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, Basic Management, Inc. (“BMI”) and the LandWell Company (“LandWell”). Kronos (NYSE: KRO), NL (NYSE: NL) and CompX (NYSE American: CIX) each file periodic reports with the SEC.
On January 26, 2018 we sold our Waste Management Segment to JFL-WCS Partners, LLC ("JFL Partners"), an entity sponsored by certain investment affiliates of J.F. Lehman & Company, for consideration consisting of the assumption of all of WCS' third-party indebtedness and other liabilities; accordingly the results of operations of our Waste Management Segment is reflected as discontinued operations in our Consolidated Statements of Income for the three and nine months ended September 30, 2018. We recognized a pre-tax gain of approximately $58 million on the transaction in the first quarter of 2018 because the carrying value of the liabilities of the business assumed by the purchaser exceeded the carrying value of the assets sold at the time of sale in large part due to a long-lived asset impairment of $170.6 million recognized with respect to the Waste Management Segment in the second quarter of 2017. Such pre-tax gain is classified as part of discontinued operations. The sale of our former Waste Management Segment enables us to focus on our remaining profitable businesses. See Note 3 to our Condensed Consolidated Financial Statements.
We have three consolidated reportable operating segments:
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Chemicals—Our chemicals segment is operated through our majority control of Kronos. Kronos is a leading global producer and marketer of value-added titanium dioxide pigments (“TiO2”). TiO2 is used to impart whiteness, brightness, opacity and durability to a wide variety of products, including paints, plastics, paper, fibers and ceramics. Additionally, TiO2 is a critical component of everyday applications, such as coatings, plastics and paper, as well as many specialty products such as inks, foods and cosmetics.
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Component Products—We operate in the component products industry through our majority control of CompX. CompX is a leading manufacturer of security products used in the recreational transportation, postal, office and institutional furniture, cabinetry, tool storage, healthcare and a variety of other industries. CompX is also a leading manufacturer of stainless steel exhaust systems, gauges, throttle controls, wake enhancement systems and trim tabs for the recreational marine industry.
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Real Estate Management and Development—We operate in real estate management and development through our majority control of BMI and LandWell. BMI provides utility services to certain industrial and municipal customers and owns real property in Henderson, Nevada. LandWell is engaged in efforts to develop certain land holdings for commercial, industrial and residential purposes in Henderson, Nevada.
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General
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, as amended. Statements in this Quarterly Report that are not historical facts are forward-looking in nature and represent management’s beliefs and assumptions based on currently available information. In some cases, you can identify forward-looking statements by the use of words such as “believes,” “intends,” “may,” “should,” “could,” “anticipates,” “expects” or comparable terminology, or by discussions of strategies or trends. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we do not know if these expectations will be correct. Such statements by their nature involve substantial risks and uncertainties that could significantly impact expected results. Actual future results could differ materially from those predicted. The factors that could cause actual future results to differ materially from those described herein are the risks and uncertainties discussed in this Quarterly Report and those described from time to time in our other filings with the SEC and include, but are not limited to, the following:
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Future supply and demand for our products;
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The extent of the dependence of certain of our businesses on certain market sectors;
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The cyclicality of certain of our businesses (such as Kronos’ TiO2 operations);
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Customer and producer inventory levels;
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Unexpected or earlier-than-expected industry capacity expansion (such as the TiO2 industry);
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Changes in raw material and other operating costs (such as ore, zinc, brass, steel and energy costs) and our ability to pass those costs on to our customers or offset them with reductions in other operating costs;
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Changes in the availability of raw materials (such as ore);
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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 and component products);
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Competitive products and prices and substitute products, including increased competition from low-cost manufacturing sources (such as China);
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Possible disruption of our business or increases in the cost of doing business resulting from terrorist activities or global conflicts;
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Customer and competitor strategies;
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Potential difficulties in integrating future acquisitions;
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Potential difficulties in upgrading or implementing accounting and manufacturing software systems;
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Potential consolidation of our competitors;
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Potential consolidation of our customers;
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The impact of pricing and production decisions;
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Competitive technology positions;
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Our ability to protect or defend intellectual property rights;
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The introduction of trade barriers;
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The ability of our subsidiaries to pay us dividends;
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The impact of current or future government regulations (including employee healthcare benefit related regulations);
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Uncertainties associated with new product development and the development of new product features;
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Fluctuations in currency exchange rates (such as changes in the exchange rate between the U.S. dollar and each of the euro, the Norwegian krone and the Canadian dollar) or possible disruptions to our business resulting from potential instability resulting from uncertainties associated with the euro or other currencies;
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Operating interruptions (including, but not limited to, labor disputes, leaks, natural disasters, fires, explosions, unscheduled or unplanned downtime, transportation interruptions and cyber-attacks);
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Decisions to sell operating assets other than in the ordinary course of business;
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The timing and amounts of insurance recoveries;
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Our ability to renew, amend, refinance or establish credit facilities;
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Our ability to maintain sufficient liquidity;
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The ultimate outcome of income tax audits, tax settlement initiatives or other tax matters, including future tax reform;
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Our ultimate ability to utilize income tax attributes, the benefits of which may or may not presently have been recognized under the more-likely-than-not recognition criteria;
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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);
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Government laws and regulations and possible changes therein (such as changes in government regulations which might impose various obligations on former manufacturers of lead pigment and lead-based paint, including NL, with respect to asserted health concerns associated with the use of such products) including new environmental health and safety regulations;
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The ultimate resolution of pending litigation (such as NL’s lead pigment litigation, environmental and other litigation);
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Our ability to comply with covenants contained in our revolving bank credit facilities;
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Our ability to complete and comply with the conditions of our licenses and permits;
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Changes in real estate values and construction costs in Henderson, Nevada;
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Water levels in Lake Mead; and
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Possible future litigation.
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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.
Operations Overview
Quarter Ended September 30, 2019 Compared to the Quarter Ended September 30, 2018 —
We reported net income from continuing operations attributable to Valhi stockholders of $13.1 million or $.04 per diluted share in the third quarter of 2019 compared to $142.8 million or $.42 per diluted share in the third quarter of 2018. As discussed more fully below, our net income from continuing operations attributable to Valhi stockholders decreased from 2018 to 2019 primarily due to the net effects of:
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The third quarter 2018 recognition of an aggregate income tax benefit of $113 million related to a change in the deferred income tax liability related to our investment in Kronos as a result of the 2017 Tax Act;
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lower operating income from our Chemicals Segment in 2019 compared to 2018;
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a securities transaction gain of $12.5 million recognized in the third quarter of 2018 related to the sale of our interest in The Amalgamated Sugar Company LLC;
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recognition of a gain on sale of land of $4.4 million in 2019; and
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lower interest expense in 2019 as a result of the deemed repayment of the Snake River debt in August 2018.
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Our diluted net income from continuing operations per share in the third quarter of 2019 includes a gain of $.01 per share related to the sale of land not used in our operations.
Our diluted net income from continuing operations per share in 2018 includes:
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a non-cash deferred income tax benefit of $.33 per diluted share related to a change in the deferred income tax liability related to our investment in Kronos related to the 2017 Tax Act; and
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a gain of $.03 per diluted share related to a securities transaction gain recognized in the third quarter related to the sale of our interest in The Amalgamated Sugar Company LLC.
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Nine Months Ended September 30, 2019 Compared to the Nine Months Ended September 30, 2018 —
We reported net income from continuing operations attributable to Valhi stockholders of $38.5 million or $.11 per diluted share in the first nine months of 2019 compared to $205.8 million or $.60 per diluted share in the first nine months of 2018. As discussed more fully below, our net income from continuing operations attributable to Valhi stockholders decreased from 2018 to 2019 primarily due to the net effects of:
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The third quarter 2018 recognition of an aggregate income tax benefit of $113 million related to a change in the deferred income tax liability related to our investment in Kronos as a result of the 2017 Tax Act;
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lower operating income from our Chemicals Segment in 2019 compared to 2018;
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a pre-tax litigation settlement expense of $19.3 million, primarily recognized in the second quarter of 2019 compared to $62.0 million recognized in the second quarter of 2018;
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a securities transaction gain of $12.5 million recognized in the third quarter of 2018 related to the sale of our interest in The Amalgamated Sugar Company;
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recognition of a gain on sale of land of $12.5 million in 2018 compared to $4.4 million recognized in 2019;
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income from tax increment infrastructure reimbursement of $8.8 million in 2019 compared to $3.1 million in 2018;
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insurance recoveries of $5.2 million primarily related to a single insurance recovery settlement in the second quarter of 2019;
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lower interest expense in 2019 as a result of the deemed repayment of the Snake River debt in August 2018; and
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lower litigation and related costs and environmental and related expenses in 2019.
