lxu-10q_20180331.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                  to                 

Commission file number 1-7677

 

LSB Industries, Inc.

(Exact name of Registrant as specified in its charter)

 

 

Delaware

 

73-1015226

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

16 South Pennsylvania Avenue, Oklahoma City, Oklahoma

 

73107

(Address of principal executive offices)

 

(Zip Code)

 

(405)  235-4546

(Registrant's telephone number, including area code)

 

None

(Former name, former address and former fiscal year, if changed since last report.)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

  Yes      No

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).

  Yes      No

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

 

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

  Yes      No

The number of shares outstanding of the Registrant's common stock was 28,613,895 shares as of April 20, 2018.

 

 

 

 

 

 


FORM 10-Q OF LSB INDUSTRIES, INC.

TABLE OF CONTENTS

 

 

 

PART I – Financial Information

 

Page

 

 

 

 

 

Item 1.

 

Financial Statements

 

3

 

 

 

 

 

Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

24

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

35

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

35

 

 

 

 

 

 

 

PART II – Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

40

 

 

 

 

 

Item 1A.

 

Risk Factors

 

40

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

40

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

40

 

 

 

 

 

Item 4.

 

Mining Safety Disclosures

 

40

 

 

 

 

 

Item 5.

 

Other Information

 

40

 

 

 

 

 

Item 6.

 

Exhibits

 

40

 

 

2


PART I

FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Information at March 31, 2018 is unaudited)

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands)

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

28,667

 

 

$

33,619

 

Accounts receivable, net

 

 

62,634

 

 

 

59,570

 

Inventories:

 

 

 

 

 

 

 

 

Finished goods

 

 

19,532

 

 

 

20,415

 

Raw materials

 

 

1,362

 

 

 

1,441

 

Total inventories

 

 

20,894

 

 

 

21,856

 

Supplies, prepaid items and other:

 

 

 

 

 

 

 

 

Prepaid insurance

 

 

7,813

 

 

 

10,535

 

Precious metals

 

 

7,269

 

 

 

7,411

 

Supplies

 

 

28,649

 

 

 

27,729

 

Prepaid and refundable income taxes

 

 

856

 

 

 

1,736

 

Other

 

 

2,043

 

 

 

1,284

 

Total supplies, prepaid items and other

 

 

46,630

 

 

 

48,695

 

Total current assets

 

 

158,825

 

 

 

163,740

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

998,366

 

 

 

1,014,038

 

 

 

 

 

 

 

 

 

 

Intangible and other assets, net

 

 

10,958

 

 

 

11,404

 

 

 

 

 

 

 

 

 

 

 

 

$

1,168,149

 

 

$

1,189,182

 

 

(Continued on following page)

3


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)

(Information at March 31, 2018 is unaudited)

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands)

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

49,047

 

 

$

55,992

 

Short-term financing

 

 

6,137

 

 

 

8,585

 

Accrued and other liabilities

 

 

30,590

 

 

 

35,573

 

Current portion of long-term debt

 

 

9,065

 

 

 

9,146

 

Total current liabilities

 

 

94,839

 

 

 

109,296

 

 

 

 

 

 

 

 

 

 

Long-term debt, net

 

 

399,416

 

 

 

400,253

 

 

 

 

 

 

 

 

 

 

Noncurrent accrued and other liabilities

 

 

11,173

 

 

 

11,691

 

 

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

53,877

 

 

 

54,787

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Redeemable preferred stocks:

 

 

 

 

 

 

 

 

Series E 14% cumulative, redeemable Class C preferred stock, no par value,

   210,000 shares issued; 139,768 outstanding; aggregate liquidation preference

   of $191,569,000 ($185,231,000 at December 31, 2017)

 

 

182,896

 

 

 

174,959

 

Series F redeemable Class C preferred stock, no par value, 1 share issued and

   outstanding; aggregate liquidation preference of $100

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 

 

Series B 12% cumulative, convertible preferred stock, $100 par value; 20,000 shares

   issued and outstanding

 

 

2,000

 

 

 

2,000

 

Series D 6% cumulative, convertible Class C preferred stock, no par value;

   1,000,000 shares issued and outstanding

 

 

1,000

 

 

 

1,000

 

Common stock, $.10 par value; 75,000,000 shares authorized, 31,280,685

   shares issued

 

 

3,128

 

 

 

3,128

 

Capital in excess of par value

 

 

195,289

 

 

 

193,956

 

Retained earnings

 

 

242,686

 

 

 

256,214

 

 

 

 

444,103

 

 

 

456,298

 

Less treasury stock, at cost:

 

 

 

 

 

 

 

 

Common stock, 2,666,790 shares (2,662,027 shares at December 31, 2017)

 

 

18,155

 

 

 

18,102

 

Total stockholders' equity

 

 

425,948

 

 

 

438,196

 

 

 

$

1,168,149

 

 

$

1,189,182

 

 

See accompanying notes.

4


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands, Except Per Share Amounts)

 

Net sales

 

$

100,450

 

 

$

123,344

 

Cost of sales

 

 

90,357

 

 

 

111,729

 

Gross profit

 

 

10,093

 

 

 

11,615

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expense

 

 

8,303

 

 

 

10,545

 

Other income, net

 

 

(94

)

 

 

(1,251

)

Operating income

 

 

1,884

 

 

 

2,321

 

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

9,306

 

 

 

9,358

 

Non-operating other expense (income), net

 

 

(909

)

 

 

231

 

Loss before benefit for income taxes

 

 

(6,513

)

 

 

(7,268

)

Benefit for income taxes

 

 

(922

)

 

 

(1,282

)

Net loss

 

 

(5,591

)

 

 

(5,986

)

 

 

 

 

 

 

 

 

 

Dividends on convertible preferred stocks

 

 

75

 

 

 

75

 

Dividends on Series E redeemable preferred stock

 

 

6,338

 

 

 

5,536

 

Accretion of Series E redeemable preferred stock

 

 

1,599

 

 

 

1,599

 

Net loss attributable to common stockholders

 

$

(13,603

)

 

$

(13,196

)

 

 

 

 

 

 

 

 

 

Basic and dilutive net loss per common share:

 

$

(0.49

)

 

$

(0.48

)

 

See accompanying notes.

