LSB INDUSTRIES, INC. annual report, FY2015

LSB Industries, Inc. — FY2015 Form 10-K

Reporting period: Year ended December 31, 2015; quarterly figures below are for the three months ended December 31, 2015. LSB is a diversified manufacturer with two main businesses: nitrogen-based chemicals and HVAC products.

Financial performance and liquidity

Metric	FY2015	FY2014
Net sales	$711.8 million	$761.2 million
Gross profit / gross margin	$103.7 million / 14.6%	$147.9 million / 19.4%
Operating income (loss)	$(50.8) million	$53.4 million
Net income (loss)	$(34.8) million	$19.6 million
Net loss attributable to common stockholders / diluted EPS	$(38.0) million / $(1.67)	$19.3 million / $0.83
Cash from continuing operations	$31.6 million	$66.7 million
Cash used in continuing investing activities	$(354.0) million	$(12.0) million
Cash from continuing financing activities	$263.1 million	$(11.5) million

FY2015 Chemical Business sales fell 11.5% to $428.1 million; operating results swung to a $41.8 million loss from $51.3 million income. Climate Control sales rose 3.3% to $274.1 million, while operating income declined 8.2% to $19.9 million.
Q4 2015 sales were $157.0 million and gross profit was $19.1 million. Continuing-operations loss was $8.0 million; net loss attributable to common stockholders was $11.0 million, or $0.48 per share. Q4 included a $3.5 million noncash impairment charge.
At year-end, cash and cash equivalents were $127.3 million; current assets were $332.7 million and current liabilities $191.9 million, for working capital of about $140.8 million. The $100 million revolving facility had no borrowings and approximately $64.4 million of borrowing availability, subject to eligible collateral and letters of credit.
Long-term debt, including current maturities and net of discount and issuance costs, was $520.4 million, versus $450.9 million a year earlier. This included $425 million of 7.75% secured notes and $50 million of 12% secured notes, both due in 2019. The company also issued $210 million of 14% Series E redeemable preferred stock in December; its year-end carrying value was $177.3 million and reported liquidation preference was $212.3 million.
Capital expenditures were substantial: cash PP&E spending was $439.8 million, and reported additions to PP&E were $470.5 million. Total assets rose to $1.36 billion from $1.13 billion, principally reflecting construction in progress.

Material changes and unusual items

Revenue declined $49.5 million year over year, primarily because Chemical Business sales fell $55.5 million; Climate Control growth partly offset the decline. Consolidated operating results deteriorated by $104.1 million.
Chemicals were affected by weaker fertilizer prices and weather-disrupted fall application, lower mining demand, expiration of the Orica take-or-pay AN agreement in April 2015, and Pryor plant downtime. Pryor downtime and repairs reduced 2015 operating results by an estimated $19 million.
FY2015 included $43.2 million of noncash impairments: $39.7 million on Marcellus Shale natural-gas interests and $3.5 million on unused Pryor ammonia equipment. The gas-property impairment reflected lower forward prices, regional price differentials, and changed drilling plans.
FY2014 included $28.0 million of Cherokee insurance recoveries, including business-interruption and property recoveries; FY2015 had none. Management states that, excluding specified impairments and insurance recoveries, Chemical operating results still weakened year over year.
Net interest expense was $7.4 million in 2015, compared with $21.6 million in 2014, because more interest was capitalized during construction ($30.6 million versus $14.1 million). Interest expense is expected to rise as projects enter service and capitalized interest declines.
The 2015 loss included a $23.6 million income-tax benefit. The filing reports a 40% effective tax rate and notes an ownership change that subjects use of tax losses and credits to an estimated annual limitation of $3.7 million.

Outlook, risks, and contingencies

The El Dorado expansion was estimated at $831 million to $855 million, including capitalized interest, up materially from the earlier $485 million to $520 million estimate. About $705 million had been spent by year-end, with $126 million to $150 million expected in 2016. The ammonia plant was mechanically complete in February 2016 and management expected production to begin early in Q2 2016, with full production targeted in the second half.
Management believed year-end financing and other liquidity sources would fund anticipated needs through completion, and forecast compliance with revolver covenants for the next 12 months. The filing also identifies potential financing shortfalls, covenant constraints, debt service, and possible preferred-stock redemption in 2019 as significant liquidity risks. Preferred dividends accrue at 14% and compound if unpaid.
Management expected stronger 2016 spring fertilizer movement, supported by forecast corn acreage and the prior fall’s weather-disrupted application season, but noted high inventories, import competition, and price pressure. U.S. nitrogen capacity additions could pressure prices when projects begin production, expected around early 2018.
Climate Control management expected medium- and long-term opportunity in commercial and institutional markets. The filing cites forecast market growth, but notes that low energy prices weaken the economics of higher-cost geothermal systems and that related tax credits were scheduled to expire at the end of 2016.
Management and the Board said they would continue reviewing strategic alternatives, including asset sales or separation of the two businesses; after the ammonia plant becomes operational, they intended to explore refinancing the capital structure.
Major risks include chemical-plant outages, commodity and feedstock price volatility, weather and agricultural cycles, declining coal demand, customer concentration (seven Chemical customers represented about 52% of Chemical sales), and environmental, health, and safety regulation.
Contingencies include continuing litigation relating to the West, Texas fertilizer-plant explosion; the company could not estimate a possible loss range. A separate supply-agreement suit by BAE alleged approximately $18 million in damages, with no liability accrued because the amount could not be reasonably estimated. Environmental matters and a subcontractor claim relating to El Dorado construction also remain relevant; the reported remaining Global claim was approximately $5 million, with no liability established for that amount.
The company reported effective disclosure controls and effective internal control over financial reporting; the auditor issued unqualified opinions on the financial statements and internal controls. ERP implementation was ongoing, with completion expected in 2017.

Important facts for investors to verify

Whether the El Dorado ammonia plant reached production on schedule, and whether final project cost stayed within the $831 million to $855 million estimate.
Whether the expansion generates expected cost savings, capacity utilization, sales volumes, and cash flow, including the contracted LDAN volumes and ammonia purchases by Koch Fertilizer.
Actual liquidity, revolver availability, covenant headroom, and funding needs after completion spending and the 2016 secured note repayment.
Terms and accumulated obligations of Series E preferred stock, including dividends, redemption rights, and any dilution from warrants or potential common-stock issuance.
Resolution and potential financial exposure from the West, Texas litigation, BAE dispute, environmental matters, and El Dorado contractor claims.
Whether Chemical margins recover despite fertilizer inventory and pricing pressure, mining-market weakness, and scheduled plant turnarounds.