FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 [X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarterly period ended March 31, 1997 ------------------------------------ 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 I.R.S. Employer incorporation or organization Identification No. 16 South Pennsylvania, 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 x NO ------ ------ The number of shares outstanding of the Registrant's voting Common Stock, as of May 1, 1997 was 12,882,656 shares excluding 2,031,820 shares held as treasury stock. PART I FINANCIAL INFORMATION Company or group of companies for which report is filed: LSB Industries, Inc. and all of its wholly-owned subsidiaries. The accompanying condensed consolidated balance sheet of LSB Industries, Inc. at March 31, 1997, the condensed consolidated statements of operations and cash flows for the three month periods ended March 31, 1997 and 1996 have been subjected to a review, in accordance with standards established by the American Institute of Certified Public Accountants, by Ernst & Young LLP, independent auditors, whose report with respect thereto appears elsewhere in this Form 10-Q. The financial statements mentioned above are unaudited and reflect all adjustments, consisting primarily of adjustments of a normal recurring nature, which are, in the opinion of management, necessary for a fair presentation of the interim periods. The results of operations for the three months ended March 31, 1997 are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet at December 31, 1996, was derived from audited financial statements as of that date. LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Information at March 31, 1997 is unaudited) (Dollars in thousands) March 31, December 31, ASSETS 1997 1996 _________________________________________ ___________ __________ Current assets: Cash and cash equivalents $ 4,597 $ 1,620 Trade accounts receivable, net of allowance 55,819 50,791 Inventories: Finished goods 39,402 36,304 Work in process 8,709 12,084 Raw materials 19,193 19,594 ___________ __________ Total inventory 67,304 67,982 Supplies and prepaid items 8,007 7,217 ___________ __________ Total current assets 135,727 127,610 Property, plant and equipment, net 118,983 103,143 Investments and other assets: Loans receivable, secured by real estate 764 15,010 Other assets, net of allowance 15,511 15,521 ___________ __________ $ 270,985 $ 261,284 =========== ========== (Continued on following page) LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Continued) (Information at March 31, 1997 is unaudited) (Dollars in thousands) March 31, December 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1997 1996 ________________________________________ ___________ __________ Current liabilities: Drafts payable $ 632 $ 536 Accounts payable 36,849 41,796 Accrued liabilities 12,947 12,780 Current portion of long-term debt 16,197 13,007 __________ __________ Total current liabilities 66,625 68,119 Long-term debt 136,959 119,277 Contingencies (Note 4) Redeemable, noncumulative convertible preferred stock, $100 par value; 1,539 shares issued and outstanding (1,539 in 1996) 146 146 Stockholders' equity (Note 3): Series B 12% cumulative, convertible preferred stock, $100 par value; 20,000 shares issued and outstanding 2,000 2,000 Series 2 $3.25 convertible, exchangeable Class C preferred stock, $50 stated value; 920,000 shares issued 46,000 46,000 Common stock, $.10 par value; 75,000,000 shares authorized, 14,914,476 shares issued (14,888,476 in 1996) 1,491 1,489 Capital in excess of par value 37,922 37,843 Accumulated deficit (8,947) (2,706) __________ __________ 78,466 84,626 Less treasury stock, at cost: Series 2 Preferred, 5,000 shares 200 200 Common stock, 1,982,620 shares (1,913,120 in 1996) 11,011 10,684 __________ __________ Total stockholders' equity 67,255 73,742 __________ __________ $ 270,985 $ 261,284 ========== ========== (See accompanying notes) LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31, 1997 and 1996 (Dollars in thousands, except per share amounts) 1997 1996 __________ __________ Revenues: Net sales $ 73,234 $ 69,495 Other income 1,630 1,411 __________ __________ 74,864 70,906 Costs and expenses: Cost of sales 62,312 54,688 Selling, general and administrative 14,872 13,718 Interest 3,056 2,969 __________ __________ 80,240 71,375 __________ __________ Loss before provision for income taxes (5,376) (469) Provision for income taxes 62 62 ---------- ---------- Net loss $ (5,438) $ (531) ========== ========== Net loss applicable to common stock (Note 2) $ (6,241) $ (1,350) Average common shares outstanding (Note 2): ========== ========== Primary 12,974,824 12,911,387 Fully diluted 12,974,824 12,911,387 Loss per common share (Note 2): Primary $ (.48) $ (.10) ========== ========== Fully diluted $ (.48) $ (.10) ========== ========== (See accompanying notes) LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) Three Months Ended March 31, 1997 and 1996 (Dollars in thousands) 1997 1996 ___________ __________ Cash flows from operations: Net loss $ (5,438) $ (531) Adjustments to reconcile net loss to cash flows used by operations: Depreciation, depletion and amortization: Property, plant and equipment 2,439 2,307 Other 283 307 Provision for possible losses on receivables and other assets 152 539 Gain on sale of assets (65) (659) Recapture of prior period provisions for loss on loans receivable secured by real estate (1,383) - Cash provided (used) by changes in assets and liabilities: Trade accounts receivable (4,841) (7,958) Inventories 678 (616) Supplies and prepaid items (791) (1,444) Accounts payable (4,947) 5,625 Accrued liabilities 169 853 ___________ __________ Net cash used by operations (13,744) (1,577) Cash flows from investing activities: Capital expenditures (2,819) (2,173) Principal payments on notes receivable 183 44 Proceeds from sales of equipment and real estate properties 160 15 Proceeds from sale of investment securities - 1,444 Increase in other assets (721) (96) ___________ __________ Net cash used in investing activities (3,197) (766) Cash flows from financing activities: Payments on long-term and other debt (21,172) (2,290) Long-term and other borrowings 54,451 - Net change in revolving debt (12,408) 4,787 Net change in drafts payable 96 (208) Dividends paid on preferred stocks (Note 3) (803) (820) Purchases of treasury stock (Note 3) (327) (7) Net proceeds from issuance of common stock 81 - ___________ __________ Net cash provided by financing activities 19,918 1,462 ___________ __________ Net increase (decrease) in cash 2,977 (881) Cash and cash equivalents at beginning of period 1,620 1,420 ----------- ---------- Cash and cash equivalents at end of period $ 4,597 $ 539 (See accompanying notes) Note 1: At December 31, 1996, the Company had regular-tax net operating loss ( NOL ) carryforwards for tax purposes of approximately $45 million (approximately $10 million alternative minimum tax NOLs). Such amounts of regular-tax NOL expire beginning in 1999. The Company also has investment tax credit carryforwards of approximately $356,000, which begin expiring in 1997. The Company s provision for income taxes for the three months ended March 31, 1997 of $62,000 is for current state income taxes and federal alternative minimum tax. Note 2: Primary earnings per common share are based upon the weighted average number of common shares and dilutive common equivalent shares outstanding during each period, after giving appropriate effect to preferred stock dividends. Fully diluted earnings per share are based on the weighted average number of common shares and dilutive common equivalent shares outstanding and the assumed conversion of dilutive convertible securities outstanding, if any, after appropriate adjustment for interest and related income tax effects on convertible notes payable. Net income applicable to common stock is computed by adjusting net income by the amount of preferred stock dividends, including past due undeclared or unpaid dividends, if cumulative. In February 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share, which is required to be adopted on December 31, 1997. At that time, the Company will he required to change the method currently used to compute earnings per share and to restate all prior periods. Under the new requirements for calculating primary earnings per share, the dilutive effect of stock options will be excluded. Due to losses incurred during the fiscal quarters ended March 31, 1997 and March 31, 1996, the impact of Statement No. 128 on the calculation of both primary and fully diluted earnings per share for these quarters is not expected to be material. Note 3: The table below provides detail of activity in the Stockholders' equity accounts for the three months ended March 31, 1997: <TABLE> <CAPTION> Retained Common Stock Non- Capital Earnings Treasury _______________ redeemable in excess (Accumu- Treasury Stock Par Preferred of par lated Stock- Prefer- Shares Value Stock Value deficit) Common red Total ______ ______ _________ ________ ______ _______ _______ ______ (In thousands) <S> <C> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 1996 14,888 $ 1,489 $ 48,000 $ 37,843 $(2,706) $(10,684) $ (200) 73,742 Net loss (5,438) (5,438) Exercise of stock options 26 2 79 81 Dividends declared: Series B 12% preferred stock ($3.00 per share) (60) (60) Series 2 preferred stock ($.81 per share) (743) (743) Purchase of treasury stock (327) (327) ______ ______ ________ _______ _______ _______ ______ ______ (1) Balance at March 31, 1997 14,914 $ 1,491 $ 48,000 $ 37,922 $(8,947) $(11,011) $ (200) $67,255 ====== ====== ======== ======= ======= ======= ====== ====== </TABLE> (1) Includes 1,982,620 shares of the Company's Common Stock held in treasury. Excluding the 1,982,620 shares held in treasury, the outstanding shares of the Company's Common Stock at March 31, 1997 were 12,931,856. Note 4: Following is a summary of certain legal actions involving the Company: A. In 1987, the U.S. Government notified one of the Company's subsidiaries along with numerous other companies, of potential responsibility for clean-up of a waste disposal site in Oklahoma. No legal action has yet been filed. The amount of the Company's cost associated with the clean-up of the site is unknown due to continuing changes in (i) the estimated total cost of clean-up of the site and (ii) the percentage of the total waste which was alleged to have been contributed to the site by the Company, accordingly, no provision for any liability which may result has been made in the accompanying financial statements. The subsidiary's insurance carriers have been notified of this matter; however, the amount of possible coverage, if any, is not yet determinable. B. The State of Arkansas performed a preliminary assessment of the Chemical Business' primary manufacturing facility (the "Site") and advised the Company that the Site has had certain releases of contaminants. On July 18, 1994, the Company received a report from the State of Arkansas which contained findings of violations of certain environmental laws and requested the Company to conduct further investigations to better determine the compliance status of the Company and releases of contaminants at the Site. On May 2, 1995, the Company signed a Consent Administrative Agreement ("Agreement") with the State of Arkansas. The Agreement provides for the Company to remediate and close a certain landfill, monitor groundwater for certain contaminants and depending on the results of the monitoring program to submit a remediaton plan, upgrade certain equipment to reduce wastewater effluent, and pay a civil penalty of $25,000. Subsequent to the signing of the Agreement on May 2, 1995, the Company completed its remediation and closure activities and had the "Closure Certification Report" approved by the State of Arkansas. The Company also submitted a "Groundwater Monitoring Work Plan" to the State of Arkansas which has been approved and the initial phase of field work has been completed. A work plan for the second phase of the monitoring has also been submitted and approved by the state of Arkansas. On February 12, 1996, the Company entered into another Consent Administrative Agreement ("Additional Agreement") with the state of Arkansas to resolve certain compliance issues associated with nitric acid concentrations. The Company has installed additional pollution control equipment to reduce opacity and constituent emissions which impact opacity. The Company was assessed $50,000 in civil penalties associated with the Original Agreement. In the summer of 1996 and then on January 28, 1997, the Company executed amendments to the Additional Agreement ("Amended Agreements"). The Amended Agreements acknowledged compliance with the requirements of the prior Agreement and imposed a $150,000 civil penalty. As of March 31, 1997, the Company has paid $144,000 of the above penalties. The Company is planning to undertake one or more supplemental environmental projects in lieu of paying the remaining penalty due. Based on information presently available, the Company does not believe that compliance with these agreements should have a material adverse effect on the Company or the Company's financial condition or results of operation. C. In 1996, a lawsuit was filed against the Company's Chemical Business by a group of residents of El Dorado, Arkansas, asserting a citizens' suit against the Chemical Business as a result of