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Our diluted net income from continuing operations per share in 2019 includes:
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a charge of $.04 per share related to the litigation settlement expense primarily recognized in the second quarter;
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a gain of $.01 per share related to tax increment infrastructure reimbursement primarily recognized in the second quarter;
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a gain of $.01 per share related to the insurance recoveries primarily recognized in the second quarter; and
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a gain of $.01 per share related to the sale of land not used in our operations in the third quarter.
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Our diluted net income from continuing operations per share in 2018 includes:
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a non-cash deferred income tax benefit of $.33 per diluted share in the third quarter related to a change in the deferred income tax liability related to our investment in Kronos as a result of the 2017 Tax Act;
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a gain of $.03 per diluted share related to a securities transaction gain recognized in the third quarter related to the sale of our interest in The Amalgamated Sugar Company LLC;
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a gain of $.03 per share related to the sale of land not used in our operations; and
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a charge of $.12 per share related to the litigation settlement expense recognized in the second quarter.
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Current Forecast for 2019—
We currently expect to report lower consolidated operating income for 2019 as compared to 2018 primarily due to the net effects of:
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lower operating income from our Chemicals Segment in 2019, as the favorable impact of higher sales volumes would be more than offset by the unfavorable impact of lower average selling prices and higher raw material costs (principally feedstock ore) in 2019; and
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higher operating income from our Real Estate Management and Development Segment in 2019 primarily due to the recognition of tax increment infrastructure reimbursement.
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Segment Operating Results—2019 Compared to 2018 –
Chemicals –
We consider TiO2 to be a “quality of life” product, with demand affected by gross domestic product, or GDP, and overall economic conditions in our markets located in various regions of the world. Over the long-term, we expect demand for TiO2 will grow by 2% to 3% per year, consistent with our expectations for the long-term growth in GDP. However, even if we and our competitors maintain consistent shares of the worldwide market, demand for TiO2 in any interim or annual period may not change in the same proportion as the change in GDP, in part due to relative changes in the TiO2 inventory levels of our customers. We believe that our customers’ inventory levels are influenced in part by their expectations for future changes in market TiO2 selling prices as well as their expectations for future availability of product. Although certain of our TiO2 grades are considered specialty pigments, the majority of our grades and substantially all of our production are considered commodity pigment products, with price and availability being the most significant competitive factors along with quality and customer service.
The factors having the most impact on our reported operating results are:
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our TiO2 sales and production volumes,
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manufacturing costs, particularly raw materials such as third-party feedstock, maintenance and energy-related expenses, and
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currency exchange rates (particularly the exchange rate for the U.S. dollar relative to the euro, the Norwegian krone and the Canadian dollar).
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Our Chemicals Segment’s key performance indicators are our TiO2 average selling prices, our level of TiO2 sales and production volumes, and the cost of our third-party feedstock. TiO2 selling prices generally follow industry trends and prices will increase or decrease generally as a result of competitive market pressures.
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Three months ended September 30,
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Nine months ended September 30,
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2018
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2019
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%
Change
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2018
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2019
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%
Change
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Net sales
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$
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410.3
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$
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437.4
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7
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%
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$
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1,312.5
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$
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1,358.4
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3
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%
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Cost of sales
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291.7
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350.3
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20
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848.3
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1,053.4
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24
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Gross margin
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$
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118.6
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$
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87.1
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(27)
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$
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464.2
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$
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305.0
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(34)
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Operating income
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$
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61.0
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$
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36.3
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(40)
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$
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295.2
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$
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139.6
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(53)
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Percent of net sales:
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Cost of sales
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71
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%
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80
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%
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65
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%
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78
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%
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Gross margin
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29
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20
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35
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22
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Operating income
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15
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8
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22
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10
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TiO2 operating statistics:
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Sales volumes*
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123
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144
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17
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%
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385
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445
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16
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%
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Production volumes*
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131
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136
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4
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400
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406
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1
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Percent change in net sales:
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TiO2 product pricing
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(5)
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%
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(7)
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%
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TiO2 sales volumes
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17
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16
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TiO2 product mix/other
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(3)
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(3)
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Changes in currency exchange rates
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(2)
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(3)
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Total
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7
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%
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3
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%
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*
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Thousands of metric tons
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Current Industry Conditions— Our Chemicals Segment started 2019 with average TiO2 selling prices 3% lower than at the beginning of 2018. Our average TiO2 selling prices declined in the first quarter of 2019 compared to the fourth quarter of 2018 before beginning to rise in the second and third quarters of 2019. Our average TiO2 selling prices at the end of the third quarter of 2019 were 2% higher than at the end of the second quarter of 2019 and were comparable to the end of 2018. Our Chemicals Segment experienced higher sales volumes in all major markets in the first nine months of 2019 as compared to the same period of 2018.
Our Chemicals Segment operated our production facilities at overall average capacity utilization rates of 97% in the first nine months of 2019 compared to 95% in the first nine months of 2018. The table below lists our comparative quarterly production capacity utilization rates.
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Production Capacity Utilization Rates
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2018
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2019
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First quarter
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95%
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97%
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Second quarter
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97%
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97%
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Third quarter
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92%
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97%
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Primarily due to a rise in the cost of third-party feedstock we procured in 2018 and 2019, our Chemicals Segment’s cost of sales per metric ton of TiO2 sold in the first nine months of 2019 was higher as compared to the first nine months of 2018 (excluding the effect of changes in currency exchange rates).
Net Sales— Our Chemicals Segment’s net sales in the third quarter of 2019 increased 7%, or $27.1 million, compared to the third quarter of 2018 primarily due to the net effect of a 5% decrease in average TiO2 selling prices (which decreased net sales by approximately $21 million) and a 17% increase in sales volumes (which increased net sales by approximately $70 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs.
Our Chemicals Segment’s sales volumes increased 17% in the third quarter of 2019 as compared to the third quarter of 2018 primarily due to higher sales in all major markets. In addition to the impact of changes in average TiO2 selling prices and sales volumes, we estimate that changes in currency exchange rates (primarily the euro) decreased our Chemicals Segment’s net sales by approximately $9 million in the third quarter of 2019 as compared to the third quarter of 2018.
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Our Chemicals Segment’s net sales in the first nine months of 2019 increased 3%, or $45.9 million, compared to the first nine months of 2018 primarily due to the net effect of a 7% decrease in average TiO2 selling prices (which decreased net sales by approximately $92 million) and a 16% increase in sales volumes (which increased net sales by approximately $210 million). TiO2 selling prices will increase or decrease generally as a result of competitive market pressures, changes in the relative level of supply and demand as well as changes in raw material and other manufacturing costs.
Our Chemicals Segment’s sales volumes increased 16% in the first nine months of 2019 as compared to the first nine months of 2018 primarily due to higher sales in all major markets. In addition to the impact of changes in average TiO2 selling prices and sales volumes, we estimate that changes in currency exchange rates decreased our Chemicals Segment’s net sales by approximately $41 million as compared to the first nine months of 2018.
Cost of Sales and Gross Margin— Our Chemicals Segment’s cost of sales increased 20% in the third quarter of 2019 compared to the third quarter of 2018 due to the net effect of a 17% increase in sales volumes, higher raw materials and other production costs of approximately $24 million (primarily caused by higher third-party feedstock costs) and currency fluctuations (primarily the euro). Our Chemicals Segment’s cost of sales as a percentage of net sales increased to 80% in the third quarter of 2019 compared to 71% in the same period of 2018 primarily due to the unfavorable effects of lower average selling prices and higher raw materials and other production costs, as discussed above.
Our Chemicals Segment’s gross margin as a percentage of net sales decreased to 20% in the third quarter of 2019 compared to 29% in the third quarter of 2018. As discussed and quantified above, our Chemicals Segment’s gross margin decreased primarily due to the net effect of lower average selling prices, higher sales volumes and higher raw materials and other production costs.
Our Chemicals Segment’s cost of sales increased 24% in the first nine months of 2019 compared to the same period in 2018 primarily due to the net impact of a 16% increase in sales volumes, higher raw materials and other production costs of approximately $101 million (including higher cost for third-party feedstock, energy and other raw materials) and currency fluctuations (primarily the euro). Our Chemicals Segement’s cost of sales as a percentage of net sales increased to 78% in the first nine months of 2019 compared to 65% in the same period of 2018 primarily due to the unfavorable effects of lower average selling prices and higher raw materials and other production costs, as discussed above.
