ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

RESULTS OF OPERATIONS

Business Overview

We are primarily a holding company. We operate through our wholly-owned and majority-owned subsidiaries, including NL Industries, Inc., Kronos Worldwide, Inc., CompX International, Inc., Tremont LLC and Waste Control Specialists LLC ("WCS"). Prior to March 26, 2007 we were the largest shareholder of Titanium Metals Corporation ("TIMET") although we owned less than a majority interest. Kronos (NYSE: KRO), NL (NYSE: NL) and CompX (NYSE: CIX) each file periodic reports with the SEC.

We have three consolidated operating segments:

· Chemicals - Our chemicals segment is operated through our majority ownership of Kronos. Kronos is a leading global producer and marketer of value-added titanium dioxide pigments ("TiO2"). TiO2 is used for a variety of manufacturing applications, including plastics, paints, paper and other industrial products.

· Component Products - We operate in the component products industry through our majority ownership of CompX. CompX is a leading global manufacturer of security products, precision ball bearing slides and ergonomic computer support systems used in the office furniture, transportation, postal, tool storage, appliance and a variety of other industries. CompX is also a leading manufacturer of stainless steel exhaust systems, gauges and throttle controls for the performance marine industry.

· Waste Management - WCS is our wholly-owned subsidiary which owns and operates a West Texas facility for the processing, treatment, storage and disposal of hazardous, toxic and certain types of low-level radioactive waste. WCS obtained a byproduct disposal license in 2008 and is in the process constructing the byproduct disposal facility, which is expected to be operational in the second half of 2009. In January 2009 WCS received a low-level radioactive waste disposal permit, and construction of the low-level radioactive waste facility is currently expected to begin in the second quarter of 2009, following the completion of some pre-construction licensing and administrative matters, and is expected to be operational in the second quarter of 2010.

On March 26, 2007 we completed a special dividend of the TIMET common stock we owned to our stockholders. We accounted for our 35% interest in TIMET by the equity method through March 31, 2007. As a result we now own approximately 1% of TIMET's outstanding common stock. Accordingly we now account for our shares of TIMET common stock as available-for-sale marketable securities carried at fair value. See Note 3 to the Consolidated Financial Statements. TIMET is a leading global producer of titanium sponge, melted products and milled products. Titanium is used for a variety of commercial, aerospace, military, medical and other emerging markets. TIMET is also the only titanium producer with major production facilities in both of the world's principal titanium markets: the U.S. and Europe.

Income (Loss) From Operations Overview

Year Ended December 31, 2007 Compared to Year Ended December 31, 2008 -

We reported a net loss of $.8 million or $.01 per diluted share in 2008 compared to a net loss of $45.7 million, or $.40 per diluted share, in 2007.

Our diluted earnings per share improved from 2007 to 2008 due primarily to the net effects of:
· an income tax charge recognized by our Chemicals Segment in 2007 primarily as a result of a reduction in German tax rates;

· ceasing to record equity in earnings from TIMET due to the distribution of our TIMET shares in the first quarter of 2007;

· an income tax charge recognized by our Chemicals Segment related to an adjustment of certain German tax attributes in 2007;

· an income tax benefit due to a net decrease in our reserve for uncertain tax positions in 2007;

· a litigation settlement gain in 2008 received by NL;

· lower operating income from each of our segments in 2008;

· a goodwill impairment recognized by our Component Products Segment in 2008;

· an income tax benefit recognized by our Chemicals Segment in 2008 related to a net reduction in our reserve for uncertain tax positions;

· an income tax charge recognized in 2008 due to a net increase in our reserve for uncertain tax positions; and

· interest income related to an escrow fund recognized by NL in 2008.

Our net loss in 2007 includes (net of tax and minority interest):
· a charge of $.52 per diluted share as a result of the effect of a reduction of the German income tax rates in 2007;

· a charge of $.05 per diluted share related to the adjustment of certain German tax attributes within our Chemicals Segment;

· an income tax benefit of $.03 per diluted share due to a net decrease in our reserve for uncertain tax positions; and

· income of $.03 per diluted share related to certain insurance recoveries recognized by NL.