certain alleged violations of the Clean Air Act, the Clean Water Act, the Chemical Business' air and water permits and certain other environmental laws, rules and regulations. The citizens' suit requests the court to order the Chemical Business to cure such alleged violations, if any, plus penalties as provided under the applicable statutes. The Company's Chemical Business will assert all defenses available to it and will vigorously defend itself. In July 1996, several of the same individuals who are plaintiffs in the citizens' suit referenced above filed a toxic tort lawsuit against the Company's Chemical Business alleging that they suffered certain injuries and damages as a result of alleged releases of toxic substances from the Chemical Business' El Dorado, Arkansas manufacturing facility. In October 1996, another toxic tort lawsuit was filed against the Company's Chemical Business. This subsequent action asserts similar damage theories as the previously discussed lawsuit, except this action attempts to have a class certified to represent substantially all allegedly affected persons. The plaintiffs are suing for an unspecified amount of actual and punitive damages. The Company's insurance carriers have been notified of these matters. The Company and the Chemical Business maintain an Environmental Impairment Insurance Policy ("EIL Insurance") that provides coverage to the Company and the Chemical Business for certain discharges, dispersals, releases, or escapes of certain contaminants and pollutants into or upon land, the atmosphere or any water course or body of water from the Site, which has caused bodily injury, property damage or contamination to others or to other property not on the Site. The EIL Insurance provides limits of liability for each loss up to $10.0 million and a similar $10.0 million limit for all losses due to bodily injury or property damage, except $5.0 million for all remediation expenses, with the maximum limit of liability for all claims under the EIL Insurance not to exceed $10.0 million for each loss or remediation expense and $10.0 million for all losses and remediation expenses. The EIL Insurance also provides a retention of the first $500,000 per loss or remediation expense that is to be paid by the Company. D. A civil cause of action has been filed against the Company's Chemical Business and five (5) other unrelated commercial explosives manufacturers alleging that the defendants allegedly violated certain federal and state antitrust laws in connection with alleged price fixing of certain explosive products. The plaintiffs are suing for an unspecified amount of damages, which, pursuant to statute, plaintiffs are requesting be trebled, together with costs. Based on the information presently available to the Company, the Company does not believe that the Chemical Business conspired with any party, including but not limited to, the five (5) other defendants, to fix prices in connection with the sale of commercial explosives. Discovery has only recently commenced in this matter. The Chemical Business intends to vigorously defend itself in this matter. The Company's Chemical Business has been added as a defendant in a separate lawsuit pending in Missouri. This lawsuit alleges a national conspiracy, as well as a regional conspiracy, directed against explosive customers in Missouri and seeks unspecified damages. The Company's Chemical Business has been included in this lawsuit because it sold products to customers in Missouri during a time in which other defendants have admitted to participating in an antitrust conspiracy, and because it has been sued in the preceding described lawsuit. Based on the information presently available to the Company, the Company does not believe that the Chemical Business conspired with any party, to fix prices in connection with the sale of commercial explosives. The Chemical Business intends to vigorously defend itself in this matter. For several years the explosive industry has been under an investigation by the U.S. Department of Justice. Certain explosive companies plead guilty to antitrust violations. In connection with that investigation, the Chemical Business received and has complied with certain document subpoenas, and certain of the Chemical Business' employees have been subpoenaed to testify in connection with such investigation. As of the date of this report, the Chemical Business has not been identified as a target of this investigation. The Company including its subsidiaries, is a party to various other claims, legal actions, and complaints arising in the ordinary course of business. In the opinion of management after consultation with counsel, all claims, legal actions (including those described above) and complaints are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that unfavorable disposition would not have a material effect on the financial position of the Company, but could have a material impact to the net income (loss) of a particular quarter or year, if resolved unfavorably. Debt Guarantee The Company has guaranteed approximately $2.6 million of indebtedness of a start-up aviation company, Kestrel Aircraft Company, in exchange for a 25.6% ownership interest, to which no value has been assigned as of March 31, 1997. The Company has advanced the aviation company $241,000 as of March 31, 1997 and is accruing losses of the aviation company based on its ownership percentage. As a result, the Company has recorded losses of $1,403,000 ($187,000 in the first quarter of 1997, and $626,000 and $590,000 in the years ended December 31, 1996 and 1995, respectively) related to the debt guarantee. The debt guarantee relates to a $2 million term note and up to $600,000 of a $2 million revolving credit facility. The $2 million term note requires interest only payments through September 1998; thereafter, it requires monthly principal payments of $11,111 plus interest beginning in October 1998 until it matures on August 8, 1999, at which time all outstanding principal and unpaid interest are due. In the event of default of this note, the Company is required to assume payments on the note with the term extended until August 2004. The $2 million revolving credit facility, on which a subsidiary of the Company has guaranteed up to $600,000 of indebtedness, had a balance of approximately $400,000 as of March 31, 1997. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") should be read in conjunction with a review of the Company's March 31, 1997 Condensed Consolidated Financial Statements. OVERVIEW The Company is pursuing a strategy of focusing on its more profitable businesses and concentrating on businesses and product lines in niche markets where the Company has established or can establish a position as a market leader. In addition, the Company is seeking to improve its liquidity and profits through liquidation of selected assets that are on its balance sheet and on which it is not realizing an acceptable return nor does it have the potential to do so. In this connection, the Company has been concentrating on reshaping the Automotive Products Business by the liquidation of certain of their assets that don't have the potential to earn an acceptable return and focusing on product lines that management believes have strategic advantages within select niche markets. The Company has also recruited new key management people in the Automotive Products Business including marketing, materials control, manufacturing, and financial. The Company continues to explore its alternatives to accomplish these goals. In addition, the Company has been liquidating certain slow moving inventory in the Industrial Products Business in the ordinary course of business. It is the present intention of the Company to limit this Business to lines of machine tools which should result in an acceptable return on capital employed. Certain statements contained in this Overview are forward- looking statements, and the results thereof could differ materially from such statements if the Company is unable to liquidate such assets in a reasonable period or on reasonable terms, and if able to liquidate such assets, it may not be able to improve profits in the Automotive Products Business or have an acceptable return on capital employed in these Businesses if general economic conditions deteriorate drastically from the environment these Businesses currently operate in or these Businesses are unable to meet competitive pressures in the market place which restrict these Businesses from manufacturing or purchasing and selling their products at acceptable prices. Information about the Company's continuing operations in different industry segments for the three months ended March 31, 1997 and 1996 is detailed below. Three Months Ended March 31, 1997 1996 ___________ __________ (In thousands) (Unaudited) Sales: Chemical $ 40,599 $ 36,520 Environmental Control 21,623 18,995 Automotive Products 7,992 10,956 Industrial Products 3,020 3,024 ___________ __________ $ 73,234 $ 69,495 =========== ========== Gross profit: Chemical $ 3,384 $ 6,800 Environmental Control 6,008 4,699 Automotive Products 1,109 2,450 Industrial Products 421 858 ___________ __________ $ 10,922 $ 14,807 =========== ========== Operating profit (loss): Chemical $ (645) $ 3,545 Environmental Control 1,551 721 Automotive Products (1,226) 139 Industrial Products (665) (497) ___________ __________ (985) 3,908 General corporate expenses (1,335) (1,408) Interest expense (3,056) (2,969) ___________ __________ Loss before provision for income taxes $ (5,376) $ (469) =========== ========== Gross profit by industry segment represents net sales less cost of sales. Operating profit by industry segment represents revenues less operating expenses before deducting general corporate expenses, interest expense and income taxes. As indicated in the above table, the operating profit (as defined) declined from $3.9 million in the first quarter of 1996 to an operating loss of $985,000 in the first quarter of 1997, while sales increased approximately $3.7 million or 5.4% in the first quarter of 1997 over the first quarter of 1996. The decline in operating profit, coupled with an increase in interest expense, resulted in a loss before provision for income taxes for 1997 of $5.4 million. Chemical Business The operating profit in the Chemical Business is down from $3.5 million profit in the first quarter of 1996 to an operating loss of $.6 million in the first quarter of 1997. During the first quarter of 1997, the Chemical Business continued to incur significant amounts of downtime at its El Dorado, Arkansas Plant site due to mechanical problems being incurred at the plant. The downtime resulted in increases in manufacturing overhead and lower absorption of such costs. The unabsorbed overhead combined with the continued high cost of the primary raw material, ammonia, led to higher cost of sales as a percent of sales and lower gross profit margins. The Chemical Business purchases approximately 250,000 tons per year of anhydrous ammonia. The cost of ammonia consumed by the Chemical Business in 1996 averaged $167 per ton, while in November and December 1996, ammonia prices took an unexpected increase to an average of approximately $200 per ton. During the first quarter of 1997, ammonia prices continued to increase through February (a high of $217 per ton) and then began to decline during March so that the price for March, 1997 approximated the average price incurred during the months of November and December 1996. The continued increase in ammonia prices had a disruptive effect on the first quarter results of the Chemical Business' operations. The decline in prices in March, 1997 did not significantly reduce the Chemical Business' cost of sales in the first quarter of 1997. The price of ammonia averaged $45 more per ton in the first quarter of 1997 than in the first quarter of 1996. The Chemical Business has substantially finalized negotiations with Bayer for the Chemical Business to build and operate on a long-term basis a nitric acid plant located on property owned by Bayer in Baytown, Texas. If the transaction is completed, the Chemical Business would provide nitric acid from such plant to Bayer's Baytown, Texas plant. Execution of the agreement between the Chemical Business and Bayer is subject to the Company finalizing the financing to construct the nitric acid plant and the final terms upon which the Chemical Business would lease such nitric acid plant. The Company has an agreement in principle with a lender to provide financing. Such nitric acid plant would be owned by a party that is not an affiliate of the Company and would be leased to the Chemical Business for a period expected to equal ten years under an operating lease. It is expected that the cost to construct the nitric acid plant would be approximately $60.0 million. Under the terms of the proposed agreement, such nitric acid plant is to be constructed and become operational within 18 months from execution of the definitive agreement. Environmental Control Business As indicated in the above table, the Environmental Control Business reported improved sales (an increase of 13.8%) and improved operating profit for the first quarter of 1997, over that of the first quarter of 1996, primarily as a result of improved market conditions for the heat pump product lines. Automotive and Industrial Products Businesses As indicated in the above table, during the first quarter of 1997 these Businesses recorded combined