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 June 30, 1999 _____________________________ 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 August 6, 1999 was 11,818,759 shares excluding 3,289,957 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 June 30, 1999, the condensed consolidated statements of operations and cash flows for the six month and three month periods ended June 30, 1999 and 1998 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 only of adjustments of a normal recurring nature, except for the loss provision recognized in the second quarter on firm raw material purchase commitments and a lower of cost or market adjustment as discussed in Note 10 to the Condensed Consolidated Financial Statements, which are, in the opinion of management, necessary for a fair presentation of the interim periods. The results of operations for the six months ended June 30, 1999, are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet at December 31, 1998, was derived from audited financial statements as of that date. Reference is made to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, for an expanded discussion of the Company's financial disclosures and accounting policies.
<TABLE> <CAPTION> LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Information at June 30, 1999 is unaudited) (dollars in thousands) June 30, December 31, ASSETS 1999 1998 ______ ________ ____________ <S> <C> <C> Current assets: Cash and cash equivalents $ 3,039 $ 1,555 Trade accounts receivable, net 58,143 52,730 Inventories: Finished goods 27,708 34,236 Work in process 7,930 7,178 Raw materials 21,469 22,431 _________ _________ Total inventory 57,107 63,845 Supplies and prepaid items 10,626 7,809 Long-lived assets to be disposed of net (Note 9) 4,694 - _________ _________ Total current assets 133,609 125,939 Property, plant and equipment, net 94,573 99,228 Other assets, net 22,523 23,480 _________ _________ $ 250,705 $ 248,647 ========= ========= </TABLE> (continued on following page) 2
<TABLE> <CAPTION> LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Information at June 30, 1999 is unaudited) (dollars in thousands) June 30, December 31, LIABILITIES AND STOCKHOLDERS' EQUITY 1999 1998 ____________________________________ ____________ ____________ <S> <C> <C> Current liabilities: Drafts payable $ 296 $ 758 Accounts payable 25,307 24,043 Accrued loss on firm purchase commitments (Note 10) 7,500 - Accrued liabilities 16,881 19,006 Current portion of long-term debt 26,020 13,954 __________ __________ Total current liabilities 76,004 57,761 Long-term debt (Note 6) 155,738 155,688 Commitments and Contingencies (Note 5) Redeemable, noncumulative convertible preferred stock, $100 par value; 1,463 shares issued and outstanding 139 139 Stockholders' equity (Notes 3 and 7): 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, 15,108,676 shares issued 1,511 1,511 Capital in excess of par value 39,286 38,329 Accumulated other comprehensive loss - (1,559) Accumulated deficit (53,687) (35,166) __________ __________ 35,110 51,115 Less treasury stock, at cost: Series 2 Preferred, 5,000 shares 200 200 Common stock, 3,289,957 shares (3,202,690 in 1998) 16,086 15,856 __________ __________ Total stockholders' equity 18,824 35,059 __________ __________ $ 250,705 $ 248,647 ========== ========== (see accompanying notes) 3
</TABLE> <TABLE> <CAPTION> LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Six Months Ended June 30, 1999 and 1998 (Amounts in thousands, except per share amounts) 1999 1998 ___________ ___________ <S> <C> <C> Businesses continuing at June 30,: Revenues: Net sales $ 149,578 $ 157,261 Other income (expenses) (147) 1,361 __________ __________ 149,431 158,622 Costs and expenses: Cost of sales (Note 10) 117,385 121,124 Selling, general and administrative 28,859 29,698 Provision for losses on firm purchase commitments (Note 10) 7,500 - Interest 8,834 8,602 __________ __________ 162,578 159,424 __________ __________ Loss before businesses disposed of or to be disposed of (13,147) (802) Businesses disposed of or to be disposed of (Note 9): Revenues 6,374 8,172 Operating costs, expenses and interest 8,105 9,404 __________ __________ (1,731) (1,232) Gain (loss) on disposal of business (1,971) 12,993 __________ __________ (3,702) 11,761 Income (loss) before provision for income taxes (16,849) 10,959 Provision for income taxes 50 260 __________ __________ Net income (loss) $ (16,899) $ 10,699 ========== ========== Net income (loss) applicable to common stock (Note 2) $ (18,521) $ 9,077 ========== ========== Weighted average common shares outstanding (Note 2): Basic 11,856,472 12,661,182 Diluted 11,856,472 17,456,828 Income (loss) per common share (Note 2): Basic $ (1.56) $ .72 ========== ========== Diluted $ (1.56) $ .61 ========== ========== </TABLE> (See accompanying notes) 4
<TABLE> <CAPTION> LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended June 30, 1999 and 1998 (Amounts in thousands, except per share amounts.) 1999 1998 _____________ ____________ <S> <C> <C> Businesses continuing at June 30: Revenues: Net sales $ 79,389 $ 83,972 Other income 62 259 ____________ ____________ 79,451 84,231 Costs and expenses: Cost of sales (Note 10) 63,310 63,585 Selling, general and administrative 14,531 14,697 Interest 4,467 3,879 Provision for losses on firm purchase commitments (Note 10) 7,500 - ____________ ____________ 89,808 82,161 ____________ ____________ Income (loss) before business disposed or to be disposed of (10,357) 2,070 Business disposed of or to be disposed of during 1999 (Note 9): Revenues 3,506 3,415 Operating costs, expenses and interest 4,267 4,084 ____________ __________ (761) (669) Loss on disposal of business (1,971) - ____________ __________ (2,732) (669) ____________ __________ Income (loss) before credit for income taxes (13,089) 1,401 Credit for income taxes - (20) ____________ __________ Net income (loss) $ (13,089) $ 1,421 ============ =========== Net income (loss) applicable to common stock (Note 2) $ (13,895) $ 618 ============ ========== Weighted average common shares outstanding (Note 2): Basic 11,835,020 12,576,185 Diluted 11,835,020 12,711,735 Income (loss) per common share (Note 2): Basic $ (1.17) $ .05 ============ =========== Diluted $ (1.17) $ .05 ============ =========== </TABLE> (see accompanying notes) 5
<TABLE> <CAPTION> LSB INDUSTRIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Six Months ended June 30, 1999 and 1998 (dollars in thousands) 1999 1998 __________ __________ <S> <C> <C> Cash flows from operations: Net income (loss) $ (16,899) $ 10,699 Adjustments to reconcile net income (loss) to cash flows provided(used) by operations: Depreciation, depletion and amortization: Property, plant and equipment 5,717 6,021 Other 636 677 Provision for possible losses on receivables and other assets 712 1,071 Inventory write-down and provision for losses on firm purchase commitments 9,100 - Loss on sale of assets 23 - Loss (gain) on businesses disposed of or to be disposed of 1,971 (12,993) Cash provided (used) by changes in assets and liabilities: Trade accounts receivable (5,669) (4,359) Inventories 5,429 3,786 Supplies and prepaid items (2,807) (1,580) Accounts payable 1,044 (2,598) Accrued liabilities (87) 544 __________ __________ Net cash provided (used) by operations (830) 1,268 Cash flows from investing activities: Capital expenditures (4,195) (3,837) Principal payments on loans receivable 480 40 Proceeds from sales of equipment and real estate properties 3 63 Proceeds from sale of the Tower - 29,266 Increase in other assets (157) (1,269) __________ __________ Net cash provided (used) by investing activities (3,869) 24,263 Cash flows from financing activities: Payments on long-term and other debt (4,341) (18,581) Borrowings on term notes 2,555 - Net change in revolving debt facilities 10,284 (3,290) Net change in drafts payable (463) 226 Dividends paid (Note 3): Preferred Stocks (1,622) (1,622) Common Stocks - (125) Purchases of treasury stock (Note 3) (230) (1,642) Net proceeds from issuance of common stock - 71 ___________ _________ Net cash provided (used) by financing activities 6,183 (24,963) ___________ _________ Net increase in cash and cash equivalents from all activities 1,484 568 Cash and cash equivalents at beginning of period 1,555 4,934 ___________ _________ Cash and cash equivalents at end of period $ 3,039 $ 5,502 =========== ========= </TABLE> (see accompanying notes) 6