5


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(Unaudited)

 

 

 

Common

Stock Shares

 

 

Treasury

Stock-Common Shares

 

 

Non-Redeemable

Preferred Stock

 

 

Common Stock

Par Value

 

 

Capital in Excess of Par Value

 

 

Retained

Earnings

 

 

Treasury

Stock-Common

 

 

Total

 

 

 

(In Thousands)

 

Balance at December 31, 2017

 

 

31,281

 

 

 

(2,662

)

 

$

3,000

 

 

$

3,128

 

 

$

193,956

 

 

$

256,214

 

 

$

(18,102

)

 

$

438,196

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,591

)

 

 

 

 

 

 

(5,591

)

Dividend accrued on redeemable

   preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(6,338

)

 

 

 

 

 

 

(6,338

)

Accretion of redeemable preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,599

)

 

 

 

 

 

 

(1,599

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,382

 

 

 

 

 

 

 

 

 

 

 

1,382

 

Other

 

 

 

 

 

 

(5

)

 

 

 

 

 

 

 

 

 

 

(49

)

 

 

 

 

 

 

(53

)

 

 

(102

)

Balance at March 31, 2018

 

 

31,281

 

 

 

(2,667

)

 

$

3,000

 

 

$

3,128

 

 

$

195,289

 

 

$

242,686

 

 

$

(18,155

)

 

$

425,948

 

 

See accompanying notes.

6


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands)

 

Cash flows from continuing operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(5,591

)

 

$

(5,986

)

Adjustments to reconcile net loss to net cash provided by continuing

   operating activities:

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

(910

)

 

 

(1,242

)

Depreciation, depletion and amortization of property, plant and equipment

 

 

17,736

 

 

 

17,115

 

Amortization of intangible and other assets

 

 

602

 

 

 

463

 

Other

 

 

627

 

 

 

(790

)

Cash provided (used) by changes in assets and liabilities (net of effects of

   discontinued operations):

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(7,443

)

 

 

(7,276

)

Inventories

 

 

1,650

 

 

 

4,857

 

Prepaid insurance

 

 

2,722

 

 

 

3,026

 

Prepaid and accrued income taxes

 

 

880

 

 

 

115

 

Accounts payable

 

 

(431

)

 

 

6,895

 

Accrued interest

 

 

(7,959

)

 

 

(7,979

)

Other assets and other liabilities

 

 

(666

)

 

 

(1,411

)

Net cash provided by continuing operating activities

 

 

1,217

 

 

 

7,787

 

 

 

 

 

 

 

 

 

 

Cash flows from continuing investing activities

 

 

 

 

 

 

 

 

Expenditures for property, plant and equipment

 

 

(6,247

)

 

 

(13,894

)

Proceeds from property insurance recovery associated with

   property, plant and equipment

 

 

1,531

 

 

 

 

Net proceeds from sale of discontinued operations

 

 

2,730

 

 

 

 

Other investing activities

 

 

95

 

 

 

502

 

Net cash used by continuing investing activities

 

 

(1,891

)

 

 

(13,392

)

 

 

 

 

 

 

 

 

 

Cash flows from continuing financing activities

 

 

 

 

 

 

 

 

Payments on other long-term debt

 

 

(1,647

)

 

 

(4,225

)

Payments of debt issuance costs

 

 

 

 

 

(90

)

Payments on short-term financing

 

 

(2,447

)

 

 

(3,717

)

Taxes paid on equity awards

 

 

(184

)

 

 

(66

)

Net cash used by continuing financing activities

 

 

(4,278

)

 

 

(8,098

)

Cash flows of discontinued operations:

 

 

 

 

 

 

 

 

Net cash used by operating activities

 

 

 

 

 

(1,212

)

Net cash used by financing activities

 

 

 

 

 

(65

)

Net cash used by discontinued operations

 

 

 

 

 

(1,277

)

Net decrease in cash and cash equivalents

 

 

(4,952

)

 

 

(14,980

)

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

33,619

 

 

 

60,017

 

Cash and cash equivalents at end of period

 

$

28,667

 

 

$

45,037

 

 

See accompanying notes.

 

7


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

 

Note 1: Summary of Significant Accounting Policies

For a complete discussion of our significant accounting policies, refer to the notes to our audited consolidated financial statements included in our Form 10-K for the year ended December 31, 2017 (“2017 Form 10-K”), filed with the Securities and Exchange Commission (“SEC”) on February 26, 2018.

Basis of Consolidation LSB Industries, Inc. (“LSB”) and its subsidiaries (the “Company”, “We”, “Us”, or “Our”) are consolidated in the accompanying condensed consolidated financial statements.  LSB is a holding company with no significant operations or assets other than cash, cash equivalents, and investments in its subsidiaries.  All material intercompany accounts and transactions have been eliminated.  Certain prior period amounts reported in our condensed consolidated financial statements and notes thereto have been reclassified to conform to current period presentation.

Nature of Business – We are engaged in the manufacture and sale of chemical products.  The chemical products we primarily manufacture, market and sell are ammonia, fertilizer grade ammonium nitrate (“HDAN”), urea ammonium nitrate (“UAN”), and ammonium nitrate (“AN”) solution for agricultural applications, high purity and commercial grade ammonia, high purity AN, sulfuric acids, concentrated, blended and regular nitric acid, mixed nitrating acids, carbon dioxide, and diesel exhaust fluid for industrial applications, and industrial grade AN (“LDAN”) and solutions for the mining industry.  We manufacture and distribute our products in four facilities; three of which we own and are located in El Dorado, Arkansas (the “El Dorado Facility”); Cherokee, Alabama (the “Cherokee Facility”); and Pryor, Oklahoma (the “Pryor Facility”); and one of which we operate on behalf of a global chemical company in Baytown, Texas (the “Baytown Facility”).  

Sales to customers include farmers, ranchers, fertilizer dealers and distributors primarily in the ranch land and grain production markets in the United States (“U.S.”); industrial users of acids throughout the U.S. and parts of Canada; and explosive manufacturers in the U.S.

Other products consisted of natural gas sales from our working interests in certain natural gas properties of our former subsidiary Zena Energy L.L.C. (“Zena”) and sales of industrial machinery and related components which were sold during the second and fourth quarters of 2017, respectively.  

During July 2016, LSB completed the sale of all of the stock of Climate Control Group Inc. (an indirect subsidiary that conducted LSB’s Climate Control Business) pursuant to the terms of a stock purchase agreement.  During the first quarter of 2018, we received the remaining proceeds held in a related indemnity escrow account of $2.7 million.