sales of $11.0 million and reported an operating loss (as defined above) of $1.9 million, as compared to combined sales of $14.0 million and an operating loss of $.4 million for the first quarter of 1996, as a result of lower sales and decreased absorption of manufacturing costs due to lower production volume. The net investment in assets of these Businesses decreased from $56.8 million at year end 1996 to $56.3 million at March 31, 1997. As a result of the stringent inventory reduction program put into place in 1995, inventories of these Businesses decreased approximately $.9 million during the three months ended March 31, 1997. RESULTS OF OPERATIONS Three months ended March 31, 1997 vs. Three months ended March 31, 1996. Revenues Total revenues for the three months ended March 31, 1997 and 1996 were $74.9 million and $70.9 million, respectively (an increase of $4.0 million). Sales increased $3.7 million. Other income increased $.2 million. Net Sales Consolidated net sales included in total revenues for the three months ended March 31, 1997 were $73.2 million, compared to $69.5 million for the first three months of 1996, an increase of $3.7 million. This increase in sales resulted principally from: (i) increased sales in the Chemical Business of $4.1 million, primarily due to higher sales in the U.S. of agricultural products and increased business volume of the Company's subsidiary located in Australia , Total Energy Systems ("TES"), (ii) increased sales in the Environmental Control Business of $2.6 million primarily due to firming of market conditions for this Business' Heat Pump product lines,offset by (iii) decreased sales in the Automotive Products Business of $3.0 due primarily to a reduced customer base. Gross Profit Gross profit was 14.9% for the first three months of 1997, compared to 21.3% for the first three months of 1996. The decrease in the gross profit percentage was due primarily to (i) decreased absorption of costs due to lower production volumes in the Automotive Products Business, and (ii) higher production costs in the Chemical Business due to the effect of higher prices of ammonia and unabsorbed overhead costs caused by excessive downtime related to modifications made to resolve problems associated with mechanical failures at the Chemical Business' primary manufacturing plant. Selling, General and Administrative Expense Selling, general and administrative ("SG&A") expenses as a percent of net sales were 20.3% in the three month period ended March 31, 1997 compared to 19.7% for the first three months of 1996. This increase is primarily the result of increased professional fees related to environmental matters in the Chemical Business and decreased sales volume in the Automotive Products Business without a corresponding decrease in SG&A. Interest Expense Interest expense for the Company, excluding capitalized interest, was $3.1 million during the first quarter of 1997, compared to $3.0 million during the first quarter of 1996. During the first quarter of 1997, $.7 million of interest expense was capitalized in connection with construction of the DSN Plant. The increase of $.8 million before the effect of capitalization primarily resulted from increased borrowings and higher interest rates. Loss Before Taxes The Company had a loss before income taxes of $5.4 million in the first quarter of 1997 compared a loss before income taxes of $.5 million in the three months ended March 31, 1996. The decreased profitability of $4.9 million was primarily due to the decline in gross profit and the increase in SG&A as previously discussed. Provision for Income Taxes As a result of the Company's current operating loss and net operating loss carryforward for income tax purposes as discussed elsewhere herein and in Note 1 of Notes to Condensed Consolidated Financial Statements, the Company's provisions for income taxes for the three months ended March 31, 1997 and the three months ended March 31, 1996 are for current state income taxes and federal alternative minimum taxes.
Liquidity and Capital Resources Cash Flow From Operations Net cash used by operations for the quarter ended March 31, 1997 was $13.7 million, after adjustments for noncash depreciation and amortization of $2.7 million and recapture of previous years provisions for possible losses of $1.4 million. This net cash usage includes the following changes in assets and liabilities: (i) accounts receivable increases of $4.8 million, (ii) inventory decreases of $0.7 million, (iii) increases in supplies and prepaid items of $0.8 million, and (iv) decreases in accounts payable and accrued liabilities of $4.8 million. The increase in accounts receivable is due mainly to seasonal sales increases in the Chemical Business. The decrease in inventories is primarily due to the inventory reduction plan being executed in the Automotive Products Business, partially offset by increased inventories at the Chemical Business' Australian subsidiary due to anticipated sales increases. The increase in supplies and prepaid items is due primarily to increases in prepaid insurance costs. The decrease in accounts payable and accrued liabilities is due primarily to a decrease in capital construction projects. Cash Flow From Investing And Financing Activities Cash used by investing activities included $2.8 million in capital expenditures (primarily in the Chemical Business) and increased other assets of $0.7 million due primarily to advances made to a potential acquisition candidate. Net cash provided by financing activities included (i) term borrowings of $54.5 million, including proceeds from the new $50 million financing discussed under "Sources of Funds", (ii) payments on term debt of $21.2 million, including $19.1 million in unscheduled payoff of debt with proceeds from the new $50 million financing, (iii) decreases in revolving debt of $12.4 million, (iv) dividends of $0.8 million, and (v) treasury stock purchases of $0.3 million. During the first quarter of 1997, the Company paid the following aggregate dividends: (1) $3.00 per share on each of the outstanding shares of its Series B 12% Cumulative Convertible Preferred Stock; (2) $.81 per share on each outstanding share of its $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2; and (3) $.03 per share on each outstanding share of its Common Stock. During the second quarter of 1997, the Company has paid a dividend of $10.00 per share on each outstanding share of its Redeemable Preferred Stock and has declared but not paid dividends of $.81 per share on each outstanding share of its $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2, $3.00 per share on each of the outstanding shares of its Series B 12% Cumulative Convertible Preferred Stock and $.03 per share on each