lxu-10q_20170331.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, 2017

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 28,405,103 shares as of April 13, 2017.

 

 

 

 


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

 

34

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

34

 

 

 

 

 

 

 

PART II – Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

39

 

 

 

 

 

Item 1A.

 

Risk Factors

 

39

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

39

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

39

 

 

 

 

 

Item 4.

 

Mining Safety Disclosures

 

39

 

 

 

 

 

Item 5.

 

Other Information

 

39

 

 

 

 

 

Item 6.

 

Exhibits

 

40

 

 

2


PART I

FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Information at March 31, 2017 is unaudited)

 

  

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands)

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

45,037

 

 

$

60,017

 

Accounts receivable, net

 

 

75,284

 

 

 

51,299

 

Inventories:

 

 

 

 

 

 

 

 

Finished goods

 

 

17,323

 

 

 

19,036

 

Raw materials

 

 

3,698

 

 

 

3,903

 

Total inventories

 

 

21,021

 

 

 

22,939

 

Supplies, prepaid items and other:

 

 

 

 

 

 

 

 

Prepaid insurance

 

 

8,191

 

 

 

11,217

 

Precious metals

 

 

7,463

 

 

 

8,648

 

Supplies

 

 

24,983

 

 

 

24,100

 

Prepaid and refundable income taxes

 

 

1,078

 

 

 

1,193

 

Other

 

 

2,966

 

 

 

1,733

 

Total supplies, prepaid items and other

 

 

44,681

 

 

 

46,891

 

Total current assets

 

 

186,023

 

 

 

181,146

 

 

 

 

 

 

 

 

 

 

Property, plant and equipment, net

 

 

1,068,892

 

 

 

1,078,958

 

 

 

 

 

 

 

 

 

 

Intangible and other assets, net

 

 

9,584

 

 

 

10,316

 

 

 

 

 

 

 

 

 

 

 

 

$

1,264,499

 

 

$

1,270,420

 

 

(Continued on following page)

3


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (continued)

(Information at March 31, 2017 is unaudited)

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands)

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

53,338

 

 

$

54,246

 

Short-term financing

 

 

5,428

 

 

 

8,218

 

Accrued and other liabilities

 

 

52,779

 

 

 

44,037

 

Current portion of long-term debt

 

 

11,752

 

 

 

13,745

 

Total current liabilities

 

 

123,297

 

 

 

120,246

 

 

 

 

 

 

 

 

 

 

Long-term debt, net

 

 

405,520

 

 

 

406,475

 

 

 

 

 

 

 

 

 

 

Noncurrent accrued and other liabilities

 

 

10,431

 

 

 

12,326

 

 

 

 

 

 

 

 

 

 

Deferred income taxes

 

 

91,529

 

 

 

93,831

 

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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 $167,324,000 ($161,788,000 at December 31, 2016)

 

 

152,164

 

 

 

145,029

 

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

 

 

192,433

 

 

 

192,172

 

Retained earnings

 

 

302,240

 

 

 

314,301

 

 

 

 

500,801

 

 

 

512,601

 

Less treasury stock, at cost:

 

 

 

 

 

 

 

 

Common stock, 2,875,582 shares (3,004,855 shares at December 31, 2016)

 

 

19,243

 

 

 

20,088

 

Total stockholders' equity

 

 

481,558

 

 

 

492,513

 

 

 

$

1,264,499

 

 

$

1,270,420

 

 

See accompanying notes.

4


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands, Except Per Share Amounts)

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

123,344

 

 

$

98,972

 

Cost of sales

 

 

111,729

 

 

 

105,136

 

Gross profit (loss)

 

 

11,615

 

 

 

(6,164

)

 

 

 

 

 

 

 

 

 

Selling, general and administrative expense

 

 

10,545

 

 

 

10,894

 

Other expense (income), net

 

 

(1,251

)

 

 

251

 

Operating income (loss)

 

 

2,321

 

 

 

(17,309

)

 

 

 

 

 

 

 

 

 

Interest expense, net

 

 

9,358

 

 

 

1,350

 

Non-operating other expense, net

 

 

231

 

 

 

1,956

 

 

 

 

 

 

 

 

 

 

Loss from continuing operations before benefit for income taxes

 

 

(7,268

)

