SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended September 30, 2006 Commission file number 1-5467
VALHI, INC.
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(Exact name of Registrant as specified in its charter)
Delaware 87-0110150
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
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Indicate by check mark:
Whether the Registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Whether the Registrant is a large accelerated filer, an accelerated filer
or a non-accelerated filer (as defined in Rule 12b-2 of the Act). Large
accelerated filer Accelerated filer X non-accelerated filer .
Whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes No X .
--- ---
Number of shares of the Registrant's common stock outstanding on November 1,
2006: 114,201,478.
VALHI, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets -
December 31, 2005;
September 30, 2006 (unaudited) 3
Condensed Consolidated Statements of Income - Three months and
nine months ended September 30, 2005
and 2006 (unaudited) 5
Condensed Consolidated Statements of Comprehensive Income -
Nine months ended September 30, 2005 and 2006
(unaudited) 6
Condensed Consolidated Statements of Cash Flows -
Nine months ended September 30, 2005 and 2006
(unaudited) 7
Condensed Consolidated Statement of Stockholders' Equity -
Nine months ended September 30, 2006
(unaudited) 9
Notes to Condensed Consolidated Financial Statements
(unaudited) 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 28
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 51
Part II. OTHER INFORMATION
Item 1. Legal Proceedings. 53
Item 1A. Risk Factors. 55
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds; Share Repurchases 55
Item 6. Exhibits. 56
Items 3, 4 and 5 of Part II are omitted because there is no information to
report.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS December 31, September 30,
2005 2006
----------- -----------
(unaudited)
Current assets:
Cash and cash equivalents $ 274,963 $ 205,534
Restricted cash equivalents 6,007 7,244
Marketable securities 11,755 11,273
Accounts and other receivables, net 218,766 273,150
Refundable income taxes 1,489 687
Receivable from affiliates 34 267
Inventories, net 283,157 271,454
Prepaid expenses and other 9,981 25,983
Deferred income taxes 10,502 8,935
---------- ----------
Total current assets 816,654 804,527
---------- ----------
Other assets:
Marketable securities:
The Amalgamated Sugar Company LLC 250,000 250,000
Other 8,705 8,665
Investment in affiliates 270,632 355,184
Unrecognized net pension obligations 11,916 12,539
Prepaid pension costs 3,529 5,830
Goodwill 361,783 384,411
Other intangible assets 3,432 4,159
Deferred income taxes 213,726 227,481
Other 61,639 55,399
---------- ----------
Total other assets 1,185,362 1,303,668
---------- ----------
Property and equipment:
Land 37,876 40,769
Buildings 220,110 234,509
Equipment 827,690 889,298
Mining properties 19,969 21,391
Construction in progress 15,771 29,702
---------- ----------
1,121,416 1,215,669
Less accumulated depreciation 545,055 627,122
---------- ----------
Net property and equipment 576,361 588,547
---------- ----------
Total assets $2,578,377 $2,696,742
========== ==========
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, September 30,
2005 2006
------------ -------------
(unaudited)
Current liabilities:
Current maturities of long-term debt $ 1,615 $ 1,332
Accounts payable 105,650 93,177
Accrued liabilities 129,429 165,320
Payable to affiliates 13,754 15,795
Income taxes 24,680 19,671
Deferred income taxes 4,313 1,199
---------- ----------
Total current liabilities 279,441 296,494
---------- ----------
Noncurrent liabilities:
Long-term debt 715,820 778,298
Accrued pension costs 140,742 139,370
Accrued OPEB costs 32,279 30,158
Accrued environmental costs 49,161 49,355
Deferred income taxes 400,964 437,088
Other 39,328 24,787
---------- ----------
Total noncurrent liabilities 1,378,294 1,459,056
---------- ----------
Minority interest 125,049 121,038
---------- ----------
Stockholders' equity:
Common stock 1,207 1,199
Additional paid-in capital 108,810 108,413
Retained earnings 786,268 792,872
Accumulated other comprehensive income:
Marketable securities 4,194 3,229
Currency translation 11,157 30,484
Pension liabilities (78,101) (78,101)
Treasury stock (37,942) (37,942)
---------- ----------
Total stockholders' equity 795,593 820,154
---------- ----------
Total liabilities, minority interest and
stockholders' equity $2,578,377 $2,696,742
========== ==========
Commitments and contingencies (Notes 12 and 15)
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share data)
Three months ended Nine months ended
September 30, September 30,
------------------- ---------------
2005 2006 2005 2006
---- ---- ---- ----
(unaudited)
Revenues and other income:
Net sales $342,204 $383,139 $1,042,895 $1,137,011
Other, net 11,789 11,441 57,834 34,584
Equity in earnings of:
Titanium Metals Corporation 15,504 19,242 48,095 61,716
Other 2,540 4,584 2,361 2,615
-------- -------- ---------- ----------
Total revenues and other income 372,037 418,406 1,151,185 1,235,926
-------- -------- ---------- ----------
Costs and expenses:
Cost of sales 259,955 299,388 771,840 880,436
Selling, general and administrative 52,974 59,289 161,597 173,218
Loss on prepayment of debt - - - 22,311
Interest 16,757 15,775 52,413 51,754
-------- -------- ---------- ----------
Total costs and expenses 329,686 374,452 985,850 1,127,719
-------- -------- ---------- ----------
Income before income taxes 42,351 43,954 165,335 108,207
Provision for income taxes 29,377 22,104 88,699 40,156
Minority interest in after-tax earnings (409) 2,236 9,888 7,181
-------- -------- ---------- ----------
Income from continuing operations 13,383 19,614 66,748 60,870
Discontinued operations - - (272) (147)
-------- -------- ---------- ----------
Net income $ 13,383 $ 19,614 $ 66,476 $ 60,723
======== ======== ========== ==========
Basic and diluted earnings per share:
Income from continuing operations $ .11 $ .17 $ .56 $ .52
Discontinued operations - - - -
------- -------- ---------- ----------
Net income $ .11 $ .17 $ .56 $ .52
======= ======== ========== ==========
Cash dividends per share $ .10 $ .10 $ .30 $ .30
======= ======== ========== ==========
Weighted average shares outstanding:
Basic 117,541 116,113 118,597 116,392
Outstanding stock options impact 361 372 364 378
-------- -------- ---------- ----------
Diluted 117,902 116,485 118,961 116,770
======== ======== ========== ==========
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Net income $ 66,476 $60,723
-------- -------
Other comprehensive income (loss), net of tax:
Marketable securities adjustment (586) (965)
Currency translation adjustment (23,347) 19,327
-------- -------
Total other comprehensive income (loss), net (23,933) 18,362
-------- -------
Comprehensive income $ 42,543 $79,085
======== =======
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from operating activities:
Net income $ 66,476 $ 60,723
Depreciation and amortization 55,981 55,941
Goodwill impairment 864 -
Securities transactions, net (20,213) (378)
Loss on prepayment of debt - 22,311
Cash premium paid on Senior Secured Notes - (20,898)
Benefit plan expense less than cash funding requirements:
Defined benefit pension plans (3,916) (2,626)
Other postretirement benefit plans (2,652) (2,384)
Deferred income taxes:
Continuing operations 44,776 20,880
Discontinued operations (577) (175)
Minority interest:
Continuing operations 9,888 7,181
Discontinued operations (205) (178)
Other, net 1,317 2,784
Equity in:
TIMET (48,095) (61,716)
Other (2,361) (2,615)
Net distributions from:
Manufacturing joint venture 5,100 500
Other 109 339
Change in assets and liabilities:
Accounts and other receivables, net (26,953) (43,909)
Inventories, net (36,870) 28,829
Accounts payable and accrued liabilities 6,773 17,657
Accounts with affiliates 1,490 1,893
Income taxes (171) (5,909)
Other, net (11,407) (19,398)
-------- --------
Net cash provided by operating activities 39,354 58,852
-------- --------
Cash flows from investing activities:
Capital expenditures (37,527) (36,533)
Purchases of:
Kronos common stock (5,482) (25,213)
TIMET common stock (17,972) (18,699)
CompX common stock (707) (2,278)
Business unit (7,342) (9,832)
Marketable securities (19,654) (26,470)
Capitalized permit costs (2,260) (5,407)
Proceeds from disposal of:
Business unit 18,094 -
Kronos common stock 19,176 -
Marketable securities 11,005 27,002
Interest in Norwegian smelting operation 3,542 -
Other property and equipment 545 -
Loans to affiliate, net 6,929 -
Cash of disposed business unit (4,006) -
Change in restricted cash equivalents, net 5,789 (994)
Other, net 2,474 3,428
-------- --------
Net cash used in investing activities (27,396) (94,996)
-------- --------
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Nine months ended September 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from financing activities:
Indebtedness:
Borrowings $ 13,678 $ 722,200
Principal payments (21,840) (688,276)
Deferred financing costs paid (28) (8,968)
Dividends paid (36,744) (36,108)
Distributions to minority interest (8,522) (6,658)
Treasury stock acquired (58,509) (18,776)
NL common stock issued 2,488 9
Valhi common and other stock issued, net 1,861 519
--------- ---------
Net cash used in financing activities (107,616) (36,058)
--------- ---------
Cash and cash equivalents - net change from:
Operating, investing and financing activities (95,658) (72,202)
Currency translation (1,792) 2,773
Cash and equivalents at beginning of period 267,829 274,963
--------- ---------
Cash and equivalents at end of period $ 170,379 $ 205,534
========= =========
Supplemental disclosures:
Cash paid for:
Interest, net of amounts capitalized $ 39,857 $ 34,967
Income taxes, net 48,068 25,029
Noncash investing activities:
Note receivable received upon disposal of
business unit $ 4,179 $ -
Inventories received as partial consideration
for disposal of interest in Norwegian
smelting operation 1,897 -
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Nine months ended September 30, 2006
(In thousands)
Accumulated other comprehensive income
Additional ---------------------------------- Total
Common paid-in Retained Marketable Currency Pension Treasury stockholders'
stock capital earnings securities translation liabilities stock equity
------ --------- -------- ---------- ----------- ----------- ------- ------
(unaudited)
Balance at December 31, 2005 $1,207 $108,810 $786,268 $4,194 $11,157 $(78,101) $(37,942) $795,593
Net income - - 60,723 - - - - 60,723
Dividends - - (36,108) - - - - (36,108)
Other comprehensive income, net - - - (965) 19,327 - - 18,362
Treasury stock:
Acquired - - - - - - (18,776) (18,776)
Retired (8) (757) (18,011) - - - 18,776 -
Other, net - 360 - - - - - 360
------ -------- -------- ------ ------- -------- -------- --------
Balance at September 30, 2006 $1,199 $108,413 $792,872 $3,229 $30,484 $(78,101) $(37,942) $820,154
====== ======== ======== ====== ======= ======== ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(unaudited)
Note 1 - Organization and basis of presentation:
Organization - We are majority owned by Contran Corporation, which directly
or through its subsidiaries owns approximately 92% of our outstanding common
stock at September 30, 2006. Substantially all of Contran's outstanding voting
stock is held by trusts established for the benefit of certain children and
grandchildren of Harold C. Simmons (for which Mr. Simmons is the sole trustee)
or is held directly by Mr. Simmons or other persons or related companies to Mr.
Simmons. Consequently, Mr. Simmons may be deemed to control Contran and us.
Basis of Presentation - Consolidated in this Quarterly Report are the
results of our majority-owned and wholly-owned subsidiaries, including NL
Industries, Inc., Kronos Worldwide, Inc., CompX International, Inc., Tremont LLC
and Waste Control Specialists LLC ("WCS"). We are also the largest shareholder
of Titanium Metals Corporation ("TIMET"), although we own less than a majority
interest and therefore we account for our investment by the equity method.
Kronos (NYSE: KRO), NL (NYSE: NL), CompX (NYSE: CIX) and TIMET (NYSE: TIE) each
file periodic reports with the Securities and Exchange Commission ("SEC").
The unaudited Condensed Consolidated Financial Statements contained in this
Quarterly Report have been prepared on the same basis as the audited
Consolidated Financial Statements included in our Annual Report on Form 10-K for
the year ended December 31, 2005 that we filed with the SEC on March 24, 2006
(the "2005 Annual Report"). In our opinion, we have made all necessary
adjustments (which include only normal recurring adjustments) in order to state
fairly, in all material respects, our consolidated financial position, results
of operations and cash flows as of the dates and for the periods presented. We
have condensed the Consolidated Balance Sheet at December 31, 2005 contained in
this Quarterly Report as compared to our audited Consolidated Financial
Statements at that date, and we have omitted certain information and footnote
disclosures (including those related to the Consolidated Balance Sheet at
December 31, 2005) normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America ("GAAP"). Our results of operations for the interim periods ended
September 30, 2006 may not be indicative of our operating results for the full
year. The Condensed Consolidated Financial Statements contained in this
Quarterly Report should be read in conjunction with our 2005 Consolidated
Financial Statements contained in our 2005 Annual Report. Certain prior year
amounts have been reclassified to conform to the current year presentation.
Unless otherwise indicated, references in this report to "we," "us" or
"our" refer to Valhi, Inc and its subsidiaries, taken as a whole.
Note 2 - Business segment information:
Our % ownership at
Business segment Entity September 30, 2006
------------------- ------------------------- ------------------
Chemicals Kronos 95%
Component products CompX 70%
Waste management WCS 100%
Titanium metals TIMET 35%
Our ownership of Kronos includes 59% we hold directly and 36% held directly
by NL. We own 83% of NL. During the first nine months of 2006, we purchased
approximately 926,000 shares of Kronos common stock in market transactions for
an aggregate purchase price of $25.2 million. We accounted for this purchase as
a step acquisition under the purchase method of accounting.
Our ownership of CompX is primarily through CompX Group, Inc, a
majority-owned subsidiary of NL. NL owns 82.4% of CompX Group, and TIMET owns
the remaining 17.6% of CompX Group. CompX Group's sole asset is 83% of the
outstanding common stock of CompX. NL also owns an additional 2% of CompX
directly. During the first nine months of 2006, NL purchased approximately
145,000 shares of CompX common stock in market transactions for an aggregate
purchase price of $2.3 million. NL accounted for this purchase as a step
acquisition under the purchase method of accounting.
We own 31% of TIMET through a wholly-owned subsidiary, and we directly own
an additional 4% of TIMET. During the first nine months of 2006, we purchased
approximately 607,000 shares of TIMET common stock for an aggregate purchase
price of $18.7 million. TIMET owns an additional 3% of CompX, .5% of NL and less
than .1% of Kronos. Because we do not consolidate TIMET, the shares of CompX
Group, CompX, NL and Kronos held by TIMET are not considered as owned by us for
financial reporting purposes.
Three months ended Nine months ended
September 30, September 30,
----------------------- ------------------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions)
Net sales:
Chemicals $292.1 $331.6 $ 895.7 $ 981.0
Component products 47.1 48.8 139.7 146.0
Waste management 3.0 2.7 7.5 10.0
------ ------ -------- --------
Total net sales $342.2 $383.1 $1,042.9 $1,137.0
====== ====== ======== ========
Cost of good sold:
Chemicals $219.9 $260.0 $ 652.3 $ 759.9
Component products 36.1 36.0 107.9 109.2
Waste management 4.0 3.4 11.7 11.3
------ ------ -------- --------
Total cost of goods sold $260.0 $299.4 $ 771.9 $ 880.4
====== ====== =======- ========
Gross margin:
Chemicals $ 72.2 $ 71.6 $ 243.4 $ 221.1
Component products 11.0 12.8 31.8 36.8
Waste management (1.0) (0.7) (4.2) (1.3)
------ ------ -------- --------
Total gross margin $ 82.2 $ 83.7 $ 271.0 $ 256.6
====== ====== ======== ========
Operating income:
Chemicals $ 35.5 $ 32.0 $ 134.2 $ 98.5
Component products 4.9 6.2 13.8 17.0
Waste management (2.8) (2.4) (9.1) (6.1)
------ ------ -------- --------
Total operating income 37.6 35.8 138.9 109.4
Equity in:
TIMET 15.5 19.2 48.1 61.7
Other 2.6 4.6 2.4 2.6
General corporate items:
Interest and dividend income 9.4 10.4 28.9 30.8
Securities transaction gains, net - .2 20.2 .4
Insurance recoveries 1.2 .1 2.4 2.9
General expenses, net (7.2) (10.5) (23.1) (25.5)
Loss on prepayment of debt - - - (22.3)
Interest expense (16.7) (15.8) (52.4) (51.8)
------ ------ -------- --------
Income before income taxes $ 42.4 $ 44.0 $ 165.4 $ 108.2
====== ====== ======== ========
In April 2006, CompX completed an acquisition of a marine component
products business for aggregate cash consideration of $9.8 million, net of cash
acquired. We completed this acquisition to expand the marine component products
business unit of CompX. We have included the results of operations and cash
flows of the acquired business in our Condensed Consolidated Financial
Statements starting in April 2006. The purchase price has been allocated among
the tangible and intangible net assets acquired based upon an estimate of the
fair value of such net assets. The pro forma effect to us, assuming this
acquisition had been completed as of January 1, 2005, is not material.