In our opinion, the unaudited condensed consolidated financial statements of the Company as of March 31, 2018 and for the three-month periods ended March 31, 2018 and 2017 include all adjustments and accruals, consisting of normal, recurring accrual adjustments, which are necessary for a fair presentation of the results for the interim periods.  These interim results are not necessarily indicative of results for a full year due, in part, to the seasonality of our sales of agricultural products and the timing of performing our major plant maintenance activities.  Our selling seasons for agricultural products are primarily during the spring and fall planting seasons, which typically extend from March through June and from September through November.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the SEC.  These condensed consolidated financial statements should be read in connection with our audited consolidated financial statements and notes thereto included in our 2017 Form 10-K.

Use of Estimates The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Income Taxes – We recognize deferred tax assets and liabilities for the expected future tax consequences attributable to net operating loss (“NOL”) carryforwards, tax credit carryforwards, and the differences, if any, between the financial statement carrying amounts and the tax basis of our assets and liabilities.  We establish valuation allowances if we believe it is more likely than not that some or all of deferred tax assets will not be realized.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period date of enactment.

8


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 1: Summary of Significant Accounting Policies (continued)

In addition, we do not recognize a tax benefit unless we conclude that it is more likely than not that the benefit will be sustained on audit by the relevant taxing authorities based solely on the technical merits of the associated tax position.  If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is greater than 50% likely to be realized.  We record interest related to unrecognized tax positions in interest expense and penalties in operating other expense.

Income tax benefits associated with amounts that are deductible for income tax purposes are recorded through the statement of operations.  These benefits are principally generated from exercises of non-qualified stock options and restricted stock. We reduce income tax expense for investment tax credits in the period the credit arises and is earned.

See Note 9 – Income Taxes discussing the Tax Cuts and Jobs Act of 2017 and Staff Accounting Bulletin No. 118 ("SAB 118") issued by the SEC.

Redeemable Preferred Stocks Our redeemable preferred stocks that are redeemable outside of our control are classified as temporary/mezzanine equity.  The redeemable preferred stocks were recorded at fair value upon issuance, net of issuance costs or discounts.  In addition, certain embedded features included in the Series E Redeemable Preferred required bifurcation and are classified as derivative liabilities.  The carrying values of the redeemable preferred stocks are being increased by periodic accretions (including the amount for dividends earned but not yet declared or paid) using the interest method so that the carrying amount will equal the redemption value as of August 2, 2019, the earliest possible redemption date by the holder, under the existing agreement.  The amount of accretion was recorded to retained earnings.

However, it is reasonably possible this accretion could change if the expected redemption date changes. See Note 13 – Subsequent Events.

Recently Adopted Accounting Pronouncements

ASU 2014-09 – In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which superseded nearly all existing revenue recognition guidance under GAAP.  In addition, the FASB issued various ASUs further amending revenue recognition guidance, which includes ASU 2016-08, 2016-10, 2016-11, 2016-12 and 2016-20.  The core principle of these ASUs (together “ASC 606”) is to allow for an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In addition, sales and other similar taxes we collect concurrently with revenue-producing activities are excluded from revenue.  Also, we have elected to recognize the cost for freight and shipping when control of the product has transferred to the customer as an expense in cost of sales.

On January 1, 2018, we adopted ASC 606 as discussed in Note 2-Adoption of ASC 606.

ASU 2016-15 – In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.  This ASU made eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows.  On January 1, 2018, we adopted ASU 2016-15 on a retrospective basis.  The adoption of this ASU did not affect the presentation or classification of cash flow activities for the three months ended March 31, 2017.

ASU 2016-18 – In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, a consensus of the FASB Emerging Issues Task Force.  The amendments in this ASU revise the guidance in Topic 230, Statement of Cash Flows, to require cash and cash equivalents to include restricted cash (and restricted cash equivalents) on the statement of cash flows.  On January 1, 2018, we adopted ASU 2016-18 on retrospective basis.  The adoption of this ASU did not affect the presentation of cash flow activities for the three months ended March 31, 2017.

ASU 2018-05 – See Note 9 – Income Taxes.

Recently Issued Accounting Pronouncements

ASU 2016-02 – In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which supersedes the lease requirements in Topic 840, Leases.  The objective of this ASU is to establish the principles that lessees and lessors shall apply to report information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease.  Extensive quantitative and qualitative disclosures, including significant judgments made by management, will be required to provide greater insight into the extent of revenue and expense recognized and expected to be recognized from existing contracts.  As of March 31, 2018, this ASU must be adopted using a modified retrospective transition; however, the FASB has proposed an additional transition method option. Under the modified retrospective transition method, we are required to apply the new guidance at the beginning of the earliest comparative period presented (including recognizing a cumulative-effect adjustment as of January 1, 2017).  Under the proposed additional transition method, we have the option to apply the new guidance (including recognizing a cumulative-effect adjustment) on

9


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 1: Summary of Significant Accounting Policies (continued)

January 1, 2019, the date we plan to adopt this ASU. Consequently, under this proposed optional method, our reporting for the comparative periods presented in the financial statements issued after the date of adoption would continue to be in accordance with current GAAP, including disclosures.  This ASU and ASU 2018-01 also provide for certain practical expedients that we are currently evaluating for possible election.  

Although we currently have a relatively small number of leases (most are currently classified as operating leases under which we are the lessee), we have obtained and continue to obtain information relating to our leases and other right-to-use arrangements for the purpose of evaluating the effect of this guidance on our consolidated financial statements and related disclosures.  We currently expect most of the effect of this guidance on our consolidated financial statements to impact our balance sheet presentation (increase the amount of our assets for the inclusion of right-of-use assets and increase the amount of our liabilities for the inclusion of the associated lease obligations).  For 2017, expenses associated with our operating lease agreements, including month-to-month leases, were $9.8 million.  As of December 31, 2017, our future minimum payments on operating lease agreements with initial or remaining terms of one year or more totaled $21.2 million.

Note 2: Adoption of ASC 606

On January 1, 2018, we adopted ASC 606 using the “modified retrospective” adoption method, meaning the standard is applied only to the most current period presented in the financial statements.  Furthermore, we elected to apply the standard only to those contracts which were not completed as of the date of the adoption. Results for reporting periods beginning on the date of adoption are presented under ASC 606, while prior period amounts have not been adjusted and continue to be reported in accordance with our historical accounting methodology pursuant to ASC 605, Revenue Recognition (“ASC 605”).

