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 June 30, 2006 Commission file number 1-5467
----------------- ------
VALHI, INC.
(Exact name of Registrant as specified in its charter)
Delaware 87-0110150
------------------------------- -------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (972) 233-1700
--------------
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 July 31, 2006:
115,477,878.
VALHI, INC. AND SUBSIDIARIES
INDEX
Page
number
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets -
December 31, 2005;
June 30, 2006 (unaudited) 3
Condensed Consolidated Statements of Income - Three months and
six months ended June 30, 2005 and 2006
(unaudited) 5
Condensed Consolidated Statements of Comprehensive Income - Six
months ended June 30, 2005 and 2006
(unaudited) 6
Condensed Consolidated Statements of Cash Flows -
Six months ended June 30, 2005 and 2006
(unaudited) 7
Condensed Consolidated Statement of Stockholders' Equity -
Six months ended June 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. 26
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 48
Item 4. Controls and Procedures 48
Part II. OTHER INFORMATION
Item 1. Legal Proceedings. 50
Item 1A. Risk Factors. 51
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds; Share Repurchases 51
Item 4. Submission of Matters to a Vote of Security Holders 51
Item 6. Exhibits. 52
Items 3 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, June 30,
2005 2006
---------- ----------
(unaudited)
Current assets:
Cash and cash equivalents $ 274,963 $ 188,733
Restricted cash equivalents 6,007 7,327
Marketable securities 11,755 11,070
Accounts and other receivables, net 218,766 279,999
Refundable income taxes 1,489 3,727
Receivable from affiliates 34 7
Inventories, net 283,157 280,192
Prepaid expenses 9,981 8,639
Deferred income taxes 10,502 9,354
---------- ----------
Total current assets 816,654 789,048
---------- ----------
Other assets:
Marketable securities:
The Amalgamated Sugar Company LLC 250,000 250,000
Other 8,705 10,303
Investment in affiliates 270,632 332,466
Unrecognized net pension obligations 11,916 12,534
Prepaid pension costs 3,529 4,704
Goodwill 361,783 384,196
Other intangible assets 3,432 4,423
Deferred income taxes 213,726 228,003
Other 61,639 69,730
---------- ----------
Total other assets 1,185,362 1,296,359
---------- ----------
Property and equipment:
Land 37,876 40,485
Buildings 220,110 233,867
Equipment 827,690 882,028
Mining properties 19,969 22,563
Construction in progress 15,771 17,673
---------- ----------
1,121,416 1,196,616
Less accumulated depreciation 545,055 608,990
---------- ----------
Net property and equipment 576,361 587,626
---------- ----------
Total assets $2,578,377 $2,673,033
========== ==========
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (CONTINUED)
(In thousands)
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, June 30,
2005 2006
---------- -----------
(unaudited)
Current liabilities:
Current maturities of long-term debt $ 1,615 $ 1,429
Accounts payable 105,650 93,119
Accrued liabilities 129,429 132,969
Payable to affiliates 13,754 15,685
Income taxes 24,680 6,757
Deferred income taxes 4,313 877
---------- ----------
Total current liabilities 279,441 250,836
---------- ----------
Noncurrent liabilities:
Long-term debt 715,820 789,904
Accrued pension costs 140,742 138,279
Accrued OPEB costs 32,279 30,732
Accrued environmental costs 49,161 49,591
Deferred income taxes 400,964 430,675
Other 39,328 39,694
---------- ----------
Total noncurrent liabilities 1,378,294 1,478,875
---------- ----------
Minority interest 125,049 121,811
---------- ----------
Stockholders' equity:
Common stock 1,207 1,203
Additional paid-in capital 108,810 108,590
Retained earnings 786,268 793,556
Accumulated other comprehensive income:
Marketable securities 4,194 4,675
Currency translation 11,157 29,530
Pension liabilities (78,101) (78,101)
Treasury stock (37,942) (37,942)
---------- ----------
Total stockholders' equity 795,593 821,511
---------- ----------
Total liabilities, minority interest and
stockholders' equity $2,578,377 $2,673,033
========== ==========
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 Six months ended
June 30, June 30,
-------------------- -------------------
2005 2006 2005 2006
---- ---- ---- ----
(unaudited)
Revenues and other income:
Net sales $359,444 $399,552 $700,691 $753,872
Other income, net 19,408 10,303 46,045 23,143
Equity in earnings of:
Titanium Metals Corporation
("TIMET") 15,790 20,339 32,591 42,474
Other (291) (238) (179) (1,969)
-------- -------- -------- --------
Total revenue and other income 394,351 429,956 779,148 817,520
-------- -------- -------- --------
Costs and expenses:
Cost of sales 259,903 308,486 511,885 581,048
Selling, general and administrative 54,192 59,837 108,623 113,929
Loss on prepayment of debt - 22,311 - 22,311
Interest 17,777 19,176 35,656 35,979
-------- -------- -------- --------
Total costs and expenses 331,872 409,810 656,164 753,267
-------- -------- -------- --------
Income before income taxes 62,479 20,146 122,984 64,253
Provision for income taxes (benefit) 29,376 (561) 59,322 18,052
Minority interest in after-tax earnings 4,800 2,315 10,297 4,945
-------- -------- -------- --------
Income from continuing operations 28,303 18,392 53,365 41,256
Discontinued operations, net of tax - (147) (272) (147)
-------- -------- -------- --------
Net income $ 28,303 $ 18,245 $ 53,093 $ 41,109
======== ======== ======== ========
Basic earnings per share:
Income from continuing operations $ .24 $ .16 $ .45 $ .35
Discontinued operations - - - -
-------- -------- -------- --------
Net income $ .24 $ .16 $ .45 $ .35
======== ======== ======== ========
Diluted earnings per share:
Income from continuing operations $ .24 $ .16 $ .44 $ .35
Discontinued operations - - - -
-------- -------- -------- --------
Net income $ .24 $ .16 $ .44 $ .35
======== ======== ======== ========
Cash dividends per share $ .10 $ .10 $ .20 $ .20
======== ======== ======== ========
Shares used in the calculation of per share amounts:
Basic earnings per common share 118,027 116,395 119,125 116,531
Dilutive impact of outstanding
stock options 382 396 366 381
-------- -------- -------- --------
Diluted earnings per share 118,409 116,791 119,491 116,912
======== ======== ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Six months ended June 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Net income $53,093 $41,109
------- -------
Other comprehensive income (loss), net of tax:
Marketable securities adjustment (166) 481
Currency translation adjustment (2,794) 18,373
------- -------
Total other comprehensive income (loss), net (2,960) 18,854
------- -------
Comprehensive income $50,133 $59,963
======= =======
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended June 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from operating activities:
Net income $ 53,093 $ 41,109
Depreciation and amortization 37,725 37,063
Goodwill impairment 864 -
Securities transactions, net (20,205) (209)
Loss on prepayment of debt - 22,311
Call premium paid on Senior Secured Notes - (20,898)
Benefit plan expense less then cash funding:
Defined benefit pension expense (3,079) (2,456)
Other postretirement benefit expense (1,651) (1,738)
Deferred income taxes:
Continuing operations 19,665 10,784
Discontinued operations (334) (175)
Minority interest:
Continuing operations 10,297 4,945