 

 

(20,615

)

Benefit for income taxes

 

 

(1,282

)

 

 

(4,850

)

Loss from continuing operations

 

 

(5,986

)

 

 

(15,765

)

 

 

 

 

 

 

 

 

 

Income from discontinued operations, net of taxes

 

 

 

 

 

824

 

Net loss

 

 

(5,986

)

 

 

(14,941

)

 

 

 

 

 

 

 

 

 

Dividends on convertible preferred stocks

 

 

75

 

 

 

75

 

Dividends on Series E redeemable preferred stock

 

 

5,536

 

 

 

7,350

 

Accretion of Series E redeemable preferred stock

 

 

1,599

 

 

 

2,243

 

Net loss attributable to common stockholders

 

$

(13,196

)

 

$

(24,609

)

 

 

 

 

 

 

 

 

 

Loss per common share:

 

 

 

 

 

 

 

 

Basic and diluted:

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.48

)

 

$

(1.11

)

Income from discontinued operations, net of taxes

 

 

 

 

 

0.03

 

Net loss

 

$

(0.48

)

 

$

(1.08

)

 

See accompanying notes.

5


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(Unaudited)

Three Months Ended March 31, 2017

 

 

 

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, 2016

 

 

31,281

 

 

 

(3,005

)

 

$

3,000

 

 

$

3,128

 

 

$

192,172

 

 

$

314,301

 

 

$

(20,088

)

 

$

492,513

 

Cumulative effect of change in accounting

    principle

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,060

 

 

 

 

 

 

 

1,060

 

Net loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,986

)

 

 

 

 

 

 

(5,986

)

Dividend accrued on redeemable

   preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,536

)

 

 

 

 

 

 

(5,536

)

Accretion of redeemable preferred stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1,599

)

 

 

 

 

 

 

(1,599

)

Stock-based compensation

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,172

 

 

 

 

 

 

 

 

 

 

 

1,172

 

Issuance of restricted stock, net

 

 

 

 

 

 

130

 

 

 

 

 

 

 

 

 

 

 

(911

)

 

 

 

 

 

 

845

 

 

 

(66

)

Balance at March 31, 2017

 

 

31,281

 

 

 

(2,875

)

 

$

3,000

 

 

$

3,128

 

 

$

192,433

 

 

$

302,240

 

 

$

(19,243

)

 

$

481,558

 

 

See accompanying notes.

6


LSB INDUSTRIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 

 

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands)

 

Cash flows from continuing operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(5,986

)

 

$

(14,941

)

Adjustments to reconcile net loss to net cash provided by continuing operating

   activities:

 

 

 

 

 

 

 

 

Income from discontinued operations, net of taxes

 

 

 

 

 

(824

)

Deferred income taxes

 

 

(1,242

)

 

 

(4,937

)

Depreciation, depletion and amortization of property, plant and equipment

 

 

17,115

 

 

 

10,590

 

Other

 

 

(327

)

 

 

1,766

 

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

   discontinued operations):

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(7,276

)

 

 

3,436

 

Inventories

 

 

4,857

 

 

 

3,562

 

Prepaid insurance

 

 

3,026

 

 

 

2,405

 

Prepaid and accrued income taxes

 

 

115

 

 

 

858

 

Accounts payable

 

 

6,895

 

 

 

15,273

 

Accrued interest

 

 

(7,979

)

 

 

(8,078

)

Other assets and other liabilities

 

 

(1,411

)

 

 

2,547

 

Net cash provided by continuing operating activities

 

 

7,787

 

 

 

11,657

 

 

 

 

 

 

 

 

 

 

Cash flows from continuing investing activities

 

 

 

 

 

 

 

 

Expenditures for property, plant and equipment

 

 

(13,894

)

 

 

(104,137

)

Other investing activities

 

 

502

 

 

 

(37

)

Net cash used by continuing investing activities

 

 

(13,392

)

 

 

(104,174

)

 

 

 

 

 

 

 

 

 

Cash flows from continuing financing activities

 

 

 

 

 

 

 

 

Proceeds from revolving debt facility

 

 

 

 

 

25,000

 

Payments on revolving debt facility

 

 

 

 

 

(25,000

)

Proceeds from other long-term debt, net of fees

 

 

 

 

