(EDGAR Online via COMTEX) -- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
We are primarily a holding company. We operate in the component products industry through our majority-owned subsidiary, CompX International Inc. We also own a noncontrolling interest in Kronos Worldwide, Inc. Both CompX /zigman2/quotes/205448789/composite CIX -8.14% and Kronos /zigman2/quotes/203604290/composite KRO -1.71% file periodic reports with the SEC.
CompX is a leading manufacturer of engineered components utilized in a variety of applications and industries. Through its Security Products operations, CompX manufactures mechanical and electronic cabinet locks and other locking mechanisms used in recreational transportation, postal, office and institutional furniture, cabinetry, tool storage and healthcare applications. CompX also manufactures stainless steel exhaust systems, gauges, throttle controls, wake enhancement systems and trim tabs for the recreational marine and other industries through its Marine Components operations.
We account for our 30% non-controlling interest in Kronos by the equity method. Kronos is a leading global producer and marketer of value-added titanium dioxide pigments. TiO2 is used for a variety of manufacturing applications including coatings, plastics, paper and other industrial products.
Net income (loss) overview
Our net loss attributable to NL stockholders was $41.0 million, or $.84 per share, in 2018 compared to net income of $116.1 million, or $2.38 per share, in 2017 and $15.3 million, or $.31 per share, in 2016.
As more fully described below, the decrease in our earnings per share attributable to NL stockholders from 2017 to 2018 is primarily due to the net effects of:
a pre-tax litigation settlement expense of $62 million recognized in the second quarter of 2018;
a pre-tax marketable equity securities expense of $60.9 million recognized in 2018 as a result of adopting ASU 2016-01 in 2018;
equity in earnings of Kronos in 2018 of $62.3 million compared to $107.8 million in 2017;
higher income from operations attributable to CompX of $2.6 million in 2018; and
higher litigation fees and litigation related costs of $2.4 million in 2018.
As more fully described below, the increase in our earnings per share attributable to NL stockholders from 2016 to 2017 is primarily due to the net effects of:
equity in earnings from Kronos in 2017 of $107.8 million compared to $13.2 million in 2016,
lower income from operations attributable to CompX in 2017 of $.4 million,
lower environmental remediation and related costs of $1.8 million in 2017,
higher interest and dividend income in 2017 of $1.8 million, and
a non-cash deferred income tax benefit of $37.5 million recognized in 2017 related to the revaluation of our net deferred income tax liability resulting from the reduction in the U.S. federal corporate income tax rate enacted into law on December 22, 2017.
Our 2018 net loss per share attributable to NL stockholders includes:
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a loss of $1.01 per share related to the litigation settlement expense recognized in the second quarter; and
a loss, net of income taxes, included in our equity in earnings of Kronos:
loss of $0.02 per share related to Kronos' tax on global intangible low-tax income, recognized in the fourth quarter; and
loss of $0.01 per share related to Kronos' reserve for uncertain tax positions, recognized in the first and fourth quarters.
Our 2017 net income per share attributable to NL stockholders includes:
income of $.77 per share related to a non-cash deferred income tax benefit related to the revaluation of our net deferred income tax liability resulting from the reduction in the U.S. federal corporate income tax rate enacted into law on December 22, 2017,
income of $.01 per share, net of income taxes, related to insurance recoveries we recognized , and
income or loss, net of income taxes, included in our equity in earnings of Kronos:
income of $.76 per share related to Kronos' non-cash deferred income tax benefit recognized as the result of the reversal of its deferred income tax asset valuation allowances associated with its German and Belgian operations, mostly recognized in the second quarter,
income of $.08 per share related to Kronos' fourth quarter non-cash deferred income tax benefit recognized as the result of the reversal of its deferred income tax asset valuation allowance related to certain U.S. deferred income tax assets of one of its non-U.S. subsidiaries (which subsidiary is treated as a dual resident for U.S. income tax purposes),
loss of $.31 per share related to Kronos' fourth quarter provisional current income tax expense as a result of a change in the 2017 Tax Act for the one-time repatriation tax imposed on the post-1986 undistributed earnings of Kronos' non-U.S. subsidiaries,
income of $.05 per share related to Kronos' income tax benefit related to the execution and finalization of an Advance Pricing Agreement between the Canada and Germany, mostly recognized in the third quarter (which includes an $8.6 million non-cash income tax benefit as a result of a net decrease in Kronos' reserve for uncertain tax positions),
loss of $.02 per share related to Kronos' fourth quarter provisional non-cash deferred income tax expense related to a change in its conclusions regarding its permanent reinvestment assertion with respect to the post-1986 undistributed earnings of Kronos' European subsidiaries, and
loss of $.02 per share related to Kronos' third quarter loss on prepayment of debt.