Upon adoption, a cumulative effect adjustment was not required; however, the primary impact of adopting the new standard relates to the reduction in net sales, cost of sales and SG&A resulting from the elimination of certain sales revenue involving products we do not control under ASC 606, including products (we do not control) associated with marketing services we are performing as an agent for our customers. The nature of these arrangements allows for other parties to maintain control of these products throughout the production process.

The following line items in our condensed consolidated statement of operations for the current reporting period have been provided to reflect both the adoption of ASC 606 as well as a comparative presentation in accordance with ASC 605 previously in affect:

 

 

 

Three Months Ended March 31, 2018

 

 

 

 

 

 

 

Balance without

 

 

Effect of Change

 

 

 

As Reported

 

 

adoption of 606

 

 

Higher/(Lower)

 

 

 

(In Thousands)

 

Net sales

 

$

100,450

 

 

$

116,550

 

 

$

(16,100

)

Cost of sales

 

 

90,357

 

 

 

106,306

 

 

 

(15,949

)

Gross profit

 

 

10,093

 

 

 

10,244

 

 

 

(151

)

Selling, general and administrative expense

 

 

8,303

 

 

 

8,454

 

 

 

(151

)

Operating income

 

 

1,884

 

 

 

1,884

 

 

 

 

 

Except for the change in accounting policies for revenue recognition as a result of adopting ASC 606, there have been no changes to our significant accounting policies as described in the 2017 Form 10-K that had a material impact on our condensed consolidated financial statements and related notes.

As mentioned in Note 1, we primarily derive our revenues from the sales of various chemical products.  The following table presents our net sales disaggregated by revenue source:

10


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 2: Adoption of ASC 606 (continued)

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017(a)

 

 

 

(Dollars In Thousands)

 

Net sales:

 

 

 

 

 

 

 

 

Agricultural products

 

$

52,269

 

 

$

63,263

 

Industrial acids and other chemical products

 

 

38,137

 

 

 

48,880

 

Mining products

 

 

10,044

 

 

 

7,616

 

Other products

 

 

 

 

 

3,585

 

Total net sales

 

$

100,450

 

 

$

123,344

 

 

a)

As noted above, prior period amounts have not been adjusted under the modified retrospective method.

Revenue Recognition and Performance Obligations

We determine revenue recognition through the following steps:

 

Identification of the performance obligations in the contract;

 

Determination of the transaction price;

 

Allocation of the transaction price to the performance obligations in the contract; and

 

Recognition of revenue when, or as, we satisfy a performance obligation.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in ASC 606.  A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied.  Generally, satisfaction occurs when control of the promised goods is transferred to the customer or as services are rendered or completed in exchange for consideration in an amount for which we expect to be entitled.  Generally, control is transferred when the preparation for shipment of the product to a customer has been completed.  Most of our contracts contain a single performance obligation with the promise to transfer a specific product.  When the terms of a contract include the transfer of multiple products, each distinct product is identified as a separate performance obligation.  

Most of our revenue is recognized from performance obligations satisfied at a point in time, however, we have a performance obligation to perform certain services that are satisfied over a period of time.  Revenue is recognized from this type of performance obligation as services are rendered and are based on the amount for which we have a right to invoice, which reflects the amount of expected consideration that corresponds directly with the value of the services performed.  

We only offer assurance-type warranties for our products to meet specifications defined by our contracts with customers, and do not have any material performance obligations related to warranties, return, or refunds.  

 

Transaction Price Constraints and Variable Consideration

For most of our contracts within the scope of ASC 606, the transaction price from the inception of a contract is constrained to a short period of time (generally one month) as these contracts contain terms with variable consideration related to both price and quantity.  These contract prices are often based on commodity indexes (such as NYMEX) published monthly and the contract quantities are typically based on estimated ranges.  The quantities become fixed and determinable over a period of time as each sale order is received from the customer.  

The nature of our contracts also gives rise to other types of variable consideration, including volume discounts and rebates, make-whole provisions, other pricing concessions, and short-fall charges. We estimate these amounts based on the expected amount to be provided to customers, which result in a transaction price adjustment reducing revenue (net sales) with the offset increasing contract or refund liabilities. These estimates are based on historical experience, anticipated performance and our best judgment at the time.  We reassess these estimates on a quarterly basis.

The aforementioned constraints over transaction prices in conjunction with the variable consideration included in our material contracts prevent a practical assignment of a specific dollar amount to performance obligations at the beginning and end of the period.  Therefore, we have applied the variable consideration allocation exception.

11


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 2: Adoption of ASC 606 (continued)

Future revenues to be earned from the satisfaction of performance obligations will be recognized when control transfers as goods are loaded and weighed or services are performed over the remaining duration of our contracts.  Although most of our contracts have an original expected duration of one year or less, for our contracts with a duration greater than one year, the average remaining expected duration was approximately 17 months at March 31, 2018.

Contract Assets and Liabilities

Our contract assets consist of receivables from contracts with customers. Our net accounts receivable primarily relate to these contract assets and are presented in our condensed consolidated balance sheets. Customer payments are generally due thirty to sixty days after the invoice date.

Our contract liabilities primarily relate to deferred revenue and customer deposits associated with cash payments received in advance from customers for volume shortfall charges and product shipments.  These contract liabilities are presented in Note - 5 Current and Noncurrent Accrued and Other Liabilities. For the three months ended March 31, 2018, revenues of $1.9 million was recognized and included in the balance at the beginning of the period.

Practical Expedients and Other Information

We elected the transitional practical expedient for all contract modifications, such that all modifications prior to our adoption date for uncompleted contracts would be evaluated in the aggregate for any potential impact to our financial statements.

We elected the practical expedient to recognize revenue in the amount we have the right to invoice relating to certain services that are performed for customers and, as a result we do not have to disclose the value of unsatisfied performance obligations.  

We elected the practical expedient by which disclosures are not required regarding the value of unsatisfied performance obligations for contracts with an original expected duration of one year or less.   

We elected the practical expedient exempting the requirement to adjust the promised amount of consideration for the effects of a significant financing component if we expect the financing time period to be one year or less.