 

9,951

 

Payments on other long-term debt

 

 

(4,225

)

 

 

(2,313

)

Payments of debt issuance costs

 

 

(90

)

 

 

(476

)

Payments of issuance costs relating to preferred stocks and warrants

 

 

 

 

 

(785

)

Payments on short-term financing

 

 

(3,717

)

 

 

(2,520

)

Other financing activities

 

 

(66

)

 

 

49

 

Net cash provided (used) by continuing financing activities

 

 

(8,098

)

 

 

3,906

 

Cash flows of discontinued operations:

 

 

 

 

 

 

 

 

Net cash provided (used) by operating activities

 

 

(1,212

)

 

 

2,276

 

Net cash used by investing activities

 

 

 

 

 

(625

)

Net cash used by financing activities

 

 

(65

)

 

 

(901

)

Net cash provided (used) by discontinued operations

 

 

(1,277

)

 

 

750

 

Net decrease in cash and cash equivalents

 

 

(14,980

)

 

 

(87,861

)

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

 

60,017

 

 

 

127,195

 

Cash and cash equivalents at end of period

 

$

45,037

 

 

$

39,334

 

 

 

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, 2016 (“2016 Form 10-K”), filed with the Securities and Exchange Commission (“SEC”) on February 27, 2017.

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.  Our ownership of working interests in natural gas properties is accounted for as an undivided interest, whereby we reflect our proportionate share of the underlying assets, liabilities, revenues and expenses. Our working interest represents our share of the costs and expenses incurred primarily to develop the underlying leaseholds and to produce natural gas while our net revenue interest represents our share of the revenues from the sale of natural gas.  The net revenue interest is less than our working interest as the result of royalty interest due to others. We are not the operator of these natural gas properties.  All material intercompany accounts and transactions have been eliminated.

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.

In our opinion, the unaudited condensed consolidated financial statements of the Company as of March 31, 2017 and for the three-month period ended March 31, 2017 and 2016 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 2016 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.

Concentration of Credit Risks for Cash and Cash Equivalents – Financial instruments relating to cash and cash equivalents potentially subject us to concentrations of credit risk.  These financial instruments were held by financial institutions within the U.S. and none of these financial instruments were in excess of the federally insured limits.

Inventories - Inventories are stated at the lower of cost (determined using the first-in, first-out (“FIFO”) basis) or net realizable value, which is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, transportation or disposal.  Finished goods include material, labor, and manufacturing overhead costs. On January 1, 2017 we adopted ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory as discussed below in “Recently Issued Accounting Pronouncements”.

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. The amount of accretion was

8


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 1: Summary of Significant Accounting Policies (continued)

recorded to retained earnings. However, it is reasonably possible this accretion could accelerate if the expected redemption date is earlier than August 2, 2019.

Equity Awards - Equity award transactions with employees are measured based on the estimated fair value of the equity awards issued.  For equity awards with only service conditions that have a graded vesting period, we recognize compensation cost on a straight-line basis over the requisite service period for the entire award.  In addition, historically we issue new shares of common stock upon the exercise of stock options but treasury shares may be used.

During the three months ended March 31, 2017, the compensation committee of our Board of Directors (the “Board”) approved the grants of 136,142 shares of restricted stock (“2017 Restricted Stock”) to certain executives under the 2016 Long Term Incentive Plan. The 2017 Restricted Stock carry dividend and voting rights.  Sales of these shares are restricted prior to the date of vesting.  Most of the 2017 Restricted Stock vest at the end of each one-year period at a rate of one-third per year for three years. Pursuant to the terms of the 2017 Restricted Stock agreements, unvested restricted shares will immediately vest upon the occurrence of certain events (such as a change in control), as defined by the agreements.  

For the three months ended March 31, 2017 and 2016, the total stock-based compensation expense associated with our continuing operations was $1.2 million and $0.9 million, respectively.