Segment results we report may differ from amounts separately reported by
our various subsidiaries and affiliates due to purchase accounting adjustments
and related amortization or differences in the way we define operating income.
Intersegment sales are not material.
Note 3 - Accounts and other receivables, net:
December 31, September 30,
2005 2006
--------- ---------
(In thousands)
Accounts receivable $211,156 $273,088
Notes receivable 4,267 3,152
Accrued interest and dividends receivable 6,158 86
Allowance for doubtful accounts (2,815) (3,176)
-------- --------
Total $218,766 $273,150
======== ========
Note 4 - Inventories, net:
December 31, September 30,
2005 2006
----------- -------------
(In thousands)
Raw materials:
Chemicals $ 52,343 $ 47,865
Component products 6,725 6,202
-------- --------
Total raw materials 59,068 54,067
-------- --------
In-process products:
Chemicals 17,959 22,178
Component products 9,116 9,260
-------- --------
Total in-process products 27,075 31,438
-------- --------
Finished products:
Chemicals 150,675 132,682
Component products 6,621 8,103
-------- --------
Total finished products 157,296 140,785
-------- --------
Supplies (primarily chemicals) 39,718 45,164
-------- --------
Total $283,157 $271,454
======== ========
Note 5 - Other assets:
December 31, September 30,
2005 2006
-------- --------
(In thousands)
Investment in affiliates:
TIMET:
Common stock $138,677 $221,453
Preferred stock 183 183
-------- --------
Total investment in TIMET 138,860 221,636
TiO2 manufacturing joint venture 115,308 114,808
Other 16,464 18,740
-------- --------
Total $270,632 $355,184
======== ========
Other noncurrent assets:
IBNR receivables $ 16,735 $ 3,542
Waste disposal site operating permits, net 14,133 19,216
Deferred financing costs 8,278 9,266
Loans and other receivables 2,502 3,081
Restricted cash equivalents 382 401
Other 19,609 19,893
-------- --------
Total $ 61,639 $ 55,399
======== ========
At September 30, 2006, we held 56.6 million shares of TIMET common stock
with a quoted market price of $25.28 per share, or an aggregate market value of
$1.4 billion. Our TIMET shares reflect the effects of a two-for-one stock split
TIMET implemented in each of February and May 2006.
Certain selected financial information of TIMET is summarized below:
December 31, September 30,
2005 2006
------------ -------------
(In millions)
Current assets $550.3 $ 717.6
Property and equipment 253.0 295.9
Marketable securities 46.5 44.4
Investment in joint ventures 26.0 34.0
Other noncurrent assets 31.5 35.7
------ --------
Total assets $907.3 $1,127.6
====== ========
Current liabilities $166.9 $ 180.3
Accrued pension and postretirement benefits 74.0 80.5
Long-term debt 51.4 55.3
Other noncurrent liabilities 39.3 35.0
Minority interest 13.5 18.0
Stockholders' equity 562.2 758.5
------ --------
Total liabilities, minority interest and
stockholders' equity $907.3 $1,127.6
====== ========
Three months ended Nine months ended
September 30, September 30,
------------------ -------------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions)
Net sales $190.0 $271.8 $529.0 $859.6
Cost of sales 134.3 174.0 396.4 547.2
Operating income 51.7 84.6 108.1 273.3
Net income attributable to common stockholders 33.4 52.7 105.1 163.8
Note 6 - Accrued liabilities:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Current:
Employee benefits $ 48,341 $ 49,106
Environmental costs 16,565 12,969
Deferred income 5,101 7,071
Interest 1,067 15,823
Other 58,355 80,351
-------- --------
Total $129,429 $165,320
======== ========
Noncurrent:
Insurance claims and expenses $ 24,257 $ 10,299
Employee benefits 4,998 6,631
Asset retirement obligations 1,381 1,537
Deferred income 573 476
Other 8,119 5,844
-------- --------
Total $ 39,328 $ 24,787
======== ========
Note 7 - Long-term debt:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Valhi - Snake River Sugar Company $250,000 $250,000
-------- --------
Subsidiary debt:
Kronos International:
6.5% Senior Secured Notes - 505,241
8.875% Senior Secured Notes 449,298 -
Kronos U.S. bank credit facility 11,500 14,850
Kronos Canadian bank credit facility - 4,495
Other 6,637 5,044
-------- --------
Total subsidiary debt 467,435 529,630
-------- --------
Total debt 717,435 779,630
Less current maturities 1,615 1,332
-------- --------
Total long-term debt $715,820 $778,298
======== ========
Senior Secured Notes - In May 2006, we redeemed our 8.875% Senior Secured
Notes at 104.437%% of their aggregate principal amount of euro 375 million for
an aggregate of $491.4 million, including the $20.9 million call premium. We
funded the redemption of our 8.875% Notes through our April 2006 issuance of
euro 400 million principal amount of 6.5% Senior Secured Notes due in 2013. Our
6.5% Notes were issued at 99.306% of the principal amount ($498.5 million when
issued). The covenants, restrictions and collateral requirements of the new 6.5%
Notes are substantially identical to those of the 8.875% Notes. We recognized a
$22.3 million pre-tax interest expense charge in the second quarter of 2006 for
the early extinguishment of the 8.875% Senior Secured Notes. The charge includes
the call premium and the write-off of deferred financing costs and unamortized
premium on the 8.875% Notes.
Revolving Credit Facilities - During the first nine months of 2006, we
borrowed a net Cdn. $5.0 million ($4.5 million when borrowed) under Kronos'
Canadian revolving credit facility and a net $3.4 million under Kronos' U.S.
bank credit facility. The average interest rates on the outstanding balances
under these facilities at September 30, 2006 were 6.75% and 8.25%, respectively.
Note 8 - Employee benefit plans:
Defined Benefit Plans - The components of net periodic defined benefit
pension cost are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 1,974 $ 1,982 $ 5,875 $ 5,817
Interest cost 5,527 6,052 17,005 17,807
Expected return on plan assets (5,508) (6,465) (16,884) (19,136)
Amortization of prior service cost 145 117 449 343
Amortization of net transition
obligations and assets (16) 128 259 378
Recognized actuarial losses 1,093 2,303 3,369 6,734
------- ------- -------- --------
Total $ 3,215 $ 4,117 $ 10,073 $ 11,943
======= ======= ======== ========
Postretirement Benefits - The components of net periodic postretirement
benefit cost are presented in the table below.
Three months ended Nine months ended
September 30, September 30,
------------------ ------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 56 $ 73 $ 165 $ 215
Interest cost 483 475 1,449 1,421
Amortization of prior service credit (231) (90) (694) (271)
Recognized actuarial losses (gains) (120) 29 (296) 86
----- ---- ------ ------
Total $ 188 $487 $ 624 $1,451
===== ==== ====== ======
Plan Assets Invested in Related Parties - The Combined Master Retirement
Trust ("CMRT") is a collective investment trust sponsored by Contran to permit
the collective investment by certain master trusts which fund certain employee
benefits plans sponsored by Contran and certain of its affiliates, including
certain plans we maintain. The CMRT owned 10% of TIMET's outstanding common
stock and 0.1% of our outstanding common stock at September 30, 2006. Because we
do not consolidate the CMRT, the shares of TIMET and Valhi owned by the CMRT are
not considered as being owned by us for financial reporting purposes.
Contributions - We expect our 2006 contributions for our pension and
postretirement benefit plans to be consistent with the amounts we disclosed in
our 2005 Annual Report.
Note 9 - Accounts with affiliates:
December 31, September 30,
2005 2006
------------ -------------
(In thousands)
Current receivables from affiliates:
Contran - income taxes, net $ 33 $ 267
Other 1 -
------- -------
Total $ 34 $ 267
======= =======
Current payables to affiliates:
Louisiana Pigment Company $ 9,803 $10,674
Contran - trade items 3,940 5,096
Other, net 11 25
------- -------
Total $13,754 $15,795
======= =======
Note 10 - Stockholders' equity:
In March 2005, our board of directors authorized the repurchase of up to
5.0 million shares of our common stock in open market transactions, including
block purchases, or in privately negotiated transactions, which may include
transactions with our affiliates or subsidiaries. The stock may be purchased
from time to time as market conditions permit. The stock repurchase program does
not include specific price targets or timetables and may be suspended at any
time. Depending on market conditions, we may terminate the program prior to
completion. We will use cash on hand to acquire the shares. Repurchased shares
could be retired and cancelled or may be added to our treasury stock and used
for employee benefit plans, future acquisitions or other corporate purposes.
During the first nine months of 2006, we purchased approximately 837,000
shares of our common stock in market transactions for an aggregate purchase
price of $18.8 million. We cancelled these treasury shares, and allocated their
cost to common stock at par value, additional paid-in capital and retained
earnings.
On November 1, 2006 our board of directors increased the share repurchase
authorization by an additional 5.0 million shares. Also on November 1, 2006 we
purchased 1.0 million shares, at a discount to the then-current market price,
from our majority shareholder Valhi Holding Company at $23.50 per share or an
aggregate purchase price of $23.5 million. The independent members of our board
of directors approved this purchase. At November 1, 2006, approximately 4.6
million shares were available for purchase under the repurchase authorization.
Note 11 - Other income, net:
Nine months ended
September 30,
----------------------
2005 2006
---- ----
(In thousands)
Securities earnings:
Dividends and interest $28,854 $30,823
Securities transactions, net 20,213 378
------- -------
Total securities earnings 49,067 31,201
Currency transactions, net 3,493 (2,986)
Insurance recoveries 2,431 2,864
Other, net 2,843 3,505
------- -------
Total other income, net $57,834 $34,584
======= =======
On October 30, 2006 we completed the sale of certain land we own in
Henderson Nevada for net proceeds of $37.8 million. We will recognize a gain of
$35.3 million ($23.0 million, net of tax) in the fourth quarter of 2006 for this
transaction. The land was not used in any of our operations.
Note 12 - Provision for income taxes:
Nine months ended
September 30,
-------------------------
2005 2006
---- ----
(In millions)
Expected tax expense $ 57.9 $ 37.9
Incremental U.S. tax and rate differences on
equity in earnings 22.0 8.2
Loss of German tax attribute 17.5 -
Non-U.S. tax rates 0.1 (1.4)
Nondeductible expenses 3.1 3.0
Excess of book basis over tax basis of shares of
Kronos common stock sold 1.7 -
Tax contingency reserve adjustment, net (16.7) (7.1)
U.S. state income taxes, net 3.8 1.2
Canadian tax rate change - (1.3)
Income tax related to shares of Kronos common
stock distributed by NL 0.7 -
Other, net (1.4) (0.3)
------ ------
Provision for income taxes $ 88.7 $ 40.2
====== ======
Comprehensive provision for income taxes allocated to:
Income from continuing operations $ 88.7 $ 40.2
Discontinued operations (0.4) (0.2)
Additional paid-in capital 0.7 -
Other comprehensive income:
Marketable securities 0.3 0.8
Currency translation (7.8) 6.5
------ ------
$ 81.5 $ 47.3
====== ======
In June 2006, Canada enacted a 2% reduction in the Canadian federal income
tax rate and the elimination of the federal surtax. The 2% reduction will be
phased in from 2008 to 2010, and the federal surtax will be eliminated in 2008.
As a result, during 2006 we recognized a $1.3 million income tax benefit related
to the effect of such reduction on our previously-recorded net deferred income
tax liability with respect to Kronos' and CompX's operations in Canada.
Due to the favorable resolution of certain income tax audits related to
Kronos' German and Belgian operations during the first six months of 2006, we
recognized a $2.0 million income tax benefit related to adjustments of prior
year income taxes. Due to an unfavorable resolution of certain income tax audit
issues related to our German operations during the third quarter of 2006, we
recognized a $2.0 million provision for income taxes related to prior year
income taxes, which offset the $2.0 million benefit we recognized in the first
six months of the year.
Tax authorities are examining certain of our non-U.S. tax returns and have
or may propose tax deficiencies, including penalties and interest. For example:
o We previously received a preliminary tax assessment related to 1993 from
the Belgian tax authorities proposing tax deficiencies for Kronos,
including related interest, of approximately euro 6 million. The Belgian
tax authorities filed a lien on the fixed assets of our Belgian TiO2
operations in connection with their assessment. This lien did not interfere
with on-going operations at the facility. We filed a protest to this
assessment, and in July 2006 the Belgian tax authorities withdrew the
assessment. The lien was subsequently released.
o The Norwegian tax authorities previously notified us of their intent to
assess tax deficiencies of approximately kroner 12 million relating to the
years 1998 through 2000 for Kronos. We objected to this proposed
assessment, and in May 2006 the Norwegian tax authorities withdrew the
assessment.
Principally as a result of the withdrawal of the Belgian and Norwegian
assessments discussed above, we have recognized a $9.2 million income tax
benefit in the first half of 2006 related to the total reduction in our income
tax contingency reserve. We increased our income tax contingency reserve by $2.1
million in the third quarter of 2006 primarily as a result of our ongoing income
tax audits in Germany.
Other U.S. and non-U.S. income tax examinations related to our operations
continue, and we cannot guarantee that these tax matters will be resolved in our
favor due to the inherent uncertainties involved in settlement initiatives and
court and tax proceedings. We believe we have adequate accruals for additional
taxes and related interest expense which could ultimately result from tax
examinations. We believe the ultimate disposition of tax examinations should not
have a material adverse effect on our consolidated financial position, results
of operations or liquidity.
Note 13 - Minority interest:
December 31, September 30,
2005 2006
-------- ---------
(In thousands)
Minority interest in net assets:
NL Industries $ 51,177 $ 53,576
Kronos Worldwide 28,167 21,698
CompX International 45,630 45,723
Subsidiary of Kronos 75 41
-------- --------
Total $125,049 $121,038
======== ========
Nine months ended
September 30,
---------------------------
2005 2006
---- ----
(In thousands)
Minority interest in net earnings - continuing operations:
NL Industries $ 5,847 $ 2,143
Kronos Worldwide 4,444 2,032
CompX International (473) 2,999
Subsidiary of Kronos 61 7
Subsidiary of NL 9 -
------- --------
Total $ 9,888 $ 7,181
======= ========
Note 14 - Discontinued operations:
Discontinued operations relates to CompX's former Thomas Regout operations
located in the Netherlands. Prior to December 2004, the Thomas Regout European
operations were classified as held for use. In December 2004, the CompX board of
directors adopted a formal disposal plan which resulted in the reclassification
of the operations to held for sale. We determined that the goodwill associated
with the assets held for sale was partially impaired, based upon the estimated
realizable value (or fair value less costs to sell) of the net assets disposed.
In determining the estimated realizable value of the Thomas Regout operations as
of December 31, 2004, when we classified it as held for sale, we used the sales
price inherent in the definitive agreement reached with the purchaser in January
2005 and our estimate of the related transaction costs (or costs to sell). In
January 2005, we completed the sale of Thomas Regout for net proceeds that were
approximately $864,000 less than previously estimated (primarily due to higher
expenses associated with the sale). These additional expenses reflect a
refinement of our previous estimate of the realizable value of the Thomas Regout
operations and accordingly we recognized a further impairment of goodwill. As a
result, discontinued operations for the first nine months of 2005 includes a
charge for the additional expenses ($272,000, net of tax and minority interest).