LSB INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 Note 1: Income Taxes At December 31, 1998, the Company had regular- tax net operating loss ("NOL") carryforwards for tax purposes of approximately $63.8 million (approximately $31.4 million alternative minimum tax NOLs). Certain amounts of regular-tax NOL expire beginning in 1999. The Company's provision for income taxes for the six months ended June 30, 1999 of $50,000 is for current state income taxes and federal alternative minimum tax. Note 2: Earnings Per Share Net income or loss applicable to common stock is computed by adjusting net income or loss by the amount of preferred stock dividends. Basic income or loss per common share is based upon the weighted average number of common shares outstanding during each period after giving appropriate effect to preferred stock dividends. Diluted income or loss per share is 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, net of related income tax effects on convertible notes payable, as applicable. The Company has stock options, convertible preferred stock, and a convertible note payable, which are potentially dilutive. All of these potentially dilutive securities were antidilutive for the first six months of 1999 and have thus, been excluded from the computation of diluted loss per share for the six month and three month periods then ended. 7
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 <TABLE> <CAPTION> Note 2: Earnings Per Share (continued) The following table sets forth the computation of basic and diluted earnings per share: (dollars in thousands, except per share amounts) Six Months Three Months 1999 1998 1999 1998 __________ __________ __________ __________ <S> <C> <C> <C> <C> Numerator: Numerator for 1998 diluted earnings per share - net income (loss) $ (16,899) $ 10,699 $(13,089) $ 1,421 Preferred stock dividends (1,622) (1,622) (806) (803) __________ __________ _________ _________ Numerator for 1999 and 1998 basic and 1999 diluted earnings per share - income (loss) available to common stockholders (18,521) 9,077 (13,895) 618 Preferred stock dividends on preferred stock assumed to be converted - 1,622 - - __________ __________ __________ __________ Numerator for 1998 diluted earnings per share $ (18,521) $ 10,699 $ (13,895) $ 618 ========== ========== ========== ========== Denominator: Denominator for basic earnings per share - weighted-average shares 11,856,472 12,661,182 11,835,020 12,576,185 Effect of dilutive securities: Employee stock options - 128,290 - 131,550 Convertible preferred stock - 4,662,726 - - Convertible note payable - 4,000 - 4,000 __________ ___________ __________ __________ Dilutive potential common shares - 4,795,646 135,550 __________ ___________ __________ __________ Denominator for diluted earnings per share - adjusted weighted- average shares and assumed conversions 11,856,472 17,456,828 11,835,020 12,711,735 =========== =========== ========== ========== Basic earnings (loss) per share $ (1.56) $ .72 $ (1.17) $ .05 =========== =========== =========== ========== Diluted earnings (loss) per share $ (1.56) $ .61 $ (1.17) $ .05 =========== =========== =========== ========= </TABLE> 8
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months ended June 30, 1999 and 1998 <TABLE> <CAPTION> Note 3: Stockholders' Equity. The table below provides detail of activity in the stockholders' equity accounts for the six months ended June 30, 1999: Common Stock Non- Capital Accumulated _______________ redeemable in excess Other Com- Par Preferred of par prehensive Shares Value Stock Value Loss _______ ______ _________ ________ __________ (In thousands) <S> <C> <C> <C> <C> <C> Balance at December 31, 1998 15,109 $ 1,511 $ 48,000 $ 38,329 $(1,559) Net loss Foreign currency trans- lation adjustment 1,559 Total comprehensive income (Note 8) Expiration of employee stock option and related accrued compensation 957 Dividends declared: Series B 12% pre- ferred stock ($6.00 per share) Series 2 preferred stock ($1.625 per share) Redeemable preferred stock ($10.00 per share) Purchase of treasury stock ______ _______ _________ ________ _________ (1) Balance at June 30, 1999 15,109 $ 1,511 $ 48,000 $ 39,286 $ -0- ======= ======= ======== ======== ======== Treasury Accumu Treasury Stock lated Stock Prefer- Deficit Common red Total _________ ________ ________ _______ <S> <C> <C> <C> <C> $(35,166) $(15,856) $ (200) $35,059 (16,899) (16,899) 1,559 ________ (15,340) 957 (120) (120) (1,487) (1,487) (15) (15) (230) (230) ________ ________ _________ _______ $(53,687) $(16,086) $ (200) $18,824 ======== ======= ========= ======= <FN> (1) Includes 3,290 shares of the Company's Common Stock held in treasury. Excluding the 3,290 shares held in treasury, the outstanding shares of the Company's Common Stock at June 30, 1999 were 11,819. </FN> </TABLE> 9
<TABLE> <CAPTION> Note 4: Segment Information ___________________________ Six Months Ended Three Months Ended June 30, June 30, ____________________ ____________________ 1999 1998 1999 1998 ____ ____ ____ ____ (in thousands) (unaudited) <S> <C> <C> <C> <C> Net sales: Businesses continuing: Chemical $ 69,690 $ 69,315 $ 38,945 $ 40,637 Climate Control 56,025 59,257 29,326 29,321 Automotive Products 18,993 21,198 8,888 10,708 Industrial Products 4,870 7,491 2,230 3,306 Business to be disposed of - Chemical 6,374 8,208 3,506 3,461 _________ _________ __________ __________ $ 155,952 $ 165,469 $ 82,895 $ 87,433 ========= ========= ========== ========= Operating profit (loss): Businesses continuing: Chemical: Recurring operations $ 4,125 $ 6,606 $ 2,678 $ 5,027 Inventory write-down and losses on purchase commitments (9,100) - (9,100) - ________ _________ _________ _________ (4,975) 6,606 (6,422) 5,027 Climate Control 5,715 6,312 3,008 3,500 Automotive Products (299) 71 (308) 478 Industrial Products (913) (518) (501) (214) Business to be disposed of - Chemical (1,488) (995) (643) (567) _________ _________ _______ _______ (1,960) 11,476 (4,866) 8,224 General corporate expenses and other (3,841) (4,671) (1,667) (2,842) Interest expense: Business to be disposed of (243) (237) (118) (102) Recurring operations (8,834) (8,602) (4,467) (3,879) _________ _________ ________ ________ (9,077) (8,839) (4,585) (3,981) Gain (loss) on business disposed of or to be disposed of (1,971) 12,993 (1,971) - _________ _________ ________ ________ Income (loss) before pro- vision for income taxes $ (16,849) $ 10,959 $ (13,089) $ 1,401 ========== ========= ========= ======== </TABLE> 10