Revenue recognized in the current period from performance obligations related to prior periods (for example, due to changes in transaction price) was not material.

Our contract cost assets primarily relate to the portion of incentive compensation earned by certain employees that are considered incremental and recoverable costs of obtaining a contract with a customer, which costs are not material. We have elected the practical expedient to expense as incurred any incremental costs of obtaining a contract if the associated period of benefit is one year or less.

 

12


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 3: Loss Per Common Share

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

 

 

2017

 

 

 

(Dollars In Thousands, Except Per Share Amounts)

 

Numerator:

 

 

 

 

 

 

 

 

Net loss

 

$

(5,591

)

 

$

(5,986

)

Adjustments for basic net loss per common share:

 

 

 

 

 

 

 

 

Dividend requirements on Series E Redeemable

   Preferred

 

 

(6,338

)

 

 

(5,536

)

Dividend requirements on Series B Preferred

 

 

(60

)

 

 

(60

)

Dividend requirements on Series D Preferred

 

 

(15

)

 

 

(15

)

Accretion of Series E Redeemable Preferred

 

 

(1,599

)

 

 

(1,599

)

Numerator for basic and dilutive net loss per common

   share - net loss attributable to common stockholders

 

$

(13,603

)

 

$

(13,196

)

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

Denominator for basic and dilutive net loss per common

   share - adjusted weighted-average shares (1)

 

 

27,518,782

 

 

 

27,248,059

 

 

 

 

 

 

 

 

 

 

Basic and dilutive net loss per common share:

 

$

(0.49

)

 

$

(0.48

)

 

 

 

 

 

 

 

 

 

 

(1)

Excludes the weighted-average shares of unvested restricted stock that are contingently returnable.

The following weighted-average shares of securities were not included in the computation of diluted net loss per common share as their effect would have been antidilutive:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2018

 

 

2017

 

Restricted stock and stock units

 

 

1,195,315

 

 

 

1,117,426

 

Convertible preferred stocks

 

 

916,666

 

 

 

916,666

 

Series E Redeemable Preferred - embedded derivative

 

 

303,646

 

 

 

303,646

 

Stock options

 

 

196,121

 

 

 

219,011

 

 

 

 

2,611,748

 

 

 

2,556,749

 

 

Note 4: Inventories

At March 31, 2018 and December 31, 2017, because costs exceeded the net realizable value, inventory adjustments were $246,000 and $933,000, respectively.

13


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 5: Current and Noncurrent Accrued and Other Liabilities

 

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands)

 

Deferred revenue

 

$

6,630

 

 

$

6,987

 

Accrued interest

 

 

5,465

 

 

 

13,424

 

Accrued payroll and benefits

 

 

4,026

 

 

 

4,855

 

Accrued death and other executive benefits

 

 

2,795

 

 

 

2,808

 

Customer deposits

 

 

2,017

 

 

 

1,334

 

Series E Redeemable Preferred - embedded derivative

 

 

1,861

 

 

 

2,660

 

Accrued health and worker compensation insurance claims

 

 

1,507

 

 

 

1,658

 

Other

 

 

17,462

 

 

 

13,538

 

 

 

 

41,763

 

 

 

47,264

 

Less noncurrent portion

 

 

11,173

 

 

 

11,691

 

Current portion of accrued and other liabilities

 

$

30,590

 

 

$

35,573

 

 

Note 6: Long-Term Debt

Our long-term debt consists of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(In Thousands)

 

Working Capital Revolver Loan, with a current interest

   rate of 5.25% (A)

 

$

 

 

$

 

Senior Secured Notes due 2019 (B)

 

 

375,000

 

 

 

375,000

 

Secured Promissory Note due 2019, with a current interest

   rate of 5.73% (C)

 

 

7,917

 

 

 

8,167

 

Secured Promissory Note due 2021, with a current interest

   rate of 5.25% (D)

 

 

10,483

 

 

 

11,262

 

Secured Promissory Note due 2023, with a current interest

   rate of 5.92% (E)

 

 

16,170

 

 

 

16,665

 

Other, with a current weighted-average interest rate of

   4.50%, most of which is secured primarily by machinery

   and equipment

 

 

2,871

 

 

 

2,994

 

Unamortized discount and debt issuance costs

 

 

(3,960

)

 

 

(4,689

)

 

 

 

408,481

 

 

 

409,399

 

Less current portion of long-term debt, net

 

 

9,065

 

 

 

9,146

 

Long-term debt due after one year, net

 

$

399,416

 

 

$

400,253

 

 

(A) Our revolving credit facility (the “Working Capital Revolver Loan”) provides for advances up to $50 million (but provides an ability to expand the commitment an additional $25 million), based on specific percentages of eligible accounts receivable and inventories and up to $10 million of letters of credit, the outstanding amount of which reduces the available for borrowing under the Working Capital Revolver Loan. At March 31, 2018, our available borrowings under our Working Capital Revolver Loan were approximately $46.3 million, based on our eligible collateral, less outstanding letters of credit. The maturity date of the Working Capital Revolver Loan is January 17, 2022.   The Working Capital Revolver Loan also provides for a springing financial covenant (the “Financial Covenant”), which requires that, if the borrowing availability is less than or equal to the greater of 10.0% of the total revolver commitments and $5 million, then the borrowers must maintain a minimum fixed charge coverage ratio of not less than 1.00 to 1.00.  The Financial Covenant, if triggered, is tested monthly.

14


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 6: Long-Term Debt (continued)

(B) The Senior Secured Notes mature on August 1, 2019.  Interest is to be paid semiannually on February 1st and August 1st, based on an annual interest rate of 8.5%.  Also see Note 13 – Subsequent Events.

(C) El Dorado Chemical Company (“EDC”), one of our subsidiaries, is party to a secured promissory note due June 29, 2019. Principal and interest are payable in equal monthly installments with a final balloon payment of approximately $6.7 million.

(D) EDC is party to a secured promissory note due March 26, 2021. Principal and interest are payable in monthly installments.

(E) El Dorado Ammonia L.L.C. (“EDA”), one of our subsidiaries, is party to a secured promissory note due in May 2023. Principal and interest are payable in equal monthly installments with a final balloon payment of approximately $6.1 million. This promissory note bears interest at a rate that is based on the monthly LIBOR rate plus a base rate.

