LSB Industries, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; interim financial statements are unaudited. LSB operates Climate Control (HVAC) and Chemical businesses. Chemical represented about 64% of nine-month sales and Climate Control about 34%.
Financial performance and liquidity
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $182.4m | $176.8m | $581.9m | $589.9m |
| Gross profit | $33.2m | $34.3m | $143.4m | $160.2m |
| Gross margin | 18.2% | 19.4% | 24.6% | 27.2% |
| Operating income | $11.9m | $12.5m | $77.3m | $94.8m |
| Net income | $6.7m | $6.3m | $47.0m | $55.9m |
| Diluted EPS | $0.28 | $0.27 | $2.00 | $2.39 |
- Q3 sales rose 3.2%, while operating income fell 4.8%; net income increased 6.4%. Nine-month sales declined 1.4%, operating income 18.5%, and net income 15.8%.
- Nine-month operating cash flow was $73.4m, versus $52.5m in 2011. Investing used $52.0m, including $61.6m of capital expenditures; financing used $12.4m. Cash increased $8.8m to $133.8m.
- At September 30, cash was $133.8m, current assets $348.7m, and current liabilities $109.0m. Short-term investments were nil, versus $10.0m at year-end 2011. Working capital was approximately $239.7m.
- Total debt was $73.6m, down from $79.5m at December 31, 2011. The $50m revolver was undrawn, with about $48.4m available subject to eligible collateral and letters of credit. Stockholders’ equity was $342.2m.
- The amended revolver matures March 2016, with a conditional extension option. The secured term loan carries a 3.96% weighted-average rate and has a $56.3m balloon due March 2016. Borrowers were reported in covenant compliance; term-loan fixed-charge coverage was 1.50x and leverage 0.77x.
Material changes and operating drivers
- Q3 Chemical sales increased 7.2% to $110.2m and operating income rose 6.0% to $7.5m. Higher agricultural, industrial and mining sales dollars reflected pricing and product mix, but production interruptions constrained volumes. Chemical nine-month operating income fell 15.1% to $67.0m, with gross profit down $11.0m.
- Q3 Climate Control sales declined 5.3% to $68.0m and operating income declined 21.5% to $6.9m, mainly from weaker residential geothermal heat-pump sales, lower volume and mix/absorption effects. Nine-month sales fell 6.7% and operating income 24.1%.
- Management attributed the nine-month Chemical gross-profit decline principally to about $21m of costs from planned and unplanned Pryor and El Dorado downtime, and the absence of an $8.6m business-interruption insurance recovery recorded in 2011.
- Capital expenditures were $61.6m for the first nine months, versus $31.1m in 2011. Management listed total committed and planned capital expenditures of $270m–$295m, including replacement nitric-acid facilities and other Chemical projects.
Outlook, risks, contingencies and unusual items
- Facility disruptions: Pryor’s ammonia production was about 50% of target in Q3; management estimated at least $14m of Q3 operating-income impact and about $38m cumulatively for the first nine months. Production had stabilized at roughly 80% of target in Q4 as of the filing, and a replacement ammonia converter was planned for early 2013. The Pryor urea plant had been down from late February to early July.
- El Dorado’s May 2012 reactor explosion damaged its DSN nitric-acid plant and other infrastructure. Management estimated about $9m of Q3 and $16m cumulative nine-month operating-income impact. Replacement nitric-acid facilities were expected to be completed by mid-2015; estimated repair cost for the damaged DSN plant was $50m–$70m, subject to ongoing engineering review. The sulfuric-acid plant was expected to restart by year-end 2012.
- Insurance carriers approved a $20m property-damage payment for El Dorado; the receivable was outstanding at September 30 and the filing says it was received in October. Business-interruption recoveries had not been recognized. Pryor’s insurance claim remained subject to a reservation-of-rights letter, and recovery was uncertain.
- Management expected low-to-moderate near-term Climate Control sales growth. It cited softer residential and commercial markets, but expected positive fertilizer supply/demand fundamentals into 2013. These expectations are subject to economic, market, weather, commodity-price and operating risks; no formal earnings guidance was provided.
- On October 31, 2012, after quarter-end, the Chemical business acquired natural-gas working interests for about $49m, funded with cash; the company was considering financing up to $35m. The acquisition is intended as a partial hedge against future gas-price increases. Its properties are operated by others, and the filing highlights price, reserve-estimation, drilling, regulatory and development risks.
- Management was considering, but had not approved, a potential El Dorado ammonia plant costing an estimated $250m–$300m and requiring 24–36 months; it was excluded from the capital-expenditure schedule. EPA/DOJ negotiations over Clean Air Act compliance could require significant pollution-control capital spending; a $0.1m potential-penalty accrual was recorded.
- Other disclosed exposures include environmental and wastewater matters, an ODEQ investigation at Pryor with no liability recorded, and possible additional El Dorado discharge-water remediation for which costs were not estimable. The Jayhawk lawsuit was resolved in LSB’s favor, with no appeal planned. A $24,000 accrual remained for alleged later NPDES violations.
- The company reported no material change in internal control over financial reporting and concluded disclosure controls were effective.
Investor verification priorities
- Confirm subsequent insurance receipts, final property-damage assessments, business-interruption claims and the scope of coverage or exclusions.
- Track Pryor converter replacement and production recovery, Cherokee’s return to full production, and El Dorado plant repairs/replacement timelines and costs.
- Reconcile the $49m post-quarter gas-property acquisition and any financing with subsequent cash, debt and capital-spending disclosures; assess reserve estimates and operator/development risks.
- Monitor actual committed capital spending, potential EPA-required controls, environmental liabilities, and whether the proposed ammonia plant advances.
- Review covenant compliance, borrowing-base availability and liquidity after the acquisition and major repair/replacement spending.