Our Chemicals Segment’s gross margin as a percentage of net sales decreased to 22% in the first nine months of 2019 compared to 35% in the first nine months of 2018. As discussed and quantified above, our Chemicals Segment’s gross margin decreased primarily due to the net effect of lower average selling prices, higher sales volumes and higher raw materials and other production costs.
Operating Income— Our Chemicals Segment’s operating income decreased 40% in the third quarter of 2019 compared to the third quarter of 2018, and operating income as a percentage of net sales decreased to 8% in 2019 from 15% in 2018. This decrease was driven by the lower gross margin discussed above. We estimate that changes in currency exchange rates increased our Chemicals Segment’s operating income by approximately $6 million in the third quarter of 2019 as compared to the same period in 2018, as discussed below.
Our Chemicals Segment’s operating income decreased 53% in the first nine months of 2019 compared to the first nine months of 2018, and operating income as a percentage of net sales decreased to 10% in 2019 from 22% in 2018. We estimate that changes in currency exchange rates increased Chemicals Segment’s operating income by approximately $5 million in the first nine months of 2019 as compared to the same period in 2018.
Our Chemicals Segment’s operating income is net of amortization of purchase accounting adjustments made in conjunction with our acquisitions of interests in NL and Kronos. As a result, we recognize additional depreciation expense above the amounts Kronos reports separately, substantially all of which is included within cost of sales. We recognized additional depreciation expense of $1.6 million in the first nine months of 2019 and $1.7 million in the same period of 2018, which reduced our reported Chemicals Segment’s operating income as compared to amounts reported by Kronos.
Currency Exchange Rates—– Our Chemicals Segment has substantial operations and assets located outside the United States (primarily in Germany, Belgium, Norway and Canada). The majority of our Chemicals Segment’s sales from non-U.S. operations are denominated in currencies other than the U.S. dollar, principally the euro, other major European currencies and the Canadian dollar. A portion of our sales generated from our non-U.S. operations is denominated in the U.S. dollar (and consequently our non-U.S. operations will generally hold U.S. dollars from time to time). Certain raw materials used worldwide, primarily titanium-containing feedstocks, are purchased primarily 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 non-U.S. sales and operating results are subject to currency exchange rate fluctuations which may favorably or unfavorably impact reported earnings and may affect the comparability of period-to-period operating results. In addition to the impact of the translation of sales and expenses over time, our non-U.S. operations also generate
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currency transaction gains and losses which primarily relate to (i) the difference between the currency exchange rates in effect when non-local currency sales or operating costs (primarily U.S. dollar denominated) are initially accrued and when such amounts are settled with the non-local currency, (ii) changes in currency exchange rates during time periods when our non-U.S. operations are holding non-local currency (primarily U.S. dollars), and (iii) relative changes in the aggregate fair value of currency forward contracts held from time to time. Our Chemicals Segment periodically uses currency forward contracts to manage a portion of our currency exchange risk, and relative changes in the aggregate fair value of any currency forward contracts we hold from time to time serves in part to mitigate the currency transaction gains or losses we would otherwise recognize from the first two items described above.
Overall, we estimate that fluctuations in currency exchange rates had the following effects on the reported amounts of our Chemicals Segment’s sales and operating income for the periods indicated.
Impact of changes in currency exchange rates
Three months ended September 30, 2019 vs September 30, 2018
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Translation
gains (losses) -
impact of
rate changes
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Total
currency
impact
2019 vs 2018
|
|
|
Transaction gains/(losses) recognized
|
|
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2018
|
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2019
|
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Change
|
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(In millions)
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Impact on:
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Net sales
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(9)
|
|
|
$
|
(9)
|
|
Operating income
|
|
(1
|
)
|
|
|
6
|
|
|
|
7
|
|
|
|
(1)
|
|
|
|
6
|
|
The $9 million decrease in our Chemicals Segment’s net sales (translation loss) was caused primarily by a strengthening of the U.S. dollar relative to the euro, as our euro-denominated sales were translated into fewer U.S. dollars in 2019 as compared to 2018. The strengthening of the U.S. dollar relative to the Canadian dollar and the Norwegian krone in 2019 did not have a significant effect on the reported amount of our Chemicals Segment’s net sales, as a substantial portion of the sales generated by our Chemicals Segment’s Canadian and Norwegian operations are denominated in the U.S. dollar.
The $6 million increase in our Chemicals Segment’s operating income was comprised of the following:
|
•
|
Approximately $7 million from net currency transaction gains primarily caused by relative changes in currency exchange rates at each applicable balance sheet date between the U.S. dollar and the euro and the Norwegian krone, which causes increases or decreases, as applicable, in U.S. dollar-denominated receivables and payables and U.S. dollar currency held by our Chemicals Segment’s non-U.S. operations, and
|
|
•
|
Approximately $1 million from net currency translation losses primarily caused by the strengthening of the U.S. dollar relative to the euro, which had a negative effect on income from operations in 2019 as compared to 2018, as the negative impact of the stronger U.S. dollar on euro-denominated sales more than offset the favorable effect of euro-denominated operating costs being translated into fewer U.S. dollars in 2019 as compared to 2018, partially offset by such translation as it related to the U.S. dollar relative to the Norwegian krone, as its local currency-denominated operating costs were translated into fewer U.S. dollars in 2019 as compared to 2018.
|
Impact of changes in currency exchange rates
Nine months ended September 30, 2019 vs September 30 2018
|
|
|
|
|
|
|
Translation
gains (losses) -
impact of
rate changes
|
|
|
Total
currency
impact
2019 vs 2018
|
|
|
Transaction gains/(losses) recognized
|
|
|
|
|
|
2018
|
|
|
2019
|
|
|
Change
|
|
(In millions)
|
|
Impact on:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
(41)
|
|
|
$
|
(41)
|
|
Operating income
|
|
4
|
|
|
|
6
|
|
|
|
2
|
|
|
|
3
|
|
|
|
5
|
|
The $41 million decrease in net sales (translation loss) was caused primarily by a strengthening of the U.S. dollar relative to the euro, as our Chemicals Segment’s euro-denominated sales were translated into fewer U.S. dollars in 2019 as compared to 2018. The strengthening of the U.S. dollar relative to the Canadian dollar and the Norwegian krone in 2019 did not have a significant effect on the reported amount of our net sales, as a substantial portion of the sales generated by our Chemicals Segment’s Canadian and Norwegian operations are denominated in the U.S. dollar.
The $5 million increase in our Chemicals Segment’s operating income was comprised of the following:
|
•
|
Approximately $2 million from net currency transaction gains primarily caused by relative changes in currency exchange rates at each applicable balance sheet date between the U.S. dollar and the euro, which causes increases or decreases, as
|
- 34 -
|
|
applicable, in U.S. dollar-denominated receivables and payables and U.S. dollar currency held by our Chemicals Segment’s non-U.S. operations, and
|
|
•
|
Approximately $3 million from net currency translation gains primarily caused by the strengthening of the U.S. dollar relative to the Canadian dollar and Norwegian krone, as its local currency-denominated operating costs were translated into fewer U.S. dollars in 2019 as compared to 2018, partially offset by such translation, as it related to the U.S. dollar relative to the euro, which had a negative effect on income from operations in 2019 as compared to 2018, as the negative impact of the stronger U.S. dollar on euro-denominated sales more than offset the favorable effect of euro-denominated operating costs being translated into fewer U.S. dollars in 2019 as compared to 2018.
|
Outlook—We expect our Chemicals Segment’s production volumes in 2019 to be slightly higher as compared to 2018 production volumes. Assuming current global economic conditions remain stable and based on anticipated production levels, we also expect our Chemicals Segment’s 2019 sales volumes to be higher as compared to 2018 sales volumes. We will continue to monitor current and anticipated near-term customer demand levels and align our production and inventories accordingly.
The cost of third-party feedstock ore our Chemicals Segment purchased in the last half of 2018 and first nine months of 2019 was higher as compared to the first half of 2018 and such higher cost feedstock ore was reflected in our Chemicals Segment’s results of operations in 2019. Consequently, our cost of sales per metric ton of TiO2 sold in the first nine months of 2019 was higher than our per-metric ton cost in the first nine months of 2018 (excluding the effect of changes in currency exchange rates). We expect our cost of sales per metric ton of TiO2 sold in 2019 to be higher than our per-metric ton cost in 2018 primarily due to higher feedstock costs.
Our Chemicals Segment started 2019 with average TiO2 selling prices 3% lower than the beginning of 2018, and average selling prices at the end of the third quarter of 2019 were comparable to the end of 2018. Average TiO2 selling prices declined by 4% in the first quarter of 2019, then improved by 2% in each of the second and third quarters of 2019. Supplies of certain grades of TiO2 remain tight, while inventories of certain other grades are adequate. Considering all of the foregoing factors, including rising raw material costs, and anticipating seasonal demand fluctuations as we enter the fourth calendar quarter, we expect selling prices to remain stable during the remainder of 2019.