Income (Loss) per Common Share - Net income (loss) attributable to common stockholders is computed by adjusting net income (loss) by the amount of dividends and dividend requirements on preferred stocks and the accretion of redeemable preferred stocks, if applicable. Basic loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding, excluding contingently returnable common shares (unvested restricted stock), if applicable.  For periods we earn net income, a proportional share of net income is allocated to participating securities, if applicable, determined by dividing total weighted average participating securities by the sum of the total weighted average common shares and participating securities (the “two-class method”). Certain securities (Series E Redeemable Preferred and restricted stock units) participate in dividends declared on our common stock and are therefore considered to be participating securities. Participating securities have the effect of diluting both basic and diluted income per common share during periods of net income. For periods we incur a net loss, no loss is allocated to participating securities because they have no contractual obligation to share in our losses. Diluted loss per common share is computed after giving consideration to the dilutive effect of our potential common stock instruments that are outstanding during the period, except where such non-participating securities would be anti-dilutive.

Recently Issued Accounting Pronouncements - In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under GAAP.  This ASU’s core principle is that a company will 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 July 2015, the FASB approved a one-year deferral of the effective date of this ASU with the option to early adopt but not before the original effective date.  In addition, the FASB has issued various ASUs further amending revenue recognition guidance, which includes ASU 2016-08, 2016-10, 2016-11, 2016-12 and 2016-20.  We plan to adopt this ASU on the effective date of January 1, 2018 using the “modified retrospective” adoption method, meaning the standard is applied only to the most current period presented in the financial statements and apply only to existing contracts as of the effective date.  

We have performed a preliminary review of a majority of our contracts with customers with significant sales in 2016.  Most of these contracts are short-term (have been completed or will be completed before the effective date); however, we do have certain long-term sales contracts that may be affected by the new requirements.  In addition, although most of our revenue stream relates to the sale of chemical products, we have identified additional smaller revenue streams, such as our working interest in natural gas properties, performing various services, and rental income.  A contract review process has been implemented to obtain and review our new or amended contracts for analysis for adopting this ASU.  We are developing a preliminary accounting policy and the methodology of identifying performance obligations, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation for the contacts that will be affected.  We plan to elect an accounting policy to account for shipping and handling activities performed after a customer obtains control of the good as activities to fulfil the promise to transfer the good to the customer.

Although we anticipate that upon adoption of this new ASU, the timing of revenue recognition for certain of our revenue streams might change, we have not determined the effect on our financial statements.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. The guidance requires an entity to measure inventory at the lower of cost or net realizable value, which is the estimated selling prices in the ordinary

9


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 1: Summary of Significant Accounting Policies (continued)

course of business, less reasonably predictable costs of completion, disposal, and transportation, rather than the lower of cost or market in the previous guidance. This amendment applies to inventory that is measured using FIFO. We prospectively adopted this ASU on January 1, 2017.  The adoption of this ASU did not impact our financial statements.

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 useful 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.  This ASU must be adopted using a modified retrospective transition, and provides for certain practical expedients. We plan to adopt this ASU on January 1, 2019.  Transition will require application of the new guidance at the beginning of the earliest comparative period presented.  Although we currently have a relatively small number of leases, we are evaluating the effect of this guidance on our consolidated financial statements and related disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation - Stock Compensation. This guidance includes provisions intended to simplify various aspects related to how share-based payments are accounted for and presented in the financial statements. We adopted this guidance on January 1, 2017 as discussed below.

Among other requirements, the new guidance requires all tax effects related to share-based payments at settlement (or expiration) to be recorded through the income statement. Previously, tax benefits in excess of compensation cost ("windfalls") were recorded in equity, and tax deficiencies ("shortfalls") were recorded in equity to the extent of previous windfalls, and then to the income statement. As required, this change was applied prospectively to all excess tax benefits and tax deficiencies resulting from settlements.

Under the new guidance, the windfall tax benefit is to be recorded when it arises, subject to normal valuation allowance considerations. Excess tax benefits that were not previously recognized because the related tax deduction had not reduced current taxes payable were recorded through a cumulative effect adjustment as of the date of the adoption. As required, this change was applied on a modified retrospective basis, with a cumulative effect adjustment of change in accounting principle of approximately $1.1 million as a deferred tax asset with the offset in retained earnings. We made an accounting policy election to account for the amount related to excess tax benefits and deficiencies utilizing the direct effect approach.