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 Note 5: Commitments and Contingencies Nitric Acid Project ___________________ In June 1997, two wholly owned subsidiaries of the Company, El Dorado Chemical Company ("EDC"), and El Dorado Nitrogen Company ("EDNC"), entered into a series of agreements with Bayer Corporation ("Bayer") (collectively, the "Bayer Agreement"). Under the Bayer Agreement, EDNC agreed to act as an agent to construct, and upon completion of construction, operate a nitric acid plant (the "EDNC Baytown Plant") at Bayer's Baytown, Texas chemical facility. The construction of the EDNC Baytown Plant was completed in May 1999, and EDNC began producing and delivering nitric acid to Bayer at that date. Sales by EDNC to Bayer out of the EDNC Baytown Plant production during the quarter ended June 30, 1999, were approximately $4 million. EDC guaranteed the performance of EDNC's obligations under the Bayer Agreement. Under the terms of the Bayer Agreement, EDNC is leasing the EDNC Baytown plant pursuant to a leveraged lease from an unrelated third party with an initial lease term of ten years. Upon expiration of the initial ten-year term, the Bayer Agreement may be renewed for up to six renewal terms of five years each; however, prior to each renewal period, either party to the Bayer agreement may opt against renewal. Financing of the EDNC Baytown Plant was provided by an unaffiliated lender. Neither the Company nor EDC has guaranteed any of the repayment obligations for the EDNC Baytown Plant. In connection with the leveraged lease, the Company entered into an interest rate forward agreement to fix the effective rate of interest implicit in such lease. As of June 30, 1999, the Company has deferred approximately $2.9 million associated with such agreement which will be amortized over the initial term of the lease. See Note 7, "Changes in Accounting," for the expected accounting upon adoption of SFAS #133. In January 1999, the contractor constructing the EDNC Baytown Plant under a turnkey agreement, informed the Company that it could not complete construction alleging a lack of financial resources. EDNC at that time demanded that the contractor's bonding company provide funds necessary for subcontractors to complete construction. A substantial portion of the costs to complete the EDNC Baytown Plant ($12.9 million), which were to be funded by the construction contractor, have been funded by proceeds from the bonding company; however, the nonperformance by the contractor constructing the EDNC Baytown Plant increased the cost of the plant which is reflected in higher rentals under the Company's leveraged lease. Debt Guarantee ______________ The Company previously guaranteed up to approximately $2.6 million of indebtedness of a start-up aviation company, Kestrel Aircraft Company ("Kestrel"), in exchange for a 44.9% ownership interest. At December 31, 1998, the Company had accrued the full amount of its commitment under the debt guarantees and fully reserved its investments and advances to Kestrel. In the first quarter of 1999, upon demand of the Company's guarantee, the Company assumed the obligation for a $2.0 million term note, due in equal monthly principal payments of $11,111, plus interest, through August 2004 11
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 and funded approximately $500,000 resulting from a subsidiary's partial guarantee of Kestrel's obligation under a revolving credit facility. In connection with the demand of the Company to perform under its guarantees, the Company and the other guarantors formed a new company ("KAC") which acquired the assets of the aviation company through foreclosure. The Company and the other shareholders of KAC are attempting to sell the assets acquired in foreclosure. Proceeds received by the Company, if any, from the sale of KAC assets will be recognized in the results of operations when and if realized. Legal Matters _____________ Following is a summary of certain legal actions involving the Company: A. In 1987, the U.S. Environmental Protection Agency ("EPA") 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. In 1990, the EPA added the site to the National Priorities List. Following the remedial investigation and feasibility study, in 1992 the Regional Administrator of the EPA signed the Record of Decision ("ROD") for the site. The ROD detailed EPA's selected remedial action for the site and estimated the cost of the remedy at $3.6 million. In 1992, the Company made settlement proposals which would have entailed a collective payment by the subsidiaries of $47,000. The site owner rejected this offer and proposed a counteroffer of $245,000 plus a reopener for costs over $12.5 million. The EPA rejected the Company's offer, allocating 60% of the cleanup costs to the potentially responsible parties and 40% to the site operator. The EPA estimated the total cleanup costs at $10.1 million as of February 1993. The site owner rejected all settlements with the EPA, after which the EPA issued an order to the site owner to conduct the remedial design/remedial action approved for the site. In August 1997, the site owner issued an "invitation to settle" to various parties, alleging the total cleanup costs at the site may exceed $22 million. 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 the estimated total cost of clean-up of the site and the percentage of the total waste which was alleged to have been contributed to the site by the Company. As of June 30, 1999, the Company has accrued an amount based on a preliminary settlement proposal by the alleged potential responsible parties; however, there is no assurance such proposal will be accepted. Such amount is not material to the Company's financial position or results of operations. This estimate is subject to material change in the near term as additional information is obtained. The subsidiary's insurance carriers have been notified of this matter; however, the amount of possible coverage, if any, is not yet determinable. 12
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 B. On February 12, 1996, the Chemical Business entered into a Consent Administrative Agreement ("Administrative Agreement") with the state of Arkansas to resolve certain compliance issues associated with nitric acid concentrators. Pursuant to the Administrative Agreement, the Chemical Business installed additional pollution control equipment to address the compliance issues. The Chemical Business was assessed $50,000 in civil penalties associated with the Administrative Agreement. In the summer of 1996 and then on January 28, 1997, the subsidiary executed amendments to the Administrative Agreement ("Amended Agreements"). The Amended Agreements imposed a $150,000 civil penalty, which penalty has been paid. Since the 1997 amendment, the Chemical Business has been assessed stipulated penalties of approximately $67,000 by the Arkansas Department of Pollution Control and Ecology ("ADPC&E") for violations of certain provisions of the 1997 Amendment. The Chemical Business believes that the El Dorado Plant has made progress in controlling certain off-site emissions; however, such off-site emissions have occurred and continue to occur from time to time, which could result in the assessment of additional penalties against the Chemical Business by the ADPC&E for violation of the 1997 Amendment. During May 1997, approximately 2,300 gallons of caustic material spilled when a valve in a storage vessel failed, which was released to a storm water drain, and according to ADPC&E records, resulted in a minor fish kill in a drainage ditch near the El Dorado Plant. In 1998, the ADPC&E issued a Consent Administrative Order ("1998 CAO") to resolve the event. The 1998 CAO includes a civil penalty in the amount of $183,700 which includes $125,000 to be paid over five years in the form of environmental improvements at the El Dorado Plant. The remaining $58,700 was paid in 1998. The 1998 CAO also requires the Chemical Business to undertake a facility-wide wastewater evaluation and pollutant source control program and wastewater facility-wide wastewater minimization program. The program requires that the subsidiary complete rainwater drain-off studies including engineering design plans for additional water treatment components to be submitted to the ADCP&E by August 2000. The construction of the additional water treatment components shall be completed by August 2001 and the El Dorado plant has been mandated to be in compliance with final effluent limits on or before February 2002. The wastewater program is currently expected to require future capital expenditures of approximately $5.0 million. C. 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 13
