanying notes to consolidated financial statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (CONTINUED)
(Unaudited)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2004 2005
------------ ------------
(Restated)
Current liabilities:
Current maturities of long-term debt $ 42 $ 161
Accounts payable 14,649 11,819
Accrued liabilities 23,134 32,585
Accrued environmental costs 16,570 17,488
Payable to affiliates 391 789
Income taxes 3,661 910
Deferred income taxes 23,842 -
---------- ----------
Total current liabilities 82,289 63,752
---------- ----------
Noncurrent liabilities:
Long-term debt 85 1,469
Accrued pension costs 7,968 6,756
Accrued postretirement benefits costs 10,572 9,581
Accrued environmental costs 51,247 41,228
Deferred income taxes 103,420 111,105
Other 4,028 2,646
---------- ----------
Total noncurrent liabilities 177,320 172,785
---------- ----------
Minority interest 58,404 47,145
---------- ----------
Stockholders' equity:
Common stock 6,054 6,070
Additional paid-in capital 369,728 369,630
Retained earnings (deficit) - -
Accumulated other comprehensive income (loss):
Marketable securities 26,783 32,511
Currency translation (135,729) (140,447)
Pension liabilities (33,207) (33,207)
---------- ----------
Total stockholders' equity 233,629 234,557
---------- ----------
$ 551,642 $ 518,239
========== ==========
Commitments and contingencies (Notes 12 and 14)
See accompanying notes to consolidated financial statements.
- 6 -
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
Three months ended Nine months ended
September 30, September 30,
-------------------------- --------------------------
2004 2005 2004 2005
---- ---- ---- ----
(Restated) (Restated)
Net sales $ 46,234 $ 47,134 $ 695,113 $ 139,707
Cost of sales 35,929 36,153 536,173 107,916
--------- --------- --------- ---------
Gross margin 10,305 10,981 158,940 31,791
Selling, general and administrative expense 5,231 6,049 87,637 17,979
Other operating income (expense):
Currency transaction gains (losses), net (105) (43) 764 (58)
Disposition of property and equipment - (4) (2) (8)
Other income 97 1,195 7,041 2,638
Corporate expense (3,719) (3,860) (15,011) (13,920)
--------- --------- --------- ---------
Income from operations 1,347 2,220 64,095 2,464
Equity in earnings of Kronos Worldwide, Inc. 5,005 2,847 5,005 22,403
Other income (expense):
Trade interest income 15 32 491 76
Interest and dividend income from affiliates 5,059 619 6,716 1,858
Other interest income 195 785 904 2,445
Securities transactions, net (33) (93) (58) 14,603
Interest expense (86) (90) (18,253) (287)
--------- --------- --------- ---------
Income from continuing operations before
income taxes and minority interest 11,502 6,320 58,900 43,562
Provision (benefit) for income taxes 3,593 5,460 (248,717) 16,485
Minority interest in after-tax earnings (losses) 1,157 (1,929) 148,982 (413)
--------- --------- --------- ---------
Income from continuing operations 6,752 2,789 158,635 27,490
Discontinued operations 219 - 409 (326)
--------- --------- --------- ---------
Net income $ 6,971 $ 2,789 $ 159,044 $ 27,164
========= ========= ========= =========
Cash dividend per share $ - $ .25 $ - $ .50
========= ========= ========= =========
Earnings per share:
Basic:
Income from continuing operations $ .14 $ .06 $ 3.28 $ .57
Discontinued operations - - .01 (.01)
--------- --------- --------- ---------
Net income $ .14 $ .06 $ 3.29 $ .56
========= ========= ========= =========
Diluted:
Income from continuing operations $ .14 $ .06 $ 3.28 $ .57
Discontinued operations - - .01 (.01)
--------- --------- --------- ---------
Net income $ .14 $ .06 $ 3.29 $ .56
========= ========= ========= =========
Weighted-average shares used in the calculation
of net income per share:
Basic 48,395 48,558 48,299 48,534
Dilutive impact of stock options 64 36 88 49
--------- --------- --------- ---------
48,459 48,594 48,387 48,583
========= ========= ========= =========
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Net income $ 159,044 $ 27,164
---------- ----------
Other comprehensive income (loss), net of tax:
Marketable securities adjustment -
unrealized holding gains (losses) arising
during the period 194 5,728
Currency translation adjustment, net of tax (105) (4,718)
---------- ----------
Total other comprehensive income (loss) 89 1,010
---------- ----------
Comprehensive income $ 159,133 $ 28,174
========== ==========
See accompanying notes to consolidated financial statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2005
(In thousands)
(Unaudited)
Accumulated other
comprehensive income (loss)
Additional Retained ---------------------------------------------
Common paid-in earnings Marketable Currency Pension
stock capital (deficit) securities translation liabilities Total
------- ----------- -------- ---------- ----------- ----------- ---------
Balance at December 31, 2004:
Previously reported $6,054 $417,760 $ 10,970 $ 26,783 $(136,648) $ (33,191) $ 291,728
Prior period adjustments - (48,032) (10,970) - 919 (16) (58,099)
------ -------- -------- --------- --------- --------- --------
Balance, as restated 6,054 369,728 - 26,783 (135,729) (33,207) 233,629
Net income - - 27,164 - - - 27,164
Issuance of common stock 16 2,564 - - - - 2,580
Dividends - (2,776) (21,503) - - - (24,279)
Distribution of shares of Kronos
Worldwide, Inc. common stock - - (2,637) - - - (2,637)
Income tax on distribution - - (3,024) - - - (3,024)
Other comprehensive income (loss), net - - - 5,728 (4,718) - 1,010
Other - 114 - - - - 114
------ -------- -------- --------- --------- --------- --------
Balance at September 30, 2005 $6,070 $369,630 $ - $ 32,511 $(140,447) $ (33,207) $ 234,557
====== ======== ======== ========= ========= ========= =========
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Cash flows from operating activities:
Net income $ 159,044 $ 27,164
Depreciation and amortization 32,724 8,420
Deferred income taxes:
Continuing operations (261,824) (11,411)
Discontinued operations 203 (187)
Minority interest:
Continuing operations 148,982 (413)
Discontinued operations (203) (151)
Net loss from disposition of property and equipment 2 149
Equity in earnings of Kronos Worldwide, Inc. (5,005) (22,403)
Distributions from Kronos Worldwide, Inc. 6,095 13,214
Distributions from TiO2 manufacturing joint venture 8,300 -
Net (gains) losses from securities transactions 58 (14,603)
Other, net 1,547 (605)
Change in assets and liabilities:
Accounts and other receivables (50,507) (1,994)
Inventories 51,113 (763)
Prepaid expenses 1,309 (1,279)
Accrued environmental costs (6,660) (8,685)
Accounts payable and accrued liabilities (34,338) 19
Income taxes 33,655 (1,370)
Accounts with affiliates 2,101 (1,407)
Other, net (3,704) (404)
---------- ----------
Net cash provided (used) by operating activities 82,892 (16,709)
---------- ----------
Cash flows from investing activities:
Capital expenditures (13,602) (8,828)
CompX business acquisition, net of cash acquired - (7,342)
Collection of loans to affiliates 2,000 2,000
Change in restricted cash equivalents and marketable
debt securities, net 5,995 5,134
Proceeds from disposal of:
Business unit - 18,094
Kronos common stock - 19,176
Property and equipment 2,218 19
Cash of disposed business unit - (4,006)
Purchase of CompX common stock - (707)
Other, net - -
---------- ----------
Net cash provided (used) by investing activities (3,389) 23,540
---------- ----------
NL INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2004 and 2005
(In thousands)
(Unaudited)
2004 2005
---- ----
(Restated)
Cash flows from financing activities:
Indebtedness:
Borrowings $ 102,221 $ -
Principal payments (128,081) (48)
Deferred financing costs paid (28) (28)
Dividends paid - (24,279)
Distributions to minority interest (12,036) (1,805)
Proceeds from issuance of common stock:
NL common stock 8,793 2,488
CompX common stock 499 639
---------- ----------
Net cash used by financing activities (28,632) (23,033)
---------- ----------
Cash and cash equivalents - net change from:
Operating, investing and financing activities 50,871 (16,202)
Currency translation (420) 120
Kronos cash balance at June 30, 2004 (88,434) -
Cash and cash equivalents at beginning of period 89,525 99,185
---------- ----------
Cash and cash equivalents at end of period $ 51,542 $ 83,103
========== ==========
Supplemental disclosures:
Cash paid (received) for:
Interest, net of amounts capitalized $ 17,062 $ 105
Income taxes, net (17,807) 32,117
Noncash investing activity - note receivable
received upon disposal of business unit $ - $ 4,179
Net assets of Kronos Worldwide, Inc. deconsolidated
as of July 1, 2004:
Cash and cash equivalents $ 88,434
Accounts and other receivables 200,845
Inventories 209,816
Other current assets 9,344
Investment in TiO2 manufacturing joint venture 120,711
Net property and equipment 413,171
Other assets 209,105
Current liabilities (156,701)
Long-term debt (346,682)
Note payable to affiliates (200,000)
Accrued pension costs (66,227)
Accrued postretirement benefits costs (10,677)
Deferred income taxes (50,730)
Other liabilities (13,408)
Minority interest (201,842)
----------
Net assets $ 205,159
==========
See accompanying notes to consolidated financial statements.
NL INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 - Restatements, Organization and basis of presentation and Other:
Restatement of financial statements
As previously disclosed, prior to December 2003 Kronos Worldwide, Inc. was
a wholly-owned subsidiary of the Company. In December 2003, NL completed the
distribution of approximately 48.8% of Kronos' common stock on a pro-rata basis
to its shareholders, and during 2004 NL paid each of its four $.20 per share
regular quarterly dividends in the form of shares of Kronos common stock.
Consequently, effective in July 2004 the Company's ownership of Kronos was
reduced to less than 50%, and the Company commenced to account for its interest
in Kronos by the equity method.
The Company is a majority-owned subsidiary of Valhi, Inc., and majority
ownership of Kronos continues to reside with Valhi and its subsidiaries,
including the Company. Valhi is a majority-owned subsidiary of Contran
Corporation. The Company and Valhi are members of the Contran Tax Group, and the
Company computes its provision for income taxes on a separate company basis.
In its previously-issued consolidated financial statements, the Company
accounted for any current income tax resulting from the distribution of shares
of Kronos common stock to its shareholders as a direct charge to equity. In
addition, the Company commenced to recognize deferred income taxes with respect
to the excess of the financial reporting carrying value of its investment in
Kronos over the adjusted income tax basis of such shares starting in July 2004,
concurrent with the Company beginning to account for its interest in Kronos by
the equity method, on a prospective basis. The Company has now concluded, among
other things, that (i) a portion of the current income taxes resulting from the
distribution of shares of Kronos common stock to its shareholders should be
included in the Company's provision for income taxes included in the
determination of net income and (ii) the Company should have commenced to
recognize deferred income taxes with respect to the excess of the financial
reporting carrying value of its investment in Kronos over the adjusted income
tax basis of such shares starting with such excess that existed in December
2003, concurrent with its distribution of 48.8% of Kronos' common stock in
December 2003.
Accordingly, during the Company's close process for its fiscal quarter
ended September 30, 2005, the Company concluded that:
o its provision for income taxes included in the determination of income from
continuing operations was misstated by an aggregate of $1.8 million, or
$.04 per diluted share, in the third quarter of 2004, by $44.7 million, or
$.92 per diluted share, in the first nine months of 2004, and by $1.2
million, or $.04 per diluted share, in the first six months of 2005;
o its provision for deferred income taxes included in the determination of
total other comprehensive income related to foreign currency translation
was misstated by an aggregate of $1.0 million in the nine months of 2004;
o its provision for income taxes accounted for as a direct reduction to
stockholders' equity was misstated by $913,000 in the first quarter of
2005; and
o with respect to its statement of changes in stockholders' equity, and in
addition to the effect of the items noted above, total stockholders' equity
was misstated by $58.1 million as of December 31, 2004,
in each case as they related to the appropriate provision for income taxes and
related items (including a $174.5 million increase to stockholders' equity in
2004 resulting from the settlement of a $227 million income tax liability by
using 5.5 million shares of Kronos common stock with an aggregate $52.5 million
carrying amount) which should have been recognized in accordance with accounting
principles generally accepted in the United States of America ("GAAP") as
provided by the guidance contained in Statement of Financial Accounting
Standards No. 109, Accounting for Income Taxes, with respect to the following
items:
o Deferred income taxes with respect to the income tax effect of the excess
of the GAAP book basis over the income tax basis of the Registrant's
investment in Kronos Worldwide, Inc., which investment the Registrant
accounts for by the equity method, giving consideration to NL's investment
in Kronos on a pure stand-alone separate company basis without regard to
tax group membership with other affiliated companies;
o Current and deferred income taxes related to the Registrant's distributions
or transfer of shares of Kronos common stock to its stockholders (including
entities under common control); and
o Current and deferred income tax provisions related to other items.