Our net loss in 2008 includes (net of tax and minority interest):
· income of $.23 per diluted share related to a litigation settlement gain received by NL;

· income of $.04 per diluted share related to the adjustment of certain German income tax attributes within our Chemicals Segment;

· income of $.04 per diluted share related to certain insurance recoveries we recognized;

· interest income of $.02 per diluted share related to certain escrow funds held for the benefit of NL;

· a charge of $.06 per diluted share related to goodwill impairment recognized on the Marine Components reporting unit of our Component Products Segment; and

· a charge of $.05 per diluted share due to a net increase in our reserve for uncertain tax positions.

We discuss these amounts more fully below.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2007 -

We reported a net loss of $45.7 million or $.40 per diluted share in 2007 compared to income of $141.7 million, or $1.20 per diluted share, in 2006.

Our diluted earnings per share decreased from 2006 to 2007 due primarily to the net effects of:
· an income tax charge recognized by our Chemicals Segment in 2007 primarily as a result of a reduction in German tax rates;

· an income tax benefit due to a net decrease in our reserve for uncertain tax positions in 2007;

· a lower effective income tax rate in 2006 primarily due to the favorable resolution in 2006 of audits in our Chemicals Segment's operations in Germany, Belgium and Norway;

· ceasing to record equity in earnings from TIMET due to the distribution of our TIMET shares in the first quarter of 2007;

· the gain in 2006 from the sale of certain land in Nevada;

· lower operating income from each of our segments in 2007;

· a charge in 2006 from the redemption of our 8.875% Senior Secured Notes;

· lower interest expense in 2007 resulting from the April 2006 refinancing of our Senior Secured Notes; and

· lower dividend income from the Amalgamated Sugar Company, LLC in 2007 as the additional dividend it owed to us was completely paid in 2006.

Our net income in 2006 includes (net of tax and minority interest, as applicable):
· a net income tax benefit of $.21 per diluted share at our Chemicals Segment related to the net effect of the withdrawal of certain income tax assessments previously made by Belgian and Norwegian tax authorities, the favorable resolution of certain income tax issues related to our German and Belgian operations and the enactment of a reduction in Canadian federal income tax rates offset by the unfavorable resolution of certain other income tax issues related to our German operations;

· income of $.20 per diluted share related to the sale of certain of our land in Nevada;

· a charge related to the redemption of our 8.875% Senior Secured Notes of $.09 per diluted share;

· a gain of $.09 per diluted share related to TIMET's sale of its minority interest in VALTIMET, a manufacturing joint venture located in France; and

· income of $.03 per diluted share related to certain insurance recoveries recognized by NL.

Our net loss in 2007 includes (net of tax and minority interest):
· a charge of $.52 per diluted share as a result of the effect of a reduction of the German income tax rates in 2007;

· a charge of $.05 per diluted share related to the adjustment of certain German tax attributes within our Chemicals Segment;

· an income tax benefit of $.03 per diluted share due to a net decrease in our reserve for uncertain tax positions; and

· income of $.03 per diluted share related to certain insurance recoveries recognized by NL.

We discuss these amounts more fully below.

Current Forecast for 2009 -

We currently expect to report a higher net loss for 2009 as compared to the net loss in 2008 primarily due to the net effects of:
· lower expected operating income from our Chemicals Segment due to anticipated higher production costs;

· recording a lower gain on litigation settlement in 2009; and

· lower operating losses at WCS as we expect more revenues with the completion of the byproduct disposal facility in the second quarter of 2009.

Critical accounting policies and estimates

We have based the accompanying "Management's Discussion and Analysis of Financial Condition and Results of Operations" upon our Consolidated Financial Statements. We prepare our Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In many cases the accounting treatment of a particular transaction does not require us to make estimates and judgments. However, in other cases we are required 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 amounts of revenues and expenses during the reported period. On an on-going basis, we evaluate our estimates, including those related to impairments of investments in marketable securities and investments accounted for by the equity method, the recoverability of other long-lived assets (including goodwill and other intangible assets), pension and other postretirement benefit obligations and the underlying actuarial assumptions related thereto, the realization of deferred income and other tax assets and accruals for environmental remediation, litigation, income tax contingencies. We base our estimates on historical experience and on various other assumptions we believe are 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 might differ significantly from previously-estimated amounts under different assumptions or conditions.