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 defendants, to fix prices in connection with the sale of commercial explosives. This litigation has been consolidated, for discovery purposes only, with several other actions in a multi-district litigation proceeding in Utah. Discovery in this litigation is in process. 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. During the third quarter of 1997, a subsidiary of the Company was served with a lawsuit in which approximately 27 plaintiffs have sued approximately 13 defendants, including a subsidiary of the Company alleging personal injury and property damage for undifferentiated compensatory and punitive damages of approximately $7,000,000. Specifically, the plaintiffs assert property damage to their residence and wells, annoyance and inconvenience, and nuisance as a result of daily blasting and round-the-clock mining activities. The plaintiffs are residents living near the Heartland Coal Company ("Heartland") strip mine in Lincoln County, West Virginia, and an unrelated mining operation operated by Pen Coal Inc. During 1999, the plaintiffs withdrew all personal injury claims previously asserted in this litigation. Heartland employed the subsidiary to provide blasting materials and personnel to load and shoot holes drilled by employees of Heartland. Down hole blasting services were provided by the subsidiary at Heartland's premises from approximately August 1991, until approximately August 1994. Subsequent to August 1994, the subsidiary supplied blasting materials to the reclamation contractor at Heartland's mine. In connection with the subsidiary's activities at Heartland, the subsidiary has entered into a contractual indemnity to Heartland to indemnify Heartland under certain conditions for acts or actions taken by the subsidiary for which the subsidiary failed to take, and Heartland is alleging that the subsidiary is liable thereunder for Heartland's defense costs and any losses to, or damages sustained by, the plaintiffs in this lawsuit as a result of the subsidiary's operations. Subject to final documentation, this litigation has been settled with the subsidiary's payment of approximately $81,000, which was accrued at June 30, 1999. The Company, including its subsidiaries, is a party to various other claims, legal actions, and complaints arising in the ordinary course of business. In 14
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 the opinion of management after consultation with counsel, all claims, legal actions (including those described above) and complaints are not presently probable of material loss, 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 is not presently expected to 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. Note 6: Long-Term Debt ______________________ In November, 1997, the Company's wholly owned subsidiary, ClimaChem, Inc. ("ClimaChem"), completed the sale of $105 million principal amount of 10 3/4% Senior Notes due 2007, (the "Notes"). Interest on the Notes is payable semiannually in arrears on June 1 and December 1 of each year, and the principal is payable in the year 2007. The Notes are senior unsecured obligations of ClimaChem and rank pari passu in right of payment to all existing senior unsecured indebtedness of ClimaChem and its subsidiaries. The Notes are effectively subordinated to all existing and future senior secured indebtedness of ClimaChem. ClimaChem owns substantially all of the companies comprising the Company's Chemical and Climate Control Businesses. ClimaChem is a holding company with no assets or operations other than its investments in its subsidiaries, and each of its subsidiaries is wholly owned, directly or indirectly, by ClimaChem. ClimaChem's payment obligations under the Notes are fully, unconditionally and joint and severally guaranteed by all of the existing subsidiaries of ClimaChem, except for El Dorado Nitrogen Company ("EDNC"). The assets, equity, and earnings of EDNC are currently inconsequential to ClimaChem. Separate financial statements and other disclosures concerning the guarantors are not presented herein because management has determined they are not material to investors. Summarized consolidated unaudited balance sheet information of ClimaChem and its subsidiaries as of June 30, 1999 and December 31, 1998 and the results of operations for the six month and three month periods ended June 30, 1999 and 1998 are detailed below. 15
<TABLE> <CAPTION> June 30, December 31, 1999 1998 _____________ _____________ (in thousands) <S> <C> <C> Balance sheet data: Current assets (1)(2) $ 103,785 $ 90,291 Property, plant and equipment, net 78,689 82,389 Income tax receivable 1,750 - Notes receivable from LSB and affiliates, net 13,443 13,443 Other assets, net 16,083 10,480 ___________ ___________ Total assets $ 213,750 $ 196,603 =========== =========== Current liabilities $ 48,540 $ 35,794 Long-term debt 138,730 127,471 Deferred income taxes 9,755 9,580 Stockholders' equity 16,725 23,758 __________ __________ Total liabilities and stockholders equity $ 213,750 $ 196,603 ========== ========== </TABLE> <TABLE> <CAPTION> Six Months Ended Three Months Ended June 30, June 30, 1999 1998 1999 1998 _________________________________________________ <S> <C> <C> <C> <C> Operations data: Total revenues $ 132,092 $ 137,327 $ 71,863 $ 73,900 Costs and expenses: Cost of sales 105,557 107,439 58,387 57,028 Selling, general and administrative 22,083 20,348 11,202 10,569 Loss on business to be disposed of 1,971 - 1,971 - Provision for losses on firm purchase commit- ments 7,500 - 7,500 - Interest 6,647 6,273 3,368 2,960 ________ _________ __________ _________ 143,758 134,060 82,428 70,557 ________ _________ __________ _________ Income (loss) before pro- vision (credit) for income taxes (11,666) 3,267 (10,565) 3,343 Provision (credit) for income taxes (3,074) 1,700 (3,124) 1,730 __________ _________ _________ ________ Net income (loss) $ (8,592) $ 1,567 $ (7,441) $ 1,613 ========== ========= ========= ========= 16