On December 21, 2005, the Company and its audit committee concluded that
the Company had failed to properly apply the guidance contained in SFAS No. 109
in so far as it related to these items. This amendment was required to correct
for the aggregate effect of these misstatements. While the effect of these
misstatements have no effect on the Company's previously-reported total cash
flows from operating, investing and financing activities, these misstatements do
have a significant effect on the Company's provision for income taxes, related
income tax accounts (principally deferred income taxes) and stockholders'
equity.
The following tables show (i) selected consolidated balance sheet data as
of December 31, 2004, and selected consolidated statements of income,
comprehensive income, stockholders' equity and cash flow data for the interim
periods ended September 30, 2004, in each case as previously reported, (ii)
adjustments to such consolidated financial statement data to reflect the
aggregate effect of this restatement and (iii) such consolidated financial
statement data, as restated to reflect the aggregate effect of this restatement.
NL INDUSTRIES, INC.
SELECTED CONSOLIDATED BALANCE SHEET DATA
(In thousands)
(Unaudited)
December 31, 2004
----------------------------------------------------
Previously
reported Adjustments As restated
---------- ----------- -----------
(In thousands)
Selected balance sheet items:
Current receivable from affiliates $ 1,634 $ 47 $ 1,681
========= ======== =========
Total current assets $ 186,126 $ 47 $ 186,173
========= ======== =========
Noncurrent deferred income taxes $ 45,274 $ 58,146 $ 103,420
========= ======== =========
Total noncurrent liabilities $ 119,174 $ 58,146 $ 177,320
========= ======== =========
Stockholders' equity:
Common stock $ 6,054 $ - $ 6,054
Additional paid-in capital 417,760 (48,032) 369,728
Retained earnings 10,970 (10,970) -
Accumulated other comprehensive
income (loss)
Marketable securities 26,783 - 26,783
Currency translation (136,648) 919 (135,729)
Pension liabilities (33,191) (16) (33,207)
--------- -------- ---------
Total stockholders' equity $ 291,728 $(58,099) $ 233,629
========= ======== =========
NL INDUSTRIES, INC.
SELECTED CONSOLIDATED INCOME STATEMENT DATA
(In thousands)
(Unaudited)
Three months ended Nine months ended
September 30, 2004 September 30, 2004
------------------------------------------- ------------------------------------------
Previously Previously
reported Adjustments As restated reported Adjustments As restated
------------ ------------ ----------- ----------- ----------- -----------
(In thousands, except per share data)
Income from continuing operations
before income taxes and minority
interest $ 11,502 $ - $ 11,502 $ 58,900 $ - $ 58,900
Provision (benefit) for income taxes 1,798 1,795 3,593 (293,393) 44,676 (248,717)
Minority interest in after tax earnings 1,157 - 1,157 148,982 - 148,982
--------- --------- --------- --------- --------- ---------
Income from continuing operations 8,547 (1,795) 6,752 203,311 (44,676) 158,635
Discontinued operations 219 - 219 409 - 409
--------- --------- --------- --------- --------- ---------
Net income $ 8,766 $ (1,795) $ 6,971 $ 203,720 $ (44,676) $ 159,044
========= ========= ========= ========= ========= =========
Earnings per share:
Basic net income per share $ .18 $ (.04) $ .14 $ 4.21 $ (.92) $ 3.29
========= ========= ========= ========= ========= =========
Diluted net income per share $ .18 $ (.04) $ .14 $ 4.21 $ (.92) $ 3.29
========= ========= ========= ========= ========= =========
NL INDUSTRIES, INC.
SELECTED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME DATA
Nine months September 30, 2004
(In thousands)
(Unaudited)
Previously
reported Adjustments As restated
---------- ----------- -----------
Consolidated other comprehensive income:
Net income $ 203,720 $(44,676) $ 159,044
========= ======== =========
Other comprehensive income, net of tax:
Marketable securities 194 - 194
Currency translation adjustment (1,120) 1,015 (105)
--------- -------- ---------
Total other comprehensive income (926) 1,015 89
--------- -------- ---------
Comprehensive income $ 202,794 $(43,661) $ 159,133
========= ======== =========
NL INDUSTRIES, INC.
SELECTED CONSOLIDATED STATEMENT OF CASH FLOW DATA
Nine months ended September 30, 2004
(In thousands)
(Unaudited)
Previously
reported Adjustments As restated
---------- ----------- -----------
Items comprising cash flow from
operating activities:
Net income $ 203,720 $ (44,676) $ 159,044
========= ======== =========
Deferred income taxes $(304,318) $ 42,494 $(261,824)
========= ======== =========
Accounts with affiliates $ 313 $ 2,182 $ 2,495
========= ======== =========
Net cash provided by operating activities $ 82,892 $ - $ 82,892
========= ======== =========
In addition, during the fourth quarter of 2004, Kronos determined that it
should have recognized an additional $17.3 million net deferred income tax
benefit during the second quarter of 2004, primarily related to the amount of
the valuation allowance related to Kronos' German operations which should have
been reversed. The Company's results of operations for the nine months ended
September 30, 2004, as presented herein, reflects this additional income tax
benefit, which aggregated $8.7 million, or $.18 per diluted share, net of
minority interest.
As previously disclosed, on May 9, 2005 the Company and its audit committee
also concluded to restate the Company's consolidated financial statements as of
December 31, 2004 and for the year then ended, to reflect an additional $4.2
million, or $.08 per diluted share, noncash deferred income tax benefit in its
results of operations for the year ended December 31, 2004. Such $4.2 million
relates to recognition of an additional noncash deferred income tax benefit
related to discontinued operations in the fourth quarter of 2004. This
restatement was included in the Company's Amendment No. 1 on Form 10-K/A of the
Company's Annual Report on Form 10-K for the year ended December 31, 2004, filed
with the SEC on May 31, 2005. The previously-reported amounts shown in the
tables above reflect, as applicable, the effect of this $4.2 million
restatement.
Organization and basis of presentation
NL Industries, Inc. (NYSE: NL) is a subsidiary of Valhi, Inc. (NYSE: VHI).
At September 30, 2005, Valhi held approximately 83% of NL's outstanding common
stock and Contran Corporation and its subsidiaries held approximately 92% of
Valhi's outstanding common stock. 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, of which Mr. Simmons is sole trustee, or
is held by Mr. Simmons or persons or other entities related to Mr. Simmons.
Consequently, Mr. Simmons may be deemed to control each of such companies.
The consolidated balance sheet of NL Industries, Inc. and Subsidiaries
(collectively, the "Company") as of December 31, 2004 has been derived from the
Company's audited consolidated financial statements at that date included in its
Annual Report on Form 10-K for the year ended December 31, 2004, filed on March
30, 2005, as amended by Amendment No. 1 on Form 10-K/A filed on May 31, 2005 and
as further amended by Amendment No. 2 on Form 10-K/A filed with the SEC on
December 21, 2005 (the "2004 Annual Report").
On September 24, 2004, the Company completed the acquisition of 10,374,000
shares of CompX International Inc. (NYSE: CIX) common stock, representing
approximately 68% of the outstanding shares of CompX common stock. NL's
acquisition was accounted for under accounting principles generally accepted in
the United States of America ("GAAP") as a transfer of net assets among entities
under common control, and accordingly resulted in a change in reporting entity.
The Company has retroactively restated its consolidated financial statements to
reflect the consolidation of CompX for all periods presented.
The consolidated balance sheet at September 30, 2005, and the consolidated
statements of income, comprehensive income (loss), stockholders' equity and cash
flows for the interim periods ended September 30, 2004 and 2005, have been
prepared by the Company, without audit, in accordance with GAAP. In the opinion
of management, all adjustments, consisting only of normal recurring adjustments,
necessary to state fairly the consolidated financial position, results of
operations and cash flows have been made. The results of operations for the
interim periods are not necessarily indicative of the operating results for a
full year or of future operations. Certain information normally included in
financial statements prepared in accordance with GAAP has been condensed or
omitted. The accompanying consolidated financial statements should be read in
conjunction with the 2004 Annual Report.
Prior to July 2004, Kronos Worldwide, Inc. (NYSE: KRO) was a majority-owned
subsidiary of the Company. Following the Company's July 2004 dividend in the
form of shares of Kronos common stock distributed to NL shareholders, the
Company's ownership of Kronos was reduced to less than 50%. Consequently,
effective July 1, 2004 the Company ceased to consolidate Kronos' financial
position, results of operations and cash flows and the Company commenced
accounting for its interest in Kronos by the equity method. The Company
continues to report Kronos as a consolidated subsidiary through June 30, 2004,
including the consolidation of Kronos' results of operations and cash flows for
the second quarter and first six months of 2004.
Other
As disclosed in the 2004 Annual Report, the Company accounts for
stock-based employee compensation in accordance with Accounting Principles Board
Opinion ("APBO") No. 25, "Accounting for Stock Issued to Employees," and its
various interpretations. See Note 16. Under APBO No. 25, no compensation cost is
generally recognized for fixed stock options in which the exercise price is
greater than or equal to the market price on the grant date. Prior to 2004, and
following the cash settlement of certain stock options held by employees of NL,
the Company commenced accounting for its stock options using the variable
accounting method of APBO No. 25 because NL could not overcome the presumption
that it would not similarly cash settle its remaining stock options. Under the
variable accounting method, the intrinsic value of all unexercised stock options
(including stock options with an exercise price at least equal to the market
price on the date of grant) is accrued as an expense, with subsequent increases
(decreases) in the Company's market price resulting in the recognition of
additional compensation expense (income). Net compensation cost recognized by
the Company in accordance with APBO No. 25 was approximately $100,000 in the
third quarter of 2004 and approximately $1.2 million in the first nine months of
2004. Net compensation expense (income) recognized by the Company was
approximately $200,000 and ($200,000) in the third quarter and first nine months
of 2005, respectively.
The following table presents what the Company's consolidated net income,
and related per share amounts, would have been in the third quarter and first
nine months of 2004 and 2005 if the Company and its subsidiaries and affiliates
had each elected to account for their respective stock-based employee
compensation related to stock options in accordance with the fair value-based
recognition provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation," for all awards granted
subsequent to January 1, 1995.
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2004 2005 2004 2005
---- ---- ---- ----
(In millions, except per share amounts)
Net income as reported $ 7.0 $ 2.8 $159.0 $27.2
Adjustments, net of applicable income
tax effects and minority interest:
Stock-based employee compensation
expense determined under APBO No. 25 .4 .1 .8 (.1)
Stock-based employee compensation expense
determined under SFAS No. 123 (.1) (.1) (.4) (.2)
------ ----- ------ -----
Pro forma net income $ 7.3 $ 2.8 $159.4 $26.9
====== ===== ====== =====
Diluted net income per share:
As reported $ .14 $ .06 $ 3.29 $ .56
Pro forma $ .15 $ .06 $ 3.30 $ .55
Note 2 - Business segment information:
% owned at
Business segment Entity September 30, 2005
- -------------------- ----------------------- ----------------------
Component products CompX International Inc. 68%
Chemicals Kronos Worldwide, Inc. 36%
The Company's ownership of CompX is held principally by CompX Group, Inc.,
an 82.4%-owned subsidiary of the Company. An affiliate of Valhi owns the
remaining 17.6% of CompX Group. CompX Group's sole asset consists of shares of
CompX common stock representing approximately 83% of the total number of CompX
shares outstanding, and the percentage ownership of CompX shown above includes
NL's ownership interest in CompX Group multiplied by CompX Group's ownership
interest in CompX. During the first nine months of 2005, NL purchased
approximately 48,000 shares of CompX common stock in open market transactions,
representing approximately .3% of CompX's outstanding common stock for an
aggregate amount of approximately $707,000.
In March 2005, NL paid its $.25 per share regular quarterly dividend in the
form of shares of Kronos common stock in which approximately 266,000 shares, or
approximately .5% of Kronos' outstanding common stock, were distributed to NL
shareholders in the form of a pro-rata dividend. NL's distribution of such
shares of Kronos common stock is taxable to NL, and NL is required to recognize
a taxable gain equal to the difference between the fair market value of the
shares of Kronos common stock distributed and NL's adjusted tax basis in such
stock at the date of distribution. The Company recognized an aggregate $3.9
million tax liability in the first quarter of 2005 related to the Kronos shares
distributed. In accordance with GAAP, the amount of such income tax represented
by the excess of the carrying value of such stock for financial reporting
purposes and the adjusted tax basis of such stock is included in the
determination of net income in the period the shares were distributed, and the
amount of such income tax represented by the excess of the fair market value of
such stock and the carrying value of such stock for financial reporting purposes
is accounted for as a direct reduction to the Company's stockholders' equity
(retained earnings). The amount of such income tax included in the determination
of net income aggregated $913,000, while the amount of such income tax accounted
for as a direct reduction to equity aggregated $3.0 million.
