LSB Industries, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. Unaudited results are presented in continuing operations unless stated otherwise. LSB manufactures nitrogen-based chemicals for agricultural, industrial and mining markets. The Climate Control Business was classified as discontinued operations and its sale to NIBE closed July 1, 2016, after the reporting date.
Financial performance and liquidity
USD amounts in millions, except per-share data.
- Q2 continuing operations: Net sales were $110.0, down 12.4% from $125.5 a year earlier. Gross profit fell to $2.1 from $12.6, a 1.9% gross margin versus 10.1%. Operating loss was $8.9 versus $1.6; continuing-operations loss was $7.7 versus $2.9. Continuing-operations loss per common share was $0.70 versus $0.13.
- Q2 total results: Net income was $15.1, or $0.20 per common share, versus $0.4, or $0.02 per share. Discontinued operations contributed $22.8, including a $17.8 tax benefit; therefore, total net income did not reflect profitable continuing operations.
- First half continuing operations: Sales were $209.0, down 19.4% from $259.1. Gross loss was $4.0 versus gross profit of $33.4; operating loss was $26.2 versus operating income of $8.2. Continuing-operations loss was $23.5 versus income of $1.4. Common-stockholder loss was $19.5, or $0.82 per share, versus income of $6.8, or $0.30 per share.
- Cash flow and investment: First-half cash provided by continuing operating activities was $24.2 versus $28.7. Continuing investing activities used $169.0, primarily for capital expenditures; cash capital expenditures were $170.1 versus $157.0. Cash declined to $22.8 at June 30 from $127.2 at December 31, 2015.
- Debt and liquidity: Debt, net of discounts and issuance costs, was $559.6 at June 30, including $30.9 drawn on the revolver, compared with $520.4 at year-end. The $425.0 of 7.75% senior secured notes and $50.0 of 12% senior secured notes mature in 2019. The revolver balance was repaid with sale proceeds on July 1; afterward, reported available revolver borrowing was approximately $38.0, subject to eligible collateral and letters of credit. The company reported a 1.4-to-1 fixed-charge coverage ratio at June 30; a 1.10-to-1 minimum applies if availability falls to the specified threshold.
- Preferred stock and equity: Series E redeemable preferred stock had a $196.7 carrying value and $227.3 aggregate liquidation preference at June 30. It carries a 14% annual cumulative dividend; approximately $17.3 of dividends had accumulated but had not been declared. Stockholders’ equity was $405.1, down from $421.6 at year-end.
Material changes and drivers
- Lower fertilizer prices outweighed higher agricultural volumes: Q2 average selling prices fell 28% for UAN, 39% for HDAN and 28% for ammonia year over year. UAN and HDAN volumes increased 36% and 43%, respectively. Management cited lower grain-related prices, expected industry capacity additions and high grain stocks.
- Industrial sales were affected by lower prices and a planned Baytown turnaround. Mining demand remained pressured by declining U.S. coal production; first-half mining sales also reflected expiration of the Orica agreement in April 2015.
- El Dorado’s new ammonia plant reached nameplate capacity of 1,150 tons per day during Q2 and began operating at that level on June 22. The facility’s Q2 operating loss was approximately $14.2, including $3.8 of startup and commissioning costs and $6.1 of higher depreciation versus Q2 2015. The final expansion cost was estimated at $835–$840.
- First-half gross profit was also affected by a one-time $12.1 cost for consulting services associated with reducing the assessed property-tax value of the El Dorado projects. Lower feedstock costs and higher sales volumes partly offset these pressures.
- Interest expense rose to $6.4 in Q2 from $2.2, partly because more capital projects entered service and less interest was capitalized. Q2 non-operating other income included a $4.0 unrealized gain from the Series E embedded derivative.
- The Climate Control Business sale was for approximately $364, subject to customary adjustments. The company said it intended to use part of the net proceeds to repay debt, redeem preferred stock, or both, but had not chosen an allocation. It expected a material discontinued-operations gain in Q3; the amount was not yet finalized. Management expected net operating losses and depreciation deductions to offset substantially all taxable gain, resulting in no material cash taxes.
Outlook, risks and contingencies
- Management said cash, revolver availability, operating cash flow and sale proceeds were expected to fund anticipated liquidity needs for the next 12 months, and forecast compliance with debt covenants over that period. This is management’s expectation, not a guarantee.
- Planned second-half 2016 capital expenditures were $30–$35; ongoing chemical-facility capital projects were expected to be $40–$50 annually beginning in 2017. A Cherokee turnaround was underway in Q3, expected to last about 25 days and cost $5–$5.5; a Pryor turnaround was also expected to last about 25 days and cost $2–$2.5.
- Management’s priorities included strengthening the capital structure, improving plant reliability, broadening HDAN distribution and reducing costs. No specific earnings guidance was provided. Results are seasonal and depend on agricultural demand, weather, fertilizer prices, natural gas costs, plant performance and industry capacity.
- Environmental exposure includes wastewater permitting and groundwater matters. The Pryor wastewater-injection permit runs through 2018 and may not be renewed; the company said alternatives were under discussion. Certain environmental and remediation costs could not be reasonably estimated.
- Litigation includes claims relating to the West, Texas fertilizer explosion; LSB reported no reserve for that matter and could not estimate a loss range. BAE asserted a pre-litigation demand of approximately $18 for an alleged supply-contract breach; no liability was recorded. A remaining Global Industrial claim and lien was approximately $5, with no liability recorded. A shareholder securities class action also remained pending, with loss not estimable.
- Other risks include volatile commodity prices, coal-market weakness, unplanned outages, increased depreciation and fixed charges, environmental and chemical-safety regulation, and the company’s substantial debt and preferred-stock obligations. Management reported disclosure controls were effective as of June 30, 2016.
Important facts for investors to verify
- Final Climate Control sale price adjustments, escrow amounts, transaction costs and realized gain, along with the actual tax and cash proceeds.
- How sale proceeds are ultimately allocated between debt repayment and redemption of the high-cost Series E preferred stock, and the resulting leverage and fixed charges.
- Whether the El Dorado ammonia plant sustains nameplate production and whether operating costs, margins and reliability improve after startup.
- Actual fertilizer pricing, volumes and margins; natural gas costs; coal-related mining demand; and performance through seasonal selling periods.
- Progress on the planned turnarounds and capital program, and any changes to liquidity, revolver availability or covenant compliance.
- Developments and potential financial effects of environmental matters and pending litigation, for which several loss estimates were not available.