<FN> (1) Notes and other receivables from LSB and affiliates are eliminated when consolidated with LSB. (2) Current assets include receivables due from LSB which aggregate $1.6 million and $5.0 million at June 30, 1999, and December 31, 1998, respectively. </FN> </TABLE> The Company funded a term and revolving line of credit of a total of $18.5 million with an asset-based lender for its Automotive Products Business on May 10, 1999. This facility replaced the Automotive Products Business' previous loan agreement under the Company's Revolver and provides for a $2.5 million term loan and a $16.0 million revolving credit facility (an increase of borrowing ability calculated as of May 10, 1999, of $3.5 million compared to the Automotive Products Business' availability under the replaced facility) based on eligible amounts of accounts receivable and inventory. This facility provides for interest at a bank's prime rate plus one percent (1%) per annum, or at the Company's option, the lender's LIBOR rate plus two and three-quarters percent (2.75%) per annum. The effective interest rate at June 30, 1999, was 7.93%. The term of this new facility is through May 7, 2001, and is renewable thereafter for successive twelve-month terms. As a result of the terms and conditions of this facility, outstanding borrowings under the revolving credit facility of $9.2 million at June 30, 1999 and $.6 million under the term loan are classified as long-term debt due within one year (borrowings by the Automotive Products Business under the Company's revolving credit agreements were classified as long-term debt due after one year in the accompanying condensed consolidated balance sheets as of December 31, 1998). The Automotive Products Business was required to secure such loan with substantially all of its assets. The loan agreement contains various affirmative and negative covenants, including a requirement to maintain tangible net worth of not less than $6.4 million. The Company was required to provide the lender with a $1.0 million standby letter of credit to further secure such loan. As a result of this financing, the Company's Revolving Credit Facility, that is not available to the Automotive Products Business, now provides for the elimination of its financial covenants so long as the remaining borrowing group maintains a minimum aggregate availability under such facility of at least $15 million. As of June 30, 1999, the remaining borrowing group had availability of $16.4 million. Note 7: Change in Accounting In June, 1998, the Financial Accounting Standards Board issued Statement No. 133 ("SFAS #133"), Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted in years beginning after June 15, 2000. The Statement permits early adoption as of the beginning of any fiscal quarter after its issuance. The Company has not yet determined when this new Statement will be adopted. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair 17
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 10, 1999 and 1998 value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company has not yet determined what all of the effects of SFAS #133 will be on the earnings and financial position of the Company; however, the Company expects that the deferred charges associated with the interest rate forward agreement discussed in Note 5, "Nitric Acid Project," will be accounted for as a cash flow hedge upon adoption of SFAS #133, with the effective portion of the hedge being classified in equity in accumulated other comprehensive income or loss. The amount included in accumulated other comprehensive income or loss will be amortized to income over the initial term of the leveraged lease. Note 8: Comprehensive Income The Company presents comprehensive income in accordance with Financial Accounting Standard No. 130 "Reporting Comprehensive Income" ("SFAS 130"). The provisions of SFAS 130 require the Company to classify items of other comprehensive income in the financial statements and display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the balance sheet. Other comprehensive income for the six month and three month periods ended June 30, 1999 and 1998 is detailed below. <TABLE> <CAPTION> Six Months Three Months Ended June 30, Ended June 30, ______________________ ______________________ 1999 1998 1999 1998 _______________________________________________ (in thousands) (in thousands) <S> <C> <C> <C> <C> Net income (loss) $ (16,899) $ 10,699 $ (13,089) $ 1,421 Foreign currency translation income (loss) 1,559 (606) 1,337 (616) _________ _________ _________ _________ Total comprehensive income (loss) $ (15,340) $ 10,093 $ (11,752) $ 805 ========= ======== ========= ========= </TABLE> Note 9: Business Disposed of or to be Disposed of. On May 7, 1999, the Company's wholly owned subsidiary, Total Energy Systems Limited and its subsidiaries ("TES") entered into an agreement (the "Asset Sale Agreement") to sell substantially all the assets of TES ("Defined Assets"). Under the Asset Sale Agreement, TES retains its liabilities and will liquidate such liabilities from the proceeds of the sale and from the collection of its accounts receivables which were retained by TES pursuant to the Asset Sale Agreement. The loss associated with this transaction included in the accompanying Condensed Consolidated Statements of Operations for the six months and three months ended June 30, 1999, is approximately $1,971,000 and is comprised of disposition costs of approximately $.3 million, the recognition in earnings of 18
LSB INDUSTRIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Six Months Ended June 30, 1999 and 1998 the cumulative foreign currency loss of approximately $1.1 million at June 30, 1999, and approximately $.6 million related to the resolution of certain environmental matters. The Company received approximately $3.4 million at closing on August 2, 1999, in net proceeds from the assets sold, exclusive of approximately $.7 million related to an agreed to retention related to the final reconciliation of the value of the inventory sold, after paying off $6.4 million bank debt and the purchaser assuming approximately $1.1 million debt related to certain capitalized lease obligations. The Company expects to complete the liquidation of the assets and liabilities retained during the fourth quarter of 1999. In March 1998, the Company closed the sale of real estate and realized proceeds of $29.3 million net of transaction costs and a gain onthe transaction of approximately $13 million. Note 10: Inventory Write-down and Loss on Firm Purchase Commitments ___________________________________________________________________ Due to decreased selling prices for certain of the Chemical Business' nitrogen-based products, the Chemical Business wrote-down the carrying value of certain inventories at June 30, 1999, by approximately $1.6 million, representing the cost in excess of market. At June 30, 1999, the Chemical Business has firm uncancelable commitments to purchase anhydrous ammonia pursuant to the terms of two contracts. The purchase price(s) the Chemical Business will be required to pay for anhydrous ammonia under one of these contracts, which is for a significant percentage of the Chemical Business' anhydrous ammonia requirements, currently exceeds and is expected to continue to exceed the spot market prices throughout the purchase period. Additionally, the current excess supply of nitrate-based products caused, in part, by the import of Russian nitrate, has caused a significant decline in the sales prices, with no improvement in sales prices expected in the near term. Due to the decline in sales prices, the cost to produce the nitrate-based products, including the cost of the anhydrous ammonia to be purchased under the contracts, exceeds the anticipated future sales prices of such products. As a result, the accompanying Condensed Consolidated Financial Statements include a loss provision for anhydrous ammonia required to be purchased during the remainder of the contracts of approximately $7.5 million. The loss provision recorded as of June 30, 1999, is based on the forward contract pricing existing at June 30, 1999. This pricing can move upward or downward in future periods. Based on forward pricing existing as of August 13, 1999, the Chemical Business would be required to recognize an additional $400,000 loss. This loss provision estimate may change in the near term. 19