During the first nine months of 2005, NL sold approximately 470,000 shares
of Kronos common stock in market transactions for an aggregate of $19.2 million.
The Company recognized a $14.7 million pre-tax securities transaction gain
related to such sales.
In August 2005, CompX completed the acquisition of a company for aggregate
cash consideration of $7.3 million, net of cash acquired. The purchase price has
been allocated among the tangible and intangible net assets (including goodwill)
acquired based upon a preliminary estimate of the fair value of such net assets.
The pro forma effect to CompX and NL, assuming such acquisition had been
completed as of January 1, 2005, is not material.
CompX (NYSE: CIX) and Kronos (NYSE: KRO) each file periodic reports with
the SEC pursuant to the Securities Exchange Act of 1934, as amended.
A summary of sales and segment profit for the Company's business segments
during the 2004 and 2005 interim periods, and other items included in the
determination of income from continuing operations before income taxes and
minority interest, are presented in the following table.
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2004 2005 2004 2005
---- ---- ---- ----
(In millions)
Net sales:
Chemicals $ - $ - $559.1 $ -
Component products 46.2 47.1 136.0 139.7
------ ----- ------ ------
Total net sales $ 46.2 $47.1 $695.1 $139.7
====== ===== ====== ======
Segment profit:
Chemicals $ - $ - $ 66.3 $ -
Component products 4.9 4.9 12.5 13.8
------ ----- ------ ------
Total segment profit 4.9 4.9 78.8 13.8
General corporate items:
Interest and dividend income from affiliates 5.1 .6 6.7 1.9
Other interest income .2 .8 .9 2.4
Securities transactions, net - (.1) - 14.6
Insurance recoveries - 1.2 .5 2.4
Other income .1 - .3 .3
General corporate expenses, net (3.7) (3.8) (15.0) (13.9)
Interest expense (.1) (.1) (18.3) (.3)
------ ----- ------ ------
6.5 3.5 53.9 21.2
Equity in earnings of Kronos 5.0 2.8 5.0 22.4
------ ----- ------ ------
Income from continuing operations before income
taxes and minority interest $ 11.5 $ 6.3 $ 58.9 $ 43.6
====== ===== ====== ======
Component products segment profit, as presented above, may differ from
amounts separately reported by CompX because the Company defines segment profit
differently than CompX.
Note 3 - Accounts and other receivables:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Trade receivables $ 24,759 $ 22,630
Recoverable VAT and other receivables 551 1,974
Allowance for doubtful accounts (1,008) (340)
--------- --------
$ 24,302 $ 24,264
========= ========
Note 4 - Inventories:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Raw materials $ 8,193 $ 7,534
Work in process 10,827 9,942
Finished products 9,696 5,169
Supplies 65 66
--------- --------
$ 28,781 $ 22,711
========= ========
Note 5 - Marketable equity securities:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Valhi common stock $ 75,770 $ 84,671
Other 23 -
--------- --------
$ 75,793 $ 84,671
========= ========
At September 30, 2005 and December 31, 2004, the Company owned
approximately 4.7 million shares of Valhi common stock with a quoted market
price of $17.98 per share and $16.09 per share, respectively.
Note 6 - Investment in Kronos:
At September 30, 2005, the Company held 17.5 million shares of Kronos with
a quoted market price of $31.74 per share, or an aggregate market value of $556
million.
Securities transaction gains in the first nine months of 2005 relate
primarily to NL's $14.7 million pre-tax gain from the sale of approximately
470,000 shares of Kronos common stock in market transactions for aggregate
proceeds of $19.2 million.
At September 30, 2005, Kronos reported total assets of $1.3 billion and
stockholders' equity of $473.1 million. Kronos' total assets at September 30,
2005 include current assets of $527.0 million, net property and equipment of
$414.4 million and an investment in a TiO2 manufacturing joint venture of $115.2
million. Kronos' total liabilities at September 30, 2005 include current
liabilities of $193.9 million, long-term debt of $457.6 million, accrued
postretirement benefits and pension costs aggregating $66.2 million and deferred
income taxes of $58.3 million.
During the three months ended September 30, 2005, Kronos reported net sales
of $292.1 million, income from operations of $38.2 million and net income of
$8.0 million (three months ended September 30, 2004: $286.1 million, $28.9
million and $10.0 million, respectively). During the nine months ended September
30, 2005, Kronos reported net sales of $895.7 million, income from operations of
$142.4 million and net income of $62.2 million (nine months ended September 30,
2004: $845.1 million, $93.6 million and $304.6 million, respectively).
Note 7 - Other noncurrent assets:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Intangible assets $ 3,190 $ 3,646
Note receivable - 2,873
Other 525 422
--------- --------
$ 3,715 $ 6,941
========= ========
The note receivable relates to part of the consideration received by CompX
from the January 2005 sale of its Thomas Regout operations in Europe. See Note
15.
Note 8 - Accrued liabilities:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Employee benefits $ 14,775 $ 13,591
Other 8,359 18,994
--------- --------
$ 23,134 $ 32,585
========= ========
Note 9 - Other noncurrent liabilities:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Insurance $ 2,507 $ 2,624
Other 1,521 22
--------- --------
$ 4,028 $ 2,646
========= ========
Note 10 - Minority interest:
December 31, September 30,
2004 2005
------------ ------------
(In thousands)
Minority interest in net assets:
CompX International Inc. $ 49,154 $ 47,145
NL Environmental Management Services, Inc. 9,250 -
--------- --------
$ 58,404 $ 47,145
========= ========
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Minority interest in net earnings:
Kronos Worldwide, Inc. $ - $ - $145,837 $ -
CompX International Inc. 1,120 (1,929) 2,551 (475)
NL Environmental Management Services, Inc. 37 - 574 62
Subsidiary of Kronos Worldwide, Inc. - - 20 -
------ ------- -------- ------
$1,157 $(1,929) $148,982 $ (413)
====== ======= ======== ======
In June 2005, NL's majority-owned subsidiary, NL Environmental Management
Services, Inc. ("EMS"), received notices from the three minority shareholders of
EMS indicating they were each exercising their right, which became exercisable
on June 1, 2005, to require EMS to purchase their preferred shares in EMS as of
June 30, 2005 for a formula-determined amount as provided in EMS' certificate of
incorporation. In accordance with the certificate of incorporation, EMS made a
determination in good faith of the amount payable to the three former minority
shareholders to purchase their shares of EMS stock, which amount may be subject
to review by a third party. In June 2005, EMS set aside funds as payment for the
shares of EMS, but as of September 30, 2005 the former minority shareholders
have not tendered their shares, and accordingly the liability owed to these
former minority shareholders, which has not been extinguished for financial
reporting purposes as of September 30, 2005, is classified as a current
liability at such date. Similarly, the funds which have been set aside are
classified as a current asset at such date.
Note 11 - Other income:
Nine months ended
September 30,
-------------------
2004 2005
---- ----
(In thousands)
Insurance recoveries $ 505 $ 2,431
Contract dispute settlement 6,289 -
Other 247 207
------- -------
$ 7,041 $ 2,638
======= =======
Insurance recoveries in the first nine months of 2005 include $1.2 million
that NL received in August 2005 in recovery from certain insolvent and former
insurance carriers relating to settlement of excess insurance coverage claims.
Note 12 - Provision for income taxes:
Nine months ended
September 30,
-------------------
2004 2005
---- ----
(Restated)
(In millions)
Expected tax expense $ 20.6 $ 15.2
Non-U.S. tax rates (.4) (.1)
Incremental U.S. tax and rate differences on
equity in earnings 44.9 3.5
Change in deferred income tax valuation
allowance, net (308.4) -
Nondeductible expenses 1.9 .2
U.S. state income taxes, net .3 .3
Refund of prior year German income taxes (3.1) -
Excess of book basis over tax basis of Kronos 2.7
common stock sold or distributed 2.2
Tax contingency reserve adjustment, net (16.0) (4.1)
Other, net 9.3 (1.2)
------- -------
$(248.7) $ 16.5
======= =======
Certain U.S. and non-U.S. tax returns of the Company and Kronos are being
examined and tax authorities 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 ($7 million at September 30,
2005). Kronos filed a protest to this assessment, and believed that a
significant portion of the assessment is without merit. The Belgian tax
authorities have filed a lien on the fixed assets of Kronos' Belgian TiO2
operations in connection with this assessment. In April 2003, Kronos
received a notification from the Belgian tax authorities of their intent to
assess a tax deficiency related to 1999 that, including interest, would
have aggregated approximately euro 9 million ($11 million). Kronos filed a
written response to the assessment, and in September 2005 the Belgian tax
authorities withdrew the assessment.
o The Norwegian tax authorities have notified Kronos of their intent to
assess tax deficiencies of approximately kroner 12 million ($2 million)
relating to the years 1998 through 2000. Kronos has objected to this
proposed assessment.
o Kronos has received a tax assessment from the Canadian tax authorities
related to the years 1998 and 1999 proposing tax deficiencies, including
interest, of approximately Cdn. $5 million ($4 million). Kronos filed a
protest and in October 2005, the Canadian tax authorities agreed to reduce
the assessment and settle all issues, including interest, for approximately
Cdn. $2 million ($1.7 million).
o During the third quarter of 2005, Kronos reached an agreement in principle
with the German tax authorities regarding such tax authorities' objection
to the value assigned to certain intellectual property rights held by
Kronos' operating subsidiary in Germany. Under the agreement in principle,
the value assigned to such intellectual property for German income tax
purposes will be reduced retroactively, resulting in a reduction in the
amount of Kronos' net operating loss carryforward in Germany as well as a
future reduction in the amount of amortization expense attributable to such
intellectual property.
o The $4.1 million non-cash tax contingency reserve adjustment recognized in
the first nine months of 2005 relates primarily to favorable developments
with respect to certain income tax items of NL in the U.S.
No assurance can be given that these unresolved tax matters will be
resolved in the Company's or Kronos' favor in view of the inherent uncertainties
involved in settlement initiatives, and court and tax proceedings. The Company
believes that it has provided adequate accruals for additional taxes and related
interest expense which may ultimately result from all such examinations and
believes that the ultimate disposition of such examinations should not have a
material adverse effect on its consolidated financial position, results of
operations or liquidity.
Under GAAP, a company is required to recognize a deferred income tax
liability with respect to the incremental U.S. taxes (federal and state) and
foreign withholding taxes that would be incurred when undistributed earnings of
a foreign subsidiary are subsequently repatriated, unless management has
determined that those undistributed earnings are permanently reinvested for the
foreseeable future. Prior to the third quarter of 2005, CompX had not recognized
a deferred tax liability related to such incremental income taxes on the
undistributed earnings of its foreign operations, as those earnings were deemed
to be permanently reinvested. GAAP requires a company to reassess the permanent
reinvestment conclusion on an ongoing basis to determine if management's
intentions have changed. As of September 30, 2005, and based primarily upon
changes in CompX management's strategic plans for its non-U.S. operations,
management has determined that the undistributed earnings of such subsidiaries
can no longer be considered to be permanently reinvested, except for the
pre-2005 earnings in Taiwan. Accordingly, and in accordance with GAAP, in the
third quarter of 2005, the Company recognized an aggregate $9.0 million
provision for deferred income taxes on the aggregate undistributed earnings of
these foreign subsidiaries.
In October 2004, the American Jobs Creation Act of 2004 was enacted into
law. The new law provided for a special 85% deduction for certain dividends
received from a controlled foreign corporation in 2005. In the third quarter of
2005, the Company and Kronos each completed its evaluation of this new provision
and determined that it would not benefit from such special dividends received
deduction.
Note 13 - Employee 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,
----------------------- -----------------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Service cost $ - $ - $ 3,128 $ -
Interest cost 760 753 10,780 2,271
Expected return on plan assets (890) (1,010) (10,290) (3,041)
Amortization of prior service cost - - 281 -
Amortization of net transition obligations and (16) (51)
assets (17) 273
Recognized actuarial losses 220 93 2,148 291
------ ------- -------- ------
$ 73 $ (180) $ 6,320 $ (530)
====== ======= ======== ======
The components of net periodic postretirement benefits other than pensions
("OPEB") cost are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
----------------------- -----------------------
2004 2005 2004 2005
---- ---- ---- ----
(In thousands)
Service cost $ - $ - $ 113 $ -
Interest cost 289 211 1,229 633
Amortization of prior service credit (72) (72) (583) (215)
Recognized actuarial losses 32 - 173 -
------ ------- -------- ------
$ 249 $ 139 $ 932 $ 418
====== ======= ======== ======
Note 14 - Commitments and contingencies:
Lead pigment litigation. NL's former operations included the manufacture of
lead pigments for use in paint and lead-based paint. NL, 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 in 2002, 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 NL is not a defendant) seeking recovery for injury
allegedly caused by lead pigment and lead-based paint. Although NL is not a
defendant in these cases, the outcome of these cases may have an impact on cases
that might be filed against NL in the future.