Discontinued operations (205) (178)
Other, net (146) 1,384
Equity in:
TIMET (32,591) (42,474)
Other 179 1,969
Net distributions from (contributions to):
Manufacturing joint venture 650 (250)
Other 109 339
Change in assets and liabilities:
Accounts and other receivables, net (54,223) (50,562)
Inventories, net (19,572) 18,584
Accounts payable and accrued liabilities (15,622) (18,859)
Accounts with affiliates 5,832 3,764
Income taxes (1,535) (22,491)
Other, net (5,968) 3,008
-------- --------
Net cash used in operating activities (26,717) (15,030)
-------- --------
Cash flows from investing activities:
Capital expenditures (25,444) (19,168)
Purchases of:
Kronos common stock (3,264) (25,213)
TIMET common stock (17,972) (17,028)
CompX common stock (572) (1,834)
Business unit, net of cash acquired - (9,832)
Marketable securities (16,638) (16,904)
Capitalized permit costs (1,508) (3,737)
Proceeds from disposal of:
Business unit 18,094 -
Kronos common stock 19,176 -
Marketable securities 6,012 15,753
Interest in Norwegian smelting operation 3,542 -
Cash of disposed business unit (4,006) -
Loans to affiliate, net 6,929 -
Change in restricted cash equivalents, net 3,623 (1,108)
Other, net 531 1,872
-------- --------
Net cash used in investing activities (11,497) (77,199)
-------- --------
VALHI, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
Six months ended June 30, 2005 and 2006
(In thousands)
2005 2006
---- ----
(unaudited)
Cash flows from financing activities:
Indebtedness:
Borrowings $ 78 $ 649,159
Principal payments (13,134) (597,788)
Deferred financing costs paid (28) (8,894)
Valhi dividends paid (24,621) (24,110)
Distributions to minority interest (5,007) (4,456)
Treasury stock acquired (41,822) (10,173)
NL common stock issued 2,693 9
Issuance of Valhi common stock and other, net 1,435 291
--------- ---------
Net cash provided by (used in) financing
Activities (80,406) 4,038
--------- ---------
Cash and cash equivalents - net change from:
Operating, investing and financing activities (118,620) (88,191)
Currency translation (1,020) 1,961
Cash and equivalents at beginning of period 267,829 274,963
--------- ---------
Cash and equivalents at end of period $ 148,189 $ 188,733
========= =========
Supplemental disclosures:
Cash paid for:
Interest, net of amounts capitalized $ 35,559 $ 28,143
Income taxes, net 36,885 28,125
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
Six months ended June 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 - - 41,109 - - - - 41,109
Dividends - - (24,110) - - - - (24,110)
Other comprehensive income, net - - - 481 18,373 - - 18,854
Treasury stock:
Acquired - - - - - - (10,173) (10,173)
Retired (5) (457) (9,711) - - - 10,173 -
Other, net 1 237 - - - - - 238
------ -------- -------- ------- ------- -------- -------- --------
Balance at June 30, 2006 $1,203 $108,590 $793,556 $ 4,675 $29,530 $(78,101) $(37,942) $821,511
====== ======== ======== ======= ======= ======== ======== ========
See accompanying Notes to Condensed Consolidated Financial Statements.
VALHI, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 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 June 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 also own a non-controlling
interest in Titanium Metals Corporation ("TIMET") that we account for 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 June
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.
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 June 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 six 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 six months of 2006, NL purchased approximately
117,000 shares of CompX common stock in market transactions for an aggregate
purchase price of $1.8 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 six months of 2006, we purchased
approximately 543,000 shares of TIMET common stock for an aggregate purchase
price of $17.0 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 being owned by
us for financial reporting purposes.
Three months ended Six months ended
June 30, June 30,
2005 2006 2005 2006
---- ---- ---- ----
(In millions)
Net sales:
Chemicals $311.7 $345.1 $603.6 $649.4
Component products 45.8 50.2 92.6 97.2
Waste management 2.0 4.3 4.5 7.3
------ ------ ------ ------
Total net sales $359.5 $399.6 $700.7 $753.9
====== ====== ====== ======
Cost of goods sold:
Chemicals $220.8 $266.8 $432.4 $499.9
Component products 35.2 37.8 71.8 73.2
Waste management 3.9 3.8 7.7 7.9
------ ------ ------ ------
$259.9 $308.4 $511.9 $581.0
====== ====== ====== ======
Gross margin*:
Chemicals $ 90.9 $ 78.3 $171.2 $149.5
Component products 10.6 12.4 20.8 24.0
Waste management (1.9) .5 (3.2) (.6)
------ ------ ------ ------
$ 99.6 $ 91.2 $188.8 $172.9
====== ====== ====== ======
Operating income:
Chemicals $ 55.1 $ 34.3 $ 98.7 $ 66.5
Component products 4.8 5.7 8.9 10.8
Waste management (3.5) (1.1) (6.3) (3.7)
------ ------ ------ ------
Total operating income 56.4 38.9 101.3 73.6
Equity in:
TIMET 15.8 20.4 32.6 42.5
Other (.3) (.3) (.2) (2.0)
General corporate items:
Interest and dividend income 9.3 10.6 19.5 20.4
Securities transaction gains, net 5.6 - 20.2 .2
Insurance recoveries 1.2 .6 1.2 2.8
General expenses, net (7.7) (8.6) (15.9) (15.0)
Loss on prepayment of debt - (22.3) - (22.3)
Interest expense (17.8) (19.2) (35.7) (36.0)
------ ------ ------ ------
Income before income taxes $ 62.5 $ 20.1 $123.0 $ 64.2
====== ====== ====== ======
*Sales less cost of goods sold.
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
immaterial 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, June 30,
2005 2006
-------- --------
(In thousands)
Accounts receivable $211,156 $279,965
Notes receivable 4,267 3,221
Accrued interest and dividends receivable 6,158 82
Allowance for doubtful accounts (2,815) (3,269)
-------- --------
Total $218,766 $279,999
======== ========
Note 4 - Inventories, net:
December 31, June 30,
2005 2006
-------- ---------
(In thousands)
Raw materials:
Chemicals $ 52,343 $ 46,769
Component products 7,022 8,363
-------- --------
Total raw materials 59,365 55,132
-------- --------
In-process products:
Chemicals 17,959 16,871
Component products 9,898 9,642
-------- --------
Total in-process products 27,857 26,513
-------- --------
Finished products:
Chemicals 150,675 146,709
Component products 5,542 5,401
-------- --------
Total finished products 156,217 152,110
-------- --------
Supplies (primarily chemicals) 39,718 46,437
-------- --------
Total $283,157 $280,192
======== ========
Note 5 - Other assets:
December 31, June 30,
2005 2006
--------- ---------
(In thousands)
Investment in affiliates:
TIMET:
Common stock $138,677 $202,567
Preferred stock 183 183
-------- --------
138,860 202,750
TiO2 manufacturing joint venture 115,308 115,558
Other 16,464 14,158
-------- --------
Total $270,632 $332,466
======== ========
Other noncurrent assets:
IBNR receivables $ 16,735 $ 16,922
Waste disposal site operating permits, net 14,133 17,641
Deferred financing costs 8,278 9,534
Loans and other receivables 2,502 2,990
Restricted cash equivalents 382 393
Other 19,609 22,250
-------- --------
Total $ 61,639 $ 69,730
======== ========
At June 30, 2006, we held 56.5 million shares of TIMET with a quoted market
price of $34.38 per share, or an aggregate market value of $1.9 billion. The
56.5 million shares of TIMET we held reflect the effects of 2:1 stock splits
TIMET implemented in each of February and May 2006.