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 the Company's June 30, 1999 Condensed Consolidated Financial Statements. Certain statements contained in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" may be deemed forward-looking statements. See "Special Note Regarding Forward-Looking Statements". OVERVIEW General _______ The Company is pursuing a strategy of focusing on its core businesses and concentrating on product lines in niche markets where the Company has established or believes it 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 and does not reasonably expect to do so. In this connection, the Company has come to the conclusion that its Automotive and Industrial Products Businesses are non-core to the Company and the Company is exploring various alternatives to maximize shareholder value from these assets. The Company is also considering the sale of other assets that are non-core to its Chemical and Climate Control Businesses. The Company recently concluded its evaluation of the spin-off of its Automotive Business ("Automotive") to its shareholders as a dividend and decided that it would not be able to spin-off Automotive. The Company is continuing to evaluate other methods of reducing or eliminating its investment in Automotive. As part of its efforts, the Company has finalized a new credit facility for Automotive. See "Liquidity & Capital Resources" of this MD&A for a description of the credit facility. The Company has further announced that it is negotiating to sell its Industrial Products Business. The terms of such sale, if any, have not been finalized, and there are no assurances that the Company will finalize its negotiations or, if such is finalized, whether the terms thereof will be acceptable to the Company. Certain statements contained in this Overview are forward-looking statements, and future results could differ materially from such statements. 20
<TABLE> <CAPTION> Information about the Company's operations in different industry segments for the six month and three month periods ended June 30, 1999 and 1998 is detailed below. Six Months Ended Three Months Ended June 30, June 30, 1999 1998 1999 1998 __________ _________ _________ _________ (in thousands) (unaudited) <S> <C> <C> <C> <C> Sales: Businesses continuing: Chemical $ 69,690 $ 69,315 $ 38,945 $ 40,637 Climate Control 56,025 59,257 29,326 29,321 Automotive Products 18,993 21,198 8,888 10,708 Industrial Products 4,870 7,491 2,230 3,306 Business to be disposed of Chemical(1) 6,374 8,208 3,506 3,461 ________ ________ ________ ________ $155,952 $165,469 $ 82,895 $ 87,433 ======== ======== ======== ======== Gross profit (loss) (2): Businesses continuing: Chemical $ 11,227 $ 12,150 $ 6,270 $ 7,725 Climate Control 17,313 17,321 8,992 8,985 Automotive Products 4,008 4,966 1,912 2,826 Industrial Products 1,247 1,700 507 851 Business to be disposed of Chemical(1) (229) 159 (71) ( 8) ________ ________ ________ ________ $ 33,566 $ 36,296 $ 17,610 $ 20,379 ======== ======== ======== ======== Operating profit (loss) (3): Businesses continuing: Chemical: Recurring operations $ 4,125 $ 6,606 $ 2,678 $ 5,027 Inventory write-down and losses on purchase commitments (9,100) - (9,100) - ________ _______ _______ _______ (4,975) 6,606 (6,422) 5,027 Climate Control 5,715 6,312 3,008 3,500 Automotive Products (299) 71 (308) 478 Industrial Products (913) (518) (501) (214) Businesses to be disposed of Chemical(1) (1,488) (995) (643) (567) ________ ________ _______ ______ (1,960) 11,476 (4,866) 8,224 General corporate expenses (3,841) (4,671) (1,667) (2,842) Interest expense: Business to be disposed of (243) (237) (118) (102) Recurring operations (8,834) (8,602) (4,467) (3,879) ________ ________ _______ _______ (9,077) (8,839) (4,585) (3,981) Gain (loss) on business disposed of or to be disposed of (1,971) 12,993 (1,971) - ________ ________ _______ _______ Income (loss) before provision for income taxes $(16,849) $ 10,959 $(13,089) $ 1,401 ======== ======== ======== ======= <FN> (1) On May 7, 1999, the Company's wholly owned Australian subsidiary, TES, entered into an agreement to sell 21
substantially all of its assets which sale was substantially completed on August 2, 1999. See Note 9 of Notes to Condensed Consolidated Financial Statements for further information. The operating results for TES have been presented separately in the above table. (2) Gross profit by industry segment represents net sales less cost of sales exclusive of the $1.6 million write-down of inventory. (3) Operating profit (loss) by industry segment represents revenues less operating expenses before deducting general corporate expenses, interest expense and income taxes and before gain on sale of the Tower in 1998. </FN> </TABLE> Chemical Business _________________ Sales in the Chemical Business (excluding the Australian subsidiary in which substantially all of its assets were disposed of in August, 1999) have increased from $69.3 million in the six months ended June 30, 1998 to $69.7 million in the six months ended June 30, 1999 and the gross profit (excluding the Australian subsidiary, the inventory write-down and provision for loss on firm purchase commitments) has decreased from $12.2 million in 1998 to $11.2 in 1999. The gross profit percentage (excluding the Australian subsidiary and the effect of the $1.6 million inventory adjustment in 1999) has decreased from 17.5% in 1998 to 16.1% in 1999. The decline in sales price exceeded the decline in raw material costs resulting in a lower gross profit margin. As of June 30, 1999, the Chemical Business has commitments to purchase approximately 200,000 tons of anhydrous ammonia under two contracts. The Company's purchase price of anhydrous ammonia under these contracts can be higher or lower than the current market spot price of anhydrous ammonia. Pricing is subject to variations due to numerous factors contained in these contracts. Based on the pricing index contained in one of these contracts, it is presently priced above the current market spot price. As of June 30, 1999, the Chemical Business has remaining purchase commitments of approximately 120,000 tons under this contract. The Chemical Business is required to purchase a minimum of 7,000 tons monthly under another contract expiring in June 2000. As stated above, the Chemical Business has commitments to purchase anhydrous ammonia pursuant to the terms of two contracts. The purchase price(s) the Chemical Business will be required to pay for anhydrous ammonia under one of these contracts currently exceeds and is expected to continue to exceed the spot market prices throughout the purchase period. Additionally, the current excess supply of nitrate-based products, caused, in part, by the import of Russian nitrate, has caused a significant decline in the sales prices; no improvement in sales prices is expected in the near term. This decline in sales price has resulted in the cost of anhydrous ammonia purchased under these contracts when combined with manufacturing and distribution costs, to exceed anticipated future sales prices. As a result, the accompanying Condensed Consolidated Financial Statements include a loss provision for anhydrous ammonia required to be purchased during the remainder of the contracts of approximately $7.5 million. The provision for 22