Overall, we expect our Chemicals Segment’s sales in 2019 will be higher as compared to 2018, principally as a result of the favorable impact of higher expected sales volumes partially offset by the unfavorable impact of lower expected average selling prices (primarily during the first half of the year). In addition, we expect our Chemicals Segment’s operating income in 2019 will be lower as compared to 2018, as the favorable impact of higher expected sales volumes would be more than offset by the unfavorable impact of lower expected average selling prices and higher raw material and other operating costs in 2019.
Due to the constraints of high capital costs and extended lead time associated with adding significant new TiO2 production capacity, especially for premium grades of TiO2 products produced from the chloride process, we believe increased and sustained profit margins will be necessary to financially justify major expansions of TiO2 production capacity required to meet expected future growth in demand. Substantial expansions of TiO2 production capacity generally take several years before such production becomes available to meet demand growth.
Our expectations for our Chemicals Segment’s future operating results are based upon a number of factors beyond our control, including worldwide growth of gross domestic product, competition in the marketplace, continued operation of competitors, unexpected or earlier-than-expected capacity additions or reductions and technological advances. If actual developments differ from our expectations, our results of operations could be unfavorably affected.
Component Products –
Our Component Products Segment’s product offerings consist of a significantly large number of products that have a wide variation in selling price and manufacturing cost, which results in certain practical limitations on our ability to quantify the impact of changes in individual product sales quantities and selling prices on the segment’s net sales, cost of sales and gross margin. In addition, small variations in period-to-period net sales, cost of sales and gross margin can result from changes in the relative mix of our products sold. The key performance indicator for our Component Products Segment is operating income and margins.
- 35 -
|
Three months ended
September 30,
|
|
|
Nine months ended
September 30,
|
|
|
2018
|
|
|
2019
|
|
|
%
Change
|
|
|
2018
|
|
|
2019
|
|
|
%
Change
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Security products
|
$
|
24.5
|
|
|
$
|
23.4
|
|
|
|
(5
|
)%
|
|
$
|
75.8
|
|
|
$
|
75.0
|
|
|
|
(1
|
)%
|
Marine components
|
|
5.5
|
|
|
|
6.3
|
|
|
|
15
|
|
|
|
15.0
|
|
|
|
19.6
|
|
|
|
31
|
|
Total net sales
|
|
30.0
|
|
|
|
29.7
|
|
|
|
(1
|
)
|
|
|
90.8
|
|
|
|
94.6
|
|
|
|
4
|
|
Cost of sales
|
|
20.4
|
|
|
|
20.2
|
|
|
|
(1
|
)
|
|
|
60.5
|
|
|
|
64.6
|
|
|
|
7
|
|
Gross margin
|
$
|
9.6
|
|
|
$
|
9.5
|
|
|
|
(1
|
)
|
|
$
|
30.3
|
|
|
$
|
30.0
|
|
|
|
(1
|
)
|
Operating income
|
$
|
4.5
|
|
|
$
|
4.3
|
|
|
|
(4
|
)
|
|
$
|
14.9
|
|
|
$
|
14.3
|
|
|
|
(5
|
)
|
Percent of net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of sales
|
|
68
|
%
|
|
|
68
|
%
|
|
|
|
|
|
|
67
|
%
|
|
|
68
|
%
|
|
|
|
|
Gross margin
|
|
32
|
|
|
|
32
|
|
|
|
|
|
|
|
33
|
|
|
|
32
|
|
|
|
|
|
Operating income
|
|
15
|
|
|
|
14
|
|
|
|
|
|
|
|
16
|
|
|
|
15
|
|
|
|
|
|
Net Sales — Our Component Products Segment’s net sales decreased $.3 million in the third quarter of 2019 compared to the same period in 2018 as higher marine components sales to the towboat market were more than offset by lower security products sales across a variety of markets, including a $.5 million decrease in each of the transportation and government security markets. Net sales increased $3.8 million in the first nine months of 2019 compared to the same period in 2018 due to strong sales growth at marine components partially offset by lower security products sales predominantly in the third quarter. Relative changes in selling prices did not have a material impact on net sales comparisons.
Costs of Sales and Gross Margin — As a percentage of net sales, our Component Products Segment’s cost of sales and gross margin for the third quarter of 2019 were comparable to the same period in 2018 as the improvement in the marine components gross margin percentage in the third quarter of 2019 compared to the third quarter 2018 offset the decline in relative contribution of security products which generally has higher gross margin percentages than marine components. Cost of sales as a percentage of net sales increased in the first nine months of 2019 compared to the same period in 2018. As a result, gross margin as a percentage of sales decreased over the same period. The decrease in gross margin percentage is the result of the decline in security products gross margin percentage for the first nine months of 2019 as compared to the same period in 2018. Security products gross margin declined in both periods primarily due to increased labor rates and associated payroll costs resulting from regional pressure on wages for certain skilled labor positions as well as reduced leverage of fixed costs on decreased production volumes.
Operating Income — Our Component Products Segment’s operating income as a percentage of net sales for the third quarter and first nine months of 2019 decreased compared to the same periods of 2018 and was primarily impacted by the factors impacting cost of goods sold and gross margin discussed above.
Outlook— As reflected in our Component Products Segment’s operating results, security products encountered generally weakening economic conditions among its customers and markets during the latter half of the third quarter. As expected, the rate of sales growth for marine components began to moderate in the third quarter relative to the same period in 2018, the quarter in which we significantly increased our deliveries of wake enhancement systems. Nevertheless, absent further economic slowdown, we believe full year sales will exceed 2018. Operating income and operating margin for security products decreased for the first nine months of 2019 relative to prior year due to higher labor rates and associated payroll costs, the effect of which we were not able to offset through higher selling prices. Although our Component Products Segment has experienced minimal direct impact from recently enacted tariffs, we believe that tariffs and related global trade concerns may be impacting our significant original equipment manufacturer customers. We will continue to monitor economic conditions and sales order rates and respond to fluctuations in customer demand through continuous evaluation of staffing levels and discretionary spending as well as consistent execution of our lean manufacturing and cost improvement initiatives. Additionally, our Component Products Segment continues to seek opportunities to gain market share in markets our Component Products Segment currently serves, to expand into new markets and to develop new product features in order to mitigate the impact of changes in demand as well as broaden our sales base.
- 36 -
Real Estate Management and Development –
|
Three months ended
September 30,
|
|
|
Nine months ended
September 30,
|
|
|
2018
|
|
|
2019
|
|
|
2018
|
|
|
2019
|
|
|
(In millions)
|
|
Net sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land sales
|
$
|
13.4
|
|
|
$
|
6.3
|
|
|
$
|
23.0
|
|
|
$
|
24.3
|
|
Water delivery sales
|
|
.9
|
|
|
|
1.4
|
|
|
|
3.7
|
|
|
|
4.9
|
|
Utility and other
|
|
.6
|
|
|
|
.4
|
|
|
|
1.4
|
|
|
|
1.3
|
|
Total net sales
|
|
14.9
|
|
|
|
8.1
|
|
|
|
28.1
|
|
|
|
30.5
|
|
Cost of sales
|
|
10.4
|
|
|
|
6.3
|
|
|
|
20.6
|
|
|
|
22.0
|
|
Gross margin
|
$
|
4.5
|
|
|
$
|
1.8
|
|
|
$
|
7.5
|
|
|
$
|
8.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income
|
$
|
3.7
|
|
|
$
|
.8
|
|
|
$
|
7.9
|
|
|
$
|
13.7
|
|
General—Our Real Estate Management and Development Segment consists of BMI and LandWell. BMI provides utility services, among other things, to an industrial park located in Henderson, Nevada, and is responsible for the delivery of water to the city of Henderson and various other users through a water distribution system owned by BMI. LandWell is actively engaged in efforts to develop certain real estate in Henderson, Nevada including approximately 2,100 acres zoned for residential/planned community purposes and approximately 400 acres zoned for commercial and light industrial use.
Beginning in December 2013 and through the third quarter of 2019, LandWell has closed or entered into escrow on approximately 610 acres of the residential/planned community and approximately 65 acres zoned for commercial and light industrial use. Contracts for land sales are negotiated on an individual basis and sales terms and prices will vary based on such factors as location (including location within a planned community), expected development work, and individual buyer needs. Although land may be under contract, we do not recognize revenue until we have satisfied the criteria for revenue recognition set forth in ASC Topic 606. In some instances, we will receive cash proceeds at the time the contract closes and record deferred revenue for some or all of the cash amount received, with such deferred revenue being recognized in subsequent periods. We expect the development work to continue for 10 to 15 years on the rest of the land held for development, especially the remainder of the residential/planned community.