share of its outstanding Common Stock. Source of Funds The Company is a diversified holding Company and its liquidity is dependent, in large part, on the operations of its subsidiaries and credit agreements with lenders. On February 13, 1997 the Company's wholly-owned subsidiaries, El Dorado Chemical Company, Slurry Explosive Corporation, and Northwest Financial Corporation. (collectively "Borrowers") completed a $50.0 million long-term financing agreement ("Financing") with an institutional lender. Approximately $19.3 million in proceeds from the Financing were used to repay other outstanding term debt and accrued interest, and the remaining $30.7 million in proceeds were used to pay down the Company's revolving credit facilities and thereby create additional borrowing availability for future working capital and other corporate needs. The Financing is secured by a first mortgage lien on the Chemical Business' property, plant, and equipment located in El Dorado, Arkansas and owned by the Borrowers, except rolling stock and excluding the DSN Plant which is security under a separate loan agreement. The $50.0 million Financing consists of $25.0 million of fixed rate notes bearing interest at 10.57% per annum and $25.0 million of floating rate notes bearing interest at LIBOR plus 4.2% (initially 9.76%). Repayment of the notes is due in quarterly installments of $833,332 plus interest commencing on July 1,1997 through April 2004 at which time the balance is due. The Financing requires the Borrowers to maintain certain financial ratios and contains other financial covenants, including the ratio of funded debt to total capitalization, current ratio, and fixed charge coverage ratio, in addition to net worth and working capital requirements. As of the date of this report, the Borrowers are in compliance with all financial covenants required by the loan agreement related to the financing. The Financing also contains certain restrictions on transactions with affiliates. The Financing limits the amount of dividends or distributions by the Borrowers to an amount equal to payments for federal income taxes determined as if the Borrowers filed returns on a separate company basis and dividends up to 50% of the Borrowers' prior year net income. The annual interest on the $50 million in outstanding debt under the Financing at March 31, 1997, at the rate then in effect, would approximate $5.1 million. The Company and certain of its subsidiaries are parties to a working capital line of credit evidenced by six separate loan agreements ("Agreements") with an unrelated lender ("Lender") collateralized by receivables, inventory, and proprietary rights of the Company and the subsidiaries that are parties to the Agreements and the stock of certain of the subsidiaries that are borrowers under the Agreements. The Agreements, as amended, provide for revolving credit facilities ("Revolver") for total direct borrowings up to $63.0 million, including the issuance of letters of credit. The Revolver provides for advances at varying percentages of eligible inventory and trade receivables. The Agreements, as amended, provide for interest at the reference rate as defined (which approximates the national prime rate) plus 1.5%, or the Eurodollar rate plus 3.875%. At March 31, 1997 the effective interest rate was 10%. The initial term of the Agreements is through December 12, 1997, and is renewable thereafter for successive thirteen month terms. The Lender has agreed to amend the initial term maturity date to April 1, 1998. At March 31, 1997, additional amounts that the Company could have borrowed under the Agreements, based on eligible collateral, were approximately $18.2 million. Borrowings under the Revolver outstanding at March 31, 1997, were $43.9 million. The Agreements, as amended, require the Company to maintain certain financial ratios and contain other financial covenants, including tangible net worth requirements and capital expenditure limitations. As of the date of this report, the Company is in compliance with all financial covenants, or if not in compliance, has obtained appropriate waivers from the Lender. The annual interest on the outstanding debt under the Revolver at March 31, 1997 at the rates then in effect would approximate $4.5 million. In addition to the Agreements discussed above, the Company had the following term loans in place as of March 31, 1997: (1) The Company s wholly-owned subsidiary, DSN Corporation ("DSN"), is a party to several loan agreements with a financing company (the Financing Company ) for three (3) projects. These loan agreements are for a $16.5 million term loan (the DSN Permanent Loan"), which was used to construct, equip, re-erect, and refurbish the DSN Plant being placed into service by the Chemical Business at its El Dorado, Arkansas facility; a loan for approximately $1.2 million to purchase additional railcars to support the DSN Plant (the Railcar Loan ); and a loan for approximately $1.1 million to finance the construction of a mixed acid plant (the Mixed Acid Plant ) in North Carolina (the Mixed Acid Loan ). At March 31, 1997, DSN had outstanding borrowings of $13.4 million under the DSN Permanent Loan, $.9 million under the Mixed Acid Loan, and $1.0 million under the Railcar Loan. The loans have repayment schedules of eighty-four (84) consecutive monthly installments of principle and interest. The interest rate on each of the loans is fixed and range from 8.24% to 8.86%. Annual interest, for the three notes as a whole, at March 31, 1997 at the agreed to interest rates would approximate $1.3 million. The loans are secured by the various DSN and Mixed Acid Plants property and equipment, and all railcars purchased under the Railcar Loan. The loan agreements require the Company to maintain certain financial ratios, including tangible net worth requirements. As of the date of this report, the Company is in compliance with all financial covenants or if not in compliance, has obtained appropriate waivers from the Financing Company. (2) As of March 31, 1997, a subsidiary of the Company ("Prime") was a party to an agreement ("Agreement") with Boatmen's Bank, N.A. ("Bank"). The Agreement, as modified, requires interest per annum at a rate equal to three quarters of one percent (.75%) above the prime rate in effect from day to day as published in the Wall Street Journal. The outstanding principal balance of the note is payable in sixty (60) monthly payments of principal and interest commencing on June 30, 1996. Payment of the note is secured by a first and priority lien and security interest in and to Prime's right, title, and interest in the loan receivable relating to the real property and office building located in Oklahoma City, Oklahoma (the "Tower"), the