Our 2016 net income per share attributable to NL stockholders includes:
income of $.01 per share, net of income taxes, related to insurance recoveries we recognized, and
income or loss, net of income taxes, included in our equity in earnings of Kronos:
income of $.01 per share related to Kronos' insurance settlement gains,
income of $.01 per share related to Kronos' current income tax benefit related to the execution and finalization of an Advance Pricing Agreement between the U.S. and Canada,
income of $.01 per share related to Kronos' recognition of a net deferred income tax benefit as the result of a net decrease in its deferred income tax asset valuation allowance related to its German and Belgian operations, and
loss of $.01 per share related to a net increase in Kronos' reserve for uncertain tax positions.
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We currently expect our net income attributable to NL stockholders in 2019 to be higher than 2018 primarily due to the $62 million litigation expense recognized in 2018 and lower expected litigation and related costs in 2019 partially offset by lower expected equity in earnings from Kronos.
Critical accounting policies and estimates
The accompanying "Management's Discussion and Analysis of Financial Condition and Results of Operations" is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reported period. On an ongoing basis, we evaluate our estimates, including those related to the recoverability of long-lived assets, pension benefit obligations and the underlying actuarial assumptions related thereto, the realization of deferred income tax assets and accruals for litigation, income tax and other contingencies. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ significantly from previously-estimated amounts under different assumptions or conditions.
The following critical accounting policies affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:
Contingencies - We record accruals for environmental, legal and other contingencies and commitments when estimated future expenditures associated with such contingencies become probable, and the amounts can be reasonably estimated. However, new information may become available, or circumstances (such as applicable laws and regulations) may change, thereby resulting in an increase or decrease in the amount required to be accrued for such matters (and therefore a decrease or increase in reported net income in the period of such change).
Obligations for environmental remediation costs are difficult to assess and estimate and it is possible that actual costs for environmental remediation will exceed accrued amounts or that costs will be incurred in the future for sites in which we cannot currently estimate our liability. If these events were to occur in 2019, our corporate expenses would be higher than we currently estimate. In addition, we adjust our environmental accruals as further information becomes available to us or as circumstances change. Such further information or changed circumstances could result in an increase in our accrued environmental costs. See Note 17 to our Consolidated Financial Statements.
Long-lived assets - We assess property and equipment for impairment only when circumstances (as specified in ASC 360-10-35, Property, Plant, and Equipment) indicate an impairment may exist. Our determination is based upon, among other things, our estimates of the amount of future net cash flows to be generated by the long-lived asset (Level 3 inputs) and our estimates of the current fair value of the asset.
Significant judgment is required in estimating such cash flows. Adverse changes in such estimates of future net cash flows or estimates of fair value could result in an inability to recover the carrying value of the long-lived asset, thereby possibly requiring an impairment charge to be recognized in the future. We do not assess our property and equipment for impairment unless certain impairment indicators specified in ASC Topic 360-10-35 are present. We did not evaluate any long-lived assets for impairment during 2018 because no such impairment indicators were present.
