LSB INDUSTRIES, INC. annual report, FY2012

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Business context and reporting period

LSB Industries, Inc. filed this Form 10-K for the fiscal year ended December 31, 2012. It is an annual report, not a standalone fourth-quarter filing. LSB operates a Chemical Business producing nitrogen-based products and a Climate Control Business manufacturing HVAC equipment; these represented approximately 63% and 35% of consolidated 2012 sales, respectively.

Financial performance and liquidity

  • Revenue: $759.0 million, down 5.7% from $805.3 million in 2011.
  • Profit: Operating income was $95.7 million versus $136.4 million; net income was $58.6 million versus $83.8 million. Net income applicable to common stock was $58.3 million, or $2.61 per basic share and $2.49 diluted, compared with $83.5 million, or $3.80 basic and $3.58 diluted, in 2011.
  • Margins: Consolidated gross profit was $183.7 million, a 24.2% gross margin, versus $223.0 million and 27.7% in 2011. Chemical gross margin fell to 20.4% from 25.5%; Climate Control gross margin was 30.4% versus 31.3%.
  • Segments: Chemical sales were $477.8 million (down 6.7%) and operating income was $82.1 million (down 29.5%). Climate Control sales were $266.2 million (down 5.5%) and operating income was $25.8 million (down 21.1%).
  • Cash flow: Continuing operating activities provided $99.5 million; investing activities used $121.7 million, including $92.6 million of capital expenditures and $50.2 million for natural gas working interests; financing activities used $4.5 million. Cash and cash equivalents declined to $98.0 million from $124.9 million.
  • Debt and liquidity: Total debt, including current maturities, was $72.4 million, down from $79.5 million. The $50 million revolving facility was undrawn, with approximately $48.4 million available at year-end. Stockholders’ equity increased to $354.5 million from $293.3 million.

Material changes, outlook, risks and unusual items

  • Three Chemical facility disruptions materially affected results: the Pryor plant experienced equipment and production problems, an El Dorado nitric acid plant exploded, and a pipe rupture damaged Cherokee’s ammonia plant. Management estimated their combined 2012 adverse operating-income impact at approximately $83 million. It expected Pryor ammonia production to restart in March 2013, Cherokee to return to full production in May 2013, and replacement nitric acid plants at El Dorado to begin production in the first half of 2015.
  • Insurance proceeds and claims remain important to liquidity and reported results. Insurers approved $40 million of unallocated payments for the El Dorado event; $20 million was received in 2012 and $20 million in January 2013. At year-end, recognized insurance claim receivables totaled $10.1 million across the El Dorado and Cherokee events. Some claims remained under reservation of rights, and additional recoveries were uncertain. The fourth quarter included a $7.3 million business-interruption recovery recorded as a reduction to cost of sales.
  • Capital plans are substantial. The replacement nitric acid project is estimated to cost up to $120 million. A proposed El Dorado ammonia plant is estimated at $250–$300 million and remains subject to board approval, permits and financing. Management also cited planned reliability, safety and natural-gas-property investments; funding depends in part on third-party financing, internal cash flow and insurance proceeds.
  • In October 2012, LSB acquired natural gas working interests for approximately $50 million as an economic hedge against feedstock price increases. A $35 million loan secured by those interests was entered into in February 2013 and guaranteed by LSB.
  • Outlook: Management cited favorable fertilizer supply-and-demand fundamentals for 2013, while noting exposure to weather, crop economics, imports and production capacity. It expected moderate near-term Climate Control sales growth; its construction outlook depended on a projected recovery in commercial/institutional and single-family residential markets. These expectations are forward-looking and uncertain.
  • Contingencies and risks: The EPA was negotiating a Clean Air Act settlement that could require pollution-control upgrades at six nitric acid plants, estimated at $2–$3 million per plant, plus a civil penalty. Oklahoma authorities were investigating Pryor emissions reporting; after year-end they executed a search warrant and subpoenaed documents. El Dorado wastewater-permit and groundwater matters, and remediation obligations at the former Hallowell site, also remain relevant. The filing notes significant customer concentration, commodity-price and plant-reliability exposure, environmental compliance costs, and restrictions on subsidiary distributions to LSB.
  • Other notable items: a $2.3 million vendor-litigation settlement gain was recognized in 2012; management expected a one-time approximately $0.45 million tax benefit in the first quarter of 2013. LSB reported no common-stock cash dividends in 2012 and did not anticipate near-term common dividends. The independent auditor issued an unqualified opinion and reported effective internal control over financial reporting.

Important facts for investors to verify

  1. Actual repair, restart and production milestones at Pryor, Cherokee and El Dorado, and whether the estimated $83 million downtime impact or ongoing losses change.
  2. Insurance claim settlements, cash receipts, reservation-of-rights issues and the recoverability of recorded receivables or additional claimed amounts.
  3. Final costs, timing, permits and financing for the nitric acid replacement project and any decision to proceed with the proposed ammonia plant.
  4. Status and potential cost of the EPA settlement, Oklahoma Pryor investigation, wastewater and groundwater matters, and Hallowell remediation.
  5. Compliance with loan covenants, access to revolver availability, ability to finance planned investment, and the $56.3 million term-loan balloon payment due in 2016.
  6. Whether fertilizer demand and Climate Control market recovery materialize, and how customer concentration, commodity prices and facility reliability affect margins and cash generation.