 

Note 7: Commitments and Contingencies

Natural Gas Purchase CommitmentsAt March 31, 2018, our natural gas contracts, which qualify as normal purchases under GAAP and thus are not mark-to-market, included volume purchase commitments with fixed prices of approximately 2.0 million MMBtus of natural gas.  These contracts extend through June 2018 at a weighted-average cost of $2.15 per MMBtu ($4.3 million) and a weighted-average market value of $2.06 per MMBtu ($4.1 million).

Legal Matters - Following is a summary of certain legal matters involving the Company:

A. Environmental Matters

Our facilities and operations are subject to numerous federal, state and local environmental laws and to other laws regarding health and safety matters (collectively, the “Environmental and Health Laws”), many of which provide for certain performance obligations, substantial fines and criminal sanctions for violations.  Certain Environmental and Health Laws impose strict liability as well as joint and several liability for costs required to remediate and restore sites where hazardous substances, hydrocarbons or solid wastes have been stored or released.  We may be required to remediate contaminated properties currently or formerly owned or operated by us or facilities of third parties that received waste generated by our operations regardless of whether such contamination resulted from the conduct of others or from consequences of our own actions that were in compliance with all applicable laws at the time those actions were taken.  In connection with certain acquisitions, we could acquire, or be required to provide indemnification against, environmental liabilities that could expose us to material losses.  In certain instances, citizen groups also have the ability to bring legal proceedings against us if we are not in compliance with environmental laws, or to challenge our ability to receive environmental permits that we need to operate.  In addition, claims for damages to persons or property, including natural resources, may result from the environmental, health and safety effects of our operations.

There can be no assurance that we will not incur material costs or liabilities in complying with such laws or in paying fines or penalties for violation of such laws.  Our insurance may not cover all environmental risks and costs or may not provide sufficient coverage if an environmental claim is made against us.  The Environmental and Health Laws and related enforcement policies have in the past resulted, and could in the future result, in significant compliance expenses, cleanup costs (for our sites or third-party sites where our wastes were disposed of), penalties or other liabilities relating to the handling, manufacture, use, emission, discharge or disposal of hazardous or toxic materials at or from our facilities or the use or disposal of certain of its chemical products.  Further, a number of our facilities are dependent on environmental permits to operate, the loss or modification of which could have a material adverse effect on their operations and our financial condition.

Historically, significant capital expenditures have been incurred by our subsidiaries in order to comply with the Environmental and Health Laws, and significant capital expenditures are expected to be incurred in the future.  We will also be obligated to manage certain discharge water outlets and monitor groundwater contaminants at our facilities should we discontinue the operations of a facility.  We did not operate the natural gas wells where we previously owned a working interest and compliance with Environmental and Health Laws was controlled by others.  We were responsible for our working interest proportionate share of the costs involved.  

As of March 31, 2018, our accrued liabilities for environmental matters totaled $156,000 relating primarily to the matters discussed below.  

15


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 7: Commitments and Contingencies (continued)

1. Discharge Water Matters

Each of our manufacturing facilities generates process wastewater, which may include cooling tower and boiler water quality control streams, contact storm water and miscellaneous spills and leaks from process equipment.  The process water discharge, storm-water runoff and miscellaneous spills and leaks are governed by various permits generally issued by the respective state environmental agencies as authorized and overseen by the U.S. Environmental Protection Agency (the “EPA”).  These permits limit the type and amount of effluents that can be discharged and control the method of such discharge.

Our Pryor Facility is authorized by permit to inject wastewater into an on-site underground injection well through 2018.  The Oklahoma Department of Environmental Quality (“ODEQ”) has indicated that the permit may not be renewed following its expiration, and the Pryor Chemical Company (“PCC”) may have to find an alternative means of waste water disposal after the permit expires.  PCC has engaged in ongoing discussions with the ODEQ regarding future disposal of this wastewater stream.

Our El Dorado Facility is subject to a National Pollutant Discharge Elimination System (“NPDES”) permit issued by the Arkansas Department of Environmental Quality (“ADEQ”) in 2004.  In 2010, the ADEQ issued a draft NPDES permit renewal for the El Dorado Facility, which contains more restrictive discharge limits than the previous 2004 permit.

These more restrictive limits could impose additional costs on the El Dorado Facility and may require the facility to make operational changes in order to meet these more restrictive limits.  From time to time, the El Dorado Facility has had difficulty meeting the more restrictive dissolved minerals NPDES permit levels, primarily related to storm-water runoff and EDC is currently working with ADEQ to resolve this issue through a new permit, which is currently in progress.

We do not believe this matter regarding meeting the permit requirements as to the dissolved minerals is a continuing issue for the process wastewater as a result of the El Dorado Facility disposing its wastewater (beginning in September 2013) via a pipeline constructed by the City of El Dorado, Arkansas.  On August 30, 2017, ADEQ issued a final NPDES permit, which included new dissolved mineral limits as anticipated.  However, EDC objected to the form of the permit specifically around the limits of storm-water runoff and filed an appeal on September 27, 2017.  The appeal places an automatic stay on the objectionable conditions and EDC is working with the ADEQ to obtain modifications to the renewed permit terms.  We believe that the issue with the storm-water runoff should be resolved, if and when the appeal is resolved.

During 2012, EDC paid a penalty of $100,000 to settle an administrative complaint issued by the EPA, and thereafter handled by the U.S. Department of Justice (“DOJ”), relating to certain alleged violations of EDC’s 2004 NPDES permit from 2004 through 2010.  At the time of settlement, the DOJ advised that an additional action may be brought for alleged permit violations occurring after 2010.  As of the date of this report, no action has been filed by the DOJ against EDC.  As a result, the cost (or range of costs) cannot currently be reasonably estimated regarding this matter.  Therefore, no liability has been established for potential future penalties as of March 31, 2018.

In November 2006, the El Dorado Facility entered into a Consent Administrative Order (the “CAO”) that recognizes the presence of nitrate contamination in the shallow groundwater.  The CAO requires EDC to perform semi-annual groundwater monitoring, continue operation of a groundwater recovery system, submit a human health and ecological risk assessment, and submit a remedial action plan.  The risk assessment was submitted in August 2007.  In February 2015, the ADEQ stated that El Dorado Chemical was meeting the requirements of the CAO and should continue semi-annual monitoring.  The ADEQ’s review of the EDC proposed remedy is ongoing.  Under the CAO, the ADEQ may require additional wells be added to the program or may allow EDC to remove wells from the program.  The final remedy for shallow groundwater contamination, should any remediation be required, would be selected pursuant to a new consent administrative order and based upon the risk assessment.  The cost of any additional remediation that may be required would be determined based on the results of the investigation and risk assessment, of which cost (or range of costs) cannot currently be reasonably estimated.  Therefore, no liability has been established at March 31, 2018, in connection with this matter.