Net Sales and Operating Income— A substantial portion of the net sales from our Real Estate Management and Development Segment in the third quarter and first nine months of 2018 and 2019 consisted of revenues from land sales. As noted above we recognize revenue in our residential/planned community over time using cost based input methods (previously known as percentage completion method) and a large majority of the revenue we recognized in 2018 and 2019 was under this method of revenue recognition. The contracts on these sales (both within the planned community and otherwise) include approximately 570 acres of the residential planned community and certain other acreage which closed in December 2013 and through the third quarter of 2019. Cost of sales related to land sales revenues was $4.8 million and $17.3 million in the third quarter and first nine months of 2019, respectively, compared to $9.1 million and $16.5 million in the same periods of 2018. Land sales revenues were lower in the third quarter of 2019 as compared to the third quarter of 2018 primarily due to a decrease in the amount of acreage sold in 2019 compared to 2018. Land sales revenues were higher in the first nine months of 2019 as compared to the same period in 2018 primarily due to an increase in the amount of acreage sold in 2019 as compared to 2018 and due to higher infrastructure development spending in 2019. Operating income also includes $8.8 million in the first nine months of 2019 (primarily in the second quarter) and $3.1 million in the first quarter of 2018 of income related to the recognition of tax increment reimbursement note receivables, as discussed in Note 12 to our Condensed Consolidated Financial Statements.
The remainder of net sales and cost of sales related to this segment primarily relates to water delivery fees and expenses. We deliver water to several customers under long-term contracts.
Outlook—Our Real Estate Management and Development Segment is actively pursuing opportunities to maximize cash proceeds from the sale of its land held for development and, in the near term, is focused on developing and selling land it manages, primarily to residential builders, for the approximately 2,100 acres zoned for residential/planned community in Henderson, Nevada. We expect the development work for the first phase of the residential/planned community to continue over the next several years, including those parcels currently under contract for which the development work is expected to be completed in 2019. We do not expect to recognize significant amounts of operating income related to these sales for the parcels currently under contract because our basis in the land value is the December 2013 acquisition date fair value; however, we do expect to generate cash proceeds from these sales in excess of our acquisition costs, which proceeds are expected to be used, in part, to fund ongoing development work for the
- 37 -
remainder of these properties. Beginning in the fourth quarter of 2017, our Real Estate Management and Development Segment began sales of parcels that have a lower book value than the parcels previously sold; as a result we would expect to recognize more land sales related operating income in 2019 than in 2018.
General Corporate Items, Interest Expense, Income Taxes and Noncontrolling Interest—2019 Compared to 2018
Securities Earnings—A significant portion of our interest and dividend income in 2018 relates to the distributions we received from The Amalgamated Sugar Company LLC. We recognized dividend income from Amalgamated of $4.2 million and $16.9 million in the third quarter and first nine months of 2018, respectively. As discussed in the 2018 Annual Report, on August 31, 2018, we sold our interest in Amalgamated for consideration consisting of $12.5 million in cash and the deemed payment in full of our $250 million in loans we owed Snake River Sugar Company. Securities earnings is expected to be significantly lower in 2019 as compared to 2018 primarily due to the August 2018 sale of our interest in Amalgamated.
Gain on Land Sales—In the first quarter of 2018 and the third quarter of 2019 we sold two parcels and one parcel, respectively, of land not used in our operating activities. See Note 12 to our Condensed Consolidated Financial Statements.
Insurance Recoveries—NL has agreements with certain insurance carriers pursuant to which the carriers reimburse NL for a portion of its past lead pigment and asbestos litigation defense costs. Insurance recoveries include amounts NL received from these insurance carriers. Substantially all of the $5.2 million insurance recoveries we recognized in the first nine months of 2019 relates to a settlement NL reached with one of its insurance carriers in which they agreed to reimburse NL for a portion of NL’s past and future litigation defense costs.
The agreements with certain of NL’s insurance carriers also include reimbursement for a portion of its future litigation defense costs. We are not able to determine how much we will ultimately recover from these carriers for defense costs incurred by us because of certain issues that arise regarding which defense costs qualify for reimbursement. Accordingly, these insurance recoveries are recognized when the receipt is probable and the amount is determinable. See Note 16 to our Condensed Consolidated Financial Statements.
Litigation Settlement Expense— We recognized a pre-tax $62.0 million and $19.3 million litigation settlement expense in the second quarter of 2018 and 2019, respectively, related to NL’s lead pigment litigation in California. See Note 16 to our Condensed Consolidated Financial Statements.
Other Components of Net Periodic Pension and OPEB Expense— We recognized other components of net periodic pension and OPEB expense of $4.1 million and $12.3 million in the third quarter and first nine months of 2019 compared to $3.7 million and $11.2 million in the same periods of 2018. The expense increased in both periods primarily due to pension costs as a result of actuarial amortizations and expected returns on plan assets.
Other General Corporate Items— Corporate expenses were 30% higher in the third quarter of 2019 compared to the third quarter of 2018 primarily due to higher environmental remediation and related costs and 13% lower in the first nine months of 2019 compared to the same periods in 2018 primarily due to lower litigation and related costs and lower environmental remediation and related costs. Included in corporate expense are:
|
•
|
litigation and related costs at NL of $1.4 million in the third quarter of 2019 compared to $1.1 million in the third quarter of 2018 and $3.3 million in the first nine months of 2019 compared to $5.1 million in the first nine months of 2018; and
|
|
•
|
environmental remediation and related costs of $.1 million in the third quarter of 2019 compared to a benefit of $1.6 million in the third quarter of 2018 and expense of nil in the first nine months of 2019 compared to expense of $2.9 million in the first nine months of 2018.
|
Overall, we currently expect that our net general corporate expenses in 2019 will be lower than in 2018 primarily due to lower litigation and related costs and environmental remediation and related costs.
The level of our litigation and related expenses varies from period to period depending upon, among other things, the number of cases in which we are currently involved, the nature of such cases and the current stage of such cases (e.g. discovery, pre-trial motions, trial or appeal, if applicable). See Note 16 to our Condensed Consolidated Financial Statements. If our current expectations regarding the number of cases in which we expect to be involved during 2019, or the nature of such cases, were to change, our corporate expenses could be higher than we currently estimate.
Obligations for environmental remediation and related costs are difficult to assess and estimate, and it is possible that actual costs for environmental remediation and related costs will exceed accrued amounts or that costs will be incurred in the future for sites in which we cannot currently estimate the liability. If these events occur in 2019, our corporate expense could be higher than we currently estimate. In addition, we adjust our accruals for environmental remediation and related costs as further information becomes available to us or as circumstances change. Such further information or changed circumstances could result in an increase or reduction in our accrued environmental remediation and related costs. See Note 16 to our Condensed Consolidated Financial Statements.
- 38 -
Changes in the Market Value of Valhi Common Stock held by Subsidiaries—Our subsidiaries, Kronos and NL, hold shares of our common stock. As discussed in the 2018 Annual Report, we account for our proportional interest in these shares of our common stock as treasury stock, at Kronos’ and NL’s historical cost basis. The remaining portion of these shares of our common stock, which are attributable to the noncontrolling interest of Kronos and NL, are reflected in our Condensed Consolidated Balance Sheet at fair value. Kronos and NL recognize unrealized gains or losses on these shares of our common stock in the determination of each of their respective net income or losses. Under the principles of consolidation we eliminate any gains or losses associated with our common stock to the extent of our proportional ownership interest in each subsidiary. We recognized a loss of $3.1 million in the third quarter of 2019 compared to a loss of $7.1 million in the same period of 2018 and a loss of $.1 million in the first nine months of 2019 compared to a loss of $11.2 million in the same period of 2018 in our Condensed Consolidated Statements of Income which represents the unrealized gain or loss in respect of these shares during such periods attributable to the noncontrolling interest of Kronos and NL.
Interest Expense—Interest expense decreased to $10.3 million in the third quarter of 2019 from $14.0 million in the third quarter of 2018 and to $30.7 million in the first nine months of 2019 from $45.4 million in the same period of 2018 primarily due to the net effects of lower average debt levels in 2019 and higher average interest rates on variable-rate indebtedness. The lower average debt levels in 2019 is primarily due to the deemed redemption of our $250 million promissory notes payable to Snake River in connection with the August 2018 sale of our interest in The Amalgamated Sugar Company LLC.
