LSB Industries, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Unless noted otherwise, dollar amounts below are in millions. The company manufactures nitrogen-based chemicals and HVAC products through its Chemical and Climate Control businesses. Interim results are seasonal and affected by plant maintenance and downtime.
Financial performance and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $202.2 | $209.3 | $352.9 | $399.5 |
| Gross profit | $38.7 | $65.7 | $64.1 | $110.2 |
| Gross margin | 19.1% | 31.4% | 18.2% | 27.6% |
| Operating income | $12.2 | $42.3 | $12.0 | $65.4 |
| Net income | $7.4 | $26.0 | $7.4 | $40.3 |
| Diluted earnings per share | $0.31 | $1.11 | $0.31 | $1.72 |
| Cash from continuing operations | Not separately provided | Not separately provided | $6.9 | $56.5 |
- Revenue mix: Q2 Chemical sales declined 12% to $121.3 million, while Climate Control sales rose 15% to $77.4 million. For the first half, Chemical sales fell 24% to $198.8 million and Climate Control sales increased 13% to $147.6 million.
- Segment profitability: Q2 Chemical operating income was $6.4 million versus $39.1 million a year earlier; Climate Control operating income increased to $9.5 million from $7.3 million. For the first half, Chemical operating income was $2.6 million versus $59.5 million, while Climate Control operating income rose to $15.8 million from $13.2 million.
- Cash and capital spending: Cash and cash equivalents were $65.6 million at June 30, down from $98.0 million at December 31, 2012. First-half capital expenditures were $82.6 million; continuing investing activities used $68.9 million, including $14.0 million of property-insurance proceeds. Cash declined $32.4 million over the half-year.
- Debt and liquidity: Debt, including current maturities, was $107.9 million at June 30, versus $72.4 million at year-end. Current assets were $265.7 million and current liabilities $123.3 million. Subsequent to quarter-end, LSB issued $425 million of 7.75% senior secured notes due 2019, receiving approximately $418 million net and using $67.2 million to repay the secured term loan. Pro forma at June 30, cash was estimated at $416.4 million and debt at $466.3 million. The amended revolving facility was increased to $100 million; it was undrawn on August 7, with approximately $80 million pro forma availability at June 30, subject to eligible collateral.
Material changes and management commentary
- Management attributed the sharp deterioration in Chemical results to extended downtime and reduced production at the Pryor, Cherokee and El Dorado facilities, including lost sales, lower fixed-cost absorption and purchases of replacement ammonia. It estimated these events reduced first-half operating income by approximately $59–$70 million, net of recognized business-interruption recoveries.
- Pryor resumed production in April and Cherokee in early May 2013, though Pryor had further intermittent repair and maintenance outages. El Dorado’s replacement 65% nitric acid plant and 98% concentrator were expected to be completed in the first half of 2015. Management estimated ongoing El Dorado operating-income effects of $1–$2 million per month until the new facilities begin production.
- Climate Control benefited from stronger commercial/institutional demand and higher sales volumes; its second-quarter gross margin improved to 32.8% from 31.1%. Management expected moderate near-term sales growth, but described residential geothermal demand as soft and noted that construction markets remained below pre-recession levels.
- Management expected $5.0–$5.5 million of 2013 spending on enhanced process-safety, reliability and mechanical-integrity programs; $1.7 million had been incurred in the first half. First-half environmental regulatory expenses were $2.9 million, with a further $2.5–$3.0 million expected during the rest of 2013.
Unusual items, risks and contingencies
- Insurance recoveries for El Dorado and Cherokee were subject to insurer investigation and reservation of rights. LSB estimated total recoveries of $100–$120 million for El Dorado and $40–$47 million for Cherokee, net of deductibles; amounts received by June 30 were $50 million and $15 million, respectively. Portions were deferred rather than recognized as income, and actual recoveries could differ from estimates.
- The company recorded $2.1 million of first-half dismantling and demolition expense and a $0.5 million one-time tax benefit from retroactive tax legislation. The first-half tax provision was $3.6 million, an effective rate of approximately 37% excluding the retroactive benefit.
- An oral agreement in principle with EPA/DOJ contemplated emission-control upgrades at six nitric acid plants, estimated at $2–$3 million per plant, a $725,000 civil penalty and a reforestation project estimated at $150,000. Definitive settlement documents and required approval were still pending. A separate ODEQ investigation concerning Pryor air-emissions reporting remained ongoing; a July 2013 settlement resolved other cited issues for $100,000.
- LSB and its subsidiary had received claim-related inquiries following the West Fertilizer explosion; neither had been named in the lawsuits reported in the filing. The company stated it did not believe its product was stored at the site, and no liability had been established.
- Other material exposures include environmental compliance and remediation, potential production interruptions, commodity and interest-rate fluctuations, and the substantial capital requirements of planned chemical projects. The company’s $250–$300 million planned El Dorado ammonia plant and other projects depend on execution, funding and required permits.
- The new notes increase leverage and carry 7.75% interest. Note and revolver covenants restrict, among other matters, additional debt, liens, distributions and asset transactions; subsidiary distributions to LSB are also limited. Management forecast compliance with applicable financial covenants over the following 12 months.
Key facts for investors to verify
- Progress, cost, permitting and production timing for the El Dorado ammonia, nitric acid and concentrator projects, and the related capital-spending plan.
- Actual operating recovery at Pryor and Cherokee, remaining El Dorado production constraints, and whether downtime estimates or reliability-program costs change.
- Insurance settlements, payments, reservations of rights and the timing and accounting for deferred recoveries.
- Final EPA/DOJ settlement terms and the status and possible consequences of the separate Pryor investigation.
- Post-issuance cash deployment, debt service, revolver availability and compliance with note and credit-facility covenants.
- Climate Control order intake and backlog conversion, and Chemical segment performance as agricultural demand, feedstock costs and plant availability evolve.