Certain selected financial information of TIMET is summarized below:
December 31, June 30,
2005 2006
---------- ----------
(In millions)
Current assets $550.3 $ 662.4
Property and equipment 253.0 276.4
Marketable securities 46.5 50.8
Investment in joint ventures 26.0 32.6
Other noncurrent assets 31.5 34.1
------ --------
Total assets $907.3 $1,056.3
====== ========
Current liabilities $166.9 $ 166.7
Accrued pension and post retirement benefits 74.0 79.3
Long-term debt 51.4 48.4
Other non current liabilities 39.3 34.5
Minority interest 13.5 16.2
Stockholders' equity 562.2 711.2
------ --------
Total liabilities and stockholders' equity $907.3 $1,056.3
====== ========
Three months ended Six months ended
June 30, June 30,
------------------ -------------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions)
Net sales $183.7 $300.9 $339.0 $587.8
Cost of sales 135.8 194.6 262.2 373.2
Operating income 36.9 93.5 56.3 188.7
Net income attributable to common stockholders 33.6 54.3 71.7 111.1
Note 6 - Accrued liabilities:
December 31, June 30,
2005 2006
(In thousands)
Current:
Employee benefits $ 48,341 $ 42,446
Environmental costs 16,565 14,209
Deferred income 5,101 2,588
Interest 1,067 7,729
Other 58,355 65,997
-------- --------
Total $129,429 $132,969
======== ========
Noncurrent:
Insurance claims and expenses $ 24,257 $ 22,685
Employee benefits 4,998 6,457
Asset retirement obligations 1,381 1,507
Deferred income 573 525
Other 8,119 8,520
-------- --------
Total $ 39,328 $ 39,694
======== ========
Note 7 - Long-term debt:
December 31, June 30,
2005 2006
------- ---------
(In thousands)
Valhi - Snake River Sugar Company $250,000 $250,000
-------- --------
Subsidiary debt:
Kronos International:
6.5% Senior Secured Notes - 499,354
8.875% Senior Secured Notes 449,298 -
Kronos U.S. bank credit facility 11,500 32,250
Kronos Canadian bank credit facility - 4,453
Other 6,637 5,276
-------- --------
Total subsidiary debt 467,435 541,333
-------- --------
Total debt 717,435 791,333
Less current maturities 1,615 1,429
-------- --------
Total long-term debt $715,820 $789,904
======== ========
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 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 six months of 2006, we
borrowed a net Cdn. $5.0 million ($4.5 million) under Kronos' Canadian revolving
credit facility and a net $20.8 million under Kronos' U.S. bank credit facility.
The average interest rates on the outstanding balance under these facilities at
June 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 Six months ended
June 30, June 30,
-------------------- -----------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 1,914 $ 1,991 $ 3,901 $ 3,835
Interest cost 5,675 5,941 11,478 11,755
Expected return on plan assets (5,632) (6,405) (11,376) (12,671)
Amortization of prior service cost 150 114 304 226
Amortization of net transition
obligations 135 127 275 250
Recognized actuarial losses 1,126 2,259 2,276 4,431
------- ------- -------- --------
Total $ 3,368 $ 4,027 $ 6,858 $ 7,826
======= ======= ======== ========
Postretirement Benefits - The components of net periodic postretirement
benefit cost are presented in the table below.
Three months ended Six months ended
June 30, June 30,
------------------ -------------------
2005 2006 2005 2006
---- ---- ---- ----
(In thousands)
Service cost $ 54 $ 71 $ 109 $ 142
Interest cost 483 473 966 946
Amortization of prior service credit (231) (90) (463) (181)
Recognized actuarial losses (gains) (34) 29 (176) 57
----- ----- ----- -----
Total $ 272 $ 483 $ 436 $ 964
===== ===== ===== =====
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 .1% of our outstanding common stock at June 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.
I Contributions - We expect our 2006 contributions for our pension and
post retirement benefit plans to be consistent with the amount we disclosed in
our 2005 Annual Report.
Note 9 - Accounts with affiliates:
December 31, June 30,
2005 2006
------- --------
(In thousands)
Current receivables from affiliates:
Contran - income taxes, net $ 33 $ -
Other 1 7
------- -------
Total $ 34 $ 7
======= =======
Payables to affiliates:
Louisiana Pigment Company $ 9,803 $ 9,791
Contran - trade items 3,940 4,967
Contran - income taxes, net - 899
Other, net 11 28
------- -------
Total $13,754 $15,685
======= =======
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 six months of 2006, we purchased an aggregate of 506,000
shares of our common stock in market transactions for an aggregate of $10.2
million. At June 30, 2006, these 506,000 treasury shares had been cancelled, and
the aggregate $10.2 million cost was allocated to common stock at par value,
additional paid-in capital and retained earnings in accordance with GAAP. At
June 30, 2006, approximately 982,000 shares were available for purchase under
the repurchase authorization.
Note 11 - Other income, net:
Six months ended
June 30,
--------------------------
2005 2006
---- ----
(In thousands)
Securities earnings:
Dividends and interest $19,503 $19,547
Securities transactions, net 20,205 209
------- -------
Total securities earnings 39,708 19,756
Currency transactions, net 3,307 (2,981)
Insurance recoveries 1,200 2,817
Other, net 1,830 3,551
------- -------
Total other income, net $46,045 $23,143
======= =======
Note 12 - Provision for income taxes:
Six months ended
June 30,
------------------------
2005 2006
---- ----
(In millions)
Expected tax expense $43.0 $22.5
Incremental U.S. tax and rate differences on
equity in earnings 11.3 6.9
Non-U.S. tax rates (.3) (.9)
Nondeductible expenses 2.1 1.6
Resolution of prior year income tax issues, net - (2.0)
Income tax on distribution of shares of
Kronos common stock .7 -
Excess of book basis over tax basis of shares of
Kronos common stock sold 1.5 -
Contingency reserve adjustment, net .4 (9.2)
Canadian tax rate change - (1.3)
U.S. state income taxes, net .9 .8
Other, net (.3) (.3)
----- -----
$59.3 $18.1
===== =====
Comprehensive provision for income taxes (benefit) allocated to:
Income from continuing operations $59.3 $18.1
Discontinued operations (.4) (.2)
Other comprehensive income:
Marketable securities .3 1.9
Currency translation (1.5) 6.1
----- -----
$57.7 $25.9
===== =====
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 the second quarter of 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 issues related to
Kronos' German and Belgian operations during the first six months of 2006, we
recognized a $2.0 million income tax benefit ($1 million in the second quarter
of 2006) related to adjustments of prior year income taxes.
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
($7.2 million at June 30, 2006). The Belgian tax authorities filed a
lien on the fixed assets of our Belgian TiO2 operations in connection
with their assessment. This lien does 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. We
expect the lien will be released by the end of 2006.
o The Norwegian tax authorities previously notified us of their intent
to assess tax deficiencies of approximately kroner 12 million ($2.4
million at June 30, 2006) 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 six months of 2006 (mostly in the second quarter) related
to the total reduction in our income tax contingency reserve. Other income tax
examinations related to our operations continue, and we cannot guarantee that
these tax matters will be resolved in our favor due to the inherent
uncertainties involved in settlement initiatives and court and tax proceedings.
We believe we have adequate accruals for additional taxes and related interest
expense which could ultimately result from tax examinations. We believe the
ultimate disposition of tax examinations should not have a material adverse
effect on our consolidated financial position, results of operations or
liquidity.