NL believes these actions are without merit, intends to continue to deny
all allegations of wrongdoing and liability and to defend against all actions
vigorously. NL has neither lost nor settled any of these cases. NL has not
accrued any amounts for pending lead pigment and lead-based paint litigation.
Liability that may result, if any, cannot reasonably be estimated. There can be
no assurance that NL will not incur liability in the future in respect of this
pending litigation in view of the inherent uncertainties involved in court and
jury rulings in pending and possible future cases. If any such future liability
were to be incurred, it could have a material adverse effect on the Company's
consolidated financial position, results of operations and liquidity.
During the first nine months of 2005, NL recognized $1.2 million of
recoveries from certain insolvent former insurance carriers relating to the
settlement of excess insurance claims received in August 2005. See Note 11. In
addition, NL has reached an agreement with one of its former insurance carriers
in which such carrier would reimburse NL for a portion of its past and future
lead pigment litigation defense costs, although the amount which NL will
ultimately recover from such carrier with respect to such defense costs incurred
by NL is not yet determinable.
In October 2005 NL was served with a complaint in OneBeacon American
Insurance Company v. NL Industries, Inc., et. al.(Supreme Court of the State of
New York, County of New York, Index No. 603429-05). The plaintiff, a former
insurance carrier, seeks a declaratory judgment of its obligations to NL under
insurance policies issued to NL by the plaintiff's predecessor with respect to
certain lead pigment lawsuits. NL has filed an action against OneBeacon and
certain other former insurance companies, captioned NL Industries, Inc. v.
OneBeacon America Insurance Company, et. al. (District Court for Dallas County,
Texas, Case No. 05-11347) asserting that OneBeacon has breached its obligations
to NL under such insurance policies and seeking a declaratory judgment of
OneBeacon's obligations to NL under such policies.
While NL continues to seek additional recoveries of defense costs, there
can be no assurance that NL will be successful in obtaining reimbursement for
either defense costs or indemnity. NL has not considered any potential insurance
recoveries in determining related accruals for lead pigment litigation matters.
Any such additional insurance recoveries would be recognized when their receipt
is deemed probable and the amount is determinable.
Environmental matters and litigation. The Company's operations are governed
by various environmental laws and regulations. Certain of the Company's
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 past and current operations and products of the
Company have the potential to cause environmental or other damage. The Company
has implemented and continues to implement various policies and programs in an
effort to minimize these risks. The Company's policy is to maintain compliance
with applicable environmental laws and regulations at all of its plants and to
strive to improve environmental performance. From time to time, the Company may
be subject to environmental regulatory enforcement under U.S. and foreign
statutes, resolution of which typically involves the establishment of compliance
programs. It is possible that future developments, such as stricter requirements
of environmental laws and enforcement policies thereunder, could adversely
affect the Company's production, handling, use, storage, transportation, sale or
disposal of such substances. The Company believes all of its plants are in
substantial compliance with applicable environmental laws.
Certain properties and facilities used in the Company's former businesses,
including divested primary and secondary lead smelters and former mining
locations of NL, are the subject of civil litigation, administrative proceedings
or investigations arising under federal and state environmental laws.
Additionally, in connection with past disposal practices, the Company has 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 currently or previously
owned, operated or used by the Company or its subsidiaries, or their
predecessors, 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 the Company may be jointly and severally liable for such
costs, in most cases it is 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 the complexity and differing interpretations of governmental
regulations, the number of PRPs and the PRPs' ability or willingness to fund
such allocation of costs, their financial capabilities and the allocation of
costs among PRPs, the solvency of other PRPs, the multiplicity of possible
solutions, and the 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 the Company is potentially
responsible for the release of hazardous substances at other sites, could result
in expenditures in excess of amounts currently estimated by the Company to be
required for such matters. In addition, with respect to other PRPs and the fact
that the Company may be jointly and severally liable for the total remediation
cost at certain sites, the Company could ultimately be liable for amounts in
excess of its accruals due to, among other things, reallocation of costs among
PRPs or the insolvency of one or more PRPs. No assurance can be given 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. Further, there can be no assurance that additional
environmental matters will not arise in the future. If any such future liability
were to be incurred, it could have a material adverse effect on the Company's
consolidated financial statements, results of operations and liquidity.
The Company records liabilities related to environmental remediation
obligations when estimated future expenditures are probable and reasonably
estimable. Such accruals are adjusted as further information becomes available
or circumstances change. Estimated future expenditures are generally not
discounted to their present value. Recoveries of remediation costs from other
parties, if any, are recognized as assets when their receipt is deemed probable.
At September 30, 2005, no receivables for such recoveries have been recognized.
The exact time frame over which the Company makes payments with respect to
its accrued environmental costs is unknown and is dependent upon, among other
things, the timing of the actual remediation process which in part depends on
factors outside the control of the Company. At each balance sheet date, the
Company makes an estimate of the amount of its accrued environmental costs which
will be paid out over the subsequent 12 months, and the Company classifies such
amount as a current liability. The remainder of the accrued environmental costs
is classified as a noncurrent liability.
A summary of the activity in the Company's accrued environmental costs
during the first nine months of 2005 is presented in the table below.
Amount
--------------
(In thousands)
Balance at the beginning of the period $ 67,817
Net additions charged to expense 1,472
Payments (10,573)
--------
Balance at the end of the period $ 58,716
========
Amounts recognized in the balance sheet
at the end of the period:
Current liability $ 17,488
Noncurrent liability 41,228
--------
$ 58,716
========
On a quarterly basis, the Company evaluates the potential range of its
liability at sites where it has been named as a PRP or defendant, including
sites for which EMS has contractually assumed the Company's obligations. At
September 30, 2005, the Company had accrued $58.7 million for those
environmental matters which the Company believes are reasonably estimable. The
Company believes it is not possible to estimate the range of costs for certain
sites. The upper end of the range of reasonably possible costs to the Company
for sites for which the Company believes it is possible to estimate costs is
approximately $81 million. The Company's estimates of such liabilities have not
been discounted to present value.
At September 30, 2005, there are approximately 20 sites for which the
Company is 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 or
not the Company actually had any association with the site, or if the Company
had an association with the site, the nature of its responsibility, if any, for
the contamination at the site and the extent of contamination. The timing on
when information would become available to the Company to allow the Company to
estimate a range of loss is unknown and dependent on events outside the control
of the Company, such as when the party alleging liability provides information
to the Company. On certain of these sites that had previously been inactive, NL
has received general and special notices of liability from the EPA alleging that
NL, along with other PRPs, is liable for past and future costs of remediating
environmental contamination allegedly caused by former operations conducted at
such sites. These notifications may assert that NL, along with other PRPs, is
liable for past clean-up costs that could be material to NL if liability for
such amounts ultimately were determined against NL.
At December 31, 2004, the Company had $8 million in restricted cash held by
special purpose trusts, the assets of which can only be used to pay for certain
of the Company's future environmental remediation and other environmental
expenditures. During the first nine months of 2005, all of such restricted
balances had been so utilized. Use of such restricted balances does not affect
the Company's consolidated net cash flows.
Other litigation. Reference is made to the 2004 Annual Report for a
discussion of certain other legal proceedings to which the Company is a party.
NL has been named as a defendant in various lawsuits in a variety of
jurisdictions, alleging personal injuries as a result of occupational exposure
primarily to products manufactured by formerly-owned operations of NL containing
asbestos, silica and/or mixed dust. Approximately 500 of these types of cases,
involving a total of approximately 12,500 plaintiffs and their spouses, remain
pending. NL has not accrued any amounts for this litigation because liability
that might result to NL, if any, cannot be reasonably estimated. To date, NL has
not been adjudicated liable in any of these matters. Based on information
available to NL, including facts concerning its historical operations, the rate
of new claims, the number of claims from which NL has been dismissed and NL's
prior experience in the defense of these matters, NL believes that the range of
reasonably possible outcomes of these matters will be consistent with NL's
historical costs with respect to these matters (which are not material), and no
reasonably possible outcome is expected to involve amounts that are material to
NL. NL has and will continue to vigorously seek dismissal from each claim and/or
a finding of no liability by NL in each case. In addition, from time to time, NL
has received notices regarding asbestos or silica claims purporting to be
brought against former subsidiaries of NL, including notices provided to
insurers with which NL has entered into settlements extinguishing certain
insurance policies. These insurers may seek indemnification from NL.
In addition to the litigation described above, the Company and its
affiliates are also involved in various other environmental, contractual,
product liability, patent (or intellectual property), employment and other
claims and disputes incidental to its present and former businesses. In certain
cases, the Company has insurance coverage for such items; however the Company
does not currently expect additional material insurance coverage for
environmental claims.
The Company currently believes that the disposition of all claims and
disputes, individually or in the aggregate, should not have a material adverse
effect on its consolidated financial position, results of operations or
liquidity beyond the accruals already provided for.
Note 15 - Discontinued operations:
As discussed in the 2004 Annual Report, in December 2004 CompX's board of
directors committed to a formal plan to dispose of its Thomas Regout operations
in the Netherlands. Such operations, which previously were included in the
Company's component products operating segment (see Note 2), met all of the
criteria under GAAP to be classified as an asset held for sale at December 31,
2004, and accordingly the results of operations of the European Thomas Regout
operations have been classified as discontinued operations for all periods
presented. The Company has not reclassified its consolidated balance sheet as of
December 31, 2004 or its 2004 statement of cash flows. In classifying the net
assets of the Thomas Regout European operations as an asset held for sale, the
Company concluded that the carrying amount of the net assets of such operations
exceeded the estimated fair value less costs to sell such operations, and
accordingly in the fourth quarter of 2004 the Company recognized a $6.5 million
impairment charge to write-down its investment in the Thomas Regout European
operations to its estimated net realizable value. Such charge represented an
impairment of goodwill.
In January 2005, CompX completed the sale of such operations for proceeds
(net of expenses) of approximately $22.3 million. The net proceeds consisted of
approximately $18.1 million in cash at the date of sale and a $4.2 million
principal amount note receivable from the purchaser bearing interest at a fixed
rate of 7% and payable over four years. The note receivable is collateralized by
a secondary lien on the assets sold and is subordinated to certain third-party
indebtedness of the purchaser. Accordingly, the Company no longer includes the
results of operations or cash flows of the Thomas Regout European operations
subsequent to December 31, 2004 in its consolidated financial statements. The
net proceeds from the January 2005 sale of the Thomas Regout European operations
were approximately $860,000 (before income tax benefit) less than the net
realizable value estimated at the time of the goodwill impairment charge
(primarily due to higher expenses associated with the disposal of such
operations), and discontinued operations in the first quarter of 2005 includes a
charge related to such differential ($326,000 loss, net of income tax benefit
and minority interest). During the first nine months of 2004, the Thomas Regout
European operations reported net sales of $30.5 million, income from operations
of $2.1 million, interest expense of $1.1 million and net income of $645,000
(approximately $409,000 to NL, net of minority interest).
Note 16 - Accounting principles not yet implemented:
Inventory costs. The Company will adopt SFAS No. 151, "Inventory Costs, an
amendment of ARB No. 43, Chapter 4," for inventory costs incurred on or after
January 1, 2006. SFAS No. 151 requires that the allocation of fixed production
overhead costs to inventory shall be based on normal capacity. Normal capacity
is not defined as a fixed amount; rather, normal capacity refers to a range of
production levels expected to be achieved over a number of periods under normal
circumstances, taking into account the loss of capacity resulting from planned
maintenance shutdowns. The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of idle plant or production levels
below the low end of normal capacity, but instead a portion of fixed overhead
costs is charged to expense as incurred. Alternatively, in periods of production
above the high end of normal capacity, the amount of fixed overhead costs
allocated to each unit of production is decreased so that inventories are not
measured above cost. SFAS No. 151 also clarifies existing GAAP to require that
abnormal freight and wasted materials (spoilage) are to be expensed as incurred.
The Company believes its production cost accounting already complies with the
requirements of SFAS No. 151, and the Company does not expect adoption of SFAS
No. 151 will have a material effect on its consolidated financial statements.
Stock options. As permitted by regulations of the SEC the Company will
adopt SFAS No. 123R, "Share-Based Payment," as of January 1, 2006. SFAS No.
123R, among other things, eliminates the alternative in existing GAAP to use the
intrinsic value method of accounting for stock-based employee compensation under
APBO No. 25. Upon adoption of SFAS No. 123R, the Company will generally be
required to recognize the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award,
with the cost recognized over the period during which an employee is required to
provide services in exchange for the award (generally, the vesting period of the
award). No compensation cost will be recognized in the aggregate for equity
instruments for which the employee does not render the requisite service
(generally, if the instrument is forfeited before it has vested). The grant-date
fair value will be estimated using option-pricing models (e.g. Black-Scholes or
a lattice model). Under the transition alternatives permitted under SFAS No.