We expect interest expense will continue to be lower in the remainder of 2019 as compared to 2018 due to lower average balances of outstanding borrowings at Valhi offset by higher average rates.
Provision for Income Taxes— We recognized income tax expense of $4.7 million in the third quarter of 2019 compared to an income tax benefit of $91.4 million in the third quarter of 2018 and income tax expense of $31.8 million in the first nine months of 2019 compared to an income tax benefit of $33.2 million in the first nine months of 2018. The difference is primarily due to the third quarter 2018 recognition of a change in the deferred income tax liability related to our investment in Kronos as a result of the 2017 Tax Act and the effect of lower income from operations in the third quarter and first nine months of 2019. Our earnings are subject to income tax in various U.S. and non-U.S. jurisdictions, and the income tax rates applicable to the pre-tax earnings (losses) of our non-U.S. operations are generally higher than the income tax rates applicable to our U.S. operations. Excluding the effect of any increase or decrease in our deferred income tax asset valuation allowance or changes in our reserve for uncertain tax positions, we would generally expect our overall effective tax rate to be higher than the U.S. federal statutory tax rate of 21% primarily because of our non-U.S. operations.
As discussed in our 2018 Annual Report, under GAAP, we were required to revalue our net deferred tax liability associated with our U.S. net deductible temporary differences at December 31, 2017, the period in which the 2017 Tax Act was enacted, based on deferred tax balances as of the enactment date, to reflect the effect of the reduction in the corporate income tax rate. During the third quarter of 2018, in conjunction with finalizing our federal income tax return we were able to obtain, prepare and analyze the necessary information to complete the accounting under ASC 740 related to the revaluation of our net deferred tax liability associated with our U.S. net taxable temporary differences as of December 31, 2017, which resulted in a measurement period adjustment and recognition of a non-cash deferred income tax expense of $59.7 million, decreasing the provisional amount we recognized at December 31, 2017. Such adjustment is almost entirely attributable to the re-measurement of our deferred income taxes with respect to the excess of the financial reporting carrying amount over the income tax basis of our direct investment in Kronos common stock discussed below.
We recognize deferred income taxes with respect to the excess of the financial reporting carrying amount over the income tax basis of our direct investment in Kronos common stock because the exemption under GAAP to avoid such recognition of deferred income taxes is not available to us. At December 31, 2018, we had recognized a deferred income tax liability with respect to our direct investment in Kronos of $40.7 million. There is a maximum amount (or cap) of such deferred income taxes we are required to recognize with respect to our direct investment in Kronos. The maximum amount of such deferred income tax liability we would be required to have recognized (the cap) is $155.4 million. During the first nine months of 2019, we recognized a non-cash deferred income tax expense with respect to our direct investment in Kronos of $3.3 million for the increase in the deferred income taxes required to be recognized with respect to the excess of the financial reporting carrying amount over the income tax basis of our direct investment in Kronos common stock, to the extent such increase related to our equity in Kronos’ net income during such period. We recognized a similar non-cash deferred income tax expense of $19.2 million in the first nine months of 2018. A portion of the net change with respect to the excess of the financial reporting carrying amount over the income tax basis of our direct investment in Kronos common stock during such periods related to our equity in Kronos’ other comprehensive income (loss) items, and the amounts allocated to other comprehensive income (loss) items includes amounts related to our equity in Kronos’ other comprehensive income (loss) items. Due to uncertainties and complexities of the 2017 Tax Act, we were still evaluating the impact of the one-time deemed repatriation of the post-1986 undistributed earnings of our non-U.S. subsidiaries up through December 31, 2017 as it relates to the income tax basis of our direct investment in Kronos at December 31, 2017. During the third quarter of 2018, in conjunction with finalizing our federal income tax return and based on additional information that became available (including proposed regulations issued by the IRS in August 2018 with respect to the Transition Tax), we recognized an adjustment, which is treated as a measurement period adjustment, to the deferred income taxes we recognized at December 31, 2017 associated with our direct investment in Kronos
- 39 -
common stock (before revaluation of our deferred tax liability related to the decrease in the corporate income tax rate). Such adjustment resulted in an investment basis adjustment under the income tax regulations which increased the income tax basis of our direct investment in Kronos attributable to the income recognition related to the deemed repatriation of the post-1986 undistributed earnings of our non-U.S. subsidiaries in 2017. Such adjustment resulted in a non-cash deferred tax measurement period adjustment decreasing the deferred income taxes we recognize with respect to the excess of the financial reporting carrying amount over the income tax basis of our direct investment in Kronos common stock. Including the impact of the non-cash deferred tax revaluation adjustment discussed above, we recognized a net non-cash deferred income tax benefit of $113 million in the third quarter of 2018 related to the incremental tax on Kronos. Excluding the impact of such adjustment, our effective income tax rate from continuing operations in the third quarter and nine months ended September 30, 2018 was 38% and 38.9%, respectively.
See Note 13 to our Condensed Consolidated Financial Statements for a tabular reconciliation of our statutory income tax provision to our actual tax provision.
Discontinued Operations—On January 26, 2018, we completed the sale of the Waste Management Segment to JFL-WCS Partners, LLC, an entity sponsored by certain investment affiliates of J.F. Lehman & Company, for consideration consisting of the assumption of all of the Waste Management Segment's third-party indebtedness and other liabilities. We recognized a pre-tax gain of approximately $58 million on the transaction in the first quarter of 2018 because the carrying value of the liabilities of the business assumed by the purchaser exceeded the carrying value of the assets sold in large part due to the long-lived asset impairment of $170.6 million recognized in the second quarter of 2017 with respect to our Waste Management Segment. Such pre-tax gain is classified as part of discontinued operations. See Note 3 to our Condensed Consolidated Financial Statements for additional information.
Noncontrolling Interest in Net Income (Loss) of Subsidiaries—Noncontrolling interest in operations of subsidiaries decreased from 2018 to 2019 primarily due to lower earnings at Kronos.
- 40 -
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 operating income. In addition to the impact of the operating, investing and financing cash flows discussed below, changes in the amount of cash, cash equivalents and restricted cash we report from period to period can be impacted by changes in currency exchange rates, since a portion of our cash, cash equivalents and restricted cash is held by our non-U.S. subsidiaries.
Cash flows from operating activities decreased to $113.0 million in the first nine months of 2019 from $191.5 million in the first nine months of 2018. This $78.5 million decrease in cash provided by operations was primarily due to the net effect of the following items:
|
•
|
consolidated operating income of $167.6 million in the first nine months of 2019, a decrease of $150.4 million compared to operating income of $318.0 million in the first nine months of 2018;
|
|
•
|
lower net cash paid for interest in 2019 of $15.5 million resulting from lower average debt levels in 2019 offset by higher average interest rates; and
|
|
•
|
an $11.2 million decrease in the amount of net cash used in relative changes in receivables, inventories, payables and accrued liabilities in the first nine months of 2019.
|
Changes in working capital were affected by accounts receivable and inventory changes as shown below:
|
•
|
Kronos’ average days sales outstanding (“DSO”) decreased from December 31, 2018 to September 30, 2019 primarily due to relative changes in the timing of collections.
|
|
•
|
Kronos’ average days sales in inventory (“DSI”) decreased from December 31, 2018 to September 30, 2019 primarily due to lower inventory volumes attributable to sales volumes outpacing production volumes for the 2019 year-to-date period.
|
|
•
|
CompX’s average DSO at September 30, 2019 increased from December 31, 2018 primarily due to relative changes in the timing of collections.
|
|
•
|
CompX’s average DSI increased from December 31, 2018 to September 30, 2019. CompX’s average DSI increased between year-end and the end of the third calendar quarter primarily due to the timing of raw material purchases and an intentional inventory build for security products related to product lines in which certain components require long lead-times.
|
For comparative purposes, we have also provided comparable prior period numbers below.
|
December 31,
2017
|
|
|
September 30,
2018
|
|
|
December 31,
2018
|
|
|
September 30,
2019
|
|
Kronos:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Days sales outstanding
|
|
63 days
|
|
|
|
74 days
|
|
|
|
76 days
|
|
|
|
71 days
|
|
Days sales in inventory
|
|
62 days
|
|
|
|
77 days
|
|
|
|
113 days
|
|
|
|
57 days
|
|
CompX:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Days sales outstanding
|
|
38 days
|
|
|
|
40 days
|
|
|
|
40 days
|
|
|
|
41 days
|
|
Days sales in inventory
|
|
79 days
|
|
|
|
76 days
|
|
|
|
80 days
|
|
|
|
85 days
|
|
- 41 -
We do not have complete access to the cash flows of our majority-owned subsidiaries, due in part to limitations contained in certain credit agreements of our subsidiaries and because we do not own 100% of these subsidiaries. A detail of our consolidated cash flows from operating activities is presented in the table below. Intercompany dividends have been eliminated.