Note 13 - Minority interest:
December 31, June 30,
2005 2006
-------- --------
(In thousands)
Minority interest in net assets:
NL Industries $ 51,177 $ 54,733
Kronos Worldwide 28,167 21,686
CompX International 45,630 45,312
Subsidiary of Kronos 75 80
-------- --------
Total $125,049 $121,811
======== ========
Six months ended
June 30,
----------------------
2005 2006
---- ----
(In thousands)
Minority interest in net earnings - continuing operations:
NL Industries $ 4,898 $1,612
Kronos Worldwide 3,877 1,455
CompX International 1,454 1,873
Subsidiary of Kronos 7 5
Subsidiary of NL 61 -
------- ----
Total $10,297 $4,945
======= ======
Note 14 - Discontinued operations, net of tax:
Discontinued operations relates to CompX's former Thomas Regout operations
in the Netherlands. Prior to December 2004, the Thomas Regout European
operations were classified as held for use. A formal plan of disposal adopted by
CompX's board of directors in December 2004 resulted in the reclassification of
the operations to held for sale. Based upon the estimated realizable value (or
fair value less costs to sell) of the net assets disposed, we determined that
the goodwill associated with the assets held for sale was partially impaired. In
determining the estimated realizable value of the Thomas Regout operations as of
December 31, 2004, when we classified it as held for sale, we used the sales
price inherent in the definitive agreement reached with the purchaser in January
2005 and our estimate of the related transaction costs (or costs to sell). In
January 2005, we completed the sale of Thomas Regout for net proceeds that were
approximately $864,000 less than previously estimated (primarily due to higher
expenses associated with the sale). These additional expenses reflect a
refinement of our previous estimate of the realizable value of the Thomas Regout
operations and accordingly we recognized a further impairment of goodwill. As a
result, discontinued operations for the first six months of 2005 includes a
charge for the additional expenses ($272,000, net of income tax benefit and
minority interest). Discontinued operations in 2006 represents an expense of
$500,000 ($147,000, net of income tax benefit 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
additional cases being filed against NL 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 against us been entered. 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 NL 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 NL 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
the abatement remedy are not currently known, and will be determined only
following additional preceedings before the trial court. Various matters remain
pending before the trial court, including NL's motion to dismiss. We intend to
appeal any adverse judgment which the trial court may enter against us.
The Rhode Island case is unique because this is the first time that an
adverse verdict in the lead pigment litigation has been entered against NL. NL
believes there are a number of meritorious issues which can be appealed in this
case; therefore, NL currently believes it is not probable it will ultimately be
found liable in this matter. In addition, NL 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 NL could in the near term conclude it is probable NL has
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 the liability is recognized, and a material adverse impact on our
financial condition and liquidity. Various other cases in which NL is a
defendant are also pending in other jurisdictions, and new cases could be filed
against NL, 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
currently 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 solvency of other PRPs,
o multiplicity of possible solutions; and
o the years of investigatory, remedial and monitoring activity required.
In addition, the imposition of more stringent standards or requirements
under environmental laws or regulations, new developments or changes respecting
site cleanup costs or allocation of 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, nor can we 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.
Environmental accruals are adjusted as further information becomes available or
circumstances change. Estimated future expenditures are generally not discounted
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 June 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 six months of
2006 are as follows:
Amount
(In thousands)
Balance at the beginning of the period $65,726
Additions charged to expense, net 1,811
Payments, net (3,737)
-------
Balance at the end of the period $63,800
=======
Amounts recognized in the balance sheet at the end of the period:
Current liability $14,209
Noncurrent liability 49,591
-------
Total $63,800
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 June 30,
2006, NL had accrued $52.7 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. NL has not discounted these
estimates to present value.
At June 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 the control of NL,
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 liability for the costs ultimately were
determined against NL.
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 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.
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 $3.3 million accrued at
June 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 the nature and extent of any final remediation measures for
this site will not be known until 2008. Tremont has not accrued costs for this
site for any final remediation measures since no reasonable estimate can
currently be made of the cost of any final remediation measures.
TIMET - At June 30, 2006, TIMET had accrued approximately $2.2 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 $4.4 million.
Other - We have also accrued approximately $7.8 million at June 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 formerly-owned operations of NL containing
asbestos, silica and/or mixed dust. Approximately 500 of these types of cases
remain pending, involving a total of approximately 10,600 plaintiffs and their
spouses. NL has not accrued any amounts for this litigation because of the
uncertainty of liability and inability to reasonably estimate the liability, if
any. To date, NL has not been adjudicated liable in any of these matters. Based
on information available to NL, including:
o facts concerning its historical operations,
o the rate of new claims,
o the number of claims from which NL has been dismissed; and
o NL's prior experience in the defense of these matters
NL believes the range of reasonably possible outcomes of these matters will be
consistent with its historical costs (which are not material), and NL does not
expect any reasonably possible outcome would involve amounts that are material
to NL. NL has and will continue to vigorously seek dismissal from each claim
and/or a finding of no liability by NL in each case. In addition, from time to
time, NL has received notices regarding asbestos or silica claims purporting to
be brought against its former subsidiaries, including notices provided to
insurers with which NL has entered into settlements extinguishing certain
insurance policies. These insurers may seek indemnification from NL.
Murphy, et al. v. NL Industries, Inc., et al. (United States District
Court, District of New Jersey, Case No. 2:06-cv-01535-WHW-SDW). In June 2006,
the plaintiffs filed an amended complaint. In July 2006, defendants filed
motions to disqualify plaintiffs' counsel, compel arbitration, transfer venue to
the Northern District of Texas, dismiss the claims against the individual
defendants for lack of personal jurisdiction and to dismiss the entire
complaint.
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 Report on Form 10-Q for the quarter ended March 31, 2006.
In addition to the litigation described above, we and our affiliates are
also involved in various other environmental, contractual, product liability,
patent (or intellectual property), employment and other claims and disputes
incidental to our present and former businesses. In certain cases, we have
insurance coverage for these items, although we do not currently 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 already provided for.
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
Report on Form 10-Q for the quarter ended March 31, 2006. Additional information
regarding such litigation, or new litigation, is below.
NL Industries, Inc. v. OneBeacon America Insurance Company, et. al.
(District Court for Dallas County, Texas, Case No. 05-11347). In June 2006, the
federal court granted our motion to remand the action to Texas state court.
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 there can be no assurance 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 $1.4 million and
$1.3 million in the second quarter and first six months of 2005, respectively,
and we recorded net compensation income of approximately $400,000 in the first
six months of 2006. We recorded no compensation income or expense in the second
quarter of 2006 for stock-based employee compensation. If we or our subsidiaries
grant a significant number of equity awards or modify, repurchase or cancel
existing equity awards in the future, the amount of equity compensation expense
in our Consolidated Financial Statements could be material.
Effective January 1, 2006, SFAS No. 123R requires the cash income tax
benefit resulting from the exercise of stock options in excess of the cumulative
income tax benefit previously recognized for GAAP financial reporting purposes
(which for us did not represent a significant amount in the first six 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 No. 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 No. 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 No. 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
No. 48 on our Consolidated Financial Statements.
--------------------------------------------------------------------------------
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.
We also own a non-controlling interest in Titanium Metals Corporation ("TIMET").
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-level radioactive
waste handling capabilities.
In addition, we account for our 35% non-controlling 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 TiO2 in
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.
Net Income Overview
Quarter Ended June 30, 2005 Compared to the Quarter Ended June 30, 2006 -
We reported income from continuing operations of $18.3 million, or $.16
per diluted share, in the second quarter of 2006 compared to income of $28.3
million, or $.24 per diluted share, in the second quarter of 2005. Our diluted
earnings per share declined from 2005 to 2006 due primarily to the net effects
of:
o lower chemicals operating income at Kronos in 2006,
o higher component products operating income at CompX in 2006,
o certain securities transaction gains realized in 2005,
o a charge in 2006 from the redemption of our 8.875% Senior Secured
Notes,
o certain income tax benefits and another non-operating income item
recognized by TIMET in 2005,
o higher operating income for TIMET in 2006, and
o certain income tax benefits recognized by Kronos in 2006.
Our income from continuing operations in 2005 includes (net of income taxes
and minority interest): 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, and o income related to certain income tax benefits
recognized by TIMET of $.01 per diluted share.
Our income from continuing operations in 2006 includes (net of income taxes
and minority interest):
o a charge related to the redemption of our 8.875% Senior Secured Notes
of $.09 per diluted share, and
o an aggregate income tax benefit of $.07 per diluted share associated
with Kronos' operations related to the withdrawal of certain income
tax assessments previously made by the 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.
These amounts are more fully discussed in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Results of
Operations" or in the 2005 Annual Report.
We currently believe net income for the full year 2006 will be lower than
2005 primarily due to lower expected chemicals operating income.