2. Other Environmental Matters

In 2002, certain of our subsidiaries sold substantially all of their operating assets relating to a Kansas chemical facility (the “Hallowell Facility”) but retained ownership of the real property where the facility is located.  Our subsidiary retained the obligation to be responsible for, and perform the activities under, a previously executed consent order to investigate the surface and subsurface contamination at the real property and develop a corrective action strategy based on the investigation.  In addition, certain of our subsidiaries agreed to indemnify the buyer of such assets for these environmental matters.

16


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 7: Commitments and Contingencies (continued)

As the successor to a prior owner of the Hallowell Facility, Chevron Environmental Management Company (“Chevron”) has agreed in writing, within certain limitations, to pay and has been paying one-half of the costs of the investigation and interim measures relating to this matter as approved by the Kansas Department of Health and Environment (the “KDHE”), subject to reallocation.

Our subsidiary and Chevron have retained an environmental consultant to prepare and perform a corrective action study work plan as to the appropriate method to remediate the Hallowell Facility.  The proposed strategy includes long-term surface and groundwater monitoring to track the natural decline in contamination.  The KDHE is currently evaluating the corrective action strategy, and, thus, it is unknown what additional work the KDHE may require, if any, at this time.  We are advised by our consultant that until the study is completed there is not sufficient information to develop a meaningful and reliable estimate (or range of estimate) as to the cost of the remediation.  

We accrued our allocable portion of costs primarily for the additional testing, monitoring and risk assessments that could be reasonably estimated, which is included in our accrued liabilities for environmental matters discussed above.  The estimated amount is not discounted to its present value.  As more information becomes available, our estimated accrual will be refined.

B. Other Pending, Threatened or Settled Litigation

In April 2013, an explosion and fire occurred at the West Fertilizer Co. (“West Fertilizer”) located in West, Texas, causing death, bodily injury and substantial property damage.  West Fertilizer is not owned or controlled by us, but West Fertilizer was a customer of EDC, and purchased AN from EDC from time to time.  LSB and EDC received letters from counsel purporting to represent subrogated insurance carriers, personal injury claimants and persons who suffered property damages informing LSB and EDC that their clients are conducting investigations into the cause of the explosion and fire to determine, among other things, whether AN manufactured by EDC and supplied to West Fertilizer was stored at West Fertilizer at the time of the explosion and, if so, whether such AN may have been one of the contributing factors of the explosion.  Initial lawsuits filed named West Fertilizer and another supplier of AN as defendants.

In 2014, EDC and LSB were named as defendants, together with other AN manufacturers and brokers that arranged the transport and delivery of AN to West Fertilizer, in the case styled City of West, Texas vs. CF Industries, Inc., et al., in the District Court of McLennan County, Texas.  The plaintiffs allege, among other things, that LSB and EDC were negligent in the production and marketing of fertilizer products sold to West Fertilizer, resulting in death, personal injury and property damage.  EDC retained a firm specializing in cause and origin investigations with particular experience with fertilizer facilities, to assist EDC in its own investigation.  LSB and EDC placed its liability insurance carrier on notice, and the carrier is handling the defense for LSB and EDC concerning this matter.  Our product liability insurance policies have aggregate limits of general liability totaling $100 million, with a self-insured retention of $250,000, which retention limit has been met relating to this matter.  In August 2015, the trial court dismissed plaintiff’s negligence claims against us and EDC based on a duty to inspect but allowed the plaintiffs to proceed on claims for design defect and failure to warn.

Subsequently, we and EDC have entered into confidential settlement agreements (with approval of our insurance carriers) with several plaintiffs that had claimed wrongful death and bodily injury and insurance companies asserting subrogation claims for damages from the explosion.  A portion of these settlements have been paid by the insurer as of March 31, 2018.  While these settlements resolve the claims of a number of the claimants in this matter for us, we continue to be party to litigation related to this explosion by other plaintiffs, in addition to indemnification or defense obligations we may have to other defendants.  We intend to continue to defend these lawsuits vigorously and we are unable to estimate a possible range of loss at this time if there is an adverse outcome in this matter as to EDC.  As of March 31, 2018, no liability reserve has been established in connection with this matter, except for the unpaid portion of the settlement agreements that are covered by insurance as discussed above.

In May 2015, our subsidiary, EDC, was sued in the matter styled BAE Systems Ordinance Systems, Inc. (“BAE”), et al. vs. El Dorado Chemical Company, in the United States District Court, Western District of Arkansas, for an alleged breach of a supply agreement to provide BAE certain products.  In March 2018, the Court granted our motion for summary judgment and dismissed BAE’s claims against the Company.

In September 2015, a case styled Dennis Wilson vs. LSB Industries, Inc., et al., was filed in the United States District Court for the Southern District of New York.  The plaintiff purports to represent a class of our shareholders and asserts that we violated federal securities laws by allegedly making material misstatements and omissions about delays and cost overruns at our El Dorado Chemical Company manufacturing facility and about our financial well-being and prospects.  The lawsuit, which also names certain current and former officers, seeks an unspecified amount of damages.  Given the uncertainty of litigation, the preliminary stage of the case, and the legal standards that must be met for, among other things, class certification and success on the merits, we cannot estimate the reasonably possible loss or range of loss that may result from this action.

17


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 7: Commitments and Contingencies (continued)

In September 2015, we and EDA received formal written notice from Global Industrial, Inc. (“Global”) of Global’s intention to assert mechanic liens for labor, service, or materials furnished under certain subcontract agreements for the improvement of the new ammonia plant at our El Dorado Facility.  Global is a subcontractor of Leidos Constructors, LLC (“Leidos”), the general contractor for EDA for the construction for the ammonia plant.  Leidos terminated the services of Global with respect to their work performed at our El Dorado Facility in July 2015 and Global claims it is entitled to payment for certain work prior to its termination in the sum of approximately $18 million.  Leidos reports that it made an estimated $6 million payment to Global on or about September 11, 2015, and EDA paid Leidos approximately $3.5 million relating to work performed by subcontractors of Global.  Leidos has not approved certain payments to Global pending the result of on-going audits and investigation undertaken to quantify the financial impact of Global’s work.  