Discontinued operations in 2006 represents an expense of $500,000 ($147,000, net
of tax and minority interest) for our change in estimate of certain
indemnification obligations we had to the purchaser of the Thomas Regout
operations.
Note 15 - Commitments and contingencies:
Lead pigment litigation - NL
NL's former operations included the manufacture of lead pigments for use in
paint and lead-based paint. We, other former manufacturers of lead pigments for
use in paint and lead-based paint, and the Lead Industries Association (which
discontinued business operations prior to 2005) have been named as defendants in
various legal proceedings seeking damages for personal injury, property damage
and governmental expenditures allegedly caused by the use of lead-based paints.
Certain of these actions have been filed by or on behalf of states, large U.S.
cities or their public housing authorities and school districts, and certain
others have been asserted as class actions. These lawsuits seek recovery under a
variety of theories, including public and private nuisance, negligent product
design, negligent failure to warn, strict liability, breach of warranty,
conspiracy/concert of action, aiding and abetting, enterprise liability, market
share or risk contribution liability, intentional tort, fraud and
misrepresentation, violations of state consumer protection statutes, supplier
negligence and similar claims.
The plaintiffs in these actions generally seek to impose on the defendants
responsibility for lead paint abatement and health concerns associated with the
use of lead-based paints, including damages for personal injury, contribution
and/or indemnification for medical expenses, medical monitoring expenses and
costs for educational programs. A number of cases are inactive or have been
dismissed or withdrawn. Most of the remaining cases are in various pre-trial
stages. Some are on appeal following dismissal or summary judgment rulings in
favor of either the defendants or plaintiffs. In addition, various other cases
are pending (in which NL is not a defendant) seeking recovery for injuries
allegedly caused by lead pigment and lead-based paint. Although we are not a
defendant in these cases, the outcome of these cases may have an impact on
pending cases and cases that might be filed against us in the future.
We believe these actions are without merit, and intend to continue to deny
all allegations of wrongdoing and liability and to defend against all actions
vigorously. We have never settled any of these cases, nor have any final adverse
judgments been entered against us. We have not accrued any amounts for pending
lead pigment and lead-based paint litigation. We cannot reasonably estimate
liability, if any, that may result. We cannot assure you that we will not incur
liability in the future as a result of pending litigation due to the inherent
uncertainties involved in court and jury rulings in pending and possible future
cases. If future liabilities are incurred, it could have a material adverse
effect on our Consolidated Financial Statements, results of operations and
liquidity.
In one of these lead pigment cases (State of Rhode Island v. Lead
Industries Association), a trial before a Rhode Island state court jury began in
September 2002 on the question of whether lead pigment in paint on Rhode Island
buildings is a public nuisance. In October 2002, the trial judge declared a
mistrial in the case when the jury was unable to reach a verdict on the
question, with the jury reportedly deadlocked 4-2 in defendants' favor. In
November 2005, the State of Rhode Island began a retrial of the case on the
State's claims of public nuisance, indemnity and unjust enrichment. Following
the State's presentation of its case, the trial court dismissed the State's
claims of indemnity and unjust enrichment. The public nuisance claim was sent to
the jury in February 2006, and the jury found that we and two other defendants
substantially contributed to the creation of a public nuisance as a result of
the collective presence of lead pigments in paints and coatings on buildings in
Rhode Island. The jury also found that we and the two other defendants should be
ordered to abate the public nuisance. Following the jury verdict, the trial
court dismissed the State's claim for punitive damages. The scope of the
abatement remedy will be determined by the judge. The extent, nature and cost of
such remedy are not currently known and will be determined only following
additional proceedings before the trial court. Various matters remain pending
before the trial court, including our motion to dismiss and other post-trial
motions which were argued in August 2006. We intend to appeal any adverse
judgment which the trial court may enter against us.
The Rhode Island case is unique in that this is the first time that an
adverse verdict in the lead pigment litigation has been entered against us. We
believe there are a number of meritorious issues which can be appealed in this
case; therefore we currently believe it is not probable that we will ultimately
be found liable in this matter. In addition, we cannot reasonably estimate
potential liability, if any, with respect to this and the other lead pigment
litigation. However, legal proceedings are subject to inherent uncertainties,
and we cannot assure you that any appeal would be successful. Therefore it is
reasonably possible we could in the near term conclude that it is probable we
have incurred some liability in this Rhode Island matter that would result in
recognizing a loss contingency accrual. The potential liability could have a
material adverse impact on net income for the interim or annual period during
which such liability is recognized, and a material adverse impact on our
financial condition and liquidity. Various other cases in which we are a
defendant are also pending in other jurisdictions, and new cases could be filed
against us, the resolution of which could also result in recognition of a loss
contingency accrual that could have a material adverse impact on our net income
for the interim or annual period during which such liability is recognized, and
a material adverse impact on our financial condition and liquidity. We cannot
reasonably estimate the potential impact on our results of operations, financial
condition or liquidity related to these matters.
Environmental matters and litigation
General - Our operations are governed by various environmental laws and
regulations. Certain of our businesses are and have been engaged in the
handling, manufacture or use of substances or compounds that may be considered
toxic or hazardous within the meaning of applicable environmental laws. As with
other companies engaged in similar businesses, certain of our past and current
operations and products have the potential to cause environmental or other
damage. We have implemented and continue to implement various policies and
programs in an effort to minimize these risks. Our policy is to maintain
compliance with applicable environmental laws and regulations at all of our
plants and to strive to improve our environmental performance. From time to
time, we may be subject to environmental regulatory enforcement under U.S. and
foreign statutes, the resolution of which typically involves the establishment
of compliance programs. Future developments, such as stricter requirements of
environmental laws and enforcement policies, could adversely affect our
production, handling, use, storage, transportation, sale or disposal of such
substances. We believe all of our plants are in substantial compliance with
applicable environmental laws.
Certain properties and facilities used in our former businesses, including
divested primary and secondary lead smelters and former mining locations 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, we have been named as a defendant,
potentially responsible party ("PRP") or both, pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act, as amended by the
Superfund Amendments and Reauthorization Act ("CERCLA"), and similar state laws
in various governmental and private actions associated with waste disposal
sites, mining locations, and facilities we or our predecessors currently or
previously owned, operated or used, certain of which are on the U.S. EPA's
Superfund National Priorities List or similar state lists. These proceedings
seek cleanup costs, damages for personal injury or property damage and/or
damages for injury to natural resources. Certain of these proceedings involve
claims for substantial amounts. Although we may be jointly and severally liable
for these costs, in most cases we are only one of a number of PRPs who may also
be jointly and severally liable.
Environmental obligations are difficult to assess and estimate for numerous
reasons including:
o complexity and differing interpretations of governmental regulations,
o number of PRPs and their ability or willingness to fund such
allocation of costs,
o financial capabilities of the PRPs and the allocation of costs among
them,
o multiplicity of possible solutions; and
o number of years of investigatory, remedial and monitoring activity
required.
In addition, the imposition of more stringent standards or requirements
under environmental laws or regulations, new developments or changes respecting
site cleanup costs or allocation of costs among PRPs, solvency of other PRPs,
the results of future testing and analysis undertaken with respect to certain
sites or a determination that we are potentially responsible for the release of
hazardous substances at other sites, could cause our expenditures to exceed our
current estimates. Because we may be jointly and severally liable for the total
remediation cost at certain sites, the amount we are ultimately liable for may
exceed our accruals due to, among other things, reallocation of costs among PRPs
or the insolvency of one or more PRPs. We cannot assure you that actual costs
will not exceed accrued amounts or the upper end of the range for sites for
which estimates have been made, and we cannot assure you that costs will not be
incurred for sites where no estimate presently can be made. Further, additional
environmental matters may arise in the future. If we were to incur any future
liability, this could have a material adverse effect on our consolidated
financial position, results of operations and liquidity.
We record liabilities related to environmental remediation obligations when
estimated future expenditures are probable and reasonably estimable. We adjust
our environmental accruals as further information becomes available to us or
circumstances change. We generally do not discounted estimated future
expenditures to their present value due to the uncertainty of the timing of the
pay out. We recognize recoveries of remediation costs from other parties, if
any, when their receipt is deemed probable. At September 30, 2006, there were no
receivables for recoveries.
We do not know and cannot estimate the exact time frame over which we will
make payments for our accrued environmental costs. The timing of payments
depends upon a number of factors including the timing of the actual remediation
process; this in turn depends on factors outside of our control. At each balance
sheet date, we estimate the amount of our accrued environmental costs we will
pay within the next 12 months. We classify this estimate as a current liability,
and we classify the remaining accrued environmental costs as a noncurrent
liability on our Consolidated Balance Sheet.
Changes in the accrued environmental costs during the first nine months
of 2006 are as follows:
Amount
--------------
(In thousands)
Balance at the beginning of the period $65,726
Additions charged to expense, net 3,840
Payments, net (7,242)
-------
Balance at the end of the period $62,324
=======
Amounts recognized in the Consolidated Balance Sheet at the end of the period:
Current liability $12,969
Noncurrent liability 49,355
-------
Total $62,324
=======
NL - On a quarterly basis, NL evaluates the potential range of its
liability at sites where it has been named as a PRP or defendant. At September
30, 2006, NL had accrued $51.5 million for those environmental matters which NL
believes are reasonably estimable. NL believes it is not possible to estimate
the range of costs for certain sites. The upper end of the range of reasonably
possible costs for sites for which NL believes it is currently possible to
estimate costs is approximately $78 million, including the amount currently
accrued. NL has not discounted these estimates to present value.
At September 30, 2006, there are approximately 20 sites for which NL 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 NL
actually had any association with the site, or if NL had an association with the
site, the nature of its responsibility, if any, for the contamination at the
site and the extent of contamination. NL cannot estimate when enough information
will become available to allow it to estimate a range of loss. The timing and
availability of information on these sites is dependent on events outside of
NL's control, such as when the party alleging liability provides information to
NL. On certain previously inactive sites, 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 the sites. These
notifications may assert that NL, along with other PRPs, is liable for past
clean-up costs. These costs could be material to us if NL were ultimately found
liable.
Tremont - Prior to 2005, Tremont, another of our wholly-owned subsidiaries,
entered into a voluntary settlement agreement with the Arkansas Department of
Environmental Quality and certain other PRPs pursuant to which Tremont and the
other PRPs will undertake certain investigatory and interim remedial activities
at a former mining site located in Hot Springs County, Arkansas. Tremont had
entered into an agreement with Halliburton Energy Services, Inc., another PRP
for this site that provides for, among other things, the interim sharing of
remediation costs associated with the site pending a final allocation of costs
and an agreed-upon procedure through arbitration with the first hearing to be
held in February 2007 to determine the final allocation of costs. On December 9,
2005, Halliburton and DII Industries, LLC, another PRP of this site, filed suit
in the United States District Court for the Southern District of Texas, Houston
Division, Case No. H-05-4160, against NL, Tremont and certain of its
subsidiaries, M-I, L.L.C., Milwhite, Inc. and Georgia-Pacific Corporation
seeking:
o to recover response and remediation costs incurred at the site,
o a declaration of the parties' liability for response and remediation
costs incurred at the site,
o a declaration of the parties' liability for response and remediation
costs to be incurred in the future at the site; and
o a declaration regarding the obligation of Tremont to indemnify
Halliburton and DII for costs and expenses attributable to the site.
On December 27, 2005, a subsidiary of Tremont filed suit in the United
States District Court for the Western District of Arkansas, Hot Springs
Division, Case No. 05-6089, against Georgia-Pacific, seeking to recover response
costs it has incurred and will incur at the site. Subsequently, plaintiffs in
the Houston litigation agreed to stay that litigation by entering into an
amendment with NL, Tremont and its affiliates to the arbitration agreement
previously agreed upon for resolving the allocation of costs at the site. The
subsidiary of Tremont has also agreed with Georgia Pacific to stay the Arkansas
litigation pending further developments in the Houston litigation, where the
court recently agreed to stay the plaintiffs claims against Tremont and its
subsidiaries, and denied Tremont's motions to dismiss and to stay the claims
made by M-I, Milwhite and Georgia Pacific. Tremont has accrued for this site
based upon the agreed-upon interim cost sharing allocation. Tremont has $3.0
million accrued at September 30, 2006 which represents the probable and
reasonably estimable costs to be incurred through 2008 with respect to the
interim remediation measures. Tremont currently expects it will be at least 2008
before the nature and extent of any final remediation measures for this site are
known. Tremont has not accrued costs for any final remediation measures at this
site because no reasonable estimate can currently be made of the cost of any
final remediation measures.
TIMET - At September 30, 2006, TIMET had accrued approximately $2.0 million
for environmental cleanup matters, principally related to their facility in
Nevada. The upper end of the range of reasonably possible costs related to these
matters, including the current accrual, is approximately $4.2 million.
Other - We have also accrued approximately $7.8 million at September 30,
2006 for other environmental cleanup matters related to us. This accrual is near
the upper end of the range of our estimate of reasonably possible costs for such
matters.
Other litigation
NL has been named as a defendant in various lawsuits in several
jurisdictions, alleging personal injuries as a result of occupational exposure
primarily to products manufactured by some of their former operations containing
asbestos, silica and/or mixed dust. Approximately 500 of these types of cases
remain pending, involving a total of approximately 10,700 plaintiffs and their
spouses. We have not accrued any amounts for this litigation because of the
uncertainty of liability and inability to reasonably estimate the liability, if
any. To date, we have not been adjudicated liable in any of these matters. Based
on information available to us, including:
o facts concerning our historical operations,
o the rate of new claims,
o the number of claims from which we have been dismissed; and
o our prior experience in the defense of these matters.
We believe the range of reasonably possible outcomes for these matters will be
consistent with our historical costs (which are not material), and we do not
expect any reasonably possible outcome would involve amounts that are material
to us. We have and will continue to vigorously seek dismissal from each claim
and/or a finding of no liability for us in each case. In addition, from time to
time, we receive notices regarding asbestos or silica claims purporting to be
brought against our former subsidiaries, including notices provided to insurers
with which we have entered into settlements extinguishing certain insurance
policies. These insurers may seek indemnification from us.
For a discussion of other legal proceedings to which we are a party, refer
to the Consolidated Financial Statements included in our 2005 Annual Report and
in our Quarterly Reports on Form 10-Q for the quarters ended March 31 and June
30, 2006.
As reflected in our 2005 Annual Report, Kronos' Belgian subsidiary and
certain of its employees were the subject of civil and criminal proceedings
relating to an accident that resulted in two fatalities at our Belgian facility
in 2000. In June 2006, the appellate court upheld a finding of civil
responsibility against the subsidiary, reduced by approximately 50% the fine
that had been imposed against the subsidiary by the lower court, and reversed
the finding of responsibility as it related to the individual Kronos employees.
No appeal was taken of the appellate court's decision.
In addition to the litigation described above, we and our affiliates are
involved in various other environmental, contractual, product liability, patent
(or intellectual property), employment and other claims and disputes incidental
to our present and former businesses. In certain cases, we have insurance
coverage for these items, although we do not expect any additional material
insurance coverage for our environmental claims.
We currently believe the disposition of all claims and disputes,
individually or in the aggregate, should not have a material adverse effect on
our consolidated financial position, results of operations and liquidity beyond
the accruals we have already provided.
Insurance coverage claims
For a complete discussion of certain litigation involving us and certain of
our former insurance carriers, refer to the 2005 Annual Report and our Quarterly
Reports on Form 10-Q for the quarters ended March 31 and June 30, 2006.
Additional information regarding such litigation, or new litigation, is below.
Certain Underwriters at Lloyds, London v. Millennium Holdings LLC et. al.
(Supreme Court of the State of New York, County of New York, Index No.
06/60026). In August 2006, the trial court denied our motion to dismiss, and we
have appealed that decision.
NL Industries, Inc. v. American Re Insurance Company, et al. (Dallas County
Court at Law, Texas, Case No. CC-06-04523-E). In September 2006, the court
stayed this proceeding pending outcome of the appeal in the two New York
actions.
In September 2006, we filed a declaratory judgment action against OneBeacon
and certain other former insurance companies, captioned NL Industries, Inc. v.