123R, the Company will apply the new standard to all new awards granted on or
after January 1, 2006, and to all awards existing as of December 31, 2005 which
are subsequently modified, repurchased or cancelled. Additionally, as of January
1, 2006, the Company will be required to recognize compensation cost previously
measured under SFAS No. 123 for the portion of any non-vested award existing as
of December 31, 2005 over the remaining vesting period. Because the number of
non-vested awards as of December 31, 2005 with respect to options granted by NL
is not expected to be material, and because the Company has not granted any
options and does not expect to grant any options prior to January 1, 2006, the
effect of adopting SFAS No. 123R is not expected to be significant in so far as
it relates to existing stock options. Should NL or its subsidiaries and
affiliates, however, either grant a significant number of options or modify,
repurchase or cancel existing options in the future, the effect on the Company's
consolidated financial statements could be material.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS:
General
The Company reported net income of $2.8 million, or $.06 per diluted share,
in the third quarter of 2005 compared to net income of $7.0 million, or $.14 per
diluted share, in the third quarter of 2004. For the first nine months of 2005,
the Company reported net income of $27.2 million, or $.56 per diluted share,
compared to net income of $159.0 million, or $3.29 per diluted share, in the
first nine months of 2004. As discussed in Note 1 to the Consolidated Financial
Statements, the Company's consolidated financial statements have been restated.
The decrease in the Company's diluted earnings per share from the third
quarter and first nine months of 2004 to the third quarter and first nine months
of 2005 is due primarily to the net effects of (i) higher component products
segment profit, (ii) higher earnings attributable to Kronos' income from
operations, (iii) security transactions gains from the sale of shares of Kronos
common stock in 2005 and (iv) a significant second quarter 2004 non-cash income
tax benefit related to Kronos. The Company currently believes its net income in
2005 will be lower than 2004 due primarily to the effect of such second quarter
2004 income tax benefits related to Kronos.
As discussed in Note 1 to the Consolidated Financial Statements, on
September 24, 2004, the Company purchased 10,374,000 shares of CompX common
stock, representing approximately 68% of the outstanding shares of CompX common
stock, from Valhi and a wholly-owned subsidiary of Valhi. Because Valhi, NL and
CompX are all entities under the common control of Contran, the Company's
acquisition of the shares of CompX common stock results in a change in reporting
entity and the Company has retroactively restated its consolidated financial
statements to reflect the consolidation of CompX for all periods presented.
Also discussed in Note 1, prior to July 2004, Kronos was a majority-owned
subsidiary of the Company. Following the Company's July 2004 dividend in the
form of shares of Kronos common stock distributed to NL shareholders, the
Company's ownership of Kronos was reduced to less than 50%. Consequently,
effective July 1, 2004 the Company ceased to consolidate Kronos' financial
position, results of operations and cash flows and the Company commenced
accounting for its interest in Kronos by the equity method. The Company
continues to report Kronos as a consolidated subsidiary through June 30, 2004,
including the consolidation of Kronos' results of operations and cash flows for
the first six months of 2004.
As provided by the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995, the Company cautions that the statements in this
Quarterly Report on Form 10-Q relating to matters that are not historical facts,
are forward-looking statements that represent management's beliefs and
assumptions based on currently available information. Forward-looking statements
can be identified 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 the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
cannot give any assurances that these expectations will prove to be correct.
Such statements by their nature involve substantial risks and uncertainties that
could significantly impact expected results, and actual future results could
differ materially from those described in such forward-looking statements. While
it is not possible to identify all factors, the Company continues to face many
risks and uncertainties. Factors that could cause 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 the
Company's other filings with the SEC include, but are not limited to, the
following:
o Future supply and demand for the Company's products,
o The extent of the dependence of certain of the Company's businesses on
certain market sectors,
o The cyclicality of the Company's businesses (such as Kronos' TiO2
operations),
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 and steel
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 and component products),
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 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,
the New Taiwan dollar and the Canadian dollar),
o Operating interruptions (including, but not limited to, labor disputes,
leaks, fires, explosions, unscheduled or unplanned downtime and
transportation interruptions),
o The timing and amounts of insurance recoveries,
o The ability of the Company to renew or refinance credit facilities,
o The ultimate outcome of income tax audits, tax settlement initiatives or
other tax matters,
o The introduction of trade barriers,
o Potential difficulties in integrating completed or future acquisitions,
o Decisions to sell operating assets other than in the ordinary course of
business,
o Uncertainties associated with new product development,
o The ultimate ability to utilize income tax attributes, the benefit of which
has been recognized under the "more-likely-than-not" recognition criteria,
o Environmental matters (such as those requiring emission and discharge
standards for existing and new facilities),
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 of lead pigment and lead-based paint,
including NL, with respect to asserted health concerns associated with the
use of such products),
o The ultimate resolution of pending litigation (such as NL's lead pigment
litigation and litigation surrounding environmental matters), and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
a development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those forecasted or expected. The
Company disclaims any intention or obligation to update or revise any
forward-looking statement whether as a result of changes in information, future
events or otherwise.
Component products
Three months ended Nine months ended
September 30, September 30,
--------------------------------- ---------------------------------
2004 2005 % Change 2004 2005 % Change
---- ---- -------- ---- ---- --------
(In millions, except percentages)
Net sales $ 46.2 $ 47.1 +2% $136.0 $ 139.7 +3%
Segment profit 4.9 4.9 * 12.5 13.8 +10%
_______________________
* less than 1%
Component product sales increased in the third quarter of 2005 as compared
to the third quarter of 2004 due primarily to sales volumes associated with a
component products business acquired in August 2005 and the net effect of
fluctuations in foreign currency exchange rates (as discussed below), partially
offset by lower precision slide and ergonomic products sales volumes. Component
products sales increased in the first nine months of 2005 as compared to the
same period in 2004 due primarily to increases in selling prices for certain
products across all segments, sales volumes associated with the acquired
business and the net effect of fluctuations in currency exchange rates (as
discussed below), partially offset by sales volume decreases for certain
products. During the third quarter of 2005, sales of precision slide and
ergonomic products were 6% and 5% lower, respectively, as compared to the third
quarter of 2005, while sales of security products increased 13%. During the
first nine months of 2005, sales of precision slide and ergonomic products were
3% and 2% higher, respectively, as compared to the first nine months of 2004,
and sales of security products were 2% higher. The percentage changes in both
precision slide and ergonomic products include the impact resulting from changes
in foreign currency exchange rates. Sales of security products are generally
denominated in U.S. dollars. The results of the business acquired in August
2005, included as part of security products results, were not material.
Component products segment profit increased in the first nine months of
2005 as compared to the same period in 2004 as the favorable impact of a
continuous focus on reducing costs were partially offset by the negative impact
of foreign currency exchange rate fluctuations (as discussed below).
CompX has substantial operations and assets located outside the United
States in Canada and Taiwan. A portion of CompX's sales generated from its
non-U.S. operations are denominated in currencies other than the U.S. dollar,
principally the Canadian dollar and the New Taiwan dollar. In addition, a
portion of CompX's sales generated from its non-U.S. operations (principally in
Canada) are denominated in the U.S. dollar. Most raw materials, labor and other
production costs for such non-U.S. operations are denominated primarily in local
currencies. Consequently, the translated U.S. dollar values of CompX's foreign
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. During the third quarter of
2005, relative changes in foreign currency exchange rates increased component
products sales by approximately $400,000 as compared to the third quarter of
2004, but decreased component products segment profit by approximately $600,000
($1.3 million increase and $2.0 million decrease, respectively, during the
year-to-date period).
While demand has stabilized across most of CompX's product segments,
certain customers continue to seek lower cost Asian sources as alternatives to
CompX's products. CompX believes the impact of this will be mitigated through
its ongoing initiatives to expand both new products and new market
opportunities. Asian-sourced competitive pricing pressures are expected to
continue to be a challenge. CompX's strategy in responding to the competitive
pricing pressure has included reducing production cost through product
reengineering, improvement in manufacturing processes or moving production to
lower-cost facilities, including CompX's Asian-based manufacturing facilities.
CompX has also emphasized and focused on opportunities where it can provide
value-added customer support services that Asian-based manufacturers are
generally unable to provide. CompX believes its combination of cost control
initiatives together with its value-added approach to development and marketing
of products helps to mitigate the impact of pricing pressures from Asian
competitors.
CompX will continue to focus on cost improvement initiatives, utilizing
lean manufacturing techniques and prudent balance sheet management in order to
minimize the impact of lower sales, particularly to the office furniture
industry, and to develop value-added customer relationships with an additional
focus on sales of CompX's higher-margin ergonomic computer support systems and
security products to improve operating results. In addition, CompX continues to
develop sources for lower cost components for certain product lines to
strengthen its ability to meet competitive pricing when practical. These
actions, along with other activities to eliminate excess capacity, have been
designed to position CompX to expand more effectively on both new product and
new market opportunities to improve CompX's profitability.
Chemicals
Relative changes in Kronos' TiO2 sales and operating income during the 2004
and 2005 periods presented are primarily due to the net effects of (i) higher
average TiO2 selling prices, (ii) lower TiO2 selling volumes and (iii) relative
changes in foreign currency exchange rates. Selling prices (in billing
currencies) for TiO2, Kronos' principal product, were generally decreasing
during the first half of 2004, increasing during the last half of 2004 and the
first six months of 2005 and decreasing during the third quarter of 2005.
Effective July 1, 2004 the Company ceased to consolidate Kronos' financial
position, results of operations and cash flows and the Company commenced
accounting for its interest in Kronos by the equity method. The Company
continues to report Kronos as a consolidated subsidiary through June 30, 2004,
including the consolidation of Kronos' results of operations and cash flows for
the first two quarters of 2004. The following table shows information about
Kronos' sales and segment profit for the 2004 and 2005 periods, including the
third quarter of 2004 and all periods in 2005 for which the Company did not
consolidate Kronos' results of operations.
Three months ended Nine months ended
September 30, September 30,
--------------------------------- ---------------------------------
2004 2005 % Change 2004 2005 % Change
---- ---- -------- ---- ---- --------
(In millions, except percentages and volumes)
Net sales $286.1 $292.1 +2% $845.1 $895.7 +6%
Segment profit 29.8 39.5 +33% 96.2 146.8 +53%
TiO2 operating statistics:
Sales volumes* 128 119 -7% 383 356 -7%
Production volumes* 123 122 -1% 363 371 +2%
Percentage change in Ti02 average
selling
prices:
Using actual foreign currency
exchange rates +8% +12%
Impact of changes in foreign
currency exchange rates -1% -3%
---- ----
In billing currencies +7% +9%
==== ====
_______________________________
* Thousands of metric tons
Kronos' sales increased $6.0 million (2%) in the third quarter of 2005
compared to the third quarter of 2004 and increased $50.6 million (6%) in the
first nine months of 2005 as compared to the same period in 2004 due primarily
to the net effects of higher average TiO2 selling prices, lower TiO2 selling
volumes and the favorable effect of fluctuations in foreign currency exchange
rates, which increased sales by approximately $2 million and $24 million in the
quarter and year-to-date periods, respectively, as further discussed below.
Excluding the effect of fluctuations in the value of the U.S. dollar relative to
other currencies, Kronos' average TiO2 selling prices in billing currencies in
the third quarter and first nine months of 2005 were 7% and 9% higher as
compared to the third quarter and first nine months of 2004, respectively. When
translated from billing currencies to U.S. dollars using actual foreign currency
exchange rates prevailing during the respective periods, Kronos' average TiO2
selling prices in the third quarter of 2005 increased 8% compared to the third
quarter of 2004 and increased 12% for the first nine months of 2005 compared to
the first nine months of 2004. Kronos' average TiO2 selling prices in billing
currencies in the third quarter of 2005 decreased 1% compared to the second
quarter of 2005.
Kronos' sales are denominated in various currencies, including the U.S.
dollar, the euro, other major European currencies and the Canadian dollar. The
disclosure of the percentage change in Kronos' average TiO2 selling prices in
billing currencies (which excludes the effects of fluctuations in the value of
the U.S. dollar relative to other currencies) is considered a "non-GAAP"
financial measure under regulations of the SEC. The disclosure of the percentage
change in Kronos' average TiO2 selling prices using actual foreign currency
exchange rates prevailing during the respective periods is considered the most
directly comparable financial measure presented in accordance with GAAP ("GAAP
measure"). Kronos discloses percentage changes in its average TiO2 prices in
billing currencies because Kronos believes such disclosure provides useful
information to investors to allow them to analyze such changes without the
impact of changes in foreign currency exchange rates, thereby facilitating
period-to-period comparisons of the relative changes in average selling prices
in the actual various billing currencies. Generally, when the U.S. dollar either
strengthens or weakens against other currencies, the percentage change in
average selling prices in billing currencies will be higher or lower,
respectively, than such percentage changes would be using actual exchange rates
prevailing during the respective periods. The difference between the 8% and 12%
increases in Kronos' average TiO2 selling prices during the third quarter and
first nine months of 2005 as compared to the third quarter and first nine months
of 2004 using actual foreign currency exchange rates prevailing during the
respective periods (the GAAP measure), and the 7% and 9% increases in Kronos'
average TiO2 selling prices in billing currencies (the non-GAAP measure) during
each of such periods is due to the effect of changes in foreign currency
exchange rates. The above table presents in a tabular format (i) the percentage
change in Kronos' average TiO2 selling prices using actual foreign currency
exchange rates prevailing during the respective periods (the GAAP measure), (ii)
the percentage change in Kronos' average TiO2 selling prices in billing
currencies (the non-GAAP measure) and (iii) the percentage change due to changes
in foreign currency exchange rates (or the reconciling item between the non-GAAP
measure and the GAAP measure).