Goodwill - Our net goodwill totaled $27.2 million at December 31, 2018. We perform a goodwill impairment test annually in the third quarter of each year. Goodwill is also evaluated for impairment
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at other times whenever an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying value. All of our net goodwill at December 31, 2018 is related to CompX's security products reporting unit. In 2018 we used the qualitative assessment of ASC 350-20-35, Goodwill, for our 2018 annual impairment test and determined it was not necessary to perform the quantitative goodwill impairment test, as we concluded it is more-likely-than-not that the fair value of CompX's Security Products reporting unit exceeded its carrying amount. See Note 7 to our Consolidated Financial Statements.
When performing a qualitative assessment considerable management judgment is necessary to evaluate the qualitative impact of events and circumstances on the fair value of a reporting unit. Events and circumstances considered in our impairment evaluations, such as historical profits and stability of the markets served, are consistent with factors utilized with our internal projections and operating plan. However, future events and circumstances could result in materially different findings which could result in the recognition of a material goodwill impairment.
Defined benefit pension plans - We maintain various defined benefit pension plans. The amounts recognized as defined benefit pension expense and the reported amounts of pension asset and accrued pension costs are actuarially determined based on several assumptions, including discount rates, expected rates of returns on plan assets, and expected mortality. Variances from these actuarially assumed rates will result in increases or decreases, as applicable, in the recognized pension obligations, pension expense and funding requirements. These assumptions are more fully described below under the heading "Assumptions on defined benefit pension plans."
Income taxes - We recognize deferred taxes for future tax effects of temporary differences between financial and income tax reporting. Deferred income tax assets and liabilities for each tax-paying jurisdiction in which we operate are netted and presented as either a noncurrent deferred income tax asset or liability, as applicable. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance, it is possible that in the future we may change our estimate of the amount of the deferred income tax assets that would more-likely-than-not be realized in the future resulting in an adjustment to the deferred income tax asset valuation allowance that would either increase or decrease, as applicable, reported net income in the period the change in estimate was made.
We record a reserve for uncertain tax positions where we believe it is more-likely-than-not our position will not prevail with the applicable tax authorities. It is possible that in the future we may change our assessment regarding the probability that our tax positions will prevail that would require an adjustment to the amount of our reserve for uncertain tax positions that could either increase or decrease, as applicable, reported net income in the period the change in assessment was made.
Income from operations of CompX and Kronos is impacted by certain significant judgments and estimates, as summarized below:
Chemicals (Kronos) - allowance for doubtful accounts, impairment of equity method investments, long-lived assets, defined benefit pension plans, loss accruals and income taxes, and
Component products (CompX) - impairment of goodwill and long-lived assets, loss accruals and income taxes.
In addition, general corporate and other items are impacted by the significant judgments and estimates for impairment of marketable securities and equity method investments, defined benefit pension plans, deferred income tax asset valuation allowances and loss accruals.
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Income (loss) from operations
The following table shows the components of our income (loss) from operations.
Years ended December 31, % Change 2016 2017 2018 2016-17 2017-18 (Dollars in millions) CompX $ 15.6 $ 15.2 $ 17.8 (2 ) % 17 % Insurance recoveries 0.4 0.4 1.3 (15 ) 246 Other income, net - .2 .6 n/m 279 Litigation settlement expense, net - - (62.0 ) - n/m Corporate expense (16.7 ) (14.1 ) (18.4 ) (16 ) 31
The following table shows the components of our income (loss) before income taxes exclusive of our income (loss) from operations.