Six Months Ended June 30, 2005 Compared to the Six Months Ended June 30,
2006 -
We reported income from continuing operations of $41.2 million, or $.35 per
diluted share, in the first six months of 2006 compared to income of $53.4
million, or $.44 per diluted share, in the first six months of 2005. Our diluted
earnings per share declined from 2005 to 2006 due primarily to the net effects
of:
o lower chemicals operating income at Kronos in 2006,
o higher component products operating income at CompX in 2006,
o certain securities transaction gains realized in 2005,
o a charge in 2006 from the redemption of our 8.875% Senior Secured
Notes,
o certain income tax benefits and another non-operating income item
recognized by TIMET in 2005,
o higher operating income for TIMET in 2006, and
o certain income tax benefits recognized by Kronos in 2006.
Our income from continuing operations in 2005 includes (net of income taxes
and minority interest): 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, and o income related to certain income tax benefits
recognized by TIMET of $.08 per diluted share.
Our income from continuing operations in 2006 includes (net of income taxes
and minority interest):
o a charge related to the redemption of our 8.875% Senior Secured Notes
of $.09 per diluted share,
o an aggregate income tax benefit of $.07 per diluted share associated
with Kronos' operations related to the withdrawal of certain income
tax assessments previously made by the 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, and
o income of $.01 per diluted share related to certain insurance
recoveries recognized by NL.
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 that 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 that 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 The level of 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 The level of our TiO2 sales and production volumes, and
o Manufacturing costs, particularly maintenance and energy-related
expenses.
The key performance indicators for our Chemicals Segment are our TiO2
average selling prices, and our TiO2 sales and production volumes.
Three months ended June 30, Six months ended June 30,
------------------------------------ ----------------------------------
2005 2006 % Change 2005 2006 % Change
-------- ------ --------- ------ ------ ----------
(Dollars in millions)
Net sales $311.7 $345.1 +11% $603.6 $649.4 +8%
Cost of sales 220.8 266.8 +21% 432.4 499.9 +16%
------ ------ ------ ------
Gross margin $ 90.9 $ 78.3 -14% $171.2 $149.5 -13%
====== ====== ====== ======
Operating income $ 55.1 $ 34.3 -38% $ 98.7 $ 66.5 -33%
Percent of net sales:
Cost of goods sold 71% 77% 72% 77%
Gross margin 29% 23% 28% 23%
Operating income 18% 10% 16% 10%
Ti02 operating statistics:
Sales volumes* 122 139 +14% 237 264 +11%
Production volumes* 127 130 +2% 249 257 +3%
Percent change in net
sales:
Product pricing -1% +1%
Sales volumes +14% +11%
Ti02 product mix -1% -1%
Foreign currency exchange rates -1% -3%
--- ---
+11% +8%
* Thousands of metric tons
Net sales - Our Chemicals sales increased $33.4 million (11%) in the second
quarter of 2006 compared to the second quarter of 2005 due primarily to the net
effects of (i) a 14% increase in TiO2 sales volumes, (ii) a 1% decrease in
average TiO2 selling prices and (iii) the unfavorable effect of fluctuations in
foreign currency exchange rates, which decreased sales by approximately $4
million, or 1%. Chemicals sales increased $45.9 million (8%) in the first six
months of 2006 compared to the first six months of 2005 due primarily to an 11%
increase in TiO2 sales volumes, somewhat offset by the unfavorable effect of
changes in currency exchange rates, which decreased Chemicals sales by
approximately $19 million, or 3%. We expect our TiO2 average selling prices will
remain reasonably stable in the second half of 2006 as compared to the second
quarter of 2006.
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
somewhat offset by lower sales volumes in Canada. Kronos' sales volumes in the
first half of 2006 were a new record for Kronos. We believe Chemicals sales
volumes in Canada have decreased as our customers demand has been affected by
the effects of the strengthened Canadian dollar. We expect demand for TiO2 will
continue to remain high for the remainder of the year.
Cost of sales - Our Chemicals cost of sales increased in 2006 due primarily
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 other operating costs (including energy costs). The negative impact
of the increase in raw materials and energy costs on our Chemicals gross margin
and operating income comparisons was somewhat offset by record TiO2 production
volumes. We continued to gain operational efficiencies at our existing TiO2
facilities by debottlenecking production to meet long-term demand. Our operating
rates were near full capacity in both periods, and our TiO2 production volumes
in the second quarter and first half of 2006 were also new records for us.
Through our debottlenecking program, we added finishing capacity in our
German chloride-process facility and 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 510,000 metric tons, with
some additional capacity expected to be available in 2007 through our continued
debottlenecking efforts.
Operating income - Our Chemicals segment operating income declined in 2006
primarily due to of the decrease in gross margin discussed above and the effect
of fluctuations in foreign currency exchange rates discussed below. Our
Chemicals operating income is stated 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 with
Chemicals cost of goods sold. We recognized an additional $8.6 million of
depreciation expense in the first six months of 2005 and $8.1 million in the
first six months of 2006, which reduced our reported Chemicals Segment operating
income as compared to amounts reported by Kronos.
Foreign currency exchange rates - We have substantial Chemicals operations
and assets located outside the United States (primarily in Germany, Belgium,
Norway and Canada). The majority of our Chemicals 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
Chemicals 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 Chemicals 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 sales and operating income in 2006 as
compared to 2005.
Increase (decrease)
Three months ended Six months ended
June 30, 2006 June 30, 2006
vs. 2005 vs. 2005
----------------- ------------
(in millions)
Impact on:
Net sales $ (4) $ (19)
Operating income (11) (16)
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 both have filed claims with our insurers. We
expect to recover our losses through the insurer in the second half of 2006,
although the amount and timing of the insurance recovery is not yet known.
Accordingly, we have not accrued a receivable for the amount of the insurance
claim and will not record the claim until negotiations with their insurer are
finalized. The effect on our Chemicals operating results will depend on the
timing and amount of insurance recoveries.
Outlook - We expect our Chemicals operating income in the second half of
2006 will continue to be lower than the second half of 2005. Our expectations as
to the future prospects of our Chemicals segment and 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 June 30, Six months ended June 30,
----------------------------------- -----------------------------------
2005 2006 % Change 2005 2006 % Change
------ ------ --------- ------ ------ ----------
(Dollars in millions)
Net sales $45.8 $50.2 +10% $92.6 $97.2 +5%
Cost of sales 35.2 37.8 +7% 71.8 73.2 +2%
----- ----- ----- -----
Gross margin $10.6 $12.4 +17% $20.8 $24.0 +15%
===== ===== ===== =====
Operating income $ 4.8 $ 5.7 +19% $ 8.9 $10.8 +21%
Percent of net sales:
Cost of goods sold 77% 75% 78% 75%
Gross margin 23% 25% 22% 25%
Operating income 10% 11% 10% 11%
Net sales - Our Component Products sales increased in the second quarter
and first six months of 2006 as compared to the second quarter and first six
months of 2005 due mainly to the effect of sales volumes generated from the
August 2005 and April 2006 acquisitions of two marine component businesses and a
general increase in sales volumes to new and existing security products
customers, offset by lower sales volumes for certain furniture component
products resulting from increased Asian competition and an unfavorable Canadian
dollar exchange rate which has caused operational difficulties for many of
CompX's Canadian customers.
Cost of sales - Our Component Products cost of goods sold increased in 2006
as compared to 2005 due to the increase in Component Products sales. As a
percent of sales, component products cost of goods sold was lower in 2006 as
compared to 2005 due primarily to an improved product mix as the decline in
lower-margin furniture components sales were offset by increased sales of
higher-margin security and marine component products.
Operating income - Component products gross margin and operating income
increased in 2006 due primarily to the increase in Component Products sales and
more favorable product mix as well as the favorable impact of a continuous focus
on reducing costs across all product lines, partially offset by the negative
impact of currency exchange rates as discussed below.
