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VHI > SEC Filings for VHI > Form 10-K on 17-Mar-2014All Recent SEC Filings

Show all filings for VALHI INC /DE/

Form 10-K for VALHI INC /DE/


17-Mar-2014

Annual Report


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"). Kronos (NYSE: KRO), NL (NYSE: NL) and CompX (NYSE MKT: CIX) each file periodic reports with the SEC.

We have three consolidated operating segments:

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.

Component Products-We operate in the component products industry through our majority control of CompX. CompX is a leading manufacturer of engineered components utilized in a variety of applications and industries. CompX manufactures engineered components that are sold to a variety of industries including recreational transportation, postal, office and institutional furniture, cabinetry, tool storage, healthcare and a variety of other industries.

Waste Management-WCS is our subsidiary which operates a West Texas facility for the processing, treatment, storage and disposal of a broad range of low-level radioactive, hazardous, toxic and other wastes. WCS obtained a byproduct disposal license in 2008 and began disposal operations at this facility in October 2009. WCS received a low-level radioactive waste ("LLRW") disposal license in September 2009. The Compact LLRW disposal facility commenced operations in 2012, and the Federal LLRW site commenced operations in 2013.

Income From Continuing Operations Overview

Year Ended December 31, 2012 Compared to Year Ended December 31, 2013-

We reported a loss from continuing operations attributable to Valhi stockholders of $98.0 million or $.29 per diluted share in 2013 compared to income from continuing operations of $141.4 million or $.41 per diluted share in 2012.

Our diluted earnings per share from continuing operations attributable to Valhi stockholders decreased from 2012 to 2013 primarily due to the net effects of:

an operating loss from our Chemicals Segment in 2013 compared to operating income in 2012, partially offset by increased operating income from our Component Products Segment and a decrease in the operating loss at our Waste Management Segment;

an aggregate non-cash gain related to our purchase of controlling interest in BMI and Landwell in December 2013, consisting of (i) a gain from the remeasurement of our existing interest in BMI and Landwell to estimated fair value and (ii) a bargain purchase gain related to the additional interest in BMI and Landwell acquired;

a gain from the sale of our TIMET common stock in 2012;

a real-estate related litigation settlement gain in 2012;

a gain on excess property sales in 2012;

a goodwill impairment in 2012;

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a higher loss on prepayment of debt in 2013 as compared to 2012 as a result of redeeming the Kronos term loan; and

higher general expenses in 2013, primarily due to increased environmental remediation and related expenses.

Our income from continuing operations attributable to Valhi stockholders in 2013 includes:

a gain of $.14 per diluted share related to our purchase of a controlling interest in BMI and Landwell in December 2013;

insurance recoveries of $.02 per diluted share;

a charge of $.01 per diluted share per diluted share related to the voluntary prepayments of the entire $390 million principal amount of Kronos' term loan; and

a charge of $.05 per diluted share related to a litigation settlement of Kronos.

Our income from continuing operations attributable to Valhi stockholders in 2012 includes:

a gain of $.04 per diluted share related to the sale of our TIMET common stock;

income of $.02 per diluted share related to a litigation settlement gain;

income of $.01 per diluted share related to a gain on the sale of excess property;

a loss of $.02 per diluted share related to a goodwill impairment; and

a loss on the prepayment of debt of $.01 per diluted share.

We discuss these amounts more fully below.

Year Ended December 31, 2011 Compared to Year Ended December 31, 2012-

We reported income from continuing operations attributable to Valhi stockholders of $141.4 million or $.41 per diluted share in 2012 compared to $214.5 million or $.63 per diluted share in 2011.

Our diluted earnings per share from continuing operations attributable to Valhi stockholders decreased from 2011 to 2012 primarily due to the net effects of:

lower operating income from each of our Chemicals and Components Products Segments in 2012 compared to 2011, partially offset by a lower operating loss from our Waste Management Segment;

a gain from the sale of our TIMET common stock in 2012;

a real-estate related litigation settlement gain in 2012;

a gain on excess property sales in 2012;

a goodwill impairment in 2012;

a higher loss on prepayment of debt in 2012 as compared to 2011 as a result of calling the remaining balance of Kronos Senior Notes;

higher insurance recoveries in 2011; and

higher general expenses in 2012, primarily due to increased environmental remediation and related expenses.