Year ended December 31, % Change 2016 2017 2018 2016-17 2017-18 (Dollars in millions) Equity in earnings of Kronos $ 13.2 $ 107.8 $ 62.3 718 % (42 ) % Marketable equity securities - - (60.9 ) n/m n/m Other components of net periodic pension and OPEB (0.3 ) (0.8 ) (0.1 ) 210 % (86 ) % Interest and dividend income, net 1.7 3.5 5.0 106 42 CompX International Inc. Years ended December 31, % Change 2016 2017 2018 2016-17 2017-18 (Dollars in millions) Net sales $ 108.9 $ 112.0 $ 118.2 3 % 6 % Cost of sales 73.7 77.2 79.9 5 4 Gross margin 35.2 34.8 38.3 (1 ) 10 Operating costs and expenses 19.6 19.6 20.5 - 4 Income from operations $ 15.6 $ 15.2 $ 17.8 (2 ) 17 Percentage of net sales: Cost of sales 67.7 % 68.9 % 67.6 % Gross margin 32.3 31.1 32.4 Operating costs and expenses 18.0 17.5 17.3 Income from operations 14.3 13.6 15.1
Net sales - Net sales increased approximately $6.2 million in 2018 compared to 2017 primarily due to higher Marine Components sales volumes to manufacturers of ski/wakeboard boats and larger center-console boats; and to a lesser extent Security Products sales to certain markets, particularly transportation and office furniture. Relative changes in selling prices did not have a material impact on net sales comparisons.
Net sales increased approximately $3.1 million in 2017 compared to 2016 primarily due to higher Security Products sales volumes to government security, electronic lock and other markets, partially offset by a decrease in sales of security products to an original equipment manufacturer of recreational transportation products. Marine Components also contributed with higher sales, primarily to the waterski/wakeboard boat market. Relative changes in selling prices did not have a material impact on net sales comparisons.
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Cost of sales and gross margin - Cost of sales increased from 2017 to 2018 primarily due to increased sales volumes for both CompX's Security Products and Marine Components businesses. Gross margin dollars and gross profit as a percentage of sales increased from 2017 to 2018 primarily due to greater fixed cost leverage facilitated by higher production volumes for each of our business segments.
Cost of sales increased from 2016 to 2017 primarily due to increased sales volumes for CompX's Security Products and Marine Components businesses, and to a lesser extent higher raw material prices (mostly zinc and brass) and increased employee medical costs. Gross margin dollars in 2017 were comparable to 2016. As a percentage of sales, gross margin for 2017 decreased compared to 2016 due primarily to unfavorable relative changes in customer and product mix, higher raw material prices and increased employee medical costs in CompX's Security Products business, as well as higher manufacturing costs for the CompX's Marine Components business.
Operating costs and expenses - Operating costs and expenses consist primarily of sales and administrative-related personnel costs, sales commissions and advertising expenses directly related to product sales and administrative costs relating to CompX's businesses and its corporate management activities, as well as gains and losses on plant, property and equipment. Operating costs and expenses were comparable in 2016, 2017 and 2018 as a percentage of sales.
Income from operations - As a percentage of net sales, operating income increased from 2017 to 2018 while operating income decreased slightly from 2016 to 2017. Operating margins were primarily impacted by the factors impacting net sales, cost of sales, gross margin and operating costs discussed above.
General - CompX's profitability primarily depends on our ability to utilize our production capacity effectively, which is affected by, among other things, the demand for our products and our ability to control our manufacturing costs, primarily comprised of labor costs and materials. The materials used in our products consist of purchased components and raw materials some of which are subject to fluctuations in the commodity markets such as zinc, brass and stainless steel. Total material costs represented approximately 45% of our cost of sales in 2018, with commodity-related raw materials accounting for approximately 12% of our cost of sales. During 2017 and 2018, markets for the primary commodity-related raw materials used in the manufacture of our locking mechanisms, primarily zinc and brass, generally strengthened, but were moderating at the end of 2018. Over that same period, the market for stainless steel, the primary raw material used for the manufacture of marine exhaust headers and pipes and wake enhancement systems, remained relatively stable. While we expect the markets for our primary commodity-related raw materials to remain stable during 2019, we recognize that economic conditions could introduce renewed volatility on these and other manufacturing materials.
CompX occasionally enter into short-term commodity-related raw material supply arrangements to mitigate the impact of future increases in commodity related raw material costs. See Item 1 - "Business- Raw Materials."