OneBeacon America Insurance Company, et al. (Dallas County Court at Law, Texas,
Case No. CC-06-13934-A) seeking interpretation of a Stand-Still Agreement, which
is governed by Texas law. The defendants have filed a motion to consolidate this
case with the NL Industries, Inc. v. American Re Insurance Company, et al. case
which we filed in April 2006. We intend to oppose consolidation of the cases.
The issue of whether insurance coverage for defense costs or indemnity or
both will be found to exist for NL's lead pigment litigation depends upon a
variety of factors, and we cannot assure you that such insurance coverage will
be available. NL has not considered any potential insurance recoveries for lead
pigment or environmental litigation matters in determining related accruals.
Note 16 - Recent accounting pronouncements:
Inventory Costs - Statement of Financial Accounting Standards ("SFAS") No.
151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, became effective
for us for inventory costs incurred on or after January 1, 2006. SFAS No. 151
requires that the allocation of fixed production overhead costs to inventory be
based on normal capacity of the production facilities, as defined by SFAS No.
151. SFAS No. 151 also clarifies the accounting for abnormal amounts of idle
facility expense, freight handling costs and wasted material, requiring those
items be recognized as current-period charges. Our existing production cost
policies complied with the requirements of SFAS No. 151, therefore the adoption
of SFAS No. 151 did not affect our Consolidated Financial Statements.
Stock Options - We adopted the fair value provisions of SFAS No. 123R,
Share-Based Payment, on January 1, 2006 using the modified prospective
application method. SFAS No. 123R, among other things, requires the cost of
employee compensation paid with equity instruments to be measured based on the
grant-date fair value. That cost is then recognized over the vesting period.
Using the modified prospective method, we will apply the provisions of the
standard to all new equity compensation granted after January 1, 2006 and any
existing awards vesting after January 1, 2006. The number of non-vested equity
awards issued by us or our subsidiaries as of December 31, 2005 is not material.
Prior to the adoption of SFAS No. 123R we accounted for our equity compensation
in accordance with APBO No. 25, Accounting for Stock Issued to Employees. Our
subsidiary NL accounted for their equity awards under the variable accounting
method whereby the equity awards were revalued based on the current trading
price at each balance sheet date. We now account for these awards using the
liability method under SFAS No. 123R, which is substantially identical to the
variable accounting method we previously used. We recorded net compensation
income for stock-based employee compensation of approximately $0.6 million in
the first nine months of 2005, and we recorded net compensation expense of
approximately $0.7 million in the third quarter of 2005. We recorded net
compensation income of approximately $0.4 million in the first nine months of
2006. We recorded no material compensation income or expense in the third
quarter of 2006. If we or our subsidiaries grant a significant number of equity
awards or modify, repurchase or cancel existing equity awards in the future, the
amount of equity compensation expense in our Consolidated Financial Statements
could be material.
Effective January 1, 2006, SFAS No. 123R requires the cash income tax
benefit we receive from the exercise of stock options in excess of the
cumulative income tax benefit previously recognized for GAAP financial reporting
purposes (which for us did not represent a significant amount in the first nine
months of 2006) to be reflected as a component of cash flows from financing
activities in our Consolidated Financial Statements. SFAS No. 123R also requires
certain expanded disclosures regarding equity compensation, and we provided
these expanded disclosures in our 2005 Annual Report.
Uncertain Tax Positions - In the second quarter of 2006 the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. ("FIN") 48,
Accounting for Uncertain Tax Positions, which will become effective for us on
January 1, 2007. FIN 48 clarifies when and how much of a benefit we can
recognize in our Consolidated Financial Statements for certain positions taken
in our income tax returns under SFAS No. 109, Accounting for Income Taxes, and
enhances the disclosure requirements for our income tax policies and reserves.
Among other things, FIN 48 will prohibit us from recognizing the benefits of a
tax position unless we believe it is more-likely-than-not our position will
prevail with the applicable tax authorities and limits the amount of the benefit
to the largest amount for which we believe the likelihood of realization is
greater than 50%. FIN 48 also requires companies to accrue penalties and
interest on the difference between tax positions taken on their tax returns and
the amount of benefit recognized for financial reporting purposes under the new
standard. Our current income tax accounting policies comply with this aspect of
the new standard. We will also be required to reclassify any reserves we have
for uncertain tax positions from deferred income tax liabilities, where they are
currently recognized, to a separate current or noncurrent liability, depending
on the nature of the tax position. We are currently evaluating the impact of FIN
48 on our Consolidated Financial Statements, and we expect to finalize our
analysis in the fourth quarter of 2006.
Planned Major Maintenance Activities - In September 2006, the FASB issued
FASB Staff Position ("FSP") No. AUG AIR-1, Accounting for Planned Major
Maintenance Activities, which will become effective for us in January 2007,
although early adoption is permitted. Under FSP No. AUG AIR-1 accruing in
advance for major maintenance is no longer permitted. Companies that previously
accrued in advance for major maintenance activities will be required to restate
retroactively their financial statements to reflect a permitted method of
expense for all periods presented. In the past our Chemicals Segment accrued in
advance for planned major maintenance. We will restate retroactively our
financial statements in the fourth quarter of 2006 to reflect the direct expense
method of accounting. The adoption of the FSP will have the following effect on
our previously reported net income for the periods indicated:
Increase (decrease)
in net income
-------------------------
2005 2006
---- ----
Quarter Ended: (In millions)
March 31 $ .9 $ .5
June 30 (.5) (.2)
September 30 - (.1)
December 31 (.3) na
---- ----
Total $ .1 $ .2
==== ====
Quantifying Financial Statement Misstatements - In the third quarter of
2006 the SEC issued Staff Accounting Bulletin ("SAB") No. 108 expressing their
views regarding the process of quantifying financial statement misstatements.
The SAB is effective for us no later than the fourth quarter of 2006. According
to SAB 108 both the "rollover" and "iron curtain" approaches must be considered
when evaluating a misstatement for materiality. This is referred to as the "dual
approach." For companies that have previously evaluated misstatements under one,
but not both, of these methods, SAB 108 provides companies with a one-time
option to record the cumulative effect of their prior unadjusted misstatements
in a manner similar to a change in accounting principle in their 2006 annual
financial statements if (i) the cumulative amount of the unadjusted
misstatements as of January 1, 2006 would have been material under the dual
approach to their annual financial statements for 2005 or (ii) the effect of
correcting the unadjusted misstatements during 2006 would cause those annual
financial statements to be materially misstated under the dual approach. We do
not expect the adoption of SAB 108 will have a material effect on our previously
reported consolidated financial position or results of operations at the date of
adoption for us and our consolidated subsidiaries. TIMET is still evaluating the
impact, if any, that SAB 108 will have on its Consolidated Financial Statements
Fair Value Measurements - In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements, which will become effective for us on January 1, 2007.
SFAS No. 157 generally provides a consistent, single fair value definition and
measurement techniques for GAAP pronouncements. SFAS No. 157 also establishes a
fair value hierarchy for different measurement techniques based on the objective
nature of the inputs in various valuation methods. We will be required to ensure
all of our fair value measurements are in compliance with SFAS No. 157 on a
prospective basis beginning in the first quarter of 2007. In addition, we will
be required to expand our disclosures regarding the valuation methods and level
of inputs we utilize in the first quarter of 2007. The adoption of this standard
will not have a material effect on our Consolidated Financial Statements.
Pension and Other Postretirement Plans - In September 2006, the FASB issued
SFAS No. 158, Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans. SFAS No. 158 requires us to recognize an asset or
liability for the over or under funded status of each of our individual defined
benefit pension and postretirement benefit plans on our Consolidated Balance
Sheets. We will recognize through other comprehensive income prior unrecognized
gains and losses and prior service costs or credits, net of tax, as of December
31, 2006 that we currently amortize through net periodic benefit cost. All
future changes in the funded status of these plans will be recognized through
comprehensive income, net of tax (either net income or other comprehensive
income). We will also provide certain new disclosures related to these plans. In
addition, we currently use September 30 as a measurement date for certain of our
pension and postretirement benefit plans, but under this standard we will be
required to use December 31 as the measurement date for all of our plans. The
measurement date requirement of SFAF No. 158 will become effective for us by the
end of 2008 and provides two alternate transition methods; we have not yet
determined which transition method we will select. This standard does not change
the existing recognition and measurement requirements that determine the amount
of periodic benefit cost recognized in net income.
The asset and liability recognition and disclosure requirements of this
standard will become effective for us as of December 31, 2006 and will be
adopted prospectively. We will not complete the 2006 assessment of the funded
status of our pension and postretirement benefit plans until after December 31,
2006. At December 31, 2005, our pension and post retirement benefit plans were
under funded by $218.4 million in the aggregate, and we had a net $174.4 million
liability recognized on our Consolidated Balance Sheet related to these plans.
Our 2006 funded status will be based in part on certain actuarial assumptions
that we cannot yet determine and differences between the actual and expected
return on plan assets during the year. Therefore, we are not able to determine
the impact this standard will have on our Consolidated Financial Statements;
however we believe the net effect of adopting SFAS No. 158 will reduce our
stockholders' equity at December 31, 2006. In addition, our investment in TIMET
and out stockholders' equity will be affected by our pro-rata share of the
effect to TIMET from adopting this standard, and TIMET believes the net effect
of adopting SFAS No. 158 will reduce their stockholders' equity. The full
disclosure of the funded status of our defined benefit pension and
postretirement benefit plans at December 31, 2005 can be found in Note 16 to our
2005 Annual Report.
-------------------------------------------------------------------------------
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
-------------------------------------------------------------------------------
RESULTS OF OPERATIONS
Business Overview
We are primarily a holding company. We operate through our wholly-owned and
majority-owned subsidiaries, including NL Industries, Inc., Kronos Worldwide,
Inc., CompX International, Inc., Tremont LLC and Waste Control Specialists LLC
("WCS"). We are also the largest shareholder of Titanium Metals Corporation
("TIMET") although we own less than a majority interest. Kronos (NYSE: KRO), NL
(NYSE: NL), CompX (NYSE: CIX) and TIMET (NYSE: TIE) each file periodic reports
with the Securities and Exchange Commission ("SEC").
We have three consolidated operating segments:
o Chemicals - Our chemicals segment is operated through our majority
ownership of Kronos. Kronos is a leading global producer and marketer
of value-added titanium dioxide pigments ("TiO2"). TiO2 is used for a
variety of manufacturing applications, including plastics, paints,
paper and other industrial products.
o Component Products - We operate in the component products industry
through our majority ownership of CompX. CompX is a leading
manufacturer of precision ball bearing slides, security products and
ergonomic computer support systems used in office furniture,
transportation, tool storage and a variety of other industries. CompX
has recently entered the performance marine components industry
through the acquisition of two performance marine manufacturers.
o Waste Management - WCS is our wholly-owned subsidiary which owns and
operates a West Texas facility for the processing, treatment, storage
and disposal of hazardous, toxic and certain types of low level
radioactive waste. WCS is in the process of obtaining regulatory
authorization to expand its low-level and mixed low-level radioactive
waste handling capabilities.
In addition, we account for our 35% less than majority interest in TIMET by
the equity method. TIMET is a leading global producer of titanium sponge, melted
products and milled products. Titanium is used for a variety of commercial,
aerospace, military, medical and other emerging markets. TIMET is also the only
titanium producer with major production facilities in both of the world's
principal titanium markets: the U.S. and Europe.
General
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Statements in this Quarterly
Report on Form 10-Q that are not historical in nature are forward-looking in
nature about our future that are not statements of historical fact. Statements
in this report including, but not limited to, statements found in Item 2 -
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," are forward-looking statements that represent our beliefs and
assumptions based on currently available information. In some cases you can
identify these forward-looking statements by the use of words such as
"believes," "intends," "may," "should," "could," "anticipates," "expected" or
comparable terminology, or by discussions of strategies or trends. Although we
believe the expectations reflected in forward-looking statements are reasonable,
we do not know if these expectations will be correct. Forward-looking statements
by their nature involve substantial risks and uncertainties that could
significantly impact expected results. Actual future results could differ
materially from those predicted. While it is not possible to identify all
factors, we continue to face many risks and uncertainties. Among the factors
that could cause our actual future results to differ materially from those
described herein are the risks and uncertainties discussed in this Quarterly
Report and those described from time to time in our other filings with the SEC
including, but not limited to, the following:
o Future supply and demand for our products,
o The extent of the dependence of certain of our businesses on certain
market sectors (such as the dependence of TIMET's titanium metals
business on the commercial aerospace industry),
o The cyclicality of certain of our businesses (such as Kronos' TiO2
operations and TIMET's titanium metals operations),
o The impact of certain long-term contracts on certain of our businesses
(such as the impact of TIMET's long-term contracts with certain of its
customers and such customers' performance thereunder and the impact of
TIMET's long-term contracts with certain of its vendors on its ability
to reduce or increase supply or achieve lower costs),
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 TiO2in
advance of anticipated price decreases, or the relationship between
inventory levels of TIMET's customers and such customers' current
inventory requirements and the impact of such relationship on their
purchases from TIMET),
o Changes in our raw material and other operating costs (such as energy
costs),
o The possibility of labor disruptions,
o General global economic and political conditions (such as changes in
the level of gross domestic product in various regions of the world
and the impact of such changes on demand for, among other things,
TiO2),
o Competitive products and substitute products,
o Possible disruption of our business or increases in the cost of doing
business resulting from terrorist activities or global conflicts,
o Customer and competitor strategies,
o The impact of pricing and production decisions,
o Competitive technology positions,
o The introduction of trade barriers,
o Fluctuations in currency exchange rates (such as changes in the
exchange rate between the U.S. dollar and each of the euro, the
Norwegian kroner and the Canadian dollar),
o Operating interruptions (including, but not limited to, labor
disputes, leaks, natural disasters, fires, explosions, unscheduled or
unplanned downtime and transportation interruptions),
o The timing and amounts of insurance recoveries,
o Our ability to renew or refinance credit facilities,
o The extent to which our subsidiaries were to become unable to pay us
dividends,
o Uncertainties associated with new product development (such as TIMET's
ability to develop new end-uses for its titanium products),
o The ultimate outcome of income tax audits, tax settlement initiatives
or other tax matters,
o The ultimate ability to utilize income tax attributes, the benefit of
which has been recognized under the "more likely than not" recognition
criteria (such as Kronos' ability to utilize its German net operating
loss carryforwards),
o Environmental matters (such as those requiring compliance with
emission and discharge standards for existing and new facilities, or
new developments regarding environmental remediation at sites related
to our former operations),
o Government laws and regulations and possible changes therein (such as
changes in government regulations which might impose various
obligations on present and former manufacturers 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 of
NL and Tremont), and
o Possible future litigation.
Should one or more of these risks materialize (or the consequences of such
development worsen), or should the underlying assumptions prove incorrect,
actual results could differ materially from those currently forecasted or
expected. We disclaim any intention or obligation to update or revise any
forward-looking statement whether as a result of changes in information, future
events or otherwise.
Income From Continuing Operations Overview
Quarter Ended September 30, 2005 Compared to the Quarter Ended September 30,
2006 -
We reported income from continuing operations of $19.6 million, or $.17 per
diluted share, in the third quarter of 2006 compared to income of $13.4 million,
or $.11 per diluted share, in the third quarter of 2005. Our diluted earnings
per share increased from 2005 to 2006 primarily due to the net effects of:
o lower effective income tax rate in 2006 primarily due to an unusually
high provision in 2005 related to audit developments in our Chemicals
Segment's operations in Germany, Belgium and Canada and a change in
the permanent reinvestment conclusion for certain earnings of certain
foreign subsidiaries of our Component Products Segment;
o higher equity in earnings from TIMET in 2006;
o higher general expenses of NL in 2006 as a result of increased
litigation costs; and
o lower operating income from our segments in 2006, as improvements in
operating income from our Component Products and Waste Management
Segments were more than offset by a decline in operating income at our
Chemicals Segment.
Our income from continuing operations in 2005 includes (net of tax and
minority interest, as applicable):
o a non-cash income tax expense of $.05 per diluted share related to
developments in certain income tax audits at NL and our Chemicals
Segment and a change in the permanent reinvestment conclusions for
earnings of certain foreign subsidiaries of our Component Products
Segment; and
o income of $.01 per diluted share related to certain income tax
benefits recognized by TIMET.