Our income from continuing operations attributable to Valhi stockholders in 2012 includes:

a gain of $.04 per diluted share related to sale of our TIMET common stock;

income of $.02 per diluted share related to a litigation settlement gain;

income of $.01 per diluted share related to a gain on the sale of excess property;

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a loss of $.02 per diluted share related to a goodwill impairment; and

a loss on the prepayment of debt of $.01 per diluted share.

Our income from continuing operations attributable to Valhi stockholders in 2011 includes:

insurance recoveries of $.03 per diluted share; and

income of $.02 per diluted share related to a net decrease in our reserve for uncertain tax positions.

We discuss these amounts more fully below.

Current Forecast for 2014-

We currently expect to report income from continuing operations attributable to Valhi stockholders for 2014 as compared to a loss from continuing operations in 2013 primarily due to the net effects of:

expected operating income from our Chemicals Segment in 2014 compared to an operating loss in 2013;

improved operating results at WCS in 2014 as we expect more revenue from the Compact and Federal LLRW disposal facilities which experienced shipment delays in the latter part of 2013;

the gain related to our purchase of a controlling interest in BMI and Landwell in December 2013;

lower expected general corporate expenses in 2014 due primarily to lower expected environmental remediation and related expenses; and

the loss on prepayment of debt in 2013.

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 Accounting Standards Codification ("ASC") 820-10-35, Fair Value Measurements and Disclosures, to determine fair value for certain of our common stock, 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 the ASC 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

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use Level 3 inputs to determine fair value of our investment in Amalgamated Sugar Company LLC. See Note 4 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, 2013, 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 97% of the aggregate carrying value of all of our marketable securities at December 31, 2013. The $250 million carrying value is equal to its cost basis.

Goodwill-Our net goodwill totaled $379.7 million at December 31, 2013 resulting primarily from our various step acquisitions of Kronos and NL (which occurred before the implementation of the current accounting standards related to noncontrolling interest) and to a lesser extent CompX's purchase of various businesses. In accordance with the applicable accounting standards for goodwill, 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 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. 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 two distinct business units. If the fair value of the reporting unit is less than its book value, the goodwill is written down to estimated fair value.

For our Chemicals Segment, we use Level 1 inputs of publicly traded market prices to compare the book value to assess impairment. We also consider control premiums when assessing fair value. Substantially all of the goodwill for our Component Products Segment relates to our security products reporting unit. In September 2011, the Financial Accounting Standards Board issued ASU No. 2011-08, which provided new guidance on testing goodwill for impairment. The new guidance allows an entity to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity is no longer required to calculate the fair value of a reporting unit unless the entity determines, based on a qualitative assessment considering the totality of relevant events and circumstances, that it is more likely than not that its fair value of the reporting unit is less than its carrying amount. We adopted this accounting standard in the third quarter of 2013 as it relates to our security products reporting unit.

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.

We performed our annual goodwill impairment test in the third quarter of 2013 for each of our reporting units and concluded there was no impairment of the goodwill for those reporting units. Such impairment test as it relates to our security products reporting unit was based on our qualitative assessment, and as a result a quantitative assessment was not required for such reporting unit for 2013.

Long-lived assets- We assess property, equipment and capitalized operating permit costs for impairment only when circumstances as specified in ASC 360-10-35, Property, Plant, and Equipment, indicate an impairment may exist. As a result of continued operating losses, certain long-lived assets of our Waste Management Segment were evaluated for impairment as of December 31, 2013. WCS has had limited operations as it sought regulatory approval for several licenses it needs for full scale operations. WCS obtained a byproduct disposal license in 2008 and began disposal operations in October 2010. In January 2010 WCS received a LLRW disposal

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permit. Construction of the Compact and Federal LLRW sites began in January 2011. The Compact LLRW site was fully certified and operational in April 2012, and the Federal LLRW site was fully certified and operational in September 2012 and commenced operations in 2013. Revenues in 2013 dropped significantly in the latter half of 2013 as customers were unable to ship waste to WCS as a result of an industry-wide shortage of approved shipping containers. WCS received the first of three shipping containers it ordered in 2012 in the first quarter of 2014 and expects revenue in 2014 to increase significantly over the latter half of 2014 as customers will be able to ship waste to WCS in its containers. 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, 2013 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 the timing and amounts of revenue associated with our LLRW facilities, forecasted growth rates and our cost of capital, are consistent with our internal projections and operating plans. However, if our future cash flows from operations less capital expenditures were to drop significantly below our current expectations (approximately 65%), it is reasonably likely we would conclude an impairment was present. At December 31, 2013 the carrying value of WCS' total assets was $270.1 million.