loss at June 30, 1999, is based on the forward contract pricing existing at June 30, 1999, and estimated market prices for products to be manufactured and sold during the remainder of the contracts. This is a forward-looking statement, and there are no assurances that such estimates will be proven to be accurate. Differences, if any, in the estimated future cost of anhydrous ammonia and the actual cost in effect at the time of purchase and differences in the estimated sales prices and actual sales prices of products manufactured could cause the Company's operating results to differ from that estimated in arriving at the loss provision recorded at June 30, 1999. The Chemical Business currently has an excess inventory of nitrogen- based products on hand. Additionally, substantial excess stocks of competing nitrogen products on the market have resulted in a cutback in the production level at the El Dorado Arkansas facility. There are no assurances that the Chemical Business will not be required to record additional loss provisions in the future. Based on the forward pricing existing as of August 13, 1999, the Chemical Business would be required to recognize an additional $400,000 loss. See "Special Note Regarding Forward-Looking Statements." Due to decreased selling prices for certain of the Chemical Business' nitrogen-based products, the Chemical Business also wrote down the carrying value of certain inventories at June 30, 1999, by approximately $1.6 million, representing the cost in excess of market value. In June, 1997, a subsidiary of the Company entered into an agreement with Bayer Corporation ("Bayer") whereby one of the Company's subsidiaries agreed to act as agent to construct a nitric acid plant located within Bayer's Baytown, Texas chemical plant complex. The construction of the plant was completed during the quarter ended June 30, 1999. This plant is being operated by the Company's subsidiary and is supplying nitric acid for Bayer's polyurethane business under a long-term supply contract. Sales from this plant were approximately $2.8 million during the quarter ended June 30, 1999. Management estimates that, at full production capacity based on terms of the Bayer Agreement and , based on the price of anhydrous ammonia as of the date of this report, the plant should generate approximately $35 million to $40 million in annual gross revenues. Unlike the Chemical Business' regular sales volume, the market risk on this additional volume is much less since the contract provides for recovery of costs, as defined, plus a profit. The Company's subsidiary is leasing the nitric acid plant pursuant to a leverage lease from an unrelated third party for an initial term of ten (10) years which began on June 23, 1999. See "Special Note Regarding Forward-Looking Statements." The results of operation of the Chemical Business' Australian subsidiary have been adversely affected due to the recent economic developments in certain countries in Asia. These economic developments 23
in Asia have had a negative impact on the mining industry in Australia which the Company's Chemical Business services. As these adverse economic conditions in Asia have continued, they have had an adverse effect on the Company's consolidated results of operations. On May 7, 1999, the Company's wholly owned Australian subsidiary entered into an agreement to sell substantially all of its assets. This transaction was substantially completed on August 2, 1999. Revenues of the Australian subsidiary for the six month and three month periods ended June 30, 1999, and June 30, 1998, were $6.4 million, $8.2 million, $3.5 million, and $3.5 million, respectively. For the year ended December 31, 1998, the Australian subsidiary had revenues of $14.2 million and a net loss of $2.9 million; $3.7 million net loss for the six months ended June 30, 1999, including a loss on sale of $2.0 million. See Note 9 of Notes to Condensed Consolidated Financial Statements for further information concerning this transaction. Climate Control _______________ The Climate Control Business manufactures and sells a broad range of hydronic fan coil, air handling, air conditioning, heating, water source heat pumps, and dehumidification products targeted to both commercial and residential new building construction and renovation. The Climate Control Business focuses on product lines in the specific niche markets of hydronic fan coils and water source heat pumps and has established a significant market share in these specific markets. Although sales of $56.0 million for the six months ended June 30, 1999, in the Climate Control Business were approximately 5% less than sales of $59.3 million in the six months ended June 30, 1998, the gross profit percentage improved from 29.2% in the first six months of 1998 to 30.9% in the first six months of 1999. Automotive and Industrial Products Businesses _____________________________________________ As indicated in the above table, during the six months ended June 30, 1999 and 1998, respectively, the Automotive and Industrial Products recorded combined sales of $23.9 million and $28.7 million, respectively, and reported operating losses (as defined above) of $1.2 million and $.4 million, respectively. The net investment in assets of these Businesses has decreased during the last three years and the Company expects to realize further reductions in future periods. During the quarter ended June 30, 1999, the Automotive Business converted its investment in a wholly-owned subsidiary, International Bearings, Inc. ("IBI") to a fifty percent (50%) non-controlling investment in a joint venture ("the JV") continuing the industrial bearings business formerly operated by IBI. Automotive sold its inventory, having a book value of approximately $2.4 million to the JV for approximately $1.5 million cash and $.9 million in interest bearing notes. Automotive retains an equity interest in the JV which has not been assigned any value at June 30, 1999. IBI retained receivables of approximately $600,000 which should be fully collected during the third quarter 1999. The Company continues to eliminate certain categories of machines from the Industrial Products product line by not replacing machines when sold. The Company previously announced that it is negotiating the sale 24
of its Industrial Products Business. The sale of the Industrial Products Business is a forward-looking statement and is subject to, among other things, the buyer's and the Company's lending institutions agreeing to the terms of the transaction, including the purchase price, approval of the Company's Board of Directors and negotiation and finalization of definitive agreements. RESULTS OF OPERATIONS Six months ended June 30, 1999 vs. Six months ended June 30, 1998. _________________________________________________________________ Revenues ________ Total revenues, excluding the gain on the disposition of a business in 1998, for the six months ended June 30, 1999 and 1998 were $155.8 million and $166.8 million, respectively (a decrease of $11.0 million). Sales decreased $9.5 million and other revenues decreased $1.5 million. The decrease in other revenues was primarily due to nonrecurring operations of the Tower, sold in March 1998. The Company recognized a pre-tax gain on the sale of approximately $13.0 million in the first quarter of 1998. Net Sales _________ Consolidated net sales included in total revenues for the six months ended June 30, 1999, were $156.0 million, compared to $165.5 million for the first six months of 1998, a decrease of $9.5 million. This decrease in sales resulted principally from: (i) decreased sales in the Climate Control Business of $3.2 million due to decreased sales volume in this Business' Heat Pump product lines, production line changes and training time for new employees which slowed production temporarily, (ii) decreased sales in the Automotive Products Business of $2.2 million, principally resulting from the presence in 1998 of certain bulk sales to an industrial user and initial stocking orders from a new retail chain store customer as well as customer mix, and (iii) decreased sales in the Industrial Products Business of $2.6 million due to decreased sales of machine tools, and (iv) decreased sales in the Chemical Business of $1.5 million primarily due to reduced sales of the Australian subsidiary and reduced selling prices on the Company's nitrogen based products due primarily to the import of Russian nitrate resulting in an over supply of nitrate-based products offset by sales of nitric acid products pursuant to the Bayer Agreements (see Note 5 of Notes to Condensed Consolidated Financial Statements). Gross Profit ____________ Gross profit, excluding the effect of the $1.6 million inventory write-down discussed in Note 10 of Notes to Condensed Consolidated Financial Statements, would have been 21.5% for the first six months of 1999, compared to 21.9% for the first six months of 1998. The decrease in the gross profit percentage was primarily the result of decreases in the Chemical and Automotive Businesses. The decrease in the Chemical Business was primarily the result of reduced selling prices for the Company's nitrogen based products. See "Overview Chemical Business" elsewhere in this 25