"Our critical accounting policies" relate to amounts having a material impact on our financial position and results of operations, and that require our most subjective or complex judgments. See Note 1 to our Consolidated Financial Statements for a detailed discussion of our significant accounting policies.

· Marketable securities - We own investments in certain companies that we account for as marketable securities carried at fair value or that we account for under the equity method. For these investments, we evaluate the fair value at each balance sheet date. We use quoted market prices, Level 1 inputs as defined in SFAS No. 157, to determine fair value for certain of our marketable debt securities and publicly traded investees. For other of our marketable debt securities the fair value is generally determined using Level 2 inputs as defined in SFAS No. 157 because although these securities are traded in many cases the market is not active and the year end valuation is based on the last trade of the year which may be several days prior to December 31. We use Level 3 inputs to determine fair value of our investment in Amalgamated Sugar Company LLC. See Note 18 to our Consolidated Financial Statements. We record an impairment charge when we believe an investment has experienced an other than temporary decline in fair value below its cost basis (for marketable securities) or below its carrying value (for equity method investees). Further adverse changes in market conditions or poor operating results of underlying investments could result in losses or our inability to recover the carrying value of the investments that may not be reflected in an investment's current carrying value, thereby possibly requiring us to recognize an impairment charge in the future.

At December 31, 2008, the carrying value (which equals their fair value) of substantially all of our marketable securities equaled or exceeded the cost basis of each investment. Our investment in The Amalgamated Sugar Company LLC represents approximately 88% of the aggregate carrying value of all of our marketable securities at December 31, 2008. The $250 million carrying value is equal to its cost basis, see Note 4 to our Consolidated Financial Statements. At December 31, 2008, the $8.81 per share quoted market price of our investment in TIMET was almost two times our cost basis per share of our investment in TIMET.

· Goodwill - Our goodwill totaled $396.8 million at December 31, 2008 resulting primarily from our various step acquisitions of Kronos and NL and to a lesser extent CompX's purchase of various businesses. In accordance with SFAF No. 142, Goodwill and Other Intangible Assets, we do not amortize goodwill.

We perform a goodwill impairment test annually in the third quarter of each year. Goodwill is also evaluated for impairment if the book value of its reporting unit exceeds its estimated fair value. A reporting unit can be a segment or an operating division based on the operations of the segment. For example, our Chemicals Segment produces a globally coordinated homogeneous product whereas our Component Products Segment operates as three distinct business units. For our Chemicals Segment, we use Level 1 inputs of publicly traded market prices to compare the book value to assess impairment. Because we test for goodwill at a reporting unit level for our Component Products Segment, we use Level 3 inputs of a discounted cash flow technique since Level 1 inputs of market prices are not available at the reporting unit level. If the fair value is less than the book value, the asset is written down to the estimated fair value.

Considerable management judgment is necessary to evaluate the impact of operating changes and to estimate future cash flows. Assumptions used in our impairment evaluations, such as forecasted growth rates and our cost of capital, are consistent with our internal projections and operating plans. However, different assumptions and estimates could result in materially different findings which could result in the recognition of a material goodwill impairment.

During the third quarter of 2008, our Component Products Segment determined that all of the goodwill associated with its marine components reporting unit was impaired. We recognized a $10.1 million charge for the goodwill impairment, which represented all of the goodwill we had previously recognized for the Marine Components reporting unit of our Component Products Segment (including a nominal amount of goodwill inherent in our investment in CompX). The factors that led us to conclude goodwill associated with the Marine Components reporting unit was fully impaired include the continued decline in consumer spending in the marine market as well as the overall negative economic outlook, both of which resulted in near-term and longer-term reduced revenue, profit and cash flow forecasts for the Marine Components unit. While we continue to believe in the long-term potential of the Marine Components reporting unit, due to the extraordinary economic downturn in the boating industry we are not currently able to foresee when the industry and our business will recover. In response to the present economic conditions, we have taken steps to reduce operating costs without inhibiting our ability to take advantage of opportunities to expand our market share.

When we performed this analysis in the third quarter of 2008, we also reviewed the goodwill associated with all of our other reporting units and concluded there was no impairment of the goodwill for those reporting units. Due to the continued weakening of the economy, we re-evaluated the goodwill associated with the furniture components reporting unit of our Component Products Segment again in the fourth quarter of 2008 and concluded no additional impairments were present.