As a result of continued operating losses in CompX's Marine Components reporting unit, we evaluated the recoverability of the Marine Components long-lived assets during the third quarter of 2013. We determined that the undiscounted cash flows exceed the current net asset value and therefore the Marine Components long-lived assets are not impaired. However, if our future cash flows from operations less capital expenditures were to drop significantly below our current expectations (approximately 85% below our expectations for each of the Custom Marine and Livorsi Marine units), it is reasonably likely we would conclude an impairment was present. At December 31, 2013 the net asset carrying values of Custom Marine and Livorsi Marine were $3.4 million and $2.8 million, respectively.

No other long-lived assets in our other reporting units were tested for impairment during 2013 because there were no circumstances indicating an impairment might exist.

Benefit plans-We provide a range of benefits including various defined benefit pension and other postretirement benefits ("OPEB") 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. We record a valuation allowance to reduce our deferred income tax assets to the amount that is believed to be realized under the more-likely-than-not recognition criteria. 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 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 such change in estimate was made. For example, we have substantial net operating loss carryforwards in Germany (the equivalent of $842 million for German corporate purposes and $127 million for German trade tax purposes at December 31, 2013). At December 31, 2013, 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 utilized a portion of such carryforwards during the most recent three-year period and (iii) we currently expect to utilize the remainder of such carryforwards over the long term. However, prior to the complete utilization of such carryforwards, if we were to

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generate losses in our German operations for an extended period of time, it is possible that we might conclude the benefit of such 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 record a reserve for uncertain tax positions where we believe it is more-likely-than-not our tax 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 2013. See Note 12 to our Consolidated Financial Statements.

We also evaluate at the end of each reporting period whether or not some or all of the undistributed earnings of our non-U.S. subsidiaries are not 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 be required to recognize a deferred income tax liability in an amount equal to the estimated incremental U.S. income taxes and withholding tax liability that would be generated if all such previously-considered permanently reinvested undistributed earnings were to be distributed to the U.S.

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 applicable GAAP for 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, 2013 we have recorded total accrued environmental liabilities of $122.7 million.

Business combinations-During 2013 we acquired a controlling interest in BMI and Landwell. We previously held a noncontrolling interest in each of these companies. The application of the purchase method of accounting for business combinations requires us to use significant estimates and assumptions in the determination of the estimated fair value of assets acquired and liabilities assumed; it also requires us to remeasure our existing ownership interest in these companies to estimated fair value. Our estimates of the fair values of assets acquired and liabilities assumed are based upon assumptions we believe are reasonable, and when appropriate, include assistance from independent third-party valuation firms. See Note 3 to our Consolidated Financial Statements.

Operating income (loss) 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 investments, goodwill and other long-lived assets, defined benefit pension plans; and loss accruals.

Component Products-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, and loss accruals.

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Segment Operating Results-2012 Compared to 2013 and 2011 Compared to 2012-

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 expectation for future changes in market TiO2 selling prices as well as their expectation 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:

- Our TiO2 sales and production volumes,

- TiO2 selling prices,

- Manufacturing costs, particularly raw materials such as third-party feedstock ore, maintenance and energy-related expenses, and

- Currency exchange rates (particularly the exchange rate for the U.S. dollar relative to the euro, the Norwegian krone and the Canadian dollar).

Our 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 ore. TiO2 selling prices generally follow industry trends and the selling prices will increase or decrease generally as a result of competitive market pressures.

                                             Years ended December 31,                   % Change
                                         2011          2012          2013         2011-12      2012-13
                                               (Dollars in millions)
Net sales                              $ 1,943.3     $ 1,976.3     $ 1,732.4            2 %        (12 )%
Cost of sales                            1,197.5       1,418.2        1622.6           18 %         14 %
Gross margin                           $   745.8     $   558.1     $   109.8          (25 )%       (80 )%
Operating income (loss)                $   553.0     $   366.8     $  (125.4 )        (34 )%      (134 )%
Percent of net sales:
Cost of sales                                 62 %          72 %          94 %
. . .
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