EDA intends to monitor the Leidos audit, and conduct its own investigation, in an effort to determine whether any additional payment should be released to Global for any work not in dispute.  LSB and EDA intend to pursue recovery of any damage or loss caused by Global’s work performed at our El Dorado Facility.  In January 2016, El Dorado, Leidos and Global reached an agreement whereby the approximately $3.6 million claims of Leidos’ remaining unpaid subcontracts, vendors and suppliers will be paid (and these suppliers and subcontractors will in turn issue releases of their respective claims and liens).  In addition, Global will reduce the value of its claim as against Leidos, and its lien amount as against the project by a similar amount.  After all such lower tier supplier and subcontractors are satisfied, the Global claim and lien amount will be reduced to approximately $5 million.  In March 2016, EDC and we were served a summons in a case styled Global Industrial, Inc. d/b/a Global Turnaround vs. Leidos Constructors, LLC et al., where in Global seeks damages under breach of contract and other claims.  We have requested indemnifications from Leidos under the terms of our contracts and we intend to vigorously defend against the allegation made by Global.  No liability has been established in connection with the remaining $5 million claim.  In addition, LSB and EDA intend to pursue recovery of any damage or loss caused by Global’s work performed at our El Dorado Facility.

We are also involved in various other claims and legal actions.  It is possible that the actual future development of claims could be different from our estimates but, after consultation with legal counsel, we believe that changes in our estimates will not have a material effect on our business, financial condition, results of operations or cash flows.

Note 8: Derivatives, Hedges, Financial Instruments and Carbon Credits

For the periods presented, the following significant instruments are accounted for on a fair value basis:

Carbon Credits and Associated Contractual Obligation

Periodically, we are issued climate reserve tonnes (“carbon credits”) by the Climate Action Reserve in relation to a greenhouse gas reduction project (“Project”) performed at the Baytown Facility. Pursuant to the terms of the agreement with Covestro, a certain portion of the carbon credits are to be sold and the proceeds given to Covestro to recover the costs of the Project, and any balance thereafter to be allocated between Covestro and EDN.  We have no obligation to reimburse Covestro for their costs associated with the Project, except through the transfer or sale of the carbon credits when such credits are issued to us.  The assets for carbon credits are accounted for on a fair value basis and the contractual obligations associated with these carbon credits are also accounted for on a fair value basis (unless we enter into a sales commitment to sell the carbon credits).  At March 31, 2018 we had approximately 227,000 carbon credits (none at December 31, 2017), all of which were subject to contractual obligations.

Embedded Derivative

Certain embedded features (“embedded derivative”) relating to the redemption of the Series E Redeemable Preferred, which includes certain contingent redemption features and the participation rights value have been bifurcated from the Series E Redeemable Preferred and recorded as a liability.  As the result of the Indenture Amendments in connection with the previously reported redemption of a portion of our Senior Secured Notes and the redemption of the portion of Series E Redeemable Preferred, we estimate that the contingent redemption feature has no fair value at March 31, 2018 based on low probability that the remaining shares of Series E Redeemable Preferred would be redeemed prior to August 2, 2019.  At March 31, 2018 and December 31, 2017, the fair value of the participation rights was based on the equivalent of 303,646 shares of our common stock at $6.13 and $8.76 per share, respectively.

The following is a summary of the classifications of valuations of fair value:

Level 1 - The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts.  At March 31, 2018 and December 31, 2017, we did not have any contracts classified as Level 1.

18


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 8: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

Level 2 - The valuations of contracts classified as Level 2 are based on quoted prices for similar contracts and valuation inputs other than quoted prices that are observable for these contracts.  At March 31, 2018 and December 31, 2017, we did not have any significant contracts classified as Level 2.

Level 3 - The valuations of assets and liabilities classified as Level 3 are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement.  At March 31, 2018, the valuation ($2.35 per carbon credit) of the carbon credits and the contractual obligations associated with these carbon credits is classified as Level 3 and is based on the most recent sales transaction and reevaluated for market changes, if any, and on the range of ask/bid prices obtained from a broker adjusted for minimal market volume activity.  At December 31, 2017, we did not have any carbon credits or related contractual obligations associated with carbon credits.  The valuation is using undiscounted cash flows based on management’s assumption that the carbon credits would be sold, and the associated contractual obligations would be extinguished in the near term.  At March 31, 2018 and December 31, 2017, the valuations of the embedded derivative are classified as Level 3.  

This derivative is valued using market information, management’s redemption assumptions, the underlying number of shares as defined in the terms of the Series E Redeemable Preferred, and the market price of our common stock. In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the embedded derivative.

 

The following details our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2018 and December 31, 2017:

 

 

 

 

 

 

 

Fair Value Measurements at

March 31, 2018 Using

 

 

 

 

 

Description

 

Total Fair

Value at

March 31,

2018

 

 

Quoted Prices

in Active

Markets for

Identical

Contracts

(Level 1)

 

 

Significant

Other

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

 

Total Fair

Value at

December 31,

2017

 

 

 

(In Thousands)

 

Assets - Supplies, prepaid items and other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carbon credits

 

$

534

 

 

$

 

 

$

 

 

$

534

 

 

$

 

Total

 

$

534

 

 

$

 

 

$

 

 

$

534

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities - Current and noncurrent accrued and

   other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations - carbon credits

 

$

(534

)

 

$

 

 

$

 

 

$

(534

)

 

$

 

Embedded derivative

 

 

(1,861

)

 

 

 

 

 

 

 

 

(1,861

)

 

 

(2,660

)

Total

 

$

(2,395

)

 

$

 

 

$

 

 

$

(2,395

)

 

$

(2,660

)

 

19


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 8: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

 

None of our liabilities measured at fair value on a recurring basis transferred between Level 1 and Level 2 classifications for the periods presented below.  The following is a reconciliation of the beginning and ending balances for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

 

 

 

Assets

 

 

Liabilities

 

 

 

Three Months Ended

 

 

Three Months Ended

 

 

 

March 31,

 

 

March 31,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017