LSB Industries, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011; unaudited. LSB manufactures climate-control equipment and nitrogen-based chemical products. The Chemical Business represented about 65% of first-half sales and Climate Control about 34%.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $235.6m | $168.4m | $413.1m | $298.8m |
| Gross profit | $72.1m | $35.1m | $125.9m | $63.4m |
| Operating income | $48.3m | $12.8m | $82.3m | $17.2m |
| Net income | $28.6m | $6.0m | $49.5m | $7.7m |
| Diluted EPS | $1.22 | $0.27 | $2.12 | $0.35 |
- Consolidated gross margin was approximately 30.6% in Q2 versus 20.9% a year earlier, and approximately 30.5% for the first half versus 21.2%.
- First-half cash from continuing operations was $41.2m, compared with $12.5m. Cash increased $49.1m during the period to $116.0m. Investing activities used $5.4m, including $14.6m of capital expenditures; financing activities provided $13.4m.
- At June 30, cash was $116.0m, with an undrawn $50m revolving facility and approximately $49.2m available. Total debt was $86.8m, versus $95.4m at year-end 2010; stockholders’ equity was $255.6m, versus $179.4m. The term loan rose to $74.1m following amendments and additional borrowing.
Changes and operating drivers
- Q2 sales rose 40% year over year. Chemical sales increased 46%, with higher volumes and prices across agricultural, industrial and mining products; Climate Control sales increased 29%, led by commercial/institutional demand and hydronic fan coils.
- Chemical operating income rose to $42.7m in Q2 from $9.2m; Climate Control operating income increased to $9.2m from $7.0m. First-half segment operating income was $71.8m for Chemical and $17.6m for Climate Control.
- Improved Chemical results reflected the Pryor Facility’s return to sustained production, stronger fertilizer demand and pricing, and production efficiencies. First-half comparisons also benefited from the Pryor facility’s limited production in 2010.
- Climate Control commercial/institutional sales improved, while residential demand remained weak. Q2 product orders were $64.3m, down from $71.7m a year earlier; backlog was $49.9m at June 30, compared with $48.2m a year earlier.
Outlook, risks and unusual items
- No formal earnings guidance was provided. Management expected modest construction-sector improvement but described the recovery as uneven; it also expected continued industrial and mining demand and generally favorable fertilizer-market fundamentals, subject to economic, weather and commodity-price risks.
- Pryor experienced unplanned ammonia and nitric-acid plant outages in Q2, reducing operating income by an estimated $4.0m. The ammonia plant returned to service in June, but the nitric-acid plant’s restart was deferred until after the July turnaround; management reported startup delays and an engineering evaluation underway. Planned production rates remained targets, not assured outcomes.
- Management estimated $6m–$7m of Chemical Business turnaround costs for the remainder of 2011, including $4.5m–$5.5m in Q3, excluding lost production and margin effects. Committed remaining-2011 capital expenditures were about $17.2m, with an additional $19.4m planned, subject to approval and conditions.
- Reported first-half results included an $8.6m business-interruption insurance recovery recorded as a reduction of cost of sales, related to the 2010 Pryor fire; the company said no related claim remained at June 30. Other notable items included $2.6m of precious-metals recoveries and a $363,000 cost related to settlement of affiliate litigation.
- Environmental exposure includes a $124,000 EPA penalty accrued for past wastewater-permit violations; potential Clean Air Act retrofit costs and penalties remain unquantified. A wastewater pipeline project is expected to cost EDC about $4m, with construction planned for completion in 2013. Environmental compliance expenses were $2.4m in the first half; management estimated another $2m–$3m for the rest of 2011.
- Debt covenants were met at June 30. The term loan matures in 2016 and includes a $56.3m balloon payment; the revolver matures in April 2012, and management intended to negotiate renewal. The two facilities have cross-default provisions and restrict transfers to LSB.
- Other risks include seasonal agricultural demand, raw-material price volatility, receivable collection, production reliability, environmental regulation and possible changes in customer demand. The filing also describes related-party real-estate dealings with Landmark, reviewed by a board special committee, and continuing litigation and environmental matters.
Investor verification priorities
- Verify how much of earnings and margin improvement is sustainable absent the $8.6m insurance recovery, precious-metals recoveries, and unusually strong fertilizer pricing and Pryor production.
- Track Pryor’s restart, production rates, turnaround costs and any further unplanned downtime or lost-sales effects.
- Monitor cash conversion and receivables: first-half operating cash flow included a $27.5m use from higher accounts receivable.
- Assess planned capital spending, environmental obligations and the potential cost of Clean Air Act compliance, which the filing says cannot yet be estimated.
- Review revolver renewal progress, covenant headroom, restricted subsidiary cash flows and the 2016 term-loan balloon.
- Examine Climate Control order trends and backlog, agricultural-season exposure, and the related-party Landmark transaction and associated put-option terms.