Under the new guidance, all tax related cash flows resulting from share-based payments are to be reported as operating activities on the statement of cash flows, a change from the previous requirement to present windfall tax benefits as an inflow from financing activities and an outflow from operating activities. In addition, cash paid by an employer to taxing authorities when the employer directly withholds shares for tax withholding purposes is to be reported as financing activities. These changes were applied on a retrospective basis, but did not impact the statement of cash flows for the three months ended March 31, 2016.  

Under the new guidance, we made an accounting policy election to account for forfeitures as they occur, a change from the previous requirement to estimate forfeitures each period. As required, this change was applied on a modified retrospective basis; however, as of December 31, 2016, we had estimated no forfeitures relating to the outstanding equity awards. As a result, no adjustment was required.

Going forward, the adoption of this ASU could cause volatility in the effective tax rate.

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 makes eight targeted changes to how cash receipts and cash payments are presented and classified in the statement of cash flows. This ASU is effective for us on January 1, 2018 and adoption will be applied on retrospective basis unless it is impracticable to apply, in which case we would be required to apply the ASU prospectively as of the earliest date practicable. Although we anticipate that upon adoption of this new ASU, the presentation and classification for certain cash flow activities might change, we have not determined the effect on our statements of cash flows or disclosures.

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.  This ASU is effective for us on January 1, 2018 and adoption will be applied on retrospective basis for all periods presented.  We plan to adopt this ASU on January 1, 2018. Although we anticipate that upon adoption of this new ASU, the presentation and classification for certain cash flow activities might change, we have not determined the effect on our statements of cash flows or disclosures.

10


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 2: Discontinued Operations

 

On July 1, 2016, LSB completed the sale of all the stock of Climate Control Group Inc. (an indirect subsidiary that conducted LSB’s Climate Control Business) pursuant to the terms of the stock purchase agreement. Additionally, pursuant to the stock purchase agreement, we agreed to have a certain portion of the purchase price proceeds deposited in an indemnity escrow account. In conjunction with the Climate Control Business sale, we entered into a transition services agreement (“TSA”), pursuant to which, among other things, we agreed to provide certain information technology, payroll, legal, tax and other general services for up to 18 months. At March 31, 2017 and December 31, 2016, our accounts receivable includes approximately $2.7 million representing an indemnity escrow balance. Additionally, at March 31, 2017 and December 31, 2016, our current and noncurrent accrued and other liabilities include approximately $4.2 million and $5.5 million, respectively, relating primarily to estimated contingent liabilities, costs associated with the TSA and severance agreements associated with the sale of the Climate Control Business.

Summarized results of discontinued operations are as follows for the three months ended March 31, 2016 (in thousands):

 

Net sales

 

$

66,627

 

Cost of sales

 

 

45,454

 

Selling, general and administrative expense

 

 

15,968

 

Other expense, net

 

 

143

 

Income from operations of discontinued operations

 

 

5,062

 

Provision for income taxes

 

 

4,238

 

Income from discontinued operations, net of taxes

 

$

824

 

 

Summarized condensed cash flow information of discontinued operations is as follows for the three months ended March 31, 2016 (in thousands):

 

Deferred income taxes

 

$

3,608

 

Depreciation and amortization of property, plant and

   equipment

 

$

1,089

 

Stock-based compensation

 

$

230

 

Expenditures for property, plant and equipment

 

$

153

 

Software and software development costs

 

$

477

 

 

11


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 3: Loss Per Common Share

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2017

 

 

2016

 

 

 

(Dollars In Thousands, Except Per

Share Amounts)

 

Numerator:

 

 

 

 

 

 

 

 

Net loss:

 

$

(5,986

)

 

$

(14,941

)

Adjustments for basic net loss per common

   share:

 

 

 

 

 

 

 

 

Dividend requirements on Series E Redeemable

   Preferred

 

 

(5,536

)

 

 

(7,350

)

Dividend requirements on Series B

   Preferred

 

 

(60

)

 

 

(60

)

Dividend requirements on Series D

   Preferred

 

 

(15

)

 

 

(15

)

Accretion of Series E Redeemable Preferred

 

 

(1,599

)

 

 

(2,243

)

Numerator for basic and diluted net loss per common

   share - net loss attributable to common stockholders

 

$

(13,196

)

 

$

(24,609

)

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

Denominator for basic and dilutive net loss per common

   share - weighted- average shares (1)

 

 

27,248,059

 

 

 

22,868,307

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per common share:

 

 