Our income from continuing operations in 2006 includes (net of tax and
minority interest):
o income tax expense of $.02 per diluted share related to the
unfavorable resolution of certain income tax issues related to our
Chemicals Segment's German operations.
Nine Months Ended September 30, 2005 Compared to the Nine Months Ended September
30, 2006 -
We reported income from continuing operations of $60.9 million, or $.52 per
diluted share, in the first nine months of 2006 compared to income of $66.7
million, or $.56 per diluted share, in the first nine months of 2005. Our
diluted earnings per share declined from 2005 to 2006 due primarily to the net
effects of:
o a charge in 2006 from the redemption of our 8.875% Senior Secured
Notes;
o certain securities transaction gains realized in 2005;
o lower operating income from our segments, as improvements in operating
income from our Component Products and Waste Management Segments were
more than offset by a decline in operating income at our Chemicals
Segment;
o lower effective income tax rate in 2006 primarily due to an unusually
high provision in 2005 related to audit developments in our Chemicals
Segment's operations in Germany, Belgium and Canada and a change in
the permanent reinvestment conclusion for earnings of certain foreign
subsidiaries at our Component Products Segment as well as an aggregate
income tax benefit recognized by our Chemicals Segment in 2006; and
o higher equity in earnings from TIMET in 2006.
Our income from continuing operations in 2005 includes (net of tax and
minority interest, as applicable):
o income related to certain income tax benefits recognized by TIMET of
$.09 per diluted share;
o gains from NL's sales of shares of Kronos common stock of $.05 per
diluted share;
o a gain from the sale of our passive interest in a Norwegian smelting
operation of $.02 per diluted share;
o income related to TIMET's sale of certain real property adjacent to
its Nevada operations of $.02 per diluted share;
o income of $.01 per diluted share related to certain insurance
recoveries recognized by NL; and
o a non-cash income tax expense of $.05 per diluted share related to
developments in certain income tax audits at NL and our Chemicals
Segment and a change in the permanent reinvestment conclusion for
earnings of certain foreign subsidiaries of our Component Products
Segment.
Our income from continuing operations in 2006 includes (net of tax and
minority interest, as applicable):
o a charge related to the redemption of our 8.875% Senior Secured Notes
of $.09 per diluted share;
o net income tax benefit of $.05 per diluted share at our Chemicals
Segment related to the net effect of the withdrawal of certain income
tax assessments previously made by Belgian and Norwegian tax
authorities, the favorable resolution of certain income tax issues
related to our German and Belgian operations and the enactment of a
reduction in Canadian federal income tax rates offset by the
unfavorable resolution of certain other income tax issues related to
our German operations; and
o income of $.01 per diluted share related to certain insurance
recoveries recognized by NL.
The third quarter and the first nine month amounts are more fully discussed
below.
We currently believe net income for the full year 2006 will be higher than
2005, as the gain from the land we sold in the fourth quarter of this year and
our higher equity in earnings of TIMET are expected to more than offset our
lower expected operating income from our Chemicals Segment. See Note 11 to the
Consolidated Financial Statements.
Segment Operating Results - 2005 Compared to 2006 -
Chemicals -
We consider TiO2 to be a "quality of life" product, with demand affected by
gross domestic product (or "GDP") in various regions of the world. Over the
long-term, we expect demand for TiO2 will grow by 2% to 3% per year, consistent
with our expectations for the long-term growth in GDP. However, even if we and
our competitors maintain consistent shares of the worldwide market, demand for
TiO2 in any interim or annual period may not change in the same proportion as
the change in GDP, in part due to relative changes in the TiO2 inventory levels
of our customers. We believe our customers' inventory levels are partly
influenced by their expectation for future changes in market TiO2 selling
prices.
The factors having the most impact on our reported operating results are:
o Our TiO2 average selling prices;
o Foreign currency exchange rates (particularly the exchange rate for
the U.S. dollar relative to the euro and the Canadian dollar);
o Our TiO2 sales and production volumes; and
o Our manufacturing costs, particularly maintenance and energy-related
expenses.
The key performance indicators for our Chemicals Segment are TiO2 average
selling prices, and TiO2 sales and production volumes.
Three months ended Nine months ended
September 30, September 30,
----------------------------- --------------------------
2005 2006 % Change 2005 2006 % Change
---- ---- -------- ---- ---- --------
(Dollars in millions)
Net sales $292.1 $331.6 14 % $895.7 $981.0 10 %
Cost of sales 219.9 260.0 18 % 652.3 759.9 17 %
------ ------ ------ ------
Gross margin $ 72.2 $ 71.6 (1)% $243.4 $221.1 (9)%
====== ====== ====== ======
Operating income $ 35.5 $ 32.0 (10)% $134.2 $ 98.5 (27)%
Percent of net sales:
Cost of goods sold 75% 78% 73% 77%
Gross margin 25% 22% 27% 23%
Operating income 12% 10% 15% 10%
TiO2 operating statistics:
Sales volumes* 119 132 11 % 356 396 11 %
Production volumes* 122 126 3 % 371 383 3 %
Percent change in net
sales:
TiO2 Product pricing (1)% - %
TiO2 Sales volumes 11 % 11 %
TiO2 product mix 1 % - %
Changes in currency exchange rates 3 % (1)%
-- ---
14 % 10 %
=== ===
* Thousands of metric tons
Net Sales - Our Chemicals Segment's sales increased significantly in the
third quarter of 2006 compared to the third quarter of 2005 due primarily to an
11% increase in TiO2 sales volumes and the favorable effect of fluctuations in
foreign currency exchange rates, which increased sales by approximately $9
million, or 3%, somewhat offset by a 1% decrease in average TiO2 selling prices.
Chemicals sales also increased significantly in the first nine months of 2006
compared to the first nine months of 2005 primarily due to an 11% increase in
TiO2 sales volumes, somewhat offset by the unfavorable effect of changes in
currency exchange rates, which decreased our Chemicals Segment's sales by
approximately $11 million, or 1%. We expect selling prices in the fourth quarter
of 2006 to decline slightly from the third quarter of 2006.
Our Chemicals Segment's sales volumes in the first nine months of 2006 were
a new record for us. The increase in our TiO2 sales volumes in 2006 was due
primarily to higher sales volumes in the United States, Europe and in export
markets, which were partially offset by lower sales volumes in Canada. Our sales
volumes in Canada have been impacted by decreased demand for TiO2 used in paper
products. We expect demand for TiO2 will continue to remain high for the
remainder of the year.
Cost of Sales - Our Chemicals Segment's cost of sales increased in 2006
primarily due to the impact of higher sales volumes and higher operating costs.
Cost of sales as a percentage of sales increased in 2006 primarily due to
increases in raw material and utility costs (primarily energy costs) and
currency fluctuations (primarily the Canadian dollar). We estimate our raw
material and utility costs increased 4% and 24%, respectively, in the third
quarter of 2006 compared to the same period last year and 5% and 21%,
respectively, in the first nine months of 2006 compared to 2005. The negative
impact of the increase in raw materials and energy costs on our Chemicals
Segment's gross margin and operating income comparisons was somewhat offset by
record TiO2 production volumes which increased 3% in both the third quarter and
first nine months of 2006 compared to the same period of 2005. We continued to
gain operational efficiencies by enhancing our processes and debottlenecking
production to meet long-term demand. Our operating rates were near full capacity
in both periods, and our TiO2 production volumes in the third quarter and first
nine months of 2006 were new records for us.
Through our debottlenecking program, we added finishing capacity in our
German chloride-process facility which along with equipment upgrades and
enhancements in several locations, have allowed us to reduce downtime for
maintenance activities. Our production capacity has increased by approximately
30% over the past ten years with only moderate capital expenditures. We believe
our annual attainable TiO2 production capacity for 2006 is approximately 515,000
metric tons, with some additional capacity expected to be available in 2007
through our continued debottlenecking efforts.
Operating Income - Our Chemicals Segment's operating income declined in
2006 primarily due to of the decrease in gross margin and the effect of
fluctuations in foreign currency exchange rates. While our sales volumes were
higher in 2006, our gross margin has decreased as pricing has not improved to
offset the negative impact of our increased operating costs (primarily raw
materials and energy costs). Changes in currency rates also negatively affected
our gross margin. We estimate the negative effect of changes in foreign currency
exchange rates decreased income from operations by $3 million and $18 million in
the third quarter and first nine months of 2006 compared to 2005.
Our Chemicals Segment's operating income is net of amortization of purchase
accounting adjustments made in conjunction with our acquisitions of interests in
NL and Kronos. As a result, we recognize additional depreciation expense above
the amounts Kronos reports separately, substantially all of which is included
within cost of goods sold. We recognized an additional $12.6 million of
depreciation expense in the first nine months of 2005 and $12.3 million in the
first nine months of 2006, which reduced our reported Chemicals Segment
operating income as compared to amounts reported by Kronos.
Foreign Currency Exchange Rates - Our Chemicals Segment has substantial
operations and assets located outside the United States (primarily in Germany,
Belgium, Norway and Canada). The majority of sales generated from our foreign
operations are denominated in foreign currencies, principally the euro, other
major European currencies and the Canadian dollar. A portion of our sales
generated from our foreign operations are denominated in the U.S. dollar.
Certain raw materials used worldwide, primarily titanium-containing feedstocks,
are purchased in U.S. dollars, while labor and other production costs are
purchased primarily in local currencies. Consequently, the translated U.S.
dollar value of our foreign sales and operating results are subject to currency
exchange rate fluctuations which may favorably or adversely impact reported
earnings and may affect the comparability of period-to-period operating results.
Overall, fluctuations in foreign currency exchange rates had the following
effects on our Chemicals Segment's net sales and operating income in 2006 as
compared to 2005.
Increase (decrease)
-----------------------------------------------
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
----------------- -----------------
(In millions)
Impact on:
Net sales $ 9 $(11)
Operating income (3) (18)
Other - On September 22, 2005, the chloride-process TiO2 facility operated
by our 50%-owned joint venture, Louisiana Pigment Company ("LPC"), temporarily
halted production due to Hurricane Rita. Although there was minimal storm damage
to core processing facilities, a variety of factors, including loss of
utilities, limited access and availability of employees and raw materials,
prevented the resumption of partial operations until October 9, 2005 and full
operations until late 2005. LPC expects the majority of its property damage and
unabsorbed fixed costs for periods in which normal production levels were not
achieved will be covered by insurance, and we believe insurance will cover our
lost profits (subject to applicable deductibles) resulting from our share of the
lost production at LPC. We and LPC have both filed claims with our respective
insurers. We expect to recover our losses through the insurer in the fourth
quarter of 2006 or early 2007, although we do not know the amount and timing of
the insurance recovery yet. Accordingly, we have not accrued a receivable for
the amount of the insurance claim and will not record the claim until we
finalize negotiations with the insurer. The effect on our Chemicals Segment's
operating results will depend on the timing and amount of insurance recoveries.
Outlook - We expect our Chemicals Segment's operating income in the fourth
quarter of 2006 will continue to be lower than the fourth quarter of 2005
primarily due to continued downward pricing pressures and increased raw material
and energy costs. Our expectations as to the future of the TiO2 industry are
based upon a number of factors beyond our 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 our expectations, our Chemicals Segment results of
operations could be unfavorably affected.
Component Products -
The key performance indicator for our Component Products Segment is
operating income margin.
Three months ended Nine months ended
September 30, September 30,
----------------------------- ------------------------------
2005 2006 % Change 2005 2006 % Change
---- ---- -------- ---- ---- --------
(Dollars in millions)
Net sales $47.1 $48.8 4% $139.7 $146.0 4%
Cost of sales 36.1 36.0 -% 107.9 109.2 1%
----- ----- ------ ------
Gross margin $11.0 $12.8 17% $ 31.8 $ 36.8 16%
===== ===== ====== ======
Operating income $ 4.9 $ 6.2 27% $ 13.8 $ 17.0 23%
Percent of net sales:
Cost of goods sold 77% 74% 77% 75%
Gross margin 23% 26% 23% 25%
Operating income 10% 13% 10% 12%
Net Sales - Our Component Products Segment's sales increased in the third
quarter and first nine months of 2006 as compared to the third quarter and first
nine months of 2005 mainly due to new sales volumes generated from the August
2005 and April 2006 acquisitions of two marine component businesses, which
increased by $2.1 million and $10.4 million in the third quarter and first nine
months of 2006, respectively, and increased sales volumes of security products
due to improved demand and the favorable effects of foreign currency exchange
rates. These sales gains were offset by lower sales volumes for certain
furniture component products resulting from competition from lower-priced Asian
manufacturers.
Cost of Sales - Our Component Products Segment's cost of goods sold
increased in 2006 as compared to 2005 due to the increase in sales volumes. As a
percent of sales, Component Products cost of goods sold was lower in 2006 as
compared to 2005 primarily due to improvements in product mix as the decline in
lower-margin furniture components sales were offset by increased sales of
higher-margin security and our marine component products.
Operating Income - Our Component Products Segment's gross margin and
operating income increased in 2006 primarily due to the increase in sales and
more favorable product mix as well as decreased operational costs as a result of
a continuous focus on reducing costs across all product lines, partially offset
by the negative impact of currency exchange rates.
Foreign Currency Exchange Rates - Our Component Products Segment has
substantial operations and assets located outside the United States in Canada
and Taiwan. The majority of sales generated from our foreign operations are
denominated in the U.S. dollar, with the rest denominated in foreign currencies,
principally the Canadian dollar and the New Taiwan dollar. Most of our raw
materials, labor and other production costs for foreign operations are
denominated primarily in local currencies. Consequently, the translated U.S.
dollar values of our 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.
Overall, fluctuations in foreign currency exchange rates had the following
effects on our Component Products Segment's sales and operating income in 2006
as compared to 2005.
Increase (decrease)
-----------------------------------------------
Three months ended Nine months ended
September 30, 2006 September 30, 2006
vs. 2005 vs. 2005
----------------- -----------------
(In thousands)
Impact on:
Net sales $ 265 $ 1,009
Operating income (226) (1,178)
Outlook - The component product markets we operate in are highly
competitive in terms of product pricing and features. Our Component Products
Segment's strategy is to focus on areas where we can provide products that have
value-added, user-oriented features which enable our customers to compete more
effectively in their markets. One of the focal points of our strategy is to
replace low margin, commodity type products with higher margin user-oriented
feature products. While this strategy is likely to result in lower volumes in
the short term, we expect the long-term effect will increase both sales and
profits. Additionally, we believe our focus on collaborating with customers to
identify solutions and our ability to provide a high level of customer service
enable us to compete effectively. In response to competitive pricing pressure,
we continually focus on reducing production costs through product reengineering,
improvement in manufacturing processes or moving production to lower cost
facilities.
Raw material prices, especially steel, zinc and copper continue to be
volatile putting pressure on our Component Products Segment's margins. We are
actively mitigating the margin impact by entering into raw material supply
agreements in order to stabilize costs for a period of time, executing larger
volume tactical spot purchases at prices that are expected to be favorable
compared to future prices and, if necessary, passing on cost increases to our
customers through surcharges and price increases. To date we have been able to
effectively mitigate the impact of higher raw material costs on our margins,
however, we may not be able to achieve these same results in future periods.
Waste Management -
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions)
Net sales $ 3.0 $ 2.7 $ 7.5 $10.0
Cost of goods sold 4.0 3.4 11.7 11.3
----- ----- ----- -----
Gross margin $(1.0) $(0.7) $(4.2) $(1.3)
===== ===== ===== =====
Operating loss $(2.8) $(2.4) $(9.1) $(6.1)
General - We continue to operate our Waste Management facility owned by WCS
on a relatively limited basis while we navigate the regulatory licensing
requirements to receive permits for the disposal of byproduct 11.e(2) waste
material and for a broad range of low-level and mixed low-level radioactive
wastes. We have previously filed license applications for such disposal
capabilities with the applicable Texas state agencies, but we are uncertain as
to the length of time it will take for the agencies to complete their reviews
and act upon our license applications. We currently believe the applicable state
agency will not issue a final decision on our application for 11.e(2) waste
material until late 2008, but we do not expect to receive a final decision on
our application for the low-level and mixed low-level radioactive waste disposal
capability until January 2009. We do not know if we will be successful in
obtaining these licenses. While the approvals for these licenses are still in
process, we currently have permits which allow us to treat, store and dispose of
a broad range of hazardous and toxic wastes, and to treat and store a broad
range of low-level and mixed low-level radioactive wastes.