|
Nine months ended
September 30,
|
|
|
2018
|
|
|
2019
|
|
|
(In millions)
|
|
Cash provided by (used in) operating activities:
|
|
|
|
|
|
|
|
Valhi exclusive of its subsidiaries
|
$
|
37.1
|
|
|
$
|
18.9
|
|
Kronos
|
|
198.9
|
|
|
|
123.7
|
|
NL exclusive of its subsidiaries
|
|
9.6
|
|
|
|
6.3
|
|
CompX
|
|
12.8
|
|
|
|
12.5
|
|
BMI
|
|
(.9
|
)
|
|
|
13.3
|
|
LandWell
|
|
1.4
|
|
|
|
6.7
|
|
WCS
|
|
2.3
|
|
|
|
-
|
|
Tremont exclusive of its subsidiaries
|
|
1.2
|
|
|
|
7.9
|
|
Eliminations and other
|
|
(70.9
|
)
|
|
|
(76.3
|
)
|
Total
|
$
|
191.5
|
|
|
$
|
113.0
|
|
Investing Activities—
We spent $37.9 million in capital expenditures during the first nine months of 2019 including:
|
•
|
$34.2 million in our Chemicals Segment;
|
|
•
|
$2.5 million in our Component Products Segment; and
|
|
•
|
$1.2 million in our Real Estate Management and Development Segment.
|
Financing Activities—
During the nine months ended September 30, 2019, we:
|
•
|
repaid $2.1 million under Tremont’s promissory note payable and $1.3 million under our credit facility with Contran; and
|
|
•
|
paid quarterly dividends to Valhi stockholders aggregating $.06 per share ($20.4 million).
|
The declaration and payment of future dividends, and the amount thereof, is discretionary and is dependent upon these and other factors deemed relevant by our Board of Directors. The amount and timing of past dividends is not necessarily indicative of the amount or timing of any future dividends which might be paid. There are currently no contractual restrictions on the amount of dividends which we may pay. Distributions to noncontrolling interest in subsidiaries in the first nine months of 2019 are comprised of CompX dividends paid to shareholders other than NL and Kronos dividends paid to shareholders other than us and NL.
Outstanding Debt Obligations
At September 30, 2019, our consolidated indebtedness attributable to continuing operations was comprised of:
|
•
|
Valhi’s $313.0 million outstanding on its $360 million credit facility with Contran which is due no earlier than December 31, 2020;
|
|
•
|
€400 million aggregate outstanding on our KII 3.75% Senior Secured Notes ($432.3 million carrying amount, net of unamortized debt issuance costs) due in September 2025;
|
|
•
|
Tremont’s promissory note payable ($7.3 million outstanding) due in December 2023;
|
|
•
|
$17.9 million on BMI’s bank loan ($17.1 million carrying amount, net of unamortized debt issuance costs) due through September 2032;
|
|
•
|
$1.9 million on LandWell’s note payable to the City of Henderson due in October 2020; and
|
|
•
|
approximately $3.8 million of other indebtedness.
|
- 42 -
Certain of our credit facilities require the respective borrowers to maintain a number of covenants and restrictions which, among other things, restrict our ability to incur additional debt, incur liens, pay dividends or merge or consolidate with, or sell or transfer substantially all of our assets to, another entity, and contain other provisions and restrictive covenants customary in lending transactions of this type. Certain of our credit agreements contain provisions which could result in the acceleration of indebtedness prior to their stated maturity for reasons other than defaults for failure to comply with typical financial or payment 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. 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. Kronos’ North American and European revolvers contain a number of covenants and restrictions which, among other things, restrict its ability to incur additional debt, incur liens, pay dividends or merge or consolidate with, or sell or transfer substantially all of its assets to, another entity, and contain other provisions and restrictive covenants customary in lending transactions of this type. Kronos’ European revolving credit facility also requires the maintenance of certain financial ratios, and one of such requirements is based on the ratio of net debt to the last twelve months EBITDA of the borrowers. The terms of all of our debt instruments (including revolving lines of credit for which we have no outstanding borrowings at September 30, 2019) are discussed in Note 9 to our 2018 Annual Report. We are in compliance with all of our debt covenants at September 30, 2019. We believe that we will be able to continue to comply with the financial covenants contained in our credit facilities through their maturity; however, if future operating results differ materially from our expectations we may be unable to maintain compliance.
Future Cash Requirements
Liquidity –
Our primary source of liquidity on an ongoing basis is our cash flows from operating activities and borrowings under various lines of credit and notes. We generally use these amounts to (i) fund capital expenditures, (ii) repay short-term indebtedness incurred primarily for working capital purposes and (iii) provide for the payment of dividends (including dividends paid to us by our subsidiaries) or treasury stock purchases. From time-to-time we will incur indebtedness, generally to (i) fund short-term working capital needs, (ii) refinance existing indebtedness, (iii) make investments in marketable and other securities (including the acquisition of securities issued by our subsidiaries and affiliates) or (iv) fund major capital expenditures or the acquisition of other assets outside the ordinary course of business. Occasionally we sell assets outside the ordinary course of business, and we generally use the proceeds to (i) repay existing indebtedness (including indebtedness which may have been collateralized by the assets sold), (ii) make investments in marketable and other securities, (iii) fund major capital expenditures or the acquisition of other assets outside the ordinary course of business or (iv) pay dividends.
We routinely compare our liquidity requirements and alternative uses of capital against the estimated future cash flows we expect to receive from our subsidiaries, and the estimated sales value of those units. As a result of this process, we have in the past sought, 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. From time to time, we and our subsidiaries may enter into intercompany loans as a cash management tool. Such notes are structured as revolving demand notes and pay and receive interest on terms we believe are generally more favorable than current debt and investment market rates. The companies that borrow under these notes have sufficient liquidity to repay the notes. All of these notes and related interest expense and income are eliminated in our Condensed Consolidated Financial Statements.
We periodically evaluate acquisitions of interests in or combinations with companies (including our affiliates) that may or may not be engaged in businesses related to our current businesses. We intend to consider such acquisition activities in the future and, in connection with this activity, may consider issuing additional equity securities and increasing indebtedness. From time to time, we also evaluate the restructuring of ownership interests among our respective subsidiaries and related companies.
We believe we will be able to comply with the financial covenants contained in our credit facilities through their maturities; however, if future operating results differ materially from our expectations we may be unable to maintain compliance. 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 (defined as the twelve-month period ending September 30, 2020) and long-term obligations (defined as the five-year period ending September 30, 2024). If actual developments differ from our expectations, our liquidity could be adversely affected.
- 43 -
At September 30, 2019, we had credit available under existing facilities of $263.9 million, which was comprised of:
|
•
|
$98.5(1) million under Kronos’ European revolving credit facility;
|
|
•
|
$118.4 million under Kronos’ North American revolving credit facility; and
|
|
•
|
$47.0(2) million under Valhi’s Contran credit facility.
|
|
(1)
|
Based on Kronos’ EBITDA over the last twelve months ending September 30, 2019, the full €90.0 million amount is available for borrowing at such date.
|
|
(2)
|
Amounts available under this facility are at the sole discretion of Contran.
|
At September 30, 2019, we had an aggregate of $557.9 million of restricted and unrestricted cash, cash equivalents and marketable securities, including $165.5 million held by our non-U.S. subsidiaries. Following implementation of a territorial tax system under the 2017 Tax Act, repatriation of any cash and cash equivalents held by our non-U.S. subsidiaries would not be expected to result in any material income tax liability as a result of such repatriation. A detail by entity is presented in the table below.
|
Total
|
|
|
Amount
held outside
U.S.
|
|
|
(In millions)
|
|
Kronos
|
$
|
387.0
|
|
|
$
|
165.2
|
|
CompX
|
|
47.6
|
|
|
|
—
|
|
NL exclusive of its subsidiaries
|
|
87.4
|
|
|
|
.3
|
|
Tremont exclusive of its subsidiaries
|
|
8.9
|
|
|
|
—
|
|
LandWell
|
|
9.7
|
|
|
|
—
|
|
BMI
|
|
17.3
|
|
|
|
—
|
|
Valhi exclusive of its subsidiaries
|
|
—
|
|
|
|
—
|
|
Total restricted and unrestricted cash, cash equivalents and
marketable securities
|
$
|
557.9
|
|
|
$
|
165.5
|
|
Capital Expenditures and Other –
We currently expect our aggregate capital expenditures for 2019 will be approximately $81 million as follows:
|
•
|
$75 million by our Chemicals Segment, including approximately $25 million in the area of environmental compliance, protection and improvement;
|
|
•
|
$4 million by our Component Products Segment; and
|
|
•
|
$2 million by our Real Estate Management and Development Segment.
|
LandWell expects to spend approximately $34 million on land development costs during 2019 (which is included in the determination of cash provided by operating activities).