 

 

 

 

 

 

Loss from continuing operations

 

$

(0.48

)

 

$

(1.11

)

Income from discontinued operations, net of taxes

 

 

 

 

 

0.03

 

Net loss

 

$

(0.48

)

 

$

(1.08

)

 

(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,

 

 

 

2017

 

 

2016

 

Restricted stock and stock units

 

 

1,117,426

 

 

 

833,642

 

Convertible preferred stocks

 

 

916,666

 

 

 

916,666

 

Series E Redeemable Preferred - embedded derivative

 

 

303,646

 

 

 

456,225

 

Stock options

 

 

219,011

 

 

 

559,167

 

Warrants

 

 

 

 

 

4,103,746

 

 

 

 

2,556,749

 

 

 

6,869,446

 

 

 

Note 4: Inventories

At March 31, 2017 and December 31, 2016, because costs exceeded the net realizable value, inventory reserves were $38,000 and $2,977,000, respectively.

 

 

12


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 5: Current and Noncurrent Accrued and Other Liabilities

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands)

 

Accrued interest

 

$

5,445

 

 

$

13,425

 

Deferred revenue

 

 

5,401

 

 

 

5,757

 

Accrued payroll and benefits

 

 

4,793

 

 

 

4,696

 

Accrued liabilities associated with discontinued operations

 

 

4,182

 

 

 

5,498

 

Customer deposits

 

 

3,869

 

 

 

2,506

 

Series E Redeemable Preferred - embedded derivative

 

 

2,848

 

 

 

2,557

 

Accrued death and other executive benefits (1)

 

 

2,764

 

 

 

4,207

 

Other

 

 

33,908

 

 

 

17,717

 

 

 

 

63,210

 

 

 

56,363

 

Less noncurrent portion

 

 

10,431

 

 

 

12,326

 

Current portion of accrued and other liabilities

 

$

52,779

 

 

$

44,037

 

(1)

During March 2017, a death benefit agreement with Jack E. Golsen, the Executive Chairman of our Board, was terminated pursuant to the terms of the agreement that allowed LSB to terminate at any time and for any reason prior to the death of the employee.  As a result, the liability of approximately $1.4 million for the estimated death benefit associated with this agreement was extinguished and derecognized with the offset classified as other income.  For the three months ended March 31, 2017, the effect of this adjustment (after income taxes of $0.5 million) decreased basic and diluted loss per share by $0.03 per share.

 

 

Note 6: Asset Retirement Obligations

Currently, we have various legal requirements related to operations of our chemical facilities, including the disposal of waste water generated at certain of these facilities.  Additionally, we have certain chemical facilities that contain asbestos insulation around certain piping and heated surfaces, which we plan to maintain or replace, as needed, with non-asbestos insulation through our standard repair and maintenance activities to prevent deterioration.  Currently, there is insufficient information to estimate the fair value for most of our asset retirement obligations (“ARO”).  In addition, we currently have no plans to discontinue the use of these facilities, and these facilities have an indefinite expected life.  As a result, a liability for only a minimal amount relating to AROs associated with certain facilities has been established.  However, we will continue to review these obligations and record a liability when a reasonable estimate of the fair value can be made.  In addition, we own working interests in certain natural gas properties.  We recognized AROs associated with the obligation to plug and abandon wells when the natural gas reserves in the wells are depleted.  At March 31, 2017 and December 31, 2016, our accrued liability for AROs was $293,000 and $546,000, respectively.

 

 

13


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 7: Long-Term Debt

Our long-term debt consists of the following:

 

 

 

March 31,

 

 

December 31,

 

 

 

2017

 

 

2016

 

 

 

(In Thousands)

 

Working Capital Revolver Loan, with a current interest rate of

   4.5% (A)

 

$

 

 

$

 

Senior Secured Notes due 2019 (B)

 

 

375,000

 

 

 

375,000

 

Secured Promissory Note due 2017, with a current

   interest rate of 4.05% (C)

 

 

4,723

 

 

 

6,566

 

Secured Promissory Note due 2019, with a current interest

   rate of 5.73% (D)

 

 

8,917

 

 

 

9,167

 

Secured Promissory Note due 2021, with a current interest

   rate of 5.25% (E)

 

 

13,532

 

 

 