Management Agreement relating to the Tower. In February 1997, the Company exercised its option to purchase the Tower by paying approximately $140,000 for the exercise price under the purchase option and related costs. Future cash requirements include working capital requirements for anticipated sales increases in all Businesses, and funding for future capital expenditures, primarily in the Chemical Business and the Environmental Control Business. Funding for the higher accounts receivable resulting from anticipated sales increases will be provided by cash flow generated by the Company and the revolving credit facilities discussed elsewhere in this report. Inventory requirements for the higher anticipated sales activity should be met by scheduled reductions in the inventories of the Industrial Products Business and in the inventories of the Automotive Products Business, which increased its inventories in 1995 beyond required levels. In 1997, the Company has planned capital expenditures of approximately $6.0 million, primarily in the Chemical and Environmental Control Businesses. Management believes that cash flows from operations, the Company's revolving credit facilities, and other sources, will be adequate to meet its presently anticipated capital expenditure, working capital, debt service, and dividend requirements. The above sentence and certain statements contained in the preceding paragraph are forward-looking statements that involve a number of risks and uncertainties that could cause actual results to differ materially, such as, a material reduction in revenues, continuing to incur losses, inability to collect a material amount of receivables, required capital expenditures in excess of those presently anticipated, or other future events, not presently predictable, which individually or in the aggregate could impair the Company's ability to obtain funds to meet its requirements. The Company currently has no material commitment for capital expenditures, except as discussed under "Overview", "Chemical Business" of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding the negotiations to build a new nitric acid plant. Foreign Subsidiary Financing The Company has guaranteed a revolving credit working capital facility (the "Facility") between TES and Bank of New Zealand. The Facility allows for borrowings based on specific percentages of qualified eligible assets. The Facility was amended on December 19, 1996 to allow for borrowings up to an aggregate of A$8.5 million Australian. This amendment also required a reduction of A$.5 million to the amount of A$8.0 million on or before February 28, 1997, then a further reduction of A$1.0 million to the amount of A$7.0 million (approximately US $5.6 million) on or before March 31, 1997. Based on the effective exchange rate at March 31, 1997,approximately US $4.6 million was borrowed at March 31, 1997. Such debt is secured by substantially all the assets of TES, plus an unlimited guarantee and indemnity from the Company. The interest rate on this debt is the Bank of New Zealand Corporate Lending Rate plus 0.5% (approximately 10.0% at March 31, 1997). The next annual review is due on September 30, 1997. TES is in technical non-compliance with a certain financial covenant contained in the loan agreement involving the Facility. However, this covenant was not met at the time of closing and the Bank of New Zealand agreed and continues to agree as of the date of this report that the covenant is something to work towards in the future and has continued to allow TES to borrow under the Facility. The outstanding borrowing under the facility at March 31, 1997 has been classified as due within one year in the accompanying Consolidated Financial Statements. Joint Ventures and Options to Purchase Prior to 1997, the Company, through a subsidiary, loaned $2.9 million to a French manufacturer of HVAC equipment whose product line is compatible with that of the Company's Environmental Control Business in the USA. Under the loan agreement, the Company has the option to exchange its rights under the loan for 100% of the borrower's outstanding common stock. The Company obtained a security interest in the stock of the French manufacturer to secure its loan. During the first quarter of 1997 the Company advanced an additional $1 million to the French manufacturer bringing the total of the loan at March 31, 1997 to $3.9 million. As of the date of this report, the decision has not been made to exercise such option and the $3.9 million loan, net of a $1.5 million valuation reserve, is carried on the books as a note receivable in other assets. During 1995, the Company executed a stock option agreement to acquire eighty percent (80%) of the stock of a specialty sales organization ("Optioned Company") to enhance the marketing of the Company's air conditioning products. The stock option has a four (4) year term, and a total option granting price of $1.0 million payable in installments including an option fee of $500,000 paid upon signing of the option agreement and annual $100,000 payments for yearly extensions of the stock option thereafter for up to three (3) years. Upon exercise of the stock option by the Company, or upon the occurrence of certain performance criteria which would give the grantors of the stock option the right to accelerate the date on which the Company must elect whether to exercise, the Company shall pay certain cash and issue promissory notes for the balance of the exercise price of the subject shares. The total exercise price of the subject shares is $4.0 million, less the amounts paid for the granting and any extensions of the stock option. In 1995, a subsidiary of the Company invested approximately $2.8 million to purchase a fifty percent (50%) equity interest in an energy conservation joint venture (the "Project"). The Project had been awarded a contract to retrofit residential housing units at a US Army base. The completed contract was for installation of energy-efficient equipment (including air conditioning and heating equipment), which would reduce utility consumption. For the installation and management, the Project will receive an average of seventy-seven percent (77%) of all energy and maintenance savings during the twenty (20) year contract term. The Project spent approximately $17.5 million to retrofit the residential housing units at the US Army base. The Project has received a loan from a lender to finance approximately $14.0 million of the cost of the Project. The Company is not guaranteeing any of the lending obligations of the Project. Debt Guarantee As disclosed in Note 4 of the Notes to Condensed Consolidated Financial Statements a subsidiary of the Company and one of its subsidiaries have guaranteed