Results by reporting unit
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The key performance indicator for CompX's reporting units is the level of their income from operations (see discussion below).
Years ended December 31, % Change 2016 2017 2018 2016-17 2017-18 (Dollars in millions) Net sales: Security Products $ 94.7 $ 96.6 $ 98.4 2 % 2 % Marine Components 14.2 15.4 19.8 8 29 Total net sales $ 108.9 $ 112.0 $ 118.2 3 6 Gross margin: Security Products $ 31.2 $ 31.1 $ 32.9 - 6 Marine Components 4.0 3.7 5.4 (7 ) 46 Total gross margin $ 35.2 $ 34.8 $ 38.3 (1 ) 10 Income from operations: Security Products $ 20.0 $ 19.2 $ 22.0 (4 ) 14 Marine Components 1.7 1.3 2.7 (21 ) 104 Corporate operating expenses (6.1 ) (5.3 ) (6.9 ) 13 (30 ) Total income from operations $ 15.6 $ 15.2 $ 17.8 (2 ) 17 Income from operations margin: Security Products 21.1 % 19.9 % 22.3 % Marine Components 12.0 8.7 13.8 Total income from operations margin 14.3 13.6 15.1
Security Products - Security Products net sales increased 2% to $98.4 million in 2018 compared to $96.6 million in 2017, primarily due to higher sales to the transportation and office furniture markets. As a percentage of sales, gross profit for 2018 increased slightly over 2017 due to lower production costs, including headcount reductions made during the second quarter of 2017, and improved coverage of fixed costs over increased production volumes. Operating costs and expenses for 2018 were slightly lower than 2017. As a result, Security Products operating income as a percentage of net sales for 2018 exceeded 2017.
Security Products net sales increased 2% to $96.6 million in 2017 compared to $94.7 million in 2016, as improved sales to government security, electronic lock and other markets more than offset a decrease of approximately $2.9 million in sales to a customer serving the recreational transportation market. As a percentage of sales, gross profit for 2017 decreased compared to 2016 primarily due to unfavorable relative changes in customer and product mix, and to a lesser extent higher raw material prices (mostly zinc and brass) and increased employee medical costs. Operating costs and expenses for 2017 were comparable to 2016. As a result, Security Products operating income as a percentage of net sales for 2017 was below 2016.
Marine Components - Marine Components net sales increased 29% in 2018 as compared to 2017 as a result of continued strong demand for our products, particularly those sold to the ski/wakeboard boat market as well as to manufacturers of large center-console boats and industrial customers. Gross profit margin and operating income as a percentage of net sales increased in 2018 compared to 2017 principally due to improved fixed cost leverage facilitated by higher production volumes.
Marine Components net sales increased 8% in 2017 as compared to 2016 as a result of continued strong demand for our products, particularly those sold to the ski/wakeboard boat market. Gross profit margin and operating income as a percentage of net sales decreased in 2017 compared to 2016 principally due to unfavorable relative changes in customer and product mix and higher manufacturing costs, including the impact of personnel turnover in key manufacturing departments.
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Outlook - CompX's 2018 sales growth was largely attributable to high demand for our marine products, where we continue to benefit from innovation and diversification in our product offerings to the recreational boat markets. We also increased sales of security products, particularly to the transportation and office furniture markets. In 2019, we will seek to maintain the positive momentum in each of our business segments to grow sales and profitability. 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 consistent execution of our lean manufacturing and cost improvement initiatives. Additionally, we continue to seek opportunities to gain market share in markets we currently serve, 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.
General corporate items, interest and dividend income, interest expense, provision for income taxes, noncontrolling interest and related party transactions
Insurance recoveries - We have agreements with certain insurance carriers pursuant to which the carriers reimburse us for a portion of our past lead pigment and asbestos litigation defense costs. Insurance recoveries include amounts we received from these insurance carriers.
The agreements with certain of our insurance carriers also include reimbursement for a portion of our future litigation defense costs. We are not able to . . .
Mar 11, 2019
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