LSB Industries, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Unaudited. LSB manufactures climate-control products and nitrogen-based chemicals.
Financial performance
Amounts below are in millions of dollars except per-share data and percentages.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $176.8 | $138.9 | $589.9 | $437.8 |
| Gross profit | $34.3 | $29.4 | $160.2 | $92.9 |
| Operating income | $12.5 | $8.5 | $94.8 | $25.7 |
| Net income | $6.3 | $3.8 | $55.9 | $11.5 |
| Diluted EPS | $0.27 | $0.17 | $2.39 | $0.52 |
- Nine-month sales increased 34.8%; operating income rose substantially, led by Chemical Business results. Gross margin was approximately 27.2%, versus 21.2% a year earlier. Nine-month net income included an $8.6 million business-interruption insurance recovery recorded as a reduction to cost of sales.
- Q3 sales increased 27.2% year over year, while gross margin declined to approximately 19.4% from 21.2%. Operating income improved, but results were affected by planned plant turnarounds and extended/unplanned downtime at Pryor. Q3 net income was $6.3 million.
- Nine-month revenue by segment: Chemical $369.8 million, up 45.7%; Climate Control $212.6 million, up 19.4%. Chemical operating income was $78.9 million, versus $12.3 million; Climate Control operating income was $26.4 million, versus $22.6 million.
- Continuing operating cash flow was $52.5 million, compared with $22.7 million. Capital expenditures were $31.1 million; continuing investing cash outflow was $22.0 million. Cash and equivalents were $108.0 million at September 30, up from $66.9 million at year-end.
- Current assets were $306.2 million and current liabilities $96.9 million, implying a current ratio of about 3.2. Total debt was $83.3 million, down from $95.4 million at year-end; stockholders’ equity was $264.2 million. The $50 million revolver was undrawn, with approximately $48.6 million available. Net cash exceeded total debt by approximately $24.7 million.
Changes, outlook and commentary
- Chemical performance benefited from higher fertilizer prices and volumes, stronger UAN results, and sustained Pryor production compared with its limited production in 2010. The prior-year comparison also included a $3.9 million property-insurance gain; 2011 included the $8.6 million business-interruption recovery.
- Climate Control sales grew, particularly commercial/institutional products and hydronic fan coils, but Q3 segment operating income declined 13.6% as gross margin pressure, warranty costs and commissions offset higher sales. Management cited weak residential construction and an uncertain, slow recovery; Q3 order backlog was $48.4 million.
- Management reported some softening in demand for certain industrial chemicals and agricultural-grade ammonium nitrate, including drought-related weakness in parts of the El Dorado market. It also reported strong demand for ammonia and UAN and that a significant share of Q4 production capacity for those products was presold. These are management expectations, not a formal earnings forecast.
- Management expected Q4 cash needs to be funded from cash on hand and internally generated cash flow. It planned approximately $11.4 million of committed Q4 capital spending, plus additional planned spending subject to approval. The revolver matures in April 2012; management intended to negotiate renewal.
- Debt covenants were met at quarter-end. The secured term loan was extended to March 2016 and increased to $75 million; it carries a $56.3 million balloon payment at maturity. LSB reported a $15 million payment to the parent during Q2 under permitted distribution provisions, while subsidiary distributions remain restricted by loan covenants.
Risks, contingencies and unusual items
- Potential Clean Air Act compliance requirements at chemical facilities could require substantial, currently unquantifiable capital expenditures and penalties; no liability was recorded. EPA disapproved a state rule change relating to El Dorado wastewater limits; the company appealed. A wastewater pipeline is expected to cost EDC approximately $4.0 million, with completion planned for 2013.
- Other environmental matters include a recorded $124,000 EPA penalty relating to past discharge-permit violations and a $165,000 estimated Hallowell environmental liability. Potential groundwater remediation costs at El Dorado could not be reasonably estimated.
- A Jayhawk Group lawsuit seeking up to $12 million plus punitive damages was tried in September 2011; the company was awaiting the court’s decision. The company reported no liability recorded and stated its insurer was defending the case, subject to a reservation of rights.
- A proposed DHS rule on ammonium-nitrate security, registration and recordkeeping could raise costs or reduce the number of willing distributors; the impact was uncertain.
- Related-party transactions included real-estate purchases from Landmark: $2.25 million for Oklahoma property, completed in June, and a $2.5 million Texas property purchase expected in Q4. The agreements include put options providing a simple 10% annual return, subject to terms; the Texas agreement also includes warrants for Landmark shares.
- Other watch items include commodity price exposure, variable-rate debt and interest-rate swaps with a $2.5 million unrealized loss, seasonal fertilizer sales, plant reliability and turnarounds, and customer/market demand. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the nine-month earnings improvement reflects sustainable Chemical margins and production versus the $8.6 million insurance recovery and other period-specific items.
- Pryor’s operating performance after its extended Q3 turnaround, and the effect of any further downtime or Q4 turnarounds on output, costs and cash flow.
- Whether demand, fertilizer prices, natural gas and purchased-ammonia costs, and drought conditions develop as management anticipated.
- Potential Clean Air Act capital costs or penalties, wastewater compliance costs, and outcomes of the Jayhawk litigation and other environmental matters.
- Renewal of the working-capital revolver before April 2012, continued covenant compliance, and the company’s ability to fund planned capital spending and the secured term-loan balloon.
- Terms, valuation and related-party safeguards for the Landmark property transactions and put options.