14,272

 

Secured Promissory Note due 2023, with a current interest

   rate of 5.04% (F)

 

 

18,150

 

 

 

18,645

 

Other, with a current weighted-average interest rate of 4.55%,

   most of which is secured primarily by machinery and

   equipment

 

 

3,833

 

 

 

4,185

 

Unamortized discount and debt issuance costs

 

 

(6,883

)

 

 

(7,615

)

 

 

 

417,272

 

 

 

420,220

 

Less current portion of long-term debt

 

 

11,752

 

 

 

13,745

 

Long-term debt due after one year, net

 

$

405,520

 

 

$

406,475

 

(A) Our revolving credit facility (the “Working Capital Revolver Loan”), as amended in January 2017, provides 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, 2017, our available borrowings under our Working Capital Revolver Loan were approximately $44.9 million, based on our eligible collateral, less outstanding letters of credit.

The maturity date of the Working Capital Revolver Loan is January 17, 2022, with a springing earlier maturity date (the “Springing Maturity Date”) that is 90 days prior to the maturity date of our Senior Secured Notes, to the extent the Senior Secured Notes are not refinanced or repaid prior to the Springing Maturity Date.

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) with respect to relevant periods ending on or prior to September 30, 2017, a minimum EBITDA in the amount set forth in the Working Capital Revolver Loan Amendment and (b) with respect to relevant periods ending after September 30, 2017, a minimum fixed charge coverage ratio of not less than 1.00 to 1.00.  The Financial Covenant, if triggered, is tested monthly.

(B) The Senior Secured Notes mature on August 1, 2019.  Interest is to be paid semiannually on February 1st and August 1st.  In September 2016, we entered into the First Supplemental Indenture to the original Indenture (the “Original 7.75% Indenture”) that, among other things, increased the annual interest rate to 8.5% from 7.75%, effective August 1, 2016.

(C) Zena Energy L.L.C. (“Zena”), one of our subsidiaries, is party to a secured promissory note due December 1, 2017.  Principal and interest are payable in monthly installments. Interest is based on the LIBOR rate plus 300 basis points.

(D) 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.

(E) El Dorado Chemical Company (“EDC”), one of our subsidiaries, is party to a secured promissory note due March 26, 2021. Principal and interest are payable in monthly installments.

14


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 7: Long-Term Debt (continued)

(F) 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 8: Commitments and Contingencies

Natural Gas Purchase Commitments At March 31, 2017, our natural gas contracts, which are exempt from mark-to-market accounting, included volume purchase commitments with fixed costs of approximately 1.2 million MMBtu of natural gas.  These contracts extend through June 2017 at a weighted-average cost of $3.17 per MMBtu ($3.8 million) and a weighted-average market value of $3.03 per MMBtu ($3.6 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”). In particular, the manufacture, production and distribution of products activities that entail environmental and public health risks and impose obligations under 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 do not operate the natural gas wells where we own a working interest and compliance with Environmental and Health Laws is controlled by others.  We are responsible for our working interest proportionate share of the costs involved.   As of March 31, 2017, our accrued liabilities for environmental matters totaled $175,000 relating primarily to the matters discussed below. It is reasonably possible that a change in the estimate of our liability could occur in the near term.  Also, see discussion in Note 6 Asset Retirement Obligations.

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.

15


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 8: Commitments and Contingencies (continued)

Our facility located in Pryor, Oklahoma (the “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 both internally and 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.

EDC believes that the El Dorado Facility has generally demonstrated its ability to comply with applicable ammonia and nitrate permit levels, but has, from time to time, had difficulty meeting the more restrictive dissolved minerals permit levels, primarily related to storm-water runoff.  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 the result of the El Dorado Facility disposing its wastewater (beginning in September 2013) via a pipeline constructed by the City of El Dorado, Arkansas.  We believe that the issue with the storm-water runoff should be resolved if and when the ADEQ issues a new NPDES discharge water permit, which we have been advised that the ADEQ is currently processing.

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, 2017.

In addition, the El Dorado Facility is currently operating under a consent administrative order (the “CAO”) that recognizes the presence of nitrate contamination in the shallow groundwater. The 2006 CAO required EDC to continue semiannual groundwater monitoring, to continue operation of a groundwater recovery system and to submit a human health and ecological risk assessment to the ADEQ relating to the El Dorado Facility.  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 final remedy for shallow groundwater contamination, should any remediation be required, will 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 will 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, 2017, in connection with this matter.