Net sales and operating loss - Our Waste Management Segment's sales
increased during the first nine months of 2006 compared to 2005, and our Waste
Management operating loss decreased, in 2006 as compared to the same periods in
2005 as we obtained new customers and existing customers increased their
utilization of our waste management services. Sales for the third quarter
decreased slightly from the prior year due to lower direct land fill revenue. We
continue to seek to increase our Waste Management Segment's sales volumes from
waste streams permitted under our current licenses.
Outlook - We are also exploring opportunities to obtain certain types of
new business (including disposal and storage of certain types of waste) that, if
obtained, could help to further increase Waste Management Segment's sales, and
decrease Waste Management Segment's operating losses, in 2007. Our ability to
achieve increased Waste Management Segment's sales volumes through these waste
streams, together with improved operating efficiencies through further cost
reductions and increased capacity utilization, are important factors in
improving our Waste Management operating results and cash flows. Until we are
able to increase our Waste Management Segment's sales volumes, we expect we wll
continue to generally report operating losses in our Waste Management Segment.
While achieving increased sales volumes could result in operating profits, we
currently do not believe we will report any significant levels of Waste
Management operating profit until we have obtained the licenses discussed above.
We believe WCS can become a viable, profitable operation, even if we are
unsuccessful in obtaining a license for the disposal of a broad range of
low-level and mixed low-level radioactive wastes. However, we do not know if we
will be successful in improving WCS's cash flows. We have in the past, and we
may in the future, consider strategic alternatives with respect to WCS. We could
report a loss in any such strategic transaction.
Equity in earnings of TIMET -
Three months ended Nine months ended
September 30, September 30,
------------------------------ ---------------------------
2005 2006 % Change 2005 2006 % Change
---- ---- -------- ---- ---- --------
(Dollars in millions)
As reported by TIMET:
Net sales $190.0 $271.8 43 % $529.0 $859.6 62 %
Cost of sales 134.3 174.0 30 % 396.4 547.2 38 %
------ ------ ------ ------
Gross margin 55.7 97.8 75 % 132.6 312.4 136 %
Other operating expenses, net 4.0 13.2 230 % 24.5 39.1 60 %
------ ------ ------ ------
Operating income 51.7 84.6 63 % 108.1 273.3 153 %
Interest expense (1.1) (.8) (2.7) (2.4)
Other, net 1.4 .6 17.5 (.8)
------ ------ ------ ------
Pre-tax income 52.0 84.4 122.9 270.1
Provision for income taxes (14.4) (28.6) (4.9) (94.7)
Minority interest (1.3) (1.6) (3.4) (6.2)
Dividends on preferred stock (2.9) (1.5) (9.5) (5.4)
------ ------ ------ ------
Net income attributable to
common stock holders $ 33.4 $ 52.7 58 % $105.1 $163.8 56 %
====== ====== ====== ======
Equity in earnings of TIMET $ 15.5 $ 19.2 24 % $ 48.1 $ 61.7 28 %
====== ====== ====== ======
Percent of net sales:
Cost of goods sold 71% 64% 75% 64%
Gross margin 29% 36% 25% 36%
Operating income 27% 31% 20% 32%
Shipment volumes (metric tons):
Melted products 1,345 1,275 (5)% 4,120 4,280 4 %
Mill products 2,940 3,150 7 % 9,380 10,575 13 %
------ ------ ------ ------
Total 4,285 4,425 3 % 13,500 14,855 10 %
====== ====== ====== ======
Average selling price ($ per kilogram):
Melted products $23.15 $38.95 68 % $18.70 $36.45 95 %
Mill products 43.60 59.75 37 % 39.85 56.80 43 %
Net Sales - We experienced significant growth in our Titanium Metals sales
and operating income during 2006 as compared to 2005, as we and the titanium
industry as a whole have benefited from significantly increased demand for
titanium across all industry sectors that has driven melted and mill titanium
prices to record levels. As a result of these market factors, our average
selling prices for melted and milled products in the third quarter of 2006
increased 68% and 37%, respectively, over the same period in 2005. For the first
nine months of 2006, these average selling prices increased 95% and 43%,
respectively.
Our combined volumes of melted and mill product shipments during the third
quarter of 2006 were consistent with the volumes of shipments in the prior year
period, but in response to market demands, our product mix shifted toward an
increased level of mill products. For the first nine months of 2006, we have
delivered 4% more melted products and 13% more mill products compared to the
2005 period. In addition, other product sales have also increased 10% and 32%,
respectively, in the third quarter and first nine months of 2006 compared to the
same periods in the prior year due principally to improved demand for our
fabrication products.
Our ability to grow sales through sales volumes increases is limited by
capacity constraints. We are currently producing at approximately 88% of
capacity at the majority of our Titanium Metals facilities. As a result of
current production levels, current demand and future outlook for demand for our
titanium products, we have initiated several strategic capital improvement
projects at our existing facilities that will add capacity to capitalize on the
anticipated increase in demand. We expect to maintain production levels near 90%
of practical capacity for the remainder of 2006.
Cost of sales and gross margin - Our cost of sales increased significantly
in 2006. A substantial portion of the increase in our cost of sales is due to
higher cost of raw materials, including purchased titanium sponge and purchased
titanium scrap. The higher cost of our purchased sponge is due principally to
our utilization in 2005 of lower-cost sponge we had purchased from the U.S.
Defense Logistics Agency stockpile. We purchased sponge from the DLA stockpile
since 2000, but the stockpile was fully depleted in 2005. The higher cost of our
purchased titanium scrap is due to increased industry-wide demand as well as
demand in non-titanium markets that use titanium as an alloying agent. The
impact of market increases in the cost of sponge and scrap was mitigated in part
because certain of our raw material purchases are subject to long term
agreements. In addition to the impact of higher raw material costs, our cost of
sales increased as we increased our manufacturing employee headcount by
approximately 170 full time equivalents in the first nine months of 2006
compared to the 2005 in order to support the continued growth of our business.
These negative cost increases were somewhat offset by a favorably product mix
and plant operating rates, which increased to 88% of practical capacity in the
first nine months of 2006 from 78% in the first nine months of 2005
Equity in Earnings of TIMET - Our Titanium Metals comparisons were also
negatively impacted in 2006 by a $1.3 million charge we recognized for a change
in estimate of the aggregate liability for worker's compensation bonds issued on
behalf of a former subsidiary of TIMET, Freedom Forge Corporation. During the
second quarter of 2005, we realized a pre-tax gain of $13.9 million on the sale
of property and during the third quarter of 2005 we recognized a pre-tax gain of
$8.3 million on the Boeing take-or-pay agreement. TIMET's effective income tax
rate is significantly higher in 2006 as compared to 2005, primarily due to
TIMET's reversal during the first nine months of 2005 of $41.3 million of its
valuation allowance attributable to its U.S. and U.K. deferred income tax
assets.
Outlook - We continued to achieve record levels for net sales, operating
income and net income through the first nine months of 2006. These operating
results were largely driven by increased demand in the commercial aerospace
sector and improved production levels. Capacity constraints for both melted and
mill products in the titanium industry coupled with a relatively short supply of
raw materials also contributed to improved selling prices for both melted and
mill products. With our plant production levels near practical capacity, our
ability to grow sales through volume increases depends upon the successful
execution of our ongoing capacity expansion plans. We have initiated several
strategic capital improvement projects at our existing facilities that will add
capacity to capitalize on the anticipated increase in demand, as further
discussed below. We are also in the process of pursuing additional capacity
expansion alternatives in melting and mill products conversion, which could
provide a significant increase in existing production capabilities. Our backlog
at September 30, 2006 was $1.0 billion, compared to $870 million at December 31,
2005 and $710 million at September 30, 2005.
We expect that current industry-wide demand trends will continue through
2011. However, we are seeing a near-term adjustment relative to the production
delays for the Airbus A380 commercial aircraft. We do not know the degree to
which our average selling prices will continue to increase as a result of the
expected continuing improvement in demand. We currently expect production
volumes to remain at current levels for the remainder of 2006, with overall
capacity utilization expected to approximate 90% of practical capacity for the
full year 2006 (as compared to 80% in 2005). However, partical capacity
utilization measures can vary significantly based on product mix. We further
anticipate maintaining high production levels through 2007, and once our
additional electron beam ("EB") cold hearth melt capacity becomes operational in
2008, we anticipate our EB melt practical capacity to increase 54% or 8,500
metric tons.
Our business is more dependent on commercial aerospace demand than the
titanium industry as a whole. We monitor various information sources including
The Airline Monitor, a leading aerospace publication, for commercial aerospace
industry demand and forecast information. In July 2006, The Airline Monitor,
issued its latest forecast for commercial aircraft deliveries. This forecast
delays the expected delivery timeline for approximately one percent of the
planes previously forecasted for delivery in 2006 and 2007. However, with an
increase in expected deliveries from 2008 through 2010, this forecast confirms
the previously projected trend of increasing large commercial aircraft
deliveries in the five years ending in 2010, and the current estimate of 3,800
delivered aircraft exceeds previous five-year estimates by 80 planes. The
current estimate of large commercial aircraft deliveries through 2010 includes
210 Boeing 787 wide bodies (which currently require a higher percentage of
titanium in their airframes, engines and other parts than any other commercial
aircraft). This updated forecast supports our belief that the titanium industry
is in the early stages of the business cycle and that current industry-wide
demand trends will likely continue through 2011.
Raw materials including titanium sponge, scrap and alloys, represent the
largest portion of our manufacturing cost structure. We expect the availability
of certain raw materials to remain tight in the near term and improve as
announced capacity expansion becomes operational in early 2007. Consequently, we
expect the prices for these raw materials to remain high in 2007. Increased
energy costs also continue to have a negative impact on gross margin. In
addition, we have certain long-term customer agreements that will somewhat limit
our ability to pass on all of our increased raw material costs. However, we
expect that the impact of higher average selling prices for melted and mill
products in the remainder of 2006 will more than offset such increased raw
materials costs, as has been the case to date during 2006. If our raw material
costs continue to increase, we do not know if we will be able to continue to
increase our average selling prices to completely offset such increased costs.
If this were to occur, our gross margins would be negatively impacted.
Based on the foregoing, we anticipate TIMET's full year 2006 net sales
revenue to range from $1.1 billion to $1.2 billion and full year 2006 operating
income to range from $350 million to $365 million.
Other - We account for our interest in TIMET by the equity method. Our
equity in earnings in TIMET is net of amortization and purchase accounting
adjustments made in conjunction with our acquisition of our interest in TIMET.
As a result, our equity in earnings differs from the amount that would be
expected by applying our ownership percentage to TIMET's stand-alone earnings.
The net effect of these differences increased our equity in earnings in TIMET by
$3.2 million in the first nine months of 2005 and $3.1 million in the first nine
months of 2006. The percentage increases in our equity in earnings of TIMET in
2006 as compared to the same periods in 2005 are lower than the percentage
increases in TIMET's separately-reported net income attributable to common
stockholders during the same periods because we owned a lower percentage of
TIMET in 2006 as compared to 2005 due to TIMET's issuance of shares of its
common stock, primarily from the conversion of shares of its convertible
preferred stock into TIMET common stock and the exercise of options to purchase
TIMET common stock held by its employees.
General Corporate Items, Interest Expense, Provision for Income Taxes, Minority
Interest and Discontinued Operations - 2006 Compared to 2005
Interest and Dividend Income - A significant portion of our interest and
dividend income in both 2005 and 2006 relates to the distributions we received
from The Amalgamated Sugar Company LLC and, in 2005, from the interest income we
earned on our $80 million loan to Snake River Sugar Company that Snake River
prepaid in October 2005. We recognized dividend income from the LLC of $6.3
million and $18.7 million in the third quarter and first nine months of 2005,
respectively, compared to $8.1 million and $22.5 million in the third quarter
and first nine months of 2006. We also recognized interest income on our $80
million loan to Snake River of $1.3 million and $4.0 million in the third
quarter and first nine months of 2005.
In October 2005, we and Snake River amended the Company Agreement of the
LLC pursuant to which, among other things, the LLC is required to make higher
minimum levels of distributions to its members (including us) as compared to
levels required under the prior Company Agreement. Under the new agreement, we
should receive aggregate annual distributions from the LLC of approximately
$25.4 million. In addition, assuming certain specified conditions are met (which
were met during the fourth quarter of 2005 and the first nine months of 2006,
and which we expect will continue to be met during the remainder of the 2006),
the LLC would be required to distribute to us at least an additional $25 million
during the 15-month period ending December 31, 2006. This distribution is in
addition to the $25.4 million distribution noted above. We received
approximately $19 million of this additional amount in the fourth quarter of
2005, and we expect the LLC will pay us the remaining $6 million during 2006
(including approximately $3.5 million which the LLC has paid us during the first
nine months of the year). We expect our interest and dividend income for all of
2006 will be lower than 2005, due to the one-time $19 million in dividend
distributions we received from the LLC in the fourth quarter of 2005.
Insurance Recoveries - NL has reached an agreement with a former insurance
carrier in which the carrier will reimburse NL for a portion of its past and
future lead pigment litigation defense costs. NL received approximately $1.1
million during the first nine months of 2006 under the agreement. We are not
able to determine how much NL will ultimately recover from the carrier for past
defense costs incurred by NL because the carrier has certain discretion
regarding which past defense costs qualify for reimbursement.
NL also received $1.8 million in insurance recoveries in the first nine
months of 2006 in settlements with certain of its former insurance carriers.
These settlements, as well as similar prior settlements NL reached in the past
few years (including $1.2 million in the third quarter of 2005), resolved court
proceedings in which NL sought reimbursement from carriers for legal defense
costs and indemnity coverage for certain of its environmental remediation
expenditures. We do not expect NL will receive any further material insurance
settlements relating to litigation concerning environmental remediation
coverages.
While NL continues to seek additional insurance recoveries, we do not know
if NL will be successful in obtaining reimbursement for either defense costs or
indemnity. NL has not considered any additional potential insurance recoveries
in determining accruals for lead pigment litigation matters. Any additional
insurance recoveries would be recognized when the receipt is probable and the
amount is determinable.
Corporate Expenses, Net - Corporate expenses were $3.3 million and $2.4
million higher in the third quarter and first nine months of 2006, respectively,
compared to the same periods in 2005, primarily due to higher litigation and
related expenses and to higher environmental remediation expenses at NL. We
expect corporate expenses in calendar 2006 will be higher than 2005, in part due
to higher expected litigation and related expenses at NL.
Obligations for environmental remediation costs are difficult to assess and
estimate, and it is possible that actual costs for environmental remediation
will exceed accrued amounts or that costs will be incurred in the future for
sites in which we cannot currently estimate the liability. If these events occur
during the fourth quarter of 2006, our corporate expenses would be higher than
our current estimates. See Note 15 to the Condensed Consolidated Financial
Statements.
Loss on Prepayment of Debt - In April 2006, we issued our euro 400 million
aggregate principal amount of 6.5% Senior Secured Notes due 2013, and used the
proceeds to redeem our euro 375 million aggregate principal amount of 8.875%
Senior Secured Notes in May 2006. As a result of this prepayment, we recognized
a $22.3 million pre-tax interest expense charge in the second quarter of 2006,
representing the call premium on the old Notes and the write-off of deferred
financing costs and the existing unamortized premium on the old Notes. See Note
7 to the Condensed Consolidated Financial Statements. The annual interest
expense on the new 6.5% Notes will be approximately euro 6 million less than on
the old 8.875% Notes.
Interest Expense - We have a significant amount of indebtedness denominated
in the euro, primarily through our subsidiary Kronos International ("KII"). KII
has euro 400 million aggregate principal amount of 6.5% Senior Secured Notes due
in 2013 outstanding (and had the euro 375 million aggregate principal amount of
8.875% Senior Secured Notes outstanding until May 2006). The interest expense we
recognize on these fixed rate Notes will vary with fluctuations in the euro
exchange rate.