Capital spending for 2019 is expected to be funded primarily through cash generated from operations and borrowing under existing credit facilities. Planned capital expenditures in 2019 at Kronos and CompX will primarily be to maintain and improve the cost-effectiveness of our facilities. In addition, Kronos’ capital expenditures in the area of environmental compliance, protection and improvement include expenditures which are primarily focused on increased operating efficiency but also result in improved environmental protection, such as lower emissions from our manufacturing plants.
Repurchases of Common Stock –
We, Kronos and CompX have programs to repurchase common stock from time to time as market conditions permit. These stock repurchase programs do not include specific price targets or timetables and may be suspended at any time. Depending on market conditions, these programs may be terminated prior to completion. Cash on hand will be used to acquire the shares and repurchased shares will be added to treasury shares and cancelled.
At September 30, 2019 Valhi had approximately 4.0 million shares of our common stock available to repurchase under the authorizations made by our board of directors.
- 44 -
Kronos’ board of directors authorized the repurchase of up to 2.0 million shares of its common stock in open market transactions, including block purchases, or in privately-negotiated transactions at unspecified prices and over an unspecified period of time. Kronos may repurchase its common stock from time to time as market conditions permit. During the first nine months of 2019, Kronos acquired 264,992 shares of its common stock in open market purchases under such repurchase program for an aggregate purchase price of $3.0 million and subsequently cancelled 110,303 of such shares, representing $1.4 million. At September 30, 2019, approximately 1.7 million shares are available for repurchase.
CompX’s board of directors authorized the repurchase of its Class A common stock in open market transactions, including block purchases, or in privately-negotiated transactions at unspecified prices and over an unspecified period of time. At September 30, 2019, approximately .7 million shares were available for purchase under these authorizations.
Dividends –
Because our operations are conducted primarily through subsidiaries and affiliates, our long-term ability to meet parent company level corporate obligations is largely dependent on the receipt of dividends or other distributions from our subsidiaries and affiliates. Kronos paid a regular dividend of $.17 per share in each quarter of 2018 for which we received $39.4 million. In February 2019 the Kronos Board of Directors increased its regular quarterly dividend to $.18 per share. If Kronos were to pay its $.18 per share in each quarter of 2019 based on the 58.0 million shares we held of Kronos common stock at September 30, 2019, we would receive aggregate annual regular dividends from Kronos of $41.8 million. NL has not paid a dividend since prior to 2018 and we do not expect to receive any cash dividends from NL during 2019. BMI and LandWell do pay cash dividends from time to time, but the timing and amount of such dividends are uncertain. In this regard, we received aggregate dividends from BMI and LandWell of $5.7 million in 2018 and $8.7 million during the first nine months of 2019. We do not know if we will receive additional dividends from BMI and LandWell during 2019. All of our ownership interest in CompX is held through our ownership in NL; as such we do not receive any dividends from CompX. Instead any dividend paid by CompX is paid to NL.
Our subsidiaries have various credit agreements with unrelated third-party lenders 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 decisions on a variety of factors, including an analysis of the optimal use of our capital, taking into account the market value of the securities and the relative value of expected returns on alternative investments. In connection with these activities, we may consider issuing additional equity securities or increasing our indebtedness. We may also evaluate the restructuring of ownership interests of our businesses among our subsidiaries and related companies.
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 might be required to sell at less than what we believe is the long-term value of such assets.
Prior to 2018, we entered into a $50 million revolving credit facility with a subsidiary of NL secured with approximately 35.2 million shares of the common stock of Kronos held by NL’s subsidiary as collateral. Outstanding borrowings under the credit facility bear interest at the prime rate plus 1.875% per annum, payable quarterly, with all amounts due on December 31, 2023. The maximum principal amount which may be outstanding from time-to-time under the credit facility is limited to 50% of the amount of the most recent closing price of the Kronos stock. The credit facility contains a number of covenants and restrictions which, among other things, restrict NL’s subsidiary’s ability to incur additional debt, incur liens, and merge or consolidate with, or sell or transfer substantially all of NL’s subsidiary’s assets to, another entity, and require NL’s subsidiary to maintain a minimum specified level of consolidated net worth. Upon an event of default (as defined in the credit facility), Valhi will be entitled to terminate its commitment to make further loans to NL’s subsidiary, declare the outstanding loans (with interest) immediately due and payable, and exercise its rights with respect to the collateral under the Loan Documents. Such collateral rights include, upon certain insolvency events with respect to NL’s subsidiary or NL, the right to purchase all of the Kronos common stock at a purchase price equal to the aggregate market value, less amounts owing to Valhi under the Loan Documents, and up to 50% of such purchase price may be paid by Valhi in the form of an unsecured promissory note bearing interest at the prime rate plus 2.75% per annum, payable quarterly, with all amounts due no later than five years from the date of purchase, with the remainder of such purchase price payable in cash at the date of purchase. We also eliminate any such intercompany borrowings in our Condensed Consolidated Financial Statements. Prior to 2018 NL’s subsidiary borrowed $.5 million under this facility, no additional amounts have been borrowed since then, and $.5 million is
- 45 -
outstanding under this facility at September 30, 2019. We eliminate any such intercompany borrowings in our Consolidated Financial Statements.
We have an unsecured revolving demand promissory note with Kronos which, as amended, provides for borrowings from Kronos of up to $60 million. We also eliminate any such intercompany borrowings in our Condensed Consolidated Financial Statements. The facility, as amended, is due on demand, but in any event no earlier than December 31, 2020. We had gross borrowings of $10.9 million and gross repayments of $5.9 million during the first nine months of 2019, and $5.0 million was outstanding at September 30, 2019. We could borrow an additional $55.0 million under our current intercompany facility with Kronos at September 30, 2019. Kronos’ obligation to loan us money under this note is at Kronos’ discretion.
We also have an unsecured revolving demand promissory note with CompX which, as amended, provides for borrowings from CompX of up to $40 million. We also eliminate any such intercompany borrowings in our Condensed Consolidated Financial Statements. The facility, as amended, is due on demand, but in any event no earlier than December 31, 2020. We had gross borrowings of $25.4 million and gross repayments of $25.4 million during the first nine months of 2019, and $40.0 million was outstanding at September 30, 2019. We have no borrowing availability under our current intercompany facility with CompX at September 30, 2019. CompX’s obligation to loan us money under this note is at CompX’s discretion.
Off-balance Sheet Financing
Following the January 1, 2019 adoption of ASU 2016-02, Leases (Topic 842), we do not have any off-balance sheet financing arrangements. See Note 18.
Commitments and Contingencies
There have been no material changes in our contractual obligations, with the exception of the Santa Clara global settlement agreement discussed in Note 16 to our Condensed Consolidated Financial Statements, since we filed our 2018 Annual Report and we refer you to that report for a complete description of these commitments.
We are subject to certain commitments and contingencies, as more fully described in Notes 1, 14 and 18 to our 2018 Annual Report, or in Notes 13 and 16 to our Condensed Consolidated Financial Statements and in Part II, Item 1 of this Quarterly Report, including:
|
•
|
certain income tax contingencies in various U.S. and non-U.S. jurisdictions;
|
|
•
|
certain environmental remediation matters involving NL, and BMI;
|
|
•
|
certain litigation related to NL’s former involvement in the manufacture of lead pigment and lead-based paint; and
|
|
•
|
certain other litigation to which we are a party.
|
In addition to such legal proceedings, various legislation and administrative regulations have, from time to time, been proposed that seek to (i) impose various obligations on present and former manufacturers of lead pigment and lead-based paint (including NL) with respect to asserted health concerns associated with the use of such products and (ii) effectively overturn court decisions in which NL and other pigment manufacturers have been successful. Examples of such proposed legislation include bills which would permit civil liability for damages on the basis of market share, rather than requiring plaintiffs to prove that the defendant’s product caused the alleged damage, and bills which would revive actions barred by the statute of limitations. While no legislation or regulations have been enacted to date that are expected to have a material adverse effect on our consolidated financial position, results of operations or liquidity, enactment of such legislation could have such an effect.
Recent Accounting Pronouncements
See Note 18 to our Condensed Consolidated Financial Statements.
Critical Accounting Policies
There have been no changes in the first nine months of 2019 with respect to our critical accounting policies presented in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our 2018 Annual Report.
- 46 -