Kronos' TiO2 sales volumes in both the third quarter and first nine months
of 2005 decreased 7% compared to the corresponding periods in 2004, with volumes
lower in all regions of the world. Kronos' production levels decreased 1% in the
third quarter of 2005 and increased 2% during the first nine months of 2005 as
compared to the same periods in 2004. Kronos' operating rates were near full
capacity in those periods, and Kronos' production volumes were a new record for
Kronos for a first nine-month period.
Kronos' segment profit in the first nine months of 2004 includes income of
$6.3 million ($2.1 million, or $.04 per diluted share, net of income taxes and
minority interest) related to settlement of a contract dispute with a customer.
Kronos has substantial operations and assets located outside the United
States (particularly in Germany, Belgium, Norway and Canada). A significant
amount of Kronos' sales generated from its 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 Kronos' sales
generated from its 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
Kronos' 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 the value of the U.S. dollar relative to other currencies,
primarily the euro, increased TiO2 sales by approximately a net $2 million in
the third quarter of 2005 as compared to the same period in 2004 and increased
TiO2 sales in the first nine months of 2005 by approximately $24 million
compared to the same period in 2004. Fluctuations in the value of the U.S.
dollar relative to other currencies similarly impacted Kronos' foreign
currency-denominated operating expenses. Kronos' operating costs that are not
denominated in the U.S. dollar, when translated into U.S. dollars, were higher
in the third quarter and first nine months of 2005 as compared to the third
quarter and first nine months of 2004. Overall, the net impact of currency
exchange rate fluctuations on Kronos' segment profit comparisons resulted in
approximately a net $2 million increase in Kronos' income from operations in the
first nine months of 2005 as compared to the corresponding period in 2004
(currency exchange rate fluctuations did not have a significant effect on the
quarter-to-quarter comparisons).
Kronos expects its segment profit in 2005 will be significantly higher than
2004, due primarily to higher overall average selling prices on a year-to-year
comparison basis. While Kronos expects its income from operations in calendar
2005 will be higher than calendar 2004, Kronos expects its income from
operations in the fourth quarter of 2005 will be consistent with the third
quarter of 2005, exclusive of the effect of any insurance recoveries which might
be recognized as a result of Hurricane Rita (as discussed below). Kronos'
expectations as to the 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.
On September 22, 2005, the chloride-process TiO2 facility operated by the
Kronos' 50%-owned joint venture, Louisiana Pigment Company ("LPC"), temporarily
halted production due to Hurricane Rita. Although storm damage to core
processing facilities was not extensive, 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. Operations
are expected to be restored in early November 2005. The joint venture expects
the majority of its property damage and unabsorbed fixed costs for periods in
which normal production levels were not achieved are covered by insurance, and
Kronos believes insurance will cover its business interruption losses (subject
to applicable deductibles) resulting from its share of the lost production from
LPC. Kronos' results of operations in the third quarter of 2005 include
approximately $1 million of costs related to Hurricane Rita (primarily Kronos'
share of LPC's unabsorbed fixed costs) for which no insurance recovery has yet
been recognized as the amounts are not presently determinable. The effect on
Kronos' financial results will depend on the timing and amount of insurance
recoveries. Kronos' owned warehouse and slurry facilities located near LPC's
facility were also temporarily closed due to the storm, but property damage to
these facilities was not significant.
Kronos' efforts to debottleneck its production facilities to meet long-term
demand continue to prove successful. Such debottlenecking efforts included,
among other things, the addition of finishing capacity in the German 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 due to debottlenecking
programs, with only moderate capital expenditures. Kronos believes its annual
attainable production capacity for 2005 (absent the effect of the hurricane
described above) is approximately 500,000 metric tons, with approximately 10,000
metric tons additional capacity expected to be available in 2006 through its
continued debottlenecking efforts.
Equity in earnings of Kronos
Three months ended Three months ended Nine months ended
September 30, September 30, September 30,
2004 2005 2005
------------------ ------------------ -----------------
(In millions)
Kronos historical:
Net sales $286.1 $292.1 $895.7
====== ====== ======
Segment profit 29.8 39.5 146.8
Security transaction gain - - 5.4
Other general corporate, net (4.9) (.9) (3.2)
Interest expense (8.7) (10.6) (34.0)
------ ------ ------
16.2 28.0 115.0
Income tax expense (6.2) (20.0) (52.8)
------ ------ ------
Net income $ 10.0 $ 8.0 $ 62.2
====== ====== ======
Equity in earnings of
Kronos Worldwide, Inc. $ 5.0 $ 2.8 $ 22.4
====== ====== ======
See the preceding discussion relating to Kronos' sales and segment profit
in 2004 and 2005. The security transaction gain in the first nine months of 2005
relates to Kronos' sale of its passive interest in a Norwegian smelting
operation, which had a nominal carrying value for financial reporting purposes,
for approximately $5.4 million ($1.3 million or $.03 per diluted share, net of
income taxes and minority interest to the Company). Kronos' interest expense in
the second quarter and first six months of 2005 relates principally to Kronos
International, Inc.'s ("KII") Senior Secured Notes. Kronos' income tax expense
in the third quarter of 2005 includes a net non-cash provision of $5.0 million
($1.2 million, or $.02 per diluted share, net of minority interest to NL)
related to developments with respect to ongoing non-U.S. income tax audits,
primarily in Germany, Belgium and Canada.
General corporate items
Securities transactions. Securities transactions in the first nine months
of 2005 relate principally to a $14.7 million pre-tax gain ($8.0 million, or
$.17 per diluted share, net of income taxes) related to NL's sale of
approximately 470,000 shares of Kronos common stock in market transactions
during the six months ended June 30, 2005. See Note 2 to the Consolidated
Financial Statements.
Interest expense. Substantially all of the interest expense in the first
nine months of 2004 relates to Kronos. Interest expense related to CompX in the
third quarter of 2005 was consistent with interest expense in the third quarter
of 2004 and declined by approximately $200,000 in the first nine months of 2005
compared to the corresponding period in 2004 due primarily to lower average
levels of outstanding debt. CompX expects interest expense will be comparable
during the fourth quarter of 2005 to the fourth quarter of 2004.
Insurance recoveries. During the first nine months of 2005, NL recognized
$1.2 million of recoveries from certain insolvent former insurance carriers
relating to the settlement of excess insurance claims received in August 2005.
See Note 11. In addition, NL has reached an agreement with one of its former
insurance carriers in which such carrier would reimburse NL for a portion of its
past and future lead pigment litigation defense costs, although the amount which
NL will ultimately recover from such carrier with respect to such defense costs
incurred by NL is not yet determinable.
While NL continues to seek additional recoveries of defense costs, there
can be no assurance that NL will be successful in obtaining reimbursement for
either defense costs or indemnity. NL has not considered any potential insurance
recoveries in determining related accruals for lead pigment litigation matters.
Any such additional insurance recoveries would be recognized when their receipt
is deemed probable and the amount is determinable.
General corporate expenses. Net general corporate expenses in the third
quarter of 2005 were approximately 4% higher than the third quarter of 2004 due
primarily to higher legal expenses of NL, but were approximately 7% lower in the
first nine months of 2005 than the same period of 2004 due primarily to
consolidation of Kronos general corporate expenses through June 30, 2004. Net
general corporate expenses in calendar 2005 are currently expected to be higher
than 2004, primarily due to higher expected legal expenses of NL in the fourth
quarter of 2005 resulting from an increase in litigation and related expenses.
However, obligations for environmental remediation are difficult to assess and
estimate and no assurance can be given that actual costs will not exceed accrued
amounts or that costs will not be incurred with respect to sites for which no
estimate of liability can presently be made. See Note 14 to the Consolidated
Financial Statements.
Provision for income taxes
The principal reasons for the difference between the Company's effective
income tax rate and the U.S. federal statutory income tax rates are explained in
Note 12 to the Consolidated Financial Statements. As discussed in Note 1 to the
Consolidated Financial Statements, the Company's consolidated financial
statements have been restated, including significant changes in the Company's
previously-reported provision for income taxes.
The Company's income tax expense in the first nine months of 2005 includes
the net non-cash effects of (i) the favorable effect of recent developments with
respect to certain income tax items of NL of $4.1 million (or $.08 per diluted
share) and (ii) the unfavorable effect with respect to a change in CompX's
permanent reinvestment conclusion regarding its non-U.S. subsidiaries of $9.0
million ($6.2 million, or $.13 per diluted share, net of minority interest). As
previously reported, the Company's income tax benefit in the first nine months
of 2004 includes (i) a $268.6 million income tax benefit ($135.7 million, or
$2.80 per diluted share, net of minority interest) related to the reversal of a
deferred income tax asset valuation allowance attributable to Kronos' income tax
attributes in Germany (principally net operating loss carryforwards) and (ii) a
$49.1 million income tax benefit ($1.00 per diluted share) related to income tax
attributes of a subsidiary of NL.
As previously disclosed, the Company commenced to recognize deferred income
taxes with respect to the excess of the financial reporting carrying amount over
the income tax basis of its investment in Kronos beginning in December 2003
following the Company's pro-rata distribution of shares of Kronos common stock
to NL's shareholders. The aggregate amount of such deferred income taxes
included in the Company's provision for income taxes was $45.4 million in the
nine months ended September 30, 2004 and $441,000 in the nine months ended
September 30, 2005. In addition, the Company's provision for income taxes in the
nine months ended September 30, 2004 and 2005 includes an aggregate $2.2 million
and $913,000, respectively, for the current income tax effect related to NL's
distribution of such shares of Kronos common stock to its shareholders.
Minority interest
See Note 10 to the Consolidated Financial Statements.
Discontinued operations.
See Note 15 to the Consolidated Financial Statements.
Accounting principles not yet implemented.
See Note 16 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES:
Consolidated cash flows
Summary
The Company's primary source of liquidity on an ongoing short-term (defined
as the twelve-month period ending September 30, 2006) and long-term (defined as
the five-year period ending December 31, 2009, the time period for which the
Company generally does long-term budgeting) basis is its cash flows from
operating activities, which is generally used to (i) fund capital expenditures,
(ii) repay any short-term indebtedness incurred primarily for working capital
purposes and (iii) provide for the payment of dividends. In addition, from
time-to-time the Company may incur indebtedness, generally to (i) fund
short-term working capital needs, (ii) refinance existing indebtedness or (iii)
fund major capital expenditures or the acquisition of other assets outside the
ordinary course of business. Also, the Company may from time-to-time sell assets
outside the ordinary course of business, the proceeds of which are generally
used to (i) repay existing indebtedness (including indebtedness which may have
been collateralized by the assets sold), (ii) make investments in marketable and
other securities, (iii) fund major capital expenditures or the acquisition of
other assets outside the ordinary course of business or (iv) pay dividends.
Operating activities
Cash flows from operating activities decreased from $82.9 million provided
by operating activities in the first nine months of 2004 to $16.7 million of
cash used by operating activities in the first nine months of 2005. This $99.6
million decrease was due primarily to the deconsolidation of Kronos, effective
July 1, 2004. As such, cash from operating activities in the first nine months
of 2005 is not comparable to the corresponding period in 2004. Relative changes
in accounts receivable are affected by, among other things, the timing of sales
and the collection of the resulting receivables. Relative changes in inventories
and accounts payable and accrued liabilities are affected by, among other
things, the timing of raw material purchases and the payment for such purchases
and the relative difference between production volumes and sales volumes.
Relative changes in accrued environmental costs are affected by, among other
things, the period in which the environmental accrual is recognized and the
period in which the remediation expenditure is actually made.
Trends in cash flows from operating activities (excluding the impact of
significant asset dispositions and relative changes in assets and liabilities)
are generally similar to trends in the Company's earnings. However, certain
items included in the determination of net income are non-cash, and therefore
such items have no impact on cash flows from operating activities. Non-cash
items included in the determination of net income include depreciation and
amortization expense, deferred income taxes and non-cash interest expense.
Non-cash interest expense relates principally to Kronos in 2004 and consists of
amortization of original issue discount or premium on certain indebtedness and
amortization of deferred financing costs.