Interest expense decreased $.9 million from $16.7 million in the third
quarter of 2005 to $15.8 million in the third quarter of 2006. Interest expense
was lower in the third quarter of 2006 because we replaced the 8.875% Senior
Secured Notes with 6.5% Senior Secured Notes during the second quarter of 2006.
This interest savings was partially offset by changes in currency exchange rates
in 2006 compared to 2005. Interest expense in the first nine months of 2006
decreased slightly compared to the first nine months of 2005, as the decreased
interest rate on the Notes offset the effect of the 30 days of interest expense
in April when both Senior Secured Notes were outstanding and the changes in
currency exchange rates.
Assuming currency exchange rates do not change significantly from their
current levels, we expect interest expense will be lower in the fourth quarter
of 2006 as compared to the quarterly interest expense in the first nine months
of the year due to the lower interest expense associated with the 6.5% Senior
Secured Notes as compared to the 8.875% Senior Secured Notes.
Provision for Income Taxes - Our income tax expense was $22.1 million in
the third quarter of 2006 compared $29.4 million in the third quarter of 2005.
For the first nine months of 2006, our income tax expense was $40.2 million
compared to $88.7 million in the first nine months of 2005. The 2005 overall
effective income tax rate was unusually high due to the loss of certain
favorable income tax attributes in Germany and a change in the permanent
reinvestment of earnings conclusion for certain foreign subsidiaries of our
Component Products Segment. Our income tax expense in 2006 includes:
o an income tax benefit of $9.2 million resulting from the reduction in
our income tax contingency reserves related to favorable developments
of income tax audit issues in Belgium and Norway;
o a $2.1 million provision for income taxes resulting from the increase
in our income tax contingency reserve principally related to our
ongoing income tax audits, in Germany;
o an income tax benefit of $2.0 million related to the favorable
resolution of certain income tax audit issues in Germany and Belgium;
o a $2.0 million provision for income taxes related to the unfavorable
resolution of certain income tax audit issues in Germany; and
o a $1.3 million benefit resulting from the enactment of a reduction in
Canadian income tax rates.
Substantially all of this aggregate income tax benefit was recognized in the
second quarter of 2006. See Note 12 to the Condensed Consolidated Financial
Statements for a tabular reconciliation of our statutory tax expense to our
actual tax expense.
Minority Interest in Continuing Operations - Minority interest in earnings
declined $2.7 million in the first nine months of 2006 to $7.2 million from $9.9
million in the same period in the prior year, primarily due to lower income at
both Kronos and NL, offset in part by higher earnings of CompX. In addition, we
purchased additional shares of Kronos and CompX common stock during the last
half of 2005 and the first nine months of 2006 which increased our ownership of
these companies as compared to last year. See Note 13 to the Condensed
Consolidated Financial Statements.
Discontinued Operations - Discontinued operations relates to the former
Thomas Regout operations of CompX located in the Netherlands. Discontinued
operations in 2005 consists of additional expenses we incurred with the sale of
Thomas Regout. Discontinued operations in 2006 relates to a change in our
estimate of certain indemnification obligations we had to the purchaser of the
Thomas Regout. See Note 14 to the Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Consolidated Cash Flows
Operating Activities -
Trends in cash flows from operating activities (excluding the impact of
significant asset dispositions and relative changes in assets and liabilities)
are generally similar to trends in our earnings.
Cash flows provided by our operating activities increased from $39.4
million in the first nine months of 2005 to $58.9 million in the first nine
months of 2006. This increase in cash provided was due primarily to the net
effects of the following items:
o higher net cash provided by changes in receivables, inventories,
payables and accrued liabilities in 2006 of $58.5 million, due
primarily to relative changes in Kronos' inventory levels;
o lower consolidated operating income in 2006 of $29.5 million, due
primarily to the lower earnings in our Chemicals Segment;
o lower cash paid for income taxes in 2006 of $23.0 million, due in part
to a $21.0 million tax payment we made in 2005 to settle a
previously-reported income tax audit of NL in the U.S.;
o the $20.9 million call premium we paid in 2006 when we prepaid our
8.875% Senior Secured Notes, which GAAP requires to be included in the
determination of cash flows from operating activities;
o lower cash paid for interest in 2006 of $4.9 million, primarily as a
result of the May 2006 redemption of our 8.875% Senior Secured Notes
(which paid interest semiannually in June and December) and the April
2006 issuance of our 6.5% Senior Secured Notes (which will pay
interest semiannually in April and October starting in October 2006);
o lower distributions received from our Louisiana joint venture of $4.6
million due to relative changes in their cash requirements in 2006;
and
o lower cash paid for environmental remediation expenditures of $4.5
million in 2006.
Changes in working capital were affected by accounts receivable and
inventory changes. Kronos' average days sales outstanding ("DSO") increased from
55 days at December 31, 2005 to 65 days at September 30, 2006 due to the timing
of collection on higher accounts receivable balances at the end of September.
CompX's average DSO increased from 40 days at December 31, 2005 to 43 days at
September 30, 2006 due to timing of collection on the higher accounts receivable
balance at the end of September. For comparative purposes, Kronos' average DSO
increased slightly from 60 days at December 31, 2004 to 61 days at September 30,
2005, and CompX's average DSO increased from 38 days to 43 days, due to the
timing of collection on their slightly higher accounts receivable balances at
the end of September 2005.
Kronos' average days sales in inventory ("DSI") decreased from 102 days at
December 31, 2005 to 87 days at September 30, 2006, as their record TiO2
production volumes in the first nine months of 2006 was exceeded by their record
TiO2 sales volumes during the period. CompX's average DSI increased slightly
from 59 days at December 31, 2005 to 60 days at September 30, 2006 due primarily
to their higher cost of commodity raw materials at September 30, 2006 as
compared to December 31, 2005. For comparative purposes, Kronos' average DSI
increased from 97 days at December 31, 2004 to 105 days at September 30, 2006
because production volumes were higher than sales volumes during the period, and
CompX's average DSI increased from 52 days, at December 31, 2004 to 57 days at
September 30, 2005 primarily as a result of lower commodity costs.
We do not have complete access to the cash flows of our majority-owned
subsidiaries, due in part to limitations contained in certain credit agreements
of our subsidiaries and because we do not own 100% of these subsidiaries. A
detail of our consolidated cash flows from operating activities is presented in
the table below. Intercompany dividends have been eliminated.
Nine months ended
September 30,
----------------------
2005 2006
---- ----
(In millions)
Cash provided by (used in) operating activities:
Kronos $ 69.3 $ 50.3
CompX 14.2 19.7
Waste Control Specialists (5.6) (1.5)
NL Parent (27.0) (1.7)
Tremont (2.3) (1.7)
Valhi Parent 50.3 48.6
Other (.7) (0.8)
Eliminations (58.8) (54.0)
------ ------
Total $ 39.4 $ 58.9
====== ======
Investing and Financing Activities -
Our Chemicals Segment accounted for approximately $26.8 million of our
consolidated capital expenditures in the first nine months of 2006, $9.1 million
for our Component Products Segment with substantially all of the remainder for
our Waste Management Segment.
We purchased the following securities in market transactions during the
first nine months of 2006:
o shares of Kronos common stock for $25.2 million; o shares of TIMET
common stock for $18.7 million;
o shares of CompX common stock for $2.3 million; and
o other marketable securities for a net of $26.5 million.
In addition, during the first nine months of 2006 we:
o sold other marketable securities for $27.0 million;
o acquired a marine components products company for approximately $9.8
million; and
o capitalized $5.4 million of expenditures related to WCS' permitting
efforts.
See Note 2 to the Condensed Consolidated Financial Statements.
In April 2006, we issued euro 400 million aggregate principal amount of our
6.5% Senior Secured Notes due 2013 ($498.5 million when issued), and used the
proceeds to redeem our euro 375 million aggregate principal amount of 8.875%
Senior Secured Notes in May 2006 ($470.5 million when redeemed). In addition, we
borrowed a net Cdn. $5.0 million ($4.5 million when borrowed) under Kronos'
Canadian revolving credit facility and $3.4 million under Kronos' U.S. bank
credit facility, and CompX repaid $1.5 million of its indebtedness. See Note 7
to the Condensed Consolidated Financial Statements.
We paid aggregate cash dividends on our common stock of $36.1 million ($.10
per share per quarter) in the first nine months of 2006 to our shareholders.
Distributions to minority interest in the first nine months of 2006 are
primarily comprised of Kronos cash dividends paid to shareholders other than us
or NL, and CompX dividends paid to shareholders other than NL.
We purchased approximately 837,000 shares of our common stock in market
transactions for $18.8 million during the first nine months of 2006. We funded
these purchases with our available cash on hand. We and some of our subsidiaries
issued a nominal amount of common stock upon the exercise of stock options.
Outstanding Debt Obligations
At September 30, 2006, our consolidated third-party indebtedness was
comprised of:
o KII's euro 400 million aggregate principal amount 6.5% Senior Secured
Notes ($505.2 million at September, 30, 2006, including the effect of
the unamortized original issue discount) due in 2013,
o Our $250 million loan from Snake River Sugar Company due in 2027,
o Kronos' U.S. revolving bank credit facility ($14.9 million
outstanding) due in 2008,
o Kronos' Canadian bank credit facility ($4.5 million outstanding) due
in 2009, and
o $5.0 million of other indebtedness.
We and all of our subsidiaries are in compliance with all of our debt
covenants at September 30, 2006. See Note 7 to the Condensed Consolidated
Financial Statements. At September 30, 2006, only $1.3 million of our
indebtedness is due within the next twelve months, and therefore we do not
currently expect we will be required to use a significant amount of our
available liquidity to repay indebtedness during the next twelve months.
Certain of our credit agreements contain provisions which could result in
the acceleration of indebtedness prior to its stated maturity for reasons other
than defaults for failure to comply with applicable covenants. For example,
certain credit agreements allow the lender to accelerate the maturity of the
indebtedness upon a change of control (as defined in the agreement) of the
borrower. The terms of Valhi's revolving bank credit facility could require
Valhi to either reduce outstanding borrowings or pledge additional collateral in
the event the fair value of the existing pledged collateral falls below
specified levels. In addition, certain credit agreements could result in the
acceleration of all or a portion of the indebtedness following a sale of assets
outside the ordinary course of business.
Future Cash Requirements
Liquidity -
Our primary source of liquidity on an ongoing basis is our cash flows from
operating activities and borrowings under various lines of credit and notes. We
generally use these amounts to (i) fund capital expenditures, (ii) repay
short-term indebtedness incurred primarily for working capital purposes and
(iii) provide for the payment of dividends (including dividends paid to us by
our subsidiaries) or treasury stock purchases. From time-to-time we will incur
indebtedness, generally to (i) fund short-term working capital needs, (ii)
refinance existing indebtedness, (iii) make investments in marketable and other
securities (including the acquisition of securities issued by our subsidiaries
and affiliates) or (iv) fund major capital expenditures or the acquisition of
other assets outside the ordinary course of business. Occasionally we sell
assets outside the ordinary course of business, and we generally use the
proceeds 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.
We routinely compare our liquidity requirements and alternative uses of
capital against the estimated future cash flows we expect to receive from our
subsidiaries, and the estimated sales value of those units. As a result of this
process, we have in the past and may in the future seek to raise additional
capital, refinance or restructure indebtedness, repurchase indebtedness in the
market or otherwise, modify our dividend policies, consider the sale of our
interests in our subsidiaries, affiliates, business units, marketable securities
or other assets, or take a combination of these and other steps, to increase
liquidity, reduce indebtedness and fund future activities. Such activities have
in the past and may in the future involve related companies.
We periodically evaluate acquisitions of interests in or combinations with
companies (including our affiliates) that may or may not be engaged in
businesses related to our current businesses. We intend to consider such
acquisition activities in the future and, in connection with this activity, may
consider issuing additional equity securities and increasing indebtedness. From
time to time, we also evaluate the restructuring of ownership interests among
our respective subsidiaries and related companies.
Based upon our expectations of our operating performance, and the
anticipated demands on our cash resources, we expect to have sufficient
liquidity to meet our short-term obligations (defined as the twelve-month period
ending September 30, 2007) and our long-term obligations (defined as the
five-year period ending December 31, 2010, our time period for long-term
budgeting). If actual developments differ from our expectations, our liquidity
could be adversely affected.
At September 30, 2006, we had credit available under existing facilities of
$283.3 million, which was comprised of:
o $135.0 million under Kronos' various U.S. and non-U.S. credit
facilities;
o $98.3 million under Valhi's revolving bank credit facility; and
o $50.0 million under CompX's revolving credit facility.
At September 30, 2006, TIMET had $157.8 million of borrowing availability under
its various U.S. and European credit agreements.
At September 30, 2006, we had an aggregate of $233.1 million of restricted
and unrestricted cash, cash equivalents and marketable securities. A detail by
entity is presented in the table below.
Amount
-------------
(In millions)
Valhi Parent $ 63.2
Kronos 92.4
NL Parent 37.7
CompX 25.8
Tremont 10.0
Waste Control Specialists 4.0
------
Total cash, cash equivalents, and marketable securities $233.1
======
Capital Expenditures -
We intend to invest a total of approximately $67 million for capital
expenditures during 2006. Capital expenditures are primarily for improvements
and upgrades to existing facilities. We spent $36.5 million though September 30,
2006.
TIMET intends to invest a total of approximately $100 million to $110
million for capital expenditures during 2006, primarily for improvements and
upgrades to our existing TIMET facilities, including expansions of sponge and
melting capacity, and other additions of plant machinery and equipment. In May
2005, we announced plans to expand TIMET's existing titanium sponge facility in
Nevada. This expansion, which we currently expect to commence start up and
commissioning near the end of 2006, will provide the capacity to produce an
additional 4,000 metric tons of sponge annually, an increase of approximately
47% over the current sponge production capacity levels at the Nevada facility.
In April 2006, we announced plans to expand TIMET's electron beam cold hearth
melt capacity in Pennsylvania. This expansion, which we currently expect will be
completed by early 2008, will have, depending on product mix, the capacity to
produce an additional 8,500 metric tons of melted products, an increase of
approximately 54% over the current production capacity levels at the
Pennsylvania facility.
Repurchases of our Common Stock -
We have in the past, and may in the future, make repurchases of our common
stock in market or privately-negotiated transactions. At November 1, 2006 we had
approximately 4.6 million shares available for repurchase of our common stock
under the authorizations described in Note 10 to the Condensed Consolidated
Financial Statements.
Dividends -
Because our operations are conducted primarily through subsidiaries and
affiliates, our long-term ability to meet parent company level corporate
obligations is largely dependent on the receipt of dividends or other
distributions from our subsidiaries and affiliates. Based on the 29.0 million
shares of Kronos we held at September 30, 2006 and Kronos' current quarterly
dividend rate of $.25 per share, we would receive aggregate annual dividends
from Kronos of $29.0 million. NL's current quarterly cash dividend is $.125 per
share, although in the past NL has paid a dividend in the form of Kronos common
stock. If NL pays its regular quarterly dividends in cash, based on the 40.4
million shares we held of NL common stock at September 30, 2006, we would
receive aggregate annual dividends from NL of $20.2 million. We do not expect to
receive any distributions from WCS or TIMET during 2006.
Our subsidiaries have various credit agreements which contain customary
limitations on the payment of dividends, typically a percentage of net income or
cash flow; however, these restrictions in the past have not significantly
impacted their ability to pay dividends.
Investment in our Subsidiaries and Affiliates and other Acquisitions -
We have in the past, and may in the future, purchase the securities of our
subsidiaries and affiliates or third parties in market or privately-negotiated
transactions. We base our purchase decision on a variety of factors, including
an analysis of the optimal use of our capital, taking into account the market
value of the securities and the relative value of expected returns on
alternative investments. In connection with these activities, we may consider
issuing additional equity securities or increasing our indebtedness. We may also
evaluate the restructuring of ownership interests of our businesses among our
subsidiaries and related companies.
We generally do not guarantee any indebtedness or other obligations of our
subsidiaries or affiliates. Our subsidiaries are not required to pay us
dividends. If one or more of our subsidiaries were unable to maintain its
current level of dividends, either due to restrictions contained in a credit
agreement or to satisfy its liabilities or otherwise, our ability to service our
liabilities or to pay dividends on our common stock could be adversely impacted.