Foreign currency exchange rates - We have substantial Component Products
operations and assets located outside the United States in Canada and Taiwan.
Component Products sales generated from our non-U.S. Component Products
operations are denominated in both the U.S. dollar and in currencies other than
the U.S. dollar, principally the Canadian dollar and the New Taiwan dollar. Most
of our raw materials, labor and other production costs for these non-U.S.
operations are denominated primarily in local currencies. Consequently, the
translated U.S. dollar values of our non-U.S. Component Products 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 sales and
operating income in 2006 as compared to 2005.
Increase (decrease)
Three months ended Six months ended
June 30, 2006 June 30, 2006
vs. 2005 vs. 2005
----------------- ------------
(In thousands)
Impact on:
Net sales $ 496 $ 744
Operating income (709) (952)
Outlook - The component product markets in which we operate are highly
competitive in terms of product pricing and features. Our Component Products
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 this strategy is to
replace low margin, commodity type products with higher margin user-oriented
feature products. Additionally, we believe that our focus on collaborating with
customers to identify solutions and our ability to provide a high level of
customer service enable us to compete effectively. In response to competitive
pricing pressure, we continually focus on reducing production cost through
product reengineering, improvement in manufacturing processes or moving
production to lower cost facilities.
Component Product raw material prices, especially steel, zinc and copper
continue to be volatile putting pressure on our Component Products margins. We
actively seek to mitigate the margin impact by entering into raw material supply
agreements in order to stabilize the cost for a period of time, execute larger
volume tactical spot purchases at prices that are expected to be favorable
compared to future prices and, if necessary, passing on the cost increases to
our customers through surcharges and price increases. To date we have been able
to effectively mitigate the impact of higher material cost on our margins,
however, we may not be able to achieve these same results in future periods.
Waste Management -
Three months ended Six months ended
June 30, June 30,
------------------ --------------
2005 2006 2005 2006
---- ---- ---- ----
(In millions) (In millions)
Net sales $ 2.0 $ 4.3 $ 4.5 $ 7.3
Cost of goods sold 3.9 3.8 7.7 7.9
----- ----- ----- -----
Gross margin $(1.9) $ .5 $(3.2) $ (.6)
===== ===== ===== =====
Operating loss $(3.5) $(1.1) $(6.3) $(3.7)
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 agency, but the length of time it
will take for the agencies to complete their review and act upon our license
applications is uncertain. We currently believe the applicable state agency will
issue a final decision on our application for 11.e(2) waste material by the end
of this year, 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 early 2008. 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 income - Our Waste Management sales increased, 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. We continue to seek to
increase our Waste Management 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 sales, and decrease
Waste Management operating losses, in the remainder of 2006 and 2007. Our
ability to achieve increased Waste Management 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 sales volumes, we expect we will continue
to generally report Waste Management operating losses. While achieving increased
sales volumes could result in us reporting Waste Management operating profits,
we currently do not believe that 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 June 30, Six months ended June 30,
--------------------------------- -----------------------------------
2005 2006 % Change 2005 2006 % Change
------ ------- -------- ----- ------ ---------
(Dollars in millions)
As reported by TIMET:
Net sales $183.7 $300.9 +64% $339.0 $587.8 +73%
Cost of sales 135.8 194.6 +43% 262.2 373.2 +42%
------ ------ ------ ------
Gross margin 47.9 106.3 +122% 76.8 214.6 +179%
Other operating expenses,
net 11.0 12.7 +16% 20.5 25.9 +26%
------ ------ ------ ------
Operating income 36.9 93.6 +153% 56.3 188.7 +235%
Gain on sale of land 13.9 - 13.9 -
Other nonoperating income
(expense), net 1.5 (1.7) 2.3 (1.4)
Interest expense (.9) (.6) (1.6) (1.6)
------ ------ ------ ------
Income before taxes 51.4 91.3 70.9 185.7
Provision for income
taxes (benefit) 13.3 32.8 (9.5) 66.1
Minority interest 1.2 2.3 2.1 4.6
Dividends on preferred stock 3.3 1.9 6.6 3.9
------ ------ ------ ------
Net income attributable to
common stockholders $ 33.6 $ 54.3 +62% $ 71.7 $111.1 +55%
====== ====== ====== ======
Our equity in earnings of
TIMET $ 15.8 $ 20.4 +29% $ 32.6 $ 42.5 +30%
====== ====== ====== ======
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 from the commercial aerospace and military sectors that has driven
melted and milled titanium prices to record levels. As a result of these market
factors, our average selling prices for melted and milled products in the second
quarter of 2006 increased 118% and 40%, respectively, over the same period in
2005. For the first six months of 2006, these average selling prices increased
114% and 45%, respectively.
In addition to the improved pricing we experienced in our Titanium Metals
business, sales volumes of our melted and mill products increased 14% and 12%,
respectively, in the second quarter of 2006 as compared to the second quarter of
2005. For the first six months of 2006, sales volumes of our melted and milled
products increased 8% and 15%, respectively, compared to 2005. These higher
sales volumes were a result of increased demand across all of our market
sectors. In addition, our other product sales increased 46% in the year-to-date
period due principally to improved demand for our fabrication products.
As a result of current and future outlook for demand for our titanium
products, we are currently producing at approximately 90% of capacity at the
majority of our Titanium Metals facilities and 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.
Cost of sales - Our cost of Titanium Metals raw materials, primarily sponge
and scrap, increased in 2006 due to increased industry-wide demand as well as
demand in non-titanium markets that use titanium as an alloying agent.
Additionally, we have experienced increasing rutile and energy costs compared to
the prior year, although these increases have somewhat been offset by a decrease
in our non-titanium alloy costs in 2006 compared to 2005. To support the
continued growth of our Titanium Metals business, we have increased our
manufacturing and other headcount levels from the comparable 2005 periods.
Somewhat offsetting these cost increases, we were favorably impacted by improved
plant operating rates, which increased to 89% of practical capacity in the first
six months of 2006 from 80% in the first six 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 certain property. TIMET's effective income tax rate is significantly higher
in 2006 as compared to 2005, due primarily to TIMET's reversal during the first
six months of 2005 of $35.6 million of its valuation allowance attributable to
its U.S. and U.K. deferred income tax assets.
Outlook - We expect that current industry-wide demand trends will continue
beyond 2006. We also continue to expect the availability of certain raw
materials will tighten, and, consequently, the prices for these raw materials
are increasing. We currently expect that the shortage in certain raw materials
will continue throughout the remainder of 2006, which could limit our ability to
produce enough titanium products to fully meet customer demand. In addition, we
are limited in our ability to increase sales volumes by our existing capacity.
We are currently aggressively increasing our capacity through capital spending
for plant expansions. We currently expect production volumes to remain at
current levels for the remainder of 2006, with overall capacity utilization
expected to approximate 89% of practical capacity for the full year 2006 (as
compared to 80% in 2005). However, practical capacity utilization measures can
vary significantly based on product mix.
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
2006 will more than offset such increased raw materials costs, as has been the
case for the first half of 2006.
In July 2006, The Airline Monitor, a leading aerospace publication, issued
its semi-annual forecast for commercial aircraft deliveries. This forecast
delays the expected delivery timeline for approximately 1% 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 the current industry-wide demand trends
will continue beyond 2006.
TIMET's backlog at June 30, 2006 was $860 million, compared to $870 million
at December 31, 2005 and $580 million at June 30, 2005. The backlog has somewhat
decreased from December 31, 2005 as discussions regarding volumes and pricing
for 2007 orders continue with certain customers, and as a result TIMET's backlog
does not yet reflect orders that we expect to acknowledge during the third and
fourth quarters of 2006.
