LSB INDUSTRIES, INC. quarterly report, Q1 FY2018

LSB Industries, Inc. — Q1 2018 Form 10-Q

Reporting period: Three months ended March 31, 2018; interim financial statements are unaudited. LSB manufactures and sells chemicals for agricultural, industrial and mining markets. Comparisons below are with Q1 2017 unless noted.

Financial results and liquidity

Metric	Q1 2018	Q1 2017
Net sales, as reported	$100.5 million	$123.3 million
Gross profit / margin	$10.1 million / 10.0%	$11.6 million / 9.4%
Operating income	$1.9 million	$2.3 million
Net loss	$5.6 million	$6.0 million
Net loss attributable to common stockholders / diluted loss per share	$13.6 million / $0.49	$13.2 million / $0.48
Net cash from continuing operating activities	$1.2 million	$7.8 million
Cash and cash equivalents at period end	$28.7 million	$33.6 million at Dec. 31, 2017

• Reported sales fell 19%. A significant portion of the decline reflects adoption of ASC 606: Q1 2018 sales would have been $116.6 million under the prior accounting method, a 5.5% decline from Q1 2017. ASC 606 reduced reported sales and cost of sales by $16.1 million and $15.9 million, respectively, without changing operating income.
• Gross margin improved to 10.0% from 9.4%, but gross profit and operating income declined. SG&A fell 21% to $8.3 million.
• Q1 cash flow from operations decreased by $6.6 million year over year, primarily reflecting working-capital use, including increased receivables and lower accrued interest. Investing cash use was $1.9 million, including $6.2 million of PP&E spending, partly offset by insurance proceeds and $2.7 million of escrow proceeds from the prior Climate Control sale. Financing cash use was $4.3 million.
• At March 31, long-term debt, including current maturities and net of discounts and issuance costs, was $408.5 million. The company had $375 million of 8.5% Senior Secured Notes due 2019, no revolver borrowings, and approximately $46.3 million of revolver availability. The springing revolver covenant was not triggered.
• Redeemable Series E preferred stock had a $182.9 million carrying value and approximately $192 million liquidation preference. Its 14% cumulative dividend accrued $6.3 million in the quarter; accumulated dividends were approximately $51.8 million.

Material changes and operating drivers

• Agricultural sales declined 17% to $52.3 million; volume fell 22%. UAN tons sold fell 35% and ammonia tons fell 25%, partly due to shipment timing, weather-related planting delays, transportation shortages and lower on-stream rates. HDAN pricing rose 11%, while UAN pricing declined 7%.
• Industrial acids and other chemical sales declined 22% as reported, but this was primarily affected by ASC 606 net presentation. Excluding the accounting change, industrial sales increased with higher ammonia volume and improved nitric acid and ammonia prices. Mining sales rose 32%, primarily on higher LDAN volume.
• Plant reliability varied: ammonia on-stream rates were 85% at Cherokee, 100% at El Dorado and 91% at Pryor. Management cited Cherokee maintenance and lower rates at Cherokee and Pryor as contributors to lost fixed-cost absorption and repair expense.
• Natural gas averaged $2.79 per MMBtu, versus $3.15 a year earlier. Management said fertilizer pricing improved from late 2017 into Q1 2018 as imports declined and new domestic supply was absorbed. It noted continued market, weather and transportation uncertainty.

Outlook, financing, risks and unusual items

• Management’s 2018 initiatives include plant reliability and safety improvements, broader distribution of AN and nitric acid, margin review and cost control. The company expected its maintenance-management system rollout by the end of Q2 and benefits in the second half of 2018; a Pryor reliability study was also expected in Q2.
• Management expected 2018 ammonia on-stream rates of at least 95% at Cherokee and El Dorado, excluding planned turnaround days, and anticipated improvement at Pryor. A procurement initiative was expected to reduce annualized expense and capital spending by $3 million to $5 million. These are expectations, not guarantees.
• Planned 2018 capital improvements were approximately $35 million, including about $32 million for the remainder of the year. Environmental project expenses were $0.8 million in Q1; management estimated another $2.9 million to $3.3 million for the remainder of 2018. It stated that cash, revolver availability and operating cash flow should cover anticipated liquidity needs for 12 months.
• Subsequent event: On April 25, 2018, LSB issued $400 million of 9.625% Senior Secured Notes due 2023 at 99.509% of face value. It used part of the proceeds to repurchase 2019 notes tendered in the offer and intended to redeem the remaining 2019 notes. The Series E holder’s redemption election date was extended from August 2019 to October 2023; its dividend rate is scheduled to increase in later years. The company was evaluating the accounting effects.
• Key uncertainties include commodity and natural-gas prices, agricultural demand and weather, facility downtime, environmental permits and compliance costs, and litigation. The West Fertilizer explosion litigation remained ongoing; possible loss could not be estimated and no reserve was recorded except for insured unpaid settlements. A remaining Global Industrial claim of approximately $5 million had no liability established. Environmental liabilities accrued were $156,000; some potential remediation and permit-related costs could not be estimated.
• The company estimated that a valuation allowance of approximately $4.1 million for state NOL carryforwards would be recorded during 2018. Its accounting for certain Tax Cuts and Jobs Act effects remained provisional. Management reported disclosure controls were effective as of March 31, 2018.

Important facts for investors to verify

• Reconcile the reported sales decline with the ASC 606 comparable presentation and monitor subsequent-period revenue trends.
• Track plant on-stream performance, turnaround timing, repair costs and whether planned reliability and procurement initiatives deliver expected benefits.
• Review completion and terms of the 2019-note refinancing, remaining redemption, new interest burden and revised Series E preferred terms.
• Monitor cash generation, working capital, capital spending and revolver availability against the company’s liquidity expectations.
• Follow developments in environmental permits and obligations, West Fertilizer and Global Industrial litigation, and the valuation of tax assets and related allowances.