If this were to occur, we might consider reducing or eliminating our dividends
or selling interests in subsidiaries or other assets. If we were required to
liquidate assets to generate funds to satisfy our liabilities, we may be
required to sell at what we believe would be less than the actual value of such
assets.
WCS is required to provide certain financial assurances to Texas
governmental agencies with respect to certain decommissioning obligations
related to its facility in West Texas. The financial assurances may be provided
by various means, including a parent company guarantee assuming the parent meets
specified financial tests. In March 2005, we agreed to guarantee certain of WCS'
specified decommissioning obligations. WCS currently estimates these obligations
at approximately $3.5 million. Such obligations would arise only upon a closure
of the facility and WCS' failure to perform such activities. We do not currently
expect we will have to perform under this guarantee for the foreseeable future.
WCS' primary source of liquidity currently consists of intercompany
borrowings from one of our wholly-owned subsidiaries under the terms of a
revolving credit facility that matures in March 2007. WCS borrowed a net $6.2
million from our subsidiary during the first nine months of 2006. The
outstanding amount of this intercompany borrowing, which is eliminated in our
Condensed Consolidated Financial Statements, was $10.7 million at September 30,
2006 and $4.6 million at December 31, 2005. We expect that WCS will likely
borrow additional amounts during the remainder of 2006 from our subsidiary.
Investment in The Amalgamated Sugar Company LLC -
The terms of The Amalgamated Sugar Company LLC Company Agreement provide
for annual "base level" of cash dividend distributions (sometimes referred to as
distributable cash) by the LLC of $26.7 million, from which we are entitled to a
95% preferential share. Distributions from the LLC are dependent, in part, upon
the operations of the LLC. We record dividend distributions from the LLC as
income when they are declared by the LLC, which is generally the same month in
which we receive the distributions, although distributions may in certain cases
be paid on the first business day of the following month. To the extent the
LLC's distributable cash is below this base level in any given year, we are
entitled to an additional 95% preferential share of any future annual LLC
distributable cash in excess of the base level until such shortfall is
recovered. Based on the LLC's current projections for 2006, we expect
distributions received from the LLC in 2006 will exceed our debt service
requirements under our $250 million loans from Snake River Sugar Company.
We may, at our option, require the LLC to redeem our interest in the LLC
beginning in 2012, and the LLC has the right to redeem our interest in the LLC
beginning in 2027. The redemption price is generally $250 million plus the
amount of certain undistributed income allocable to us, if any. In the event we
require the LLC to redeem our interest in the LLC, Snake River has the right to
accelerate the maturity of and call our $250 million loans from Snake River.
Redemption of our interest in the LLC would result in us reporting income
related to the disposition of our LLC interest for income tax purposes, although
we would not be expected to report a gain in earnings for financial reporting
purposes at the time its LLC interest was redeemed. However, because of Snake
River's ability to call our $250 million loans from Snake River upon redemption
of our interest in the LLC, the net cash proceeds (after repayment of the debt)
generated by the redemption of our interest in the LLC could be less than the
income taxes that we would be required to pay as a result of the disposition.
Off-balance Sheet Financing
We do not have any off-balance sheet financing agreements other than the
operating leases discussed in our 2005 Annual Report.
Commitments and Contingencies
There have been no material changes in our contractual obligations since we
filed our 2005 Annual Report, and we refer you to the report for a complete
description of these commitments.
We are subject to certain commitments and contingencies, as more fully
described in Notes 12 and 15 to the Condensed Consolidated Financial Statements
and in Part II, Item 1 of this Quarterly Report, including
o certain income tax examinations which are underway in various U.S. and
non-U.S. jurisdictions,
o certain environmental remediation matters involving NL, Tremont, Valhi
and TIMET,
o certain litigation related to NL's former involvement in the
manufacture of lead pigment and lead-based paint, and
o certain other litigation to which we are a party.
In addition to those legal proceedings described in Note 15 to the
Condensed Consolidated Financial Statements, various legislation and
administrative regulations have, from time to time, been proposed that seek to
(i) impose various obligations on present and former manufacturers of lead
pigment and lead-based paint (including NL) with respect to asserted health
concerns associated with the use of such products and (ii) effectively overturn
court decisions in which 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.
Recent Accounting Pronouncements
See Note 16 to the Condensed Consolidated Financial Statements
Critical Accounting Policies
There have been no changes in the first nine months of 2006 with respect to
our critical accounting policies presented in Management's Discussion and
Analysis of Financial Condition and Results of Operation in our 2005 Annual
Report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We are exposed to market risk, including foreign currency exchange rates,
interest rates and security prices. For a discussion of such market risk items,
refer to Part I, Item 7A - "Quantitative and Qualitative Disclosure About Market
Risk" in our 2005 Annual Report. There have been no material changes in these
market risks during the first nine months of 2006.
We have substantial operations located outside the United States for which
the functional currency is not the U.S. dollar. As a result, our assets and
liabilities, results of operations and cash flows will fluctuate based upon
changes in foreign currency exchange rates.
We periodically use currency forward contracts to manage a portion of
foreign currency exchange rate market risk associated with trade receivables, or
similar exchange rate risk associated with future sales, denominated in a
currency other than the holder's functional currency. These contracts generally
relate to our Chemicals and Component Products operations. We have not entered
into these contracts for trading or speculative purposes in the past, nor do we
currently anticipate entering into such contracts for trading or speculative
purposes in the future. Some of the currency forward contracts we enter into
meet the criteria for hedge accounting under GAAP and are designated as cash
flow hedges. For these currency forward contracts, gains and losses representing
the effective portion of our hedges are deferred as a component of accumulated
other comprehensive income, and are subsequently recognized in earnings at the
time the hedged item affects earnings. For the currency forward contracts we
enter into which do not meet the criteria for hedge accounting, we
mark-to-market the estimated fair value of such contracts at each balance sheet
date, with any resulting gain or loss recognized in income currently as part of
net currency transactions. We had no forward contracts outstanding at September
30, 2006.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures -
We maintain a system of disclosure controls and procedures. The term
"disclosure controls and procedures," as defined by regulations of the SEC,
means controls and other procedures that are designed to ensure that information
required to be disclosed in the reports we file or submit to the SEC under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported, within the time periods specified in the SEC's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information we are required to disclose in
the reports we file or submit to the SEC under the Act is accumulated and
communicated to our management, including our principal executive officer and
our principal financial officer, or persons performing similar functions, as
appropriate to allow timely decisions to be made regarding required disclosure.
Each of Steven L. Watson, our President and Chief Executive Officer, and Bobby
D. O'Brien, our Vice President and Chief Financial Officer, have evaluated the
design and operations effectiveness of our disclosure controls and procedures as
of September 30, 2006. Based upon their evaluation, these executive officers
have concluded that our disclosure controls and procedures were effective as of
September 30, 2006.
Internal Control Over Financial Reporting -
We also maintain internal control over financial reporting. The term
"internal control over financial reporting," as defined by SEC regulations,
means a process designed by, or under the supervision of, our principal
executive and principal financial officers, or persons performing similar
functions, and effected by our board of directors, management and other
personnel, to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with GAAP, and includes those policies and procedures
that:
o pertain to the maintenance of records that in reasonable detail
accurately and fairly reflect our transactions and dispositions of our
assets,
o provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance
with GAAP, and that our receipts and expenditures are made only in
accordance with authorizations of our management and directors, and
o provide reasonable assurance regarding prevention or timely detection
of unauthorized acquisition, use or disposition of our assets that
could have a material effect on our Condensed Consolidated Financial
Statements.
As permitted by the SEC, our assessment of internal control over financial
reporting excludes (i) internal control over financial reporting of our equity
method investees and (ii) internal control over the preparation of our financial
statement schedules required by Article 12 of Regulation S-X. However, our
assessment of internal control over financial reporting with respect to our
equity method investees did include our controls over the recording of amounts
related to our investment that are recorded in our Condensed Consolidated
Financial Statements, including controls over the selection of accounting
methods for our investments, the recognition of equity method earnings and
losses and the determination, valuation and recording of our investment account
balances.
Changes in Internal Control Over Financial Reporting -
There has been no change to our internal control over financial reporting
during the quarter ended September 30, 2006 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings.
In addition to the matters discussed below, refer to Note 15 to the
Condensed Consolidated Financial Statements, our 2005 Annual Report and our
Quarterly Reports on Form 10-Q for the quarters ended March 31 and June 30,
2006.
Thomas v. Lead Industries Association, et al. (Circuit Court, Milwaukee,
Wisconsin, Case No. 99-CV-6411). In August 2006, the trial court rejected any
claim by the plaintiff other than a failure to warn claim.
Smith, et al. v. Lead Industries Association, et al. (Circuit Court for
Baltimore City, Maryland, Case No. 24-C-99-004490). In September 2006, the
plaintiffs filed a certiorari petition with the Maryland Court of Appeals, and
we opposed the petition in October.
City of Milwaukee v. NL Industries, Inc. and Mautz Paint (Circuit Court,
Civil Division, Milwaukee County, Wisconsin, Case No. 01CV003066). In September
2006, the court removed the case from the January 2007 trial calendar and in
October 2006, the court set a trial date of May 23, 2007.
Jones v. NL Industries, Inc., et al. (Circuit Court of LeFlore County,
Mississippi, Civil Action No. 2002-0241-CICI). In August 2006, the plaintiffs
filed a motion for a new trial, which was denied by the district court in
October 2006.
Terry, et al. v. NL Industries, Inc., et al. (United States District Court,
Southern District of Mississippi, Case No. 4:04 CV 269 PB). In September 2006,
we informed the court of the result in the Jones case.
In October 2006, we were served with a complaint in Davis v. Millennium
Holding LLC, et al. (District Court, Douglas County, Nebraska, Case No.
1061-619). Plaintiff alleges injuries purportedly caused by lead on the surfaces
of various homes in which he has resided. Plaintiff seeks punitive and
compensatory damages. We intend to deny all liability and to defend against all
of the claims vigorously. In October 2006, we filed a motion to dismiss the
complaint.
In October 2006, we were served with a complaint in Tyler v. Sherwin
Williams Company et al. (District Court, Douglas County, Nebraska, Case No.
1058-174). Plaintiff alleges injuries purportedly caused by lead on the surfaces
of various homes in which he has resided. Plaintiff seeks punitive and
compensatory damages, as well as equitable relief to move the plaintiff's family
from a home alleged to contain lead paint. We intend to deny all liability and
to defend against all of the claims vigorously. In October 2006, we filed a
motion to dismiss the complaint.
In October 2006, we were served with a complaint in City of Akron, Ohio v.
Sherwin-Williams Company et al.(Court of Common Pleas, Summit County, Ohio, Case
No. CV-2006-106309). The City seeks compensatory and punitive damages, detection
and abatement in residences, schools, hospitals and public and private buildings
within the City accessible to children and damages for funding of a public
education campaign and health screening programs. Plaintiff seeks judgments of
joint and several liability against the former pigment manufacturers and the
Lead Industries Association ("LIA").In November 2006 at the City of Akron's
request, the court dismissed the complaint without prejudice.
In October 2006, we were served with a complaint in City of E. Cleveland,
Ohio v. Sherwin-Williams Company et al.(Court of Common Pleas, Cuyahoga County,
Ohio, Case No. CV06602785). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
In October 2006, we were served with a complaint in City of Lancaster, Ohio
v. Sherwin-Williams Company et al.(Court of Common Pleas, Fairfield County,
Ohio, Case No. 2006 CV 01055). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
In October 2006, we were served with a complaint in City of Toledo, Ohio v.
Sherwin-Williams Company et al.(Court of Common Pleas, Lucas County, Ohio, Case
No. G-4801-CI-200606040-000). The City seeks compensatory and punitive damages,
detection and abatement in residences, schools, hospitals and public and private
buildings within the City accessible to children and damages for funding of a
public education campaign and health screening programs. Plaintiff seeks
judgments of joint and several liability against the former pigment
manufacturers and the LIA. We intend to deny all liability and to defend against
all of the claims vigorously.
Brown et. al. v. NL Industries, Inc. et. al. (Circuit Court Wayne County,
Michigan, Case No. 06-602096 CZ). In August 2006, the plaintiffs amended their
complaint to drop the class action allegations, and are now seeking recovery
solely on their individual claims.
Park Hills, Mo. Site. In August 2006, Doe Run ceased to negotiate with us
regarding allocation. We intend to pursue Doe Run for its share of the costs
associated with complying with the Order.
Donnelly and Donnelley v. NL Industries, Inc. (United States District
Court, Northern District of New York, Case No. 1:06-CV-0851). In July 2006, we
removed this case to Federal Court. In August 2006, we answered the complaint
and denied all of the plaintiffs' allegations.
In July 2006, we were served with a complaint in Norampac Industries, Inc.
v. NL Industries, Inc. (United States District Court, Western District of New
York, Case No. 06-CV-0479). The plaintiff sued under CERCLA and New York's
Navigation Law for contribution for costs that have been, or will be, expended
by the plaintiff to clean up a former Magnus Metals facility. The complaint also
alleges common-law claims for negligence, public nuisance, private nuisance,
indemnification, natural resource damages and declaratory relief. In September
2006, we denied all liability for, and we intend to defend vigorously against,
all of the claims raised in the complaint. In October 2006, the matter was
referred to mediation by the court.
In October 2006, we entered into a consent decree in the United States
District Court for the District of Kansas, in which we agreed to perform
remedial design and remedial actions in OU-6, Waco Subsite, of the Cherokee
County Superfund Site. We conducted milling activities on the portion of the
site which we have agreed to remediate. We are also sharing responsibility with
other potentially-responsible parties for remediating a tributary that drains
the portions of the site in which the potentially-responsible parties operated.
We will also reimburse EPA for a portion of its past and future response costs
related to the site.
Item 1A. Risk Factors.
For a discussion of the risk factors related to our businesses, refer to
Part I, Item 1A, "Risk Factors," in our 2005 Annual report. There have been no
material changes to such risk factors during the first nine months of 2006.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds; Share
Repurchases.
In March 2005, our board of directors authorized the repurchase of up to
5.0 million shares of our common stock in open market transactions, including
block purchases, or in privately negotiated transactions, which may include
transactions with our affiliates. We may repurchase our common stock from time
to time as market conditions permit. The stock repurchase program does not
include specific price targets or timetables and may be suspended at any time.
Depending on market conditions, we may terminate the program prior to its
completion. We will use cash on hand to acquire the shares. Repurchased shares
may be retired and cancelled or may be added to our treasury and used for
employee benefit plans, future acquisitions or other corporate purposes. On
November 1, 2006 the independent members of our board of directors increased the
share repurchase authorization by an additional 5.0 million shares. See Note 10
to the Condensed Consolidated Financial Statements.
The following table discloses certain information regarding the shares of
our common stock we purchased during the third quarter of 2006. All of these
purchases were made under the repurchase program in open market transactions.
Maximum number of
Average Total number of shares that may yet
price paid shares purchased be purchased under
Total number per share, as a part of a the publicly-
of shares including publicly-announced announced plan at
Period purchased commissions plan end of period
------ --------- ----------- ------------------ ---------------
July 1, 2006
to July 31,
2006 78,400 $24.50 78,400 903,400
August 1, 2006
to August 31,
2006 200,600 26.56 200,600 702,800
September 1, 2006
to September 30,
2006 52,200 25.94 52,200 650,600
------- -------
331,200 331,200
======= =======
Item 6. Exhibits.
10.1 - Stock Purchase Agreement, dated November 1, 2006,
between Valhi, Inc. and Valhi Holding Company -
incorporated by reference to Exhibit 10.1 - to our
Current Report on Form 8-K (File No. 1-5467) dated
November 1, 2006
31.1 - Certification
31.2 - Certification
32.1 - Certification
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALHI, INC.
-----------------------
(Registrant)
Date November 8, 2006 By /s/ Bobby D. O'Brien
-------------------- ------------------------------
Bobby D. O'Brien
Vice President and Chief Financial
Officer
(Principal Financial Officer)
Date November 8, 2006 By /s/ Gregory M. Swalwell
------------------- ------------------------------
Gregory M. Swalwell
Vice President and Controller
(Principal Accounting Officer)