2. Air Matters

PCC has been advised by the ODEQ that the agency is conducting an investigation into whether the Pryor Facility is in compliance with certain ODEQ air quality rules and regulations and whether PCC’s reports of certain air emissions, primarily in 2011, were intentionally misreported to the ODEQ.  PCC is cooperating with the ODEQ in connection with this ongoing investigation. As of March 31, 2017, we are not aware of any recommendations made or to be made by the ODEQ with respect to legal action to be taken or recommended as a result of this ongoing investigation.

3. Other Environmental Matters

In November 2006, EDC entered into a Consent Administrative Order (“CAO”) with the ADEQ to address nitrates in 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. EDC’s risk assessment and the remedial action plan, initially submitted to the ADEQ in 2007, recommended monitored natural attenuation.  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. At this time, the duration and cost (or range of costs) of the ground water monitoring program or the necessity for any additional remediation cannot be reasonably estimated.

16


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 8: Commitments and Contingencies (continued)

During 2014, the Cherokee Facility received Notice of Violation (“NOV”) from the EPA as a result of a 2013 risk management inspection at the facility.  The NOV listed eleven alleged violations.  We reached a settlement of the NOV in March 2016 whereby we agreed and paid a penalty in the form of providing approximately $100,000 to purchase emergency response equipment for local first responders plus a civil penalty to the EPA of approximately $26,000.

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.

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.  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, 2017.  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, 2017, no liability reserve has been established in connection with this matter, except for the unpaid portion of the settlement agreements discussed above, but we have incurred professional fees up to our self-insured retention amount.

17


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 8: Commitments and Contingencies (continued)

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.  It is EDC’s position, among other things, that its inability to deliver to BAE was due to a force majeure event caused by a fire and explosion at EDC’s nitric acid plant, and that a force majeure clause in the supply agreement therefore excuses EDC’s performance under the supply agreement.  BAE’s pre-litigation demand indicated a claim of approximately $18 million.  EDC intends to vigorously defend this matter.  The cost (or range of costs), if any, EDC would incur relating to this matter cannot currently be reasonably estimated.  Therefore, no liability has been established at March 31, 2017.

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.

In September 2015, we and El Dorado Ammonia L.L.C. (“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 like 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 9: 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, 2017, we had approximately 369,000 carbon credits (none at December 31, 2016), all of which were subject to contractual obligations.  The cash flows associated with the carbon credits and the associated contractual obligations are included in cash flows from continuing investing activities.

18


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

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.  At March 31, 2017, 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, 2017 based on low probability that the remaining shares of Series E Redeemable Preferred would be redeemed prior to August 2, 2019.  At March 31, 2017 and December 31, 2016, the fair value of the participation rights was based on the equivalent of 303,646 shares of our common stock at $9.38 and $8.42 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, 2017 and December 31, 2016, we did not have any contracts classified as Level 1.

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, 2017 and December 31, 2016, 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, 2017, 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, 2016, 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, 2017 and December 31, 2016, 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 carbon credits or the embedded derivative.

19


LSB INDUSTRIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)

(Unaudited)

 

Note 9: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

The following details our assets and liabilities that are measured at fair value on a recurring basis at March 31, 2017 and December 31, 2016:

 

 

 

 

 

 

 

Fair Value Measurements at

March 31, 2017 Using

 

 

 

 

 

Description

 

Total Fair

Value at

March 31,

2017

 

 

Quoted Prices in Active

Markets for Identical

Assets

(Level 1)

 

 

Significant

Other

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

 

Total Fair

Value at

December 31,

2016

 

 

 

(In Thousands)

 

Assets - Supplies, prepaid items and other:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Carbon credits

 

$

867

 

 

$

 

 

$

 

 

$

867

 

 

$

 

Total

 

$

867

 

 

$

 

 

$

 

 

$

867

 

 

$

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities - Current and noncurrent accrued and

   other liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contractual obligations - carbon credits

 

$

(867

)

 

$

 

 

$

 

 

$

(867

)

 

$

 

Embedded derivative

 

 

(2,848

)