LSB Industries, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. LSB manufactures HVAC products through its Climate Control business and nitrogen-based chemicals through its Chemical business. The interim results are unaudited; agricultural sales and major plant maintenance are seasonal.
Financial performance
Unless otherwise noted, amounts are in millions of dollars. Comparative changes are versus the corresponding 2011 period.
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $209.3 | $235.6 | $399.5 | $413.1 |
| Gross profit | $65.7 | $72.1 | $110.2 | $125.9 |
| Operating income | $42.3 | $48.3 | $65.4 | $82.3 |
| Net income | $26.0 | $28.6 | $40.3 | $49.5 |
| Diluted EPS | $1.11 | $1.22 | $1.72 | $2.12 |
| Gross margin | 31.4% | 30.6% | 27.6% | 30.5% |
| Operating margin | 20.2% | 20.5% | 16.4% | 19.9% |
- Q2 sales fell 11.2% and operating income declined 12.3%; six-month sales fell 3.3% and operating income declined 20.5%. Q2 net income was down about 9%, while six-month net income declined about 19%.
- Q2 Climate Control sales were $67.5 million, down 12.5%, and operating income was $7.3 million, down 20.3%. Six-month sales were $130.3 million, down 7.5%, and operating income was $13.2 million, down 25.4%.
- Q2 Chemical sales were $138.1 million, down 11.2%, and operating income was $39.1 million, down 8.4%. Six-month sales were $262.3 million, down 1.8%, and operating income was $59.5 million, down 17.2%. The six-month Chemical gross margin fell to 25.7% from 29.6%.
- Six-month continuing operating cash flow was $56.5 million, versus $41.2 million. Investing activities used $32.9 million, including $32.5 million of capital expenditures; financing activities used $9.8 million. Cash and equivalents increased to $138.7 million from $124.9 million at year-end.
- At June 30, cash, equivalents and short-term investments totaled $148.7 million. Total debt, including current maturities, was $74.8 million, down from $79.5 million at year-end; the company had net cash of approximately $73.9 million on this basis. Current assets were $338.6 million and current liabilities $83.4 million.
Material changes, outlook and risks
- Plant disruptions: Pryor’s urea plant was out of service from late February through June for reactor repairs and resumed limited UAN production in July. Management estimated first-half operating-income impact of about $24 million, including $10 million in Q2. El Dorado’s nitric-acid reactor exploded May 15; management estimated a further $7 million Q2 operating-income impact. The event also damaged other facilities and constrained production.
- Insurance and reconstruction: LSB recorded a $13.5 million insurance-claim receivable for El Dorado property damage and cleanup, but did not recognize business-interruption recoveries. Pryor insurance claims remain unrecognized; the insurer reserved rights and cited possible policy exclusions. The replacement nitric-acid plants are expected to take at least two years and cost more than $100 million; management expects most, if not all, costs to be funded by insurance proceeds. Timing and amount of recoveries are uncertain.
- Operations and demand: Management expected low-to-moderate near-term Climate Control sales growth relative to first-half 2012. July Climate Control orders were approximately $20.8 million and backlog $50.3 million. Management cited softer construction markets, but expected agricultural fertilizer fundamentals to remain favorable; this outlook depends on crop prices, planting, weather, imports and other market factors. Mining demand was affected by high coal supply, lower coal demand and low natural-gas prices.
- Capital and liquidity: Management expected remainder-of-2012 cash needs to include working capital, operations and capital spending, funded primarily from cash on hand and internally generated cash flow, with El Dorado repair and replacement spending expected to rely substantially on insurance. Committed remainder-of-year capital expenditures were $22.6 million, with an additional $31.3 million planned. These estimates and funding assumptions are subject to change.
- Debt: The $50 million revolving facility was amended and extended to March 2016, with approximately $48.6 million available at quarter-end. The $70.3 million secured term loan matures in March 2016 and includes a $56.3 million balloon payment. Borrowers were compliant with term-loan covenants; the company forecast compliance for the rest of 2012. The facilities have cross-default provisions and restrict distributions to LSB.
- Environmental and legal matters: EPA/DOJ discussions concerning Clean Air Act compliance could require pollution-control upgrades at ten nitric-acid plants; costs could be significant and are not yet reliably estimated. A $0.1 million potential-penalty liability was recorded. El Dorado groundwater remediation costs remain unestimable. The Hallowell environmental liability was $0.208 million. The Jayhawk Group seeks up to $12 million plus punitive damages; LSB awaits a court decision and recorded no liability, citing insurance defense coverage subject to reservation of rights.
- Other items: The company recorded no Q2 insurance recovery for business interruption, and prior-year Q2 Chemical results included an $8.6 million insurance recovery, making the comparison less favorable. LSB declared and paid $0.3 million of preferred dividends; it said it did not anticipate common dividends in the near term. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Progress, costs and operating restart timing at Pryor and El Dorado, and the actual production and earnings effects of the outages.
- Insurance coverage decisions, claim collections and business-interruption recoveries, including whether proceeds can fund the more-than-$100-million El Dorado rebuild.
- EPA/DOJ settlement terms, potential pollution-control capital costs and any additional environmental liabilities.
- Availability under the revolver, covenant compliance, cash generation and the ability to address the March 2016 term-loan balloon.
- Climate Control order trends and backlog conversion, along with agricultural, industrial and mining demand and feedstock price movements.
- Resolution of the Jayhawk litigation and the terms and governance implications of the Landmark real-estate transactions and related-party arrangements.