Our Titanium Metals cost of sales is affected by a number of factors
including customer and product mix, material yields, plant operating rates, raw
material costs, labor costs and energy costs. Raw material costs, which include
sponge, scrap and alloys, represent the largest portion of our manufacturing
cost structure, and, as previously discussed, continued cost increases for
certain raw materials have occurred during the first half of 2006 and are
expected to continue throughout the remainder of 2006. Scrap and other certain
raw material costs have continued to rise, and increased energy costs also
continue to have a negative impact on gross margin.
Based on the foregoing, we anticipate our full year 2006 Titanium Metals
net sales revenue will range from $1.1 billion to $1.2 billion and our full year
2006 operating income will range from $325 million to $350 million.
Outlook - 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 and 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 $2.3
million in the first six months of 2005 and $2.4 million in the first six 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
(Benefit), 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 $6.1 million and $12.4 million in the
second quarter and first six months of 2005, respectively, compared to $7.3
million and $14.4 million in the second quarter and first six months of 2006. We
also recognized interest income on our $80 million loan to Snake River of $1.3
million and $2.7 million in the second quarter and first six 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 six 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 $1.7 million which the LLC has paid us during the first
six 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 six months of 2006 under the agreement (including $300,000 in the second
quarter). 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 $1.7 million in insurance recoveries in the first six
months of 2006 in settlements with certain of its former insurance carriers
(including approximately $300,000 in the second quarter). These settlements, as
well as similar prior settlements NL reached in the past few years (including
$1.2 million in the second 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 -
Corporate expenses were $15.0 million in the first six months of 2006,
slightly lower than the $15.9 million in the first six months of 2005, as lower
environmental remediation expenses of NL were partially offset by higher
litigation and related expenses for NL. Corporate expenses were approximately
$900,000 higher in the second quarter of 2006 as compared to the second quarter
of 2005 due primarily to higher environmental remediation and litigation and
related expenses of NL. We expect corporate expenses in calendar 2006 will be
higher than 2005, in part due to higher expected litigation and related expenses
of NL. However, 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. 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 increased $1.4 million from $17.8 million in the second
quarter of 2005 to $19.2 million in the second quarter of 2006. Interest expense
was higher in the second quarter of 2006 because the 8.875% Senior Secured Notes
and the 6.5% Senior Secured Notes were both outstanding for 30 days during the
quarter. This additional interest expense was partially offset by changes in
currency exchange rates in 2006 compared to 2005. Interest expense in the first
six months of 2006 increased slightly compared to the first six months of 2005,
as the effect of the 30 days of interest expense on both Senior Secured Notes
was mostly offset by 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 second half of
2006 as compared to the first half 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 (Benefit) -
We recognized an income tax benefit of $600,000 in the second quarter of
2006 compared to a provision for income taxes of $29.4 million in the second
quarter of 2005. For the first six months of 2006, we recognized a provision for
income taxes of $18.1 million compared to a provision of $59.3 million in the
first six months of 2005. The income tax benefit we recognized in the second
quarter of 2006, and the unusually low overall effective income tax rate we
recognized in the first six months of 2006, is due primarily to a $9.2 million
reduction in our tax contingency reserves related to favorable developments with
income tax audits for our Belgian and Norwegian operations, a $2.0 million
benefit associated with favorable developments with certain income tax issues
related to our German and Belgium operations and 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 $5.4 million in the first six months
of 2006 to $4.9 million from $10.3 million in the same period in the prior year,
primarily due to lower income at both Kronos and NL. In addition, we purchased
additional shares of Kronos and CompX common stock during the last half of 2005
and the first six 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, Net of Tax -
Discontinued operations relates to the former Thomas Regout operations of
CompX 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 used in our operating activities decreased from a $26.7 million
use of cash in the first six months of 2005 to a $15.0 million use of cash in
the first six months of 2006. This decrease in the use of cash was due primarily
to the net effects of the following items:
o Lower consolidated operating income in 2006 of $27.7 million, due
primarily to the lower chemicals earnings, o Lower cash paid for
interest in 2006 of $7.4 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 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 income taxes in 2006 of $8.8 million, due in part
to a $21 million tax payment we made in 2005 to settle a
previously-reported income tax audit of NL in the U.S.,
o Higher net cash provided by changes in receivables, inventories,
payables and accrued liabilities in 2006 of $33.8 million, due
primarily to relative changes in Kronos' inventory levels, and
o Lower cash paid for environmental remediation expenditures of $2.9
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 June 30, 2006 due to the timing of
collection on higher accounts receivable balances at the end of June. CompX's
average DSO increased from 40 days at December 31, 2005 to 41 days at June 30,
2006 due to timing of collection on the higher accounts receivable balance at
the end of June. For comparative purposes, Kronos' average DSO increased from 60
days at December 31, 2004 to 64 days at June 30, 2005, and CompX's average DSO
increased from 38 days to 42 days, due to the timing of collection on their
slightly higher accounts receivable balances at the end of June 2005.
Kronos' average days sales in inventory ("DSI") decreased from 102 days at
December 31, 2005 to 88 days at June 30, 2006, as their strong TiO2 production
volumes in the first six months of 2006 still exceeded their strong TiO2 sales
volumes during such period by approximately 7,000 metric tons. CompX's average
DSI decreased from 59 days at December 31, 2005 to 57 days at June 30, 2006 due
primarily to their lower commodity raw material balance at June 30, 2006 as
compared to December 31, 2005. For comparative purposes, Kronos' and CompX's
average DSI of 97 days and 52 days, respectively, at December 31, 2004 were both
comparable to their average DSI at June 30, 2005.
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 the 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.
Six months ended
June 30,
--------------------
2005 2006
---- ----
(In millions)
Cash provided by (used in) operating activities:
Kronos $ 2.4 $(19.0)
CompX 8.6 11.3
Waste Control Specialists (3.2) (2.8)
NL Parent (24.2) (2.4)
Tremont (1.5) (.8)
Valhi Parent 27.4 34.8
Other (.3) (.1)
Eliminations (35.9) (36.0)
------ ------
Total $(26.7) $(15.0)
====== ======
Investing and Financing Activities -
Our Chemicals Segment accounted for approximately $13.4 million of our
consolidated capital expenditures in the first six months of 2006, $5.4 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 six months of 2006:
o shares of Kronos common stock for $25.2 million,
o shares of TIMET common stock for $17.0 million,
o shares of CompX common stock for $1.8 million, and
o other marketable securities for a net of $1.1 million.
In addition, during the first six months of 2006 we:
o acquired a marine components products company for approximately $9.8
million, and
o capitalized $3.7 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 $20.8 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 Valhi common stock of $24.1 million
($.10 per share per quarter) in the first six months of 2006 to our
shareholders. Distributions to minority interest in the first six 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 506,000 shares of our common stock in market
transactions for $10.2 million during the first six 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 June 30, 2006, consolidated third-party indebtedness was comprised of:
o KII's euro 400 million aggregate principal amount 6.5% Senior Secured
Notes ($449.4 million at June, 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 ($32.3 million
outstanding) due in 2008,
o Kronos' Canadian bank credit facility ($4.5 million outstanding) due
in 2009, and
o $5.3 million of other indebtedness.
We and all of our subsidiaries are in compliance with all of our debt
covenants at June 30, 2006. See Note 7 to the Condensed Consolidated Financial
Statements. At June 30, 2006, only $1.4 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 the 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 on-going 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 related companies) perceived by management to be
undervalued in the marketplace. These companies may or may not be engaged in
businesses related to our current businesses. We intend to consider such
acquisition activities in the future and, in connection with this activity, may
consider issuing additional equity securities and increasing indebtedness. From
time to time, we also evaluate the restructuring of ownership interests among
our respective subsidiaries and related companies.