Certain other items included in the determination of net income may have an
impact on cash flows from operating activities, but the impact of such items on
cash flows from operating activities will differ from their impact on net
income. For example, equity in earnings of affiliates will generally differ from
the amount of distributions received from such affiliates, and equity in losses
of affiliates does not necessarily result in current cash outlays paid to such
affiliates. The amount of periodic defined benefit pension plan expense and
periodic OPEB expense depends upon a number of factors, including certain
actuarial assumptions, and changes in such actuarial assumptions will result in
a change in the reported expense. In addition, the amount of such periodic
expense generally differs from the outflows of cash required to be currently
paid for such benefits.
Certain other items included in the determination of net income have no
impact on cash flows from operating activities, but such items do impact cash
flows from investing activities (although their impact on such cash flows
differs from their impact on net income). For example, realized gains and losses
from the disposal of long-lived assets are included in the determination of net
income, although the proceeds from any such disposal are shown as part of cash
flows from investing activities.
Relative changes in working capital assets and liabilities can have a
significant effect on cash flows from operating activities. CompX's average days
sales outstanding related to its continuing operations increased from 38 days at
December 31, 2004 to 43 days at September 30, 2005, due to the timing of
collection on the slightly higher accounts receivable balance at the end of
September. CompX's average number of days in inventory related to its continuing
operations was 52 days at December 31, 2004 and 57 days at September 30, 2005.
The increase in days in inventory is primarily due to higher raw material
prices, primarily steel.
Relative changes in assets and liabilities generally result from the timing
of production, sales, purchases and income tax payments. Such relative changes
can significantly impact the comparability of cash flow from operations from
period to period, as the income statement impact of such items may occur in a
different period from when the underlying cash transaction occurs. For example,
raw materials may be purchased in one period, but the payment for such raw
materials may occur in a subsequent period. Similarly, inventory may be sold in
one period, but the cash collection of the receivable may occur in a subsequent
period.
NL does not have complete access to the cash flows of its subsidiaries and
affiliates, in part due to limitations contained in certain credit agreements as
well as the fact that certain of such subsidiaries and affiliates are not 100%
owned by NL. A detail of NL's consolidated cash flows from operating activities
is presented in the table below. Eliminations consist of intercompany dividends
(most of which are paid by Kronos to NL in 2004, and by CompX to NL in 2005).
Nine months ended
September 30,
-----------------------
2004 2005
---- ----
(In millions)
Cash provided (used) by operating activities:
Kronos $ 67.5 $ -
CompX 20.8 14.2
NL Parent 7.6 (8.7)
Other (.6) (18.3)
Eliminations (12.4) (3.9)
------ ------
$ 82.9 $(16.7)
====== ======
Investing and financing activities
In 2005, substantially all of the Company's consolidated capital
expenditures relate to CompX. During the first nine months of 2005, (i) NL sold
shares of Kronos common stock in market transactions for $19.2 million, (ii)
CompX received a net $18.1 million from the sale of its Thomas Regout European
operations (which had approximately $4.0 million of cash at the date of
disposal), (iii) NL acquired CompX common stock in market transactions for
$707,000, (iv) NL collected $2 million on its loan to one of the Contran family
trusts and (v) CompX acquired a company for an aggregate of $7.3 million. See
Notes 2 and 15 to the Consolidated Financial Statements.
Distributions to minority interest in 2005 consist of CompX dividends paid
to shareholders other than NL. Other cash flows from financing activities in
2005 relate primarily to proceeds from the issuance of NL and CompX common stock
upon exercise of stock options.
At September 30, 2005, unused credit available under existing credit
facilities approximated $47.5 million, all under CompX's revolving credit
facility. CompX expects to close on an extension of its credit facility during
the fourth quarter of 2005.
Provisions contained in certain of the Company's and its subsidiaries' and
affiliates' 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,
which provision was waived in connection with CompX's sale of its Thomas Regout
European operations. Other than operating leases discussed in the 2004 Annual
Report, neither NL nor any of its subsidiaries or affiliates are parties to any
off-balance sheet financing arrangements.
Component products - CompX
CompX received approximately $18.1 million cash (net of expenses) in
January 2005 upon the sale of its Thomas Regout operations in the Netherlands.
See Note 15 to the Consolidated Financial Statements. CompX believes that its
cash on hand, together with cash generated from operations and borrowing
availability under its bank credit facility, will be sufficient to meet CompX's
liquidity needs for working capital, capital expenditures and dividends. To the
extent that CompX's actual operating results or developments differ from CompX's
expectations, CompX's liquidity could be adversely affected. CompX, which had
suspended its regular quarterly dividend of $.125 per share in the second
quarter of 2003, reinstated its regular quarterly dividend at the $.125 per
share rate in the fourth quarter of 2004.
In August 2005, CompX completed an acquisition of a company for $7.3
million, net of cash acquired. See Note 2 to the Consolidated Financial
Statements. During the fourth quarter of 2005, CompX expects to obtain an
extension of its $47.5 million revolving bank credit facility, which currently
expires in January 2006. CompX had no balance outstanding under such facility at
September 30, 2005.
Certain of the CompX's sales generated by its non-U.S. operations are
denominated in U.S. dollars. CompX periodically uses currency forward contracts
to manage a portion of foreign exchange rate risk associated with receivables
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 does CompX currently anticipate entering into such contracts for
trading or speculative purposes in the future. Derivatives used to hedge
forecasted transactions and specific cash flows associated with foreign currency
denominated financial assets and liabilities which meet the criteria for hedge
accounting are designated as cash flow hedges. Consequently, the effective
portion of gains and losses is deferred as a component of accumulated other
comprehensive income and is recognized in earnings at the time the hedged item
affects earnings. Contracts that do not meet the criteria for hedge accounting
are marked-to-market at each balance sheet date with any resulting gain or loss
recognized in income currently as part of net currency transactions. CompX had
no such foreign currency contracts outstanding at September 30, 2005.
CompX periodically evaluates its liquidity requirements, alternative uses
of capital, capital needs and available resources in view of, among other
things, its capital expenditure requirements, dividend policy and estimated
future operating cash flows. As a result of this process, CompX has in the past
and may in the future seek to raise additional capital, refinance or restructure
indebtedness, issue additional securities, modify its dividend policy,
repurchase shares of its common stock or take a combination of such steps or
other steps to manage its liquidity and capital resources. In the normal course
of business, CompX may review opportunities for acquisitions, divestitures,
joint ventures or other business combinations in the component products
industry. In the event of any such transaction, CompX may consider using cash,
issuing additional equity securities or increasing the indebtedness of CompX or
its subsidiaries.
Chemicals - Kronos
At September 30, 2005, Kronos had cash, cash equivalents and marketable
debt securities of $66.5 million, including restricted balances of $3.6 million,
and Kronos had approximately $147 million available for borrowing under its
U.S., Canadian and European credit facilities. Based upon Kronos' expectations
for the TiO2 industry and anticipated demands on Kronos' cash resources as
discussed herein, Kronos expects to have sufficient liquidity to meet its future
obligations including operations, capital expenditures, debt service and current
dividend policy. To the extent that actual developments differ from Kronos'
expectations, Kronos' liquidity could be adversely affected.
At September 30, 2005, Kronos' outstanding debt was comprised of (i) $457.6
million related to KII's Senior Secured Notes and (ii) approximately $200,000 of
other indebtedness. During the second quarter of 2005, Kronos extended the
respective maturity dates of its European and U.S. revolving credit facilities,
each by three years to June 2008 and September 2008, respectively.
Kronos' assets consist primarily of investments in its operating
subsidiaries, and Kronos' ability to service its parent level obligations,
including the Senior Secured Notes, depends in large part upon the distribution
of earnings of its subsidiaries, whether in the form of dividends, advances or
payments on account of intercompany obligation, or otherwise. None of Kronos'
subsidiaries have guaranteed the Senior Secured Notes, although KII has pledged
65% of the common stock or other ownership interest of certain of KII's
first-tier operating subsidiaries as collateral of such Senior Secured Notes.
Pricing within the TiO2 industry is cyclical, and changes in industry
economic conditions significantly impact Kronos' earnings and operating cash
flows. Cash flows from operations is considered the primary source of liquidity
for Kronos. Changes in TiO2 pricing, production volumes and customer demand,
among other things, could significantly affect the liquidity of Kronos.
Based upon Kronos' expectations for the TiO2 industry and anticipated
demand for Kronos' cash resources as discussed herein, Kronos expects to have
sufficient short-term and long-term liquidity to meet its future obligations
including operations, capital expenditures, debt service and dividends. To the
extent that actual developments differ from Kronos' expectations, Kronos'
liquidity could be adversely affected.
See Note 12 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of Kronos' income tax
returns in various non-U.S. jurisdictions, and see Note 14 to the Consolidated
Financial Statements with respect to legal proceedings with respect to Kronos.
Certain of the Kronos' sales generated by its non-U.S. operations are
denominated in U.S. dollars. Kronos periodically uses currency forward contracts
to manage a very nominal portion of foreign exchange rate risk associated with
receivables denominated in a currency other than the holder's functional
currency or similar exchange rate risk associated with future sales. Kronos has
not entered into these contracts for trading or speculative purposes in the
past, nor does Kronos currently anticipate entering into such contracts for
trading or speculative purposes in the future. Derivatives used to hedge
forecasted transactions and specific cash flows associated with foreign currency
denominated financial assets and liabilities which meet the criteria for hedge
accounting are designated as cash flow hedges. Consequently, the effective
portion of gains and losses is deferred as a component of accumulated other
comprehensive income and is recognized in earnings at the time the hedged item
affects earnings. Contracts that do not meet the criteria for hedge accounting
are marked-to-market at each balance sheet date with any resulting gain or loss
recognized in income currently as part of net currency transactions. For the
periods ended September 30, 2004 and 2005, Kronos has not used hedge accounting
for any of its contracts. To manage such exchange rate risk, at September 30,
2005, Kronos held a series of contracts, which mature through December 2005, to
exchange an aggregate of U.S. $10.0 million for an equivalent amount of Canadian
dollars at an exchange rate of Cdn. $1.25 to Cdn. $1.26 per U.S. dollar. At
September 30, 2005, the actual exchange rate was Cdn. $1.18 per U.S. dollar. The
estimated fair value of such foreign currency forward contracts at September 30,
2005 was not material.
Kronos International Inc.'s assets consist primarily of investments in its
operating subsidiaries, and its ability to service its parent level obligations,
including the Senior Secured Notes, depends in large part upon the distribution
of earnings of its subsidiaries, whether in the form of dividends, advances or
payments on account of intercompany obligation, or otherwise. None of its
subsidiaries have guaranteed the Senior Secured Notes, although Kronos
International has pledged 65% of the common stock or other ownership interest of
certain of its first-tier operating subsidiaries as collateral of such Senior
Secured Notes.
Kronos periodically evaluates its liquidity requirements, alternative uses
of capital, capital needs and availability of resources in view of, among other
things, its dividend policy, its debt service and capital expenditure
requirements and estimated future operating cash flows. As a result of this
process, Kronos has in the past and may in the future seek to reduce, refinance,
repurchase or restructure indebtedness, raise additional capital, repurchase
shares of its common stock, modify its dividend policy, restructure ownership
interests, sell interests in subsidiaries or other assets, or take a combination
of such steps or other steps to manage its liquidity and capital resources. In
the normal course of its business, Kronos may review opportunities for the
acquisition, divestiture, joint venture or other business combinations in the
chemicals or other industries, as well as the acquisition of interests in, and
loans to, related entities. In the event of any such transaction, Kronos may
consider using available cash, issuing equity securities or increasing
indebtedness to the extent permitted by the agreements governing Kronos'
existing debt.
Kronos has substantial operations located outside the United States for
which the functional currency is not the U.S. dollar. As a result, the reported
amounts of Kronos' assets and liabilities related to its non-U.S. operations,
and therefore Kronos' net assets, will fluctuate based upon changes in currency
exchange rates.
NL Industries
At September 30, 2005, NL (exclusive of CompX) had cash, cash equivalents
and marketable debt securities of $66.9 million, including restricted balances
of $12.1 million. See Note 14 to the Consolidated Financial Statements.
See Note 12 to the Consolidated Financial Statements for certain income tax
examinations currently underway with respect to certain of NL's income tax
returns, and see Note 14 to the Consolidated Financial Statements and Part II,
Item 1, "Legal Proceedings" for discussion of certain legal proceedings and
environmental matters with respect to NL.
In addition to those legal proceedings described in Note 14 to the
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 with respect to asserted health concerns associated with the
use of such products and (ii) effectively overturn court decisions in which NL
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 NL's consolidated financial position, results of operations or
liquidity, enactment of such legislation could have such an effect.