If our future results were to be significantly below our current expectations, it is reasonably likely we would conclude additional impairments of the goodwill and intangible assets associated with the furniture components reporting unit would be present. As of December 31, 2008 our Furniture Components reporting unit had approximately $10.6 million of goodwill, including goodwill inherent in our investment in CompX. Holding all other assumptions constant at the re-evaluation date, a 100 to 200 basis point increase in the discount rate would reduce the enterprise value for the furniture components reporting unit, indicating potential impairment. If we record additional impairment charges in the future, it could cause CompX to fail to comply with one or more of the financial covenants contained in its credit facility. See Note 9 to the Consolidated Financial Statements. In the event CompX were to fail to comply with one or more covenants, we would attempt to negotiate waivers of any noncompliance; however, there can be no assurance that we would be able to obtain any waivers. In addition the costs or conditions associated with any waivers could be significant. At December 31, 2008 CompX had no balances outstanding under the facility and it does not anticipate needing to utilize the facility for operations in 2009.

· Long-lived assets - We account for our long-lived assets, including our investment in WCS, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. We assess property, equipment and capitalized permit costs for impairment only when circumstances as specified in SFAS No. 144 indicate an impairment may exist. During 2008, as a result of continued operating losses, certain long-lived assets of our Waste Management Segment were evaluated for impairment as of December 31, 2008. WCS has had limited operations as it seeks regulatory approval for several licenses it needs for full scale operations. In January 2009, WCS received an order for the final license it needs to commence full scale operations. We have begun construction of the byproduct disposal facility which we expect to begin operations in the second quarter of 2009 and currently plan to commence construction of the low-level and mixed low-level site in the second half of 2009, following the completion of some pre-construction licensing and administrative matters. We estimate it will cost approximately $70 million to construct this facility which will be incurred over the construction period from the second quarter of 2009 until the third quarter of 2010. Our impairment analysis is based on estimated future undiscounted cash flows of WCS' operations, and this analysis indicated no impairment was present at December 31, 2008 and that the carrying value of WCS is recoverable as the aggregate future undiscounted cash flow estimate exceeded the carrying value of WCS' net assets by at least two times. Considerable management judgment is necessary to evaluate the impact of operating changes and to estimate future cash flows. Assumptions used in our impairment evaluations, such as when we will receive final regulatory licenses, the cost and timing of construction, forecasted growth rates and our cost of capital, are consistent with our internal projections and operating plans. However, different assumptions and estimates could result in materially different findings which could result in the recognition of a material asset impairment.

During the third quarter of 2008, as a result of the goodwill impairment discussed above, certain long-lived intangible assets of our Marine Component reporting segment were evaluated for impairment. This analysis indicated no impairment was present and that the carrying value of our Marine Components long-lived intangible assets, including customer lists, trademarks and patents, are recoverable as the estimated aggregate future undiscounted cash flows exceeds the carrying value of the assets. Assumptions used in our impairment evaluations, such as forecasted growth rates and our cost of capital, are consistent with our internal projections and operating plans. However, different assumptions and estimates could result in materially different findings which could result in the recognition of a material asset impairment.

No other long-lived assets in our other reporting units were tested for impairment during 2008 because there were no circumstances to indicate an impairment may exists at these units.

· Employee benefit plan costs - We provide a range of benefits including various defined benefit pension and other postretirement benefits for our employees. We record annual amounts related to these plans based upon calculations required by GAAP, which make use of various actuarial assumptions, such as: discount rates, expected rates of returns on plan assets, compensation increases, employee turnover rates, mortality rates and expected health care trend rates. We review our actuarial assumptions annually and make modifications to the assumptions based on current rates and trends when we believe appropriate. As required by GAAP, modifications to the assumptions are generally recorded and amortized over future periods. Different assumptions could result in the recognition of materially different expense amounts over different periods of times and materially different asset and liability amounts in our Consolidated Financial Statements. These assumptions are more fully described below under "-Assumptions on defined benefit pension plans and OPEB plans."