approximately $2.6 million of indebtedness of a start up aviation company in exchange for an ownership interest. The debt guarantee relates to two note instruments. One note for which the subsidiary had guaranteed up to $600,000 had a balance of approximately $400,000 as of March 31, 1997. The other note in the amount of $2.0 million requires monthly principal payments of $11,111 plus interest beginning in October 1998 through August 8, 1999, at which time all outstanding principal and accrued interest are due. In the event of default of the $2.0 million note, the Company is required to assume payments on the note with the term extended until August 2004. Both notes are current as to principal and interest. In 1996, the aviation company received a cash infusion of $4.0 million from an unrelated third party investor for a 41.6% ownership interest in the aviation company. The investor also retained an option to purchase additional stock of the aviation company in exchange for $4.0 million. Availability of Company's Loss Carryovers The Company anticipates that its cash flow in future years will benefit from its ability to use net operating loss ("NOL") carryovers from prior periods to reduce the federal income tax payments which it would otherwise be required to make with respect to income generated in such future years; however, such benefit will be limited by the Company's reduced NOL for alternative minimum tax purposes which is approximately $10.0 million at December 31, 1996. As of December 31, 1996, the Company had available NOL carryovers of approximately $45.0 million, based on its federal income tax returns as filed with the Internal Revenue Service for taxable years through 1995, and on the Company's estimates for 1996. These NOL carryovers will expire beginning in the year 1999. The above paragraph contains certain forward-looking statements. The amount of these carryovers has not been audited or approved by the Internal Revenue Service and, accordingly, no assurance can be given that such carryovers will not be reduced as a result of audits in the future. In addition, the ability of the Company to utilize these carryovers in the future will be subject to a variety of limitations applicable to corporate taxpayers generally under both the Internal Revenue Code of 1986, as amended, and the Treasury Regulations. These include, in particular, limitations imposed by Code Section 382 and the consolidated return regulations. Contingencies As discussed in Note 4 of Notes to Condensed Consolidated Financial Statements, the Company has several contingencies that could impact its liquidity in the event that the Company is unsuccessful in defending against the claimants. Although management does not anticipate that these claims will result in substantial adverse impacts on its liquidity, it is not possible to determine the outcome. The preceding sentence is a forward looking statement that involves a number of risks and uncertainties that could cause actual results to differ materially, such as, among other factors, the following: the EIL Insurance does not provide coverage to the Company and the Chemical Business for any material claims made by the claimants, the claimants alleged damages are not covered by the EIL Policy which a court may find the Company and/or the Chemical Business liable for, such as punitive damages or penalties, a court finds the Company and/or the Chemical Business liable for damages to such claimants for a material amount in excess of the limits of coverage of the EIL Insurance or a court finds the Chemical Business liable for a material amount of damages in the antitrust lawsuits pending against the Chemical Business in a manner not presently anticipated by the Company. Independent Accountants' Review Report Board of Directors LSB Industries, Inc. We have reviewed the accompanying condensed consolidated balance sheet of LSB Industries, Inc. and subsidiaries as of March 31, 1997, and the related condensed consolidated statements of operations and cash flows for the three month periods ended March 31, 1997 and 1996. These financial statements are the responsibility of the Company's management. We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our reviews, we are not aware of any material modifications that should be made to the accompanying condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of LSB Industries, Inc. as of December 31, 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended (not presented herein); and in our report dated March 7, 1997, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1996, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. Oklahoma City, Oklahoma May 20, 1997 ERNST & YOUNG LLP PART II OTHER INFORMATION Item 1. Legal Proceedings There are no additional material legal proceedings pending against the Company and/or its subsidiaries not previously reported by the Company in Item 3 of its Form 10-K for the fiscal period ended December 31, 1996, which Item 3 is incorporated by reference herein. Item 2. Changes in Securities Not applicable. Item 3. Defaults upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders Not applicable. Item 5. Other Information Not applicable. Item 6. Exhibits and Reports on Form 8-K (A) Exhibits. The Company has included the following exhibits in this report: 3.0(ii) The Bylaws of the Company, as amended. 4.1 Seventh Amendment dated April 11, 1997 to the Loan and Security Agreement dated December 12, 1994, between the Company and BankAmerica Business Credit, Inc. Substantially identical First Amendments dated April 11, 1997 to the Loan and Security Agreements dated December 12, 1994, were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing, Corp., and El Dorado Chemical Company and Slurry Explosive Corporation with BankAmerica Business Credit, Inc. and are hereby omitted and such will be provided upon the Commission's request. 10.1 Letter Amendment dated May 14, 1997 to Loan and Security Agreement between DSN Corporation and The CIT Group/Equipment Financing, Inc. 11.1 Statement Re: Computation of Per Share Earnings. 15.1 Letter Re: Unaudited Interim Financial Information. 27.1 Financial Data Schedule (B) Reports of Form 8-K. The Company did not file any reports on Form 8-K during the quarter ended March 31, 1997. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Company has caused the undersigned, duly- authorized, to sign this report on its behalf on this 20th day of May, 1997. LSB INDUSTRIES, INC. By: /s/ Tony M. Shelby -------------------------------- Tony M. Shelby, Senior Vice President of Finance (Principal Financial Officer) By: /s/ Jim D. Jones ---------------------------------- Jim D. Jones Vice President, Controller and Treasurer(Principal Accounting Officer)