NL periodically evaluates its liquidity requirements, alternative uses of
capital, capital needs and availability of resources in view of, among other
things, its dividend policy and capital expenditure requirements and estimated
future operating cash flows. As a result of this process, NL has in the past and
may in the future seek to reduce, refinance, repurchase or restructure
indebtedness, raise additional capital, repurchase shares of its common stock,
modify its dividend policy, restructure ownership interests, sell interests in
subsidiaries or other assets, or take a combination of such steps or other steps
to manage its liquidity and capital resources. In the normal course of its
business, NL may review opportunities for the acquisition, divestiture, joint
venture or other business combinations in the chemicals or other industries, as
well as the acquisition of interests in, and loans to, related entities.
Because NL's operations are conducted primarily through its subsidiaries
and affiliates, NL's long-term ability to meet its parent company level
corporate obligations is dependent in large measure on the receipt of dividends
or other distributions from its subsidiaries and affiliates. In the fourth
quarter of 2004, CompX reinstated its regular quarterly dividend at the $.125
per share rate. At that rate, and based on the 10.4 million shares of CompX held
directly or indirectly by NL at September 30, 2005, NL would receive aggregate
annual dividends from CompX of $5.2 million. Kronos' current quarterly dividend
is $.25 per share. At that rate, and based on the 17.5 million shares of Kronos
held by NL at September 30, 2005, NL would receive aggregate annual dividends
from Kronos of $17.5 million.
The Company and related entities routinely 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 the Company's current
businesses. The Company intends to consider such acquisition activities in the
future and, in connection with this activity, may consider issuing additional
equity securities and increasing the indebtedness of the Company, its
subsidiaries and related companies. From time to time, the Company and related
entities also evaluate the restructuring of ownership interests among their
respective subsidiaries and related companies.
Non-GAAP financial measures
In an effort to provide investors with additional information regarding the
Company's results of operations as determined by GAAP, the Company has disclosed
certain non-GAAP information which the Company believes provides useful
information to investors.
o The Company discloses percentage changes in Kronos' average TiO2 selling
prices in billing currencies, which excludes the effects of foreign
currency translation. The Company believes disclosure of such percentage
changes allows investors to analyze such changes without the impact of
changes in foreign currency exchange rates, thereby facilitating
period-to-period comparisons of the relative changes in average selling
prices in the actual various billing currencies. Generally, when the U.S.
dollar either strengthens or weakens against other currencies, the
percentage change in average selling prices in billing currencies will be
higher or lower, respectively, than such percentage changes would be using
actual exchange rates prevailing during the respective periods.
ITEM 4. CONTROLS AND PROCEDURES
Restatement. As disclosed in Note 1 to the Consolidated Financial
Statements, the Company and its audit committee concluded to restate the
Company's consolidated financial statements as of December 31, 2004, and for the
interim periods ended September 30, 2004 as well as the March 31, 2005 and June
30, 2005 interim periods. The restatement relates to misstatements of the
Company's provision for income taxes for the interim periods ended September 30,
2004, and the Company's related income tax accounts (current and deferred) as of
December 31, 2004.
The guidance set forth in Auditing Standard No. 2 of the Public Company
Accounting Oversight Board states that a restatement of previously-issued
financial statements to reflect the correction of a misstatement should be
regarded as at least a significant control deficiency and as a strong indicator
that a material weakness in internal control over financial reporting exists. As
a result of this restatement, the Company has concluded that a material weakness
existed at December 31, 2004 and September 30, 2005.
Evaluation of Disclosure Controls and Procedures. The Company maintains 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 that the Company files or submits 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 required to be disclosed by the
Company in the reports that it files or submits to the SEC under the Act is
accumulated and communicated to the Company's management, including its
principal executive officer and its 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, the Company's
President and Chief Executive Officer, and Gregory M. Swalwell, the Company's
Vice President and Chief Financial Officer, have evaluated the Company's
disclosure controls and procedures as of September 30, 2005. Based upon their
evaluation, and as a result of the material weakness discussed below, these
executive officers have concluded that the Company's disclosure controls and
procedures are not effective as of the date of such evaluation.
A material weakness is a control deficiency, or a combination of control
deficiencies, that results in a more than remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As of September 30, 2005, the Company did not maintain effective
controls over the accounting for income taxes, including the determination and
reporting of income taxes payable to affiliates, deferred income tax assets and
liabilities, deferred income tax asset valuation allowance, and the provision
for income taxes which contributed to the following material weaknesses:
a) The Company did not have effective controls over the proper consideration
of the effect of subsequent events on the evaluation of certain income tax
attributes and related deferred income tax asset valuation allowances in
the preparation of its consolidated financial statements in accordance with
accounting principles generally accepted in the United States of America.
Specifically, the Company did not have effective controls in place to
consider that as a result of the capital gains generated from the Company's
first quarter 2005 sales of certain securities that the Company should not
have recognized a valuation allowance against certain deferred income tax
assets as of December 31, 2004. This control deficiency resulted in the
restatement of the 2004 Company's consolidated financial statements as of
and for the year ended December 31, 2004 included in the Original Form
10-K. Additionally, this control deficiency could result in a misstatement
of deferred income tax assets and liabilities and the related income tax
provision that would result in a material misstatement to the Company's
annual or interim consolidated financial statements that would not be
prevented or detected.
b) The Company did not have adequate personnel with sufficient knowledge of
accounting principles generally accepted in the United States of America
related to income tax accounting and reporting. Additionally, the Company
did not maintain effective controls over the review and monitoring of the
accuracy, completeness and valuation of the components of the income tax
provision and related deferred income taxes, and income taxes payable
resulting in errors in (i) the accounting for the income tax effect of the
difference between book and income tax basis of the Company's investment in
Kronos Worldwide, Inc., an equity-method investment of the Company as of
December 31, 2004, (ii) current and deferred income taxes related to the
Company's distributions of Kronos common stock to the Company's
stockholders and (iii) current and deferred income taxes related to other
items, that were not prevented or detected. This control deficiency
resulted in the restatement of the Company's 2002, 2003 and 2004
consolidated financial statements and 2004 and 2005 interim financial
information. Additionally, this control deficiency could result in a
misstatement of income taxes payable, deferred income tax assets and
liabilities, deferred income tax asset valuation allowance, and the
provision for income taxes that would result in a material misstatement to
the Company's annual or interim consolidated financial statements that
would not be prevented or detected.
Accordingly, management of the Company determined that each of these
control deficiencies constitutes a material weakness.
Remediation.In order to remediate this material weakness, the Company
intends to increase its financial reporting staff, with particular emphasis on
obtaining additional personnel with a background in the financial reporting
requirements for the determination of the provision for income taxes in
accordance with SFAS No. 109 and related GAAP. Such additional staff could be
employees of the Company and/or independent contractors hired by the Company
with qualifications in the required area. As of December 23, 2005, two such
persons have been hired. Management believes that the addition of such staff
with these qualifications will help ensure that GAAP has been appropriately and
consistently applied with respect to the accurate calculation and classification
within the consolidated financial statements of income tax provisions and
related current and deferred income tax accounts.
Changes in Internal Control Over Financial Reporting. There has been no
change to the Company's internal control over financial reporting during the
quarter ended September 30, 2005 that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Reference is made to Note 14 to the Consolidated Financial Statements and
to the 2004 Annual Report for descriptions of certain previously reported legal
proceedings.
Thomas v. Lead Industries Association, et al (Circuit Court, Milwaukee,
Wisconsin, Case No. 99-CV-6411). This previously reported case is now proceeding
in the trial court.
State of Rhode Island v. Lead Industries Association, et al. (Superior
Court of Rhode Island, No. 99-5226). In September 2005, the state dismissed its
Unfair Trade Practices Act claim against NL without prejudice. Trial commenced
on November 1, 2005 on the state's remaining claims of public nuisance,
indemnity and unjust enrichment. In addition to compensatory and punitive
damages, the state is seeking abatement of lead pigment from residential housing
in the State.
City of St. Louis v. Lead Industries Association, et al. (Missouri Circuit
Court 22nd Judicial Circuit, St. Louis City, Cause No. 002-245, Division 1). In
March 2005, the defendants filed a motion for summary judgment. A new trial date
will not be determined until after the court rules on this motion.
City of Milwaukee v. NL Industries, Inc. and Mautz Paint (Circuit Court,
Civil Division, Milwaukee County, Wisconsin, Case No. 01CV003066). This
previously reported case is now proceeding in the trial court.
In re: Lead Paint Litigation (Superior Court of New Jersey, Middlesex
County, Case Code 702). In August 2005, the appellate court affirmed the trial
court's dismissal of all counts except for the state's public nuisance count,
which has been reinstated. In November 2005, the New Jersey Supreme Court
granted defendants' petition seeking review of the appellate court's ruling on
the public nuisance count.
Liberty Independent School District v. Lead Industries Association, et al.
(District Court of Liberty County, Texas, No. 63,332). In September 2005, the
plaintiff voluntarily dismissed the case without prejudice.
Brownsville Independent School District v. Lead Industries Association, et
al. (District Court of Cameron County, Texas, No. 2002-052081 B). In November
2005, the plaintiff voluntarily dismissed the case without prejudice.
Jones v. NL Industries, Inc., et al. (Circuit Court of LeFlore County,
Mississippi, Civil Action No. 2002-0241-CICI). In September 2005, the court
reset the trial date for July 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 August 2005, the
court denied NL's motion to strike plaintiffs' fraud claim for lack of
particularity, allowing plaintiffs to re-plead this claim.
In October 2005, NL was served with a complaint in Evans v. Atlantic
Richfield Company, et. al. (Circuit Court, Milwaukee, Wisconsin, Case No.
05-CV-9281). Plaintiff, a minor, alleges injuries purportedly caused by lead on
the surfaces of premises in homes in which she resided. Plaintiff seeks
compensatory and punitive damages. NL intends to deny all allegations of
liability.
In December 2005, NL was served with a complaint in Hurkmans v. Salczenko,
et. al. (Circuit Court, Marinette County, Wisconsin, Case No. 05-CV-418).
Plaintiff, a minor, alleges injuries purportedly caused by lead on the surfaces
of the home in which he resided. Plaintiff seeks compensatory damages. NL
intends to deny all allegations of liability.
Item 6. Exhibits
31.1 - Certification
31.2 - Certification
32.1 - Certification
The Company has retained a signed original of any of the above exhibits
that contains signatures, and the Company will provide such exhibit to the
Commission or its staff upon request. NL will also furnish, without charge, a
copy of its Code of Business Conduct and Ethics, its Audit Committee Charter and
its Corporate Governance Guidelines, each as adopted by the Company's board of
directors, upon request. Such requests should be directed to the attention of
NL's Corporate Secretary at NL's corporate offices located at 5430 LBJ Freeway,
Suite 1700, Dallas, Texas 75240.
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 December 22, 2005 By /s/ Gregory M. Swalwell
----------------- -------------------------------
Gregory M. Swalwell
Vice President, Finance
and Chief Financial
Officer (Principal
Financial Officer)
Date December 22, 2005 By /s/ James W. Brown
----------------- -------------------------------
James W. Brown
Vice President and Controller
(Principal Accounting Officer)
CERTIFICATION
I, Harold C. Simmons, the Chief Executive Officer of NL Industries, Inc.,
certify that:
1) I have reviewed this quarterly report on Form 10-Q of NL Industries, Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: December 22, 2005
/s/ Harold C. Simmons
- -------------------------------
Harold C. Simmons
Chief Executive Officer
CERTIFICATION
I, Gregory M. Swalwell, the Chief Financial Officer of NL Industries, Inc.,
certify that:
1) I have reviewed this quarterly report on Form 10-Q of NL Industries, Inc.;
2) Based on my knowledge, this report does not contain any untrue statement of
a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this
report;
3) Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4) The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and we have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Designed such internal control over financial reporting, or caused
such internal control over financial reporting to be designed under
our supervision, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted
accounting principles;
c) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5) The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of internal control over financial reporting, to
the registrant's auditors and the audit committee of registrant's board of
directors (or persons performing the equivalent function):
a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: December 22, 2005
/s/ Gregory M. Swalwell
- ------------------------------
Gregory M. Swalwell
Chief Financial Officer
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of NL Industries, Inc. (the Company) on
Form 10-Q for the quarter ended September 30, 2005 as filed with the Securities
and Exchange Commission on the date hereof (the Report), I, Harold C. Simmons,
Chief Executive Officer of the Company, and I, Gregory M. Swalwell, Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350,
as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
/s/ Harold C. Simmons
- --------------------------
Harold C. Simmons
Chief Executive Officer
/s/ Gregory M. Swalwell
- --------------------------
Gregory M. Swalwell
Chief Financial Officer
December 22, 2005
Note: The certification the registrant furnishes in this exhibit is not deemed
"filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as
amended, or otherwise subject to the liabilities of that Section. Registration
Statements or other documents filed with the Securities and Exchange Commission
shall not incorporate this exhibit by reference, except as otherwise expressly
stated in such filing.