· Income taxes - We recognize deferred taxes for future tax effects of temporary differences between financial and income tax reporting in accordance with SFAS 109, Accounting for Income Taxes. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a deferred income tax asset 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. If such changes take place, there is a risk that an adjustment to our deferred income tax asset valuation allowance may be required that would either increase or decrease, as applicable, our reported net income in the period such change in estimate was made. For example, our Chemicals Segment has substantial net operating loss carryforwards in Germany (the equivalent of $817 million for German corporate purposes and $229 million for German trade tax purposes at December 31, 2008). At December 31, 2008, we have concluded that no deferred income tax asset valuation allowance is required to be recognized with respect to such carryforwards, principally because (i) such carryforwards have an indefinite carryforward period, (ii) we have generated cumulative income in Germany over the most recent three-year period and consequently utilized a portion of such carryforwards during that period and
(iii) we currently expect to utilize the remainder of such carryforwards over the long term. However, prior to the complete utilization of these carryforwards, particularly if the current economic downturn continues and we were to generate operating losses in our German operations for an extended period of time, it is possible we might conclude the benefit of the carryforwards would no longer meet the more-likely-than-not recognition criteria, at which point we would be required to recognize a valuation allowance against some or all of the then-remaining tax benefit associated with the carryforwards.

We also evaluate at the end of each reporting period whether some or all of the undistributed earnings of our foreign subsidiaries are permanently reinvested (as that term is defined in GAAP). While we may have concluded in the past that some undistributed earnings are permanently reinvested, facts and circumstances can change in the future, such as a change in the expectation regarding the capital needs of our foreign subsidiaries, could result in a conclusion that some or all of the undistributed earnings are no longer permanently reinvested. If our prior conclusions change, we would recognize a deferred income tax liability in an amount equal to the estimated incremental U.S. income tax and withholding tax liability that would be generated if all of such previously-considered permanently reinvested undistributed earnings were distributed to us. We did not change our conclusions on our undistributed foreign earnings in 2008.

Beginning in 2007, we record a reserve for uncertain tax positions in accordance with FIN No. 48, Accounting for Uncertain Tax Positions, for tax positions where we believe it is more-likely-than-not our position will not prevail with the applicable tax authorities. From time to time, tax authorities will examine certain of our income tax returns. Tax authorities may interpret tax regulations differently than we do. Judgments and estimates made at a point in time may change based on the outcome of tax audits and changes to or further interpretations of regulations, thereby resulting in an increase or decrease in the amount we are required to accrue for uncertain tax positions (and therefore a decrease or increase in our reported net income in the period of such change). Our reserve for uncertain tax positions changed during 2008. See Note 18 to our Consolidated Financial Statements.

· Litigation and environmental liabilities - We are involved in numerous legal and environmental actions in part due to NL's former involvement in the manufacture of lead-based products. In accordance with SFAS No. 5, Accounting for Contingencies, we record accruals for these liabilities when estimated future expenditures associated with such contingencies become probable, and we can reasonably estimate the amounts of such future expenditures. However, new information may become available to us, or circumstances (such as applicable laws and regulations) may change, thereby resulting in an increase or decrease in the amount we are required to accrue for such matters (and therefore a decrease or increase in our reported net income in the period of such change). At December 31, 2008 we have recorded total accrued environmental liabilities of $52.9 million.

Operating income for each of our three operating segments is impacted by certain of these significant judgments and estimates, as summarized below:

· Chemicals - allowance for doubtful accounts, reserves for obsolete or unmarketable inventories, impairment of equity method investees, goodwill and other long-lived assets, defined benefit pension and OPEB plans and loss accruals.

· Component Products - reserves for obsolete or unmarketable inventories, impairment of goodwill and long-lived assets and loss accruals.

· Waste Management - impairment of long-lived assets and loss accruals.

In addition, general corporate and other items are impacted by the significant judgments and estimates for impairment of marketable securities and equity method investees, defined benefit pension and OPEB plans, deferred income tax asset valuation allowances and loss accruals.

Segment Operating Results - 2007 Compared to 2008 and 2006 Compared to 2007 -

Chemicals -

We consider TiO2 to be a "quality-of-life" product, with demand affected by gross domestic product ("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 our customers' inventory levels are partly influenced by their expectation for future changes in market TiO2 selling prices. The majority of our TiO2 grades and substantially all of our production are considered commodity . . .