Based upon our expectations of our operating performance, and the
anticipated demands on our cash resources, we expect to have sufficient
liquidity to meet our short-term obligations (defined as the twelve-month period
ending June 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 June 30, 2006, we had credit available under existing facilities of
approximated $266.3 million, which was comprised of:
o $50.0 million under CompX's revolving credit facility,
o $118.0 million under Kronos' various U.S. and non-U.S. credit
facilities, and
o $98.3 million under Valhi's revolving bank credit facility.
At June 30, 2006, TIMET had $179.7 million of borrowing availability under
its various U.S. and European credit agreements.
At June 30, 2006, we had an aggregate of $217.8 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 $ 71.7
Kronos 65.4
NL Parent 43.4
CompX 22.8
Tremont 10.0
Waste Control Specialists 4.4
Other .1
------
Total cash, cash equivalents, and marketable securities $217.8
======
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 $19.2 million though June 30,
2006.
TIMET intends to invest a total of approximately $110 million to $120
million for capital expenditures during 2006, primarily for improvements and
upgrades to our existing Titanium Metals 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 will be
completed by the end of 2006, will provide the capacity to produce an additional
4,000 metric tons of sponge annually, an increase of approximately 42% 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 June 30, 2006 we had
approximately 982,000 shares available for repurchase of our common stock under
the authorization 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 June 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 June 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 $5.8
million from our subsidiary during the first six months of 2006. The outstanding
amount of this intercompany borrowing, which is eliminated in our Condensed
Consolidated Financial Statements, was $10.4 million at June 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 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, 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 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 second quarter 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 six 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.
At June 30, 2006, we held a series of contracts, with expiration dates
ranging from July 2006 to September 2006, to exchange an aggregate of U.S. $19.6
million for an equivalent amount of Canadian dollars at exchange rates ranging
from Cdn. $1.11 to Cdn. $1.16 per U.S. dollar. At June 30, 2006, the actual
exchange rate was Cdn. $1.12 per U.S. dollar. The estimated fair value of such
foreign currency forward contracts at June 30, 2006 is insignificant.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures -
We maintain a system of disclosure controls and procedures. The term
"disclosure controls and procedures," as defined by regulations of the SEC,
means controls and other procedures that are designed to ensure that information
required to be disclosed in the reports we file or submit to the SEC under the
Securities Exchange Act of 1934, as amended (the "Act"), is recorded, processed,
summarized and reported, within the time periods specified in the SEC's rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information we are required to
disclose in the reports we file or submit to the SEC under the Act is
accumulated and communicated to our management, including our principal
executive officer and our principal financial officer, or persons performing
similar functions, as appropriate to allow timely decisions to be made regarding
required disclosure. Each of 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 June 30, 2006. Based upon their evaluation, these
executive officers have concluded that our disclosure controls and procedures
were effective as of June 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 June 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 Report on Form 10-Q for the quarter ended March 31, 2006.
Lewis, et al. v. Lead Industries Association, et al. (Circuit Court of Cook
County, Illinois, County Department, Chancery Division, Case No. 00CH09800). In
May 2006, defendants' petition seeking review of the appellate court's ruling
was denied by the Illinois Supreme Court.
Jones v. NL Industries, Inc., et al. (Circuit Court of LeFlore County,
Mississippi, Civil Action No. 2002-0241-CICI). In May 2006, the court granted
defendants' summary judgment motion with respect to the failure to warn and
fraudulent concealment claims, but denied the rest of the motion. Trial began
before a Mississippi federal court jury in July 2006, and in August 2006 the
jury returned a verdict in favor of the defendants on all counts.
Terry, et al. v. NL Industries, Inc., et al. (United States District Court,
Southern District of Mississippi, Case No. 4:04 CV 269 PB). Following plaintiffs
re-pleading the fraud claim, defendants answered the non-fraud counts of the
complaint and moved to dismiss the fraud claim for lack of sufficiency; however,
the court has stayed the case pending trial in the Jones v. NL Industries, Inc.,
et al. (Circuit Court of LeFlore County, Mississippi, Civil Action No.
2002-0241-CICI) case.
Evans v. Atlantic Richfield Company, et. al. (Circuit Court, Milwaukee,
Wisconsin, Case No. 05-CV-9281). In April 2006, the court allowed plaintiff to
amend the complaint to avoid defendants' motion to dismiss. Plaintiff amended
the complaint; however, in July 2006, defendants renewed their motion to dismiss
the defective product claims.
Hess, et. al. v. NL Industries, Inc., et al. (Missouri Circuit Court 22nd
Judicial Circuit, St. Louis City, Cause No. 052-11799). In May 2006, plaintiffs
moved to remand the case back to state court, and in June 2006, the court
remanded the case.
In July 2006, we began work on an additional removal action with respect to
ponds located within a residential area at the site of a formerly owned lead
smelting facility located in Collinsville, Illinois. We anticipate that the
removal action will be completed in the fourth quarter of 2006.
Brown et. al. v. NL Industries, Inc. et. al. (Circuit Court Wayne County,
Michigan, Case No. 06-602096 CZ). In April 2006, defendants filed a motion to
dismiss the plaintiffs' claims for trespass and violations of certain Michigan
state laws.
In June 2006, we and several other PRPs received a Unilateral
Administrative Order from the U.S. EPA regarding a formerly owned mine and
smelting facility located in Park Hills, Missouri. The Doe Run Company is the
current owner of the site, and its predecessor purchased the site from us in
approximately 1948. Doe Run is also named in the Order. We intend to comply with
the Order and are negotiating with Doe Run an appropriate allocation of costs
for the remediation.
In June 2006, we were served with a complaint in Donnelly and Donnelly v.
NL Industries, Inc. (State of New York Supreme Court, County of Rensselaer,
Cause No. 218149). The plaintiff, a man who claims to have worked near one of
our former sites in New York, and his wife allege that he suffered injuries
(which are not described in the complaint) as a result of exposure to harmful
levels of toxic substances as a result of NL's conduct. Plaintiffs claim damages
for negligence, product liability and derivative losses on the part of the wife.
We believe that these claims are without merit and intend to deny all of the
allegations and to defend against all of the claims vigorously.
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 six months ended June 30, 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
are retired and cancelled or may be added to our treasury and used for employee
benefit plans, future acquisitions or other corporate purposes. See Note 10 to
the Condensed Consolidated Financial Statements.
The following table discloses certain information regarding shares of Valhi
common stock we purchased during the second quarter of 2006. All purchases were
made under the repurchase program in open market transactions.
Average Maximum number of shares
price paid Total number of shares that may yet be purchased
Total number per share, purchased as part of a under the
of shares including publicly-announced publicly-announced plan at
Period purchased commissions plan end of period
------ --------- ----------- ------------------ ---------------
April 1, 2006
to April 30,
2006 64,200 $18.86 64,200 1,148,800
May 1, 2006
to May 31, 2006 84,800 24.33 84,800 1,064,000
June 1, 2006
to June 30, 2006 82,200 24.29 82,200 981,800
------- -------
231,200 231,200
======= =======
Item 4. Submission of Matters to a Vote of Security Holders.
Our 2005 Annual Meeting of Shareholders was held on May 25, 2006. Thomas E.
Barry, Normal S. Edelcup, W. Hayden McIlroy, Glenn R. Simmons, Harold C.
Simmons, J. Walter Tucker, Jr. and Steven L. Watson were elected as directors,
each receiving votes "For" their election from at least 97.7% of the 115.8
million common shares eligible to vote at the Annual Meeting.
Item 6. Exhibits.
31.1 - Certification
31.2 - Certification
32.1 - Certification.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VALHI, INC.
(Registrant)
Date August 7, 2006 By /s/ Bobby D. O'Brien
------------------ ------------------------------
Bobby D. O'Brien
Vice President and Chief Financial
Officer
(Principal Financial Officer)
Date August 7, 2006 By /s/ Gregory M. Swalwell
----------------- ------------------------------
Gregory M. Swalwell
Vice President and Controller
(Principal Accounting Officer)