"Managements Discussion and Analysis of Financial Condition and Results of Operations" for further discussion of the Chemical Business' decreased sales. The decrease in the Automotive Business was primarily due to customer mix. Selling, General and Administrative Expense ___________________________________________ Selling, general and administrative ("SG&A") expenses as a percent of net sales from businesses continuing at June 30, 1999, were 19.3% in the six-month period ended June 30, 1999, compared to 18.9% for the first six months of 1998. This increase is primarily the result of decreased sales volume in the Climate Control Business, the Industrial Products Business and, the Automotive Business without equivalent corresponding decreases in SG&A. Additionally, costs associated with new start-up operations in 1999, by the Climate Control Business, having minimal or no sales, contributed to the increase in dollars as well as expense as a percent of sales. Interest Expense ________________ Interest expense for the Company was $9.1 million in the first six months of 1999, compared to $8.8 million for the first six months of 1998. The increase of $.3 million primarily resulted from increased borrowings. Income (Loss) Before Taxes __________________________ The Company had a loss before income taxes of $16.8 million in the first six months of 1999 compared to income before income taxes of $11.0 million in the six months ended June 30, 1998. The decreased profitability of $27.8 million was primarily due to the gain on the sale of the Tower in 1998, the lower gross profit, the loss on disposition of the Australian subsidiary, lower sales, the inventory write-down and the provision for losses on purchase commitments, as previously discussed. Provision for Income Taxes __________________________ As a result of the Company's 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 six months ended June 30, 1999 and the six months ended June 30, 1998 are for current state income taxes and federal alternative minimum taxes. 26
Three months ended June 30, 1999 vs. Three months ended June 30, 1998. _____________________________________________________________________ Revenues ________ Total revenues for the three months ended June 30, 1999, and 1998 were $83.0 million, and $87.6 million, respectively (a decrease of $4.6 million). Sales decreased $4.5 million and other income increased $.1 million. Net Sales _________ Consolidated net sales included in total revenue for the three months ended June 30, 1999, were $82.9 million, compared to $87.4 million for the three months ended June 30, 1998. The decrease in sales resulted principally from: (i) decreased sales in the Chemical Business (excluding the Australian subsidiary) of approximately $1.7 million resulting from reduced selling prices for the Company's nitrogen based products, partially offset by sales of nitric acid to Bayer Corporation as discussed elsewhere in this report, (ii) decreased sales by the Automotive Business due to customer mix in 1999 and certain bulk sales to an industrial user and initial stocking order from a new retail chain store customer in 1998, and (iii) decreased sales in the Industrial Products Business resulting from the effects of the Company limiting the product lines that it markets as well as diminished demand for the products of the Business. Sales in the Climate Control Business was approximately the same in both periods. Gross Profit ___________ Gross profit, excluding the effect of the $1.6 million inventory write-down discussed in Note 10 of Notes to Condensed Financial Statements, would have been 21.2% for the second quarter of 1999, compared to 23.3% for the comparable quarter of 1998. The decrease in the gross profit percentage was primarily the result of decreases in the Chemical and Automotive Businesses. The decrease in the Chemical Business was the result of reduced selling prices for the Company's nitrogen based products. The decrease in the Automotive Business was primarily due to customer mix. Selling, General and Administrative Expense ___________________________________________ Selling, general and administrative ("SG&A") expenses as a percent of net sales from businesses continuing at June 30, 1999 were 18.3% in the three months ended June 30, 1999, compared to 17.5% for the three months ended June 30, 1998. The increase in SG&A as a percent of sales principally resulted from sales decreasing without a corresponding decrease in SG&A expense and increased cost of the Company sponsored medical care programs for its employees due to increased health care costs. SG&A expense decreased approximately $.2 million while sales decreased $4.5 million. 27
Interest Expense ________________ Interest expense for the Company was $4.6 million in the three months ended June 30, 1999, compared to $4.0 million for the three months ended June 30,1998. The increase of $.6 million primarily resulted from increased borrowings. Income (Loss) Before Taxes __________________________ The Company had a loss before income taxes of $13.1 million in the second quarter of 1999 compared to income before income taxes of $1.4 million in the second quarter 1998. The decreased profitability of $14.5 million was primarily due to an inventory write-down of $1.6 million, the provision for losses of $7.5 million on firm uncancelable purchase commitments , $2.0 million loss on the sale of the Australian subsidiaries assets, and decreased gross profit from sales in the Chemical and Automotive Businesses, as previously discussed. Liquidity and Capital Resources _______________________________ Cash Flow From Operations _________________________ Historically, the Company's primary cash needs have been for operating expenses, working capital and capital expenditures. The Company has financed its cash requirements primarily through internally generated cash flow, borrowings under its revolving credit facilities, and the issuance of senior unsecured notes by its wholly owned subsidiary, ClimaChem, Inc., in November 1997. Net cash used by operations for the six months ended June 30, 1999 was $.8 million, after $6.4 million for noncash depreciation and amortization, $.7 million in provisions for possible losses on accounts receivable, provision for loss on the disposition of the Australian subsidiary of $2.0 million, inventory write-down for $1.6 million, provision for losses on purchase commitments of $7.5 million and including the following changes in assets and liabilities: (i) accounts receivable increases of $5.7 million; (ii) inventory decreases of $5.4 million excluding the effect of the write- down; (iii) increases in supplies and prepaid items of $2.8 million; and (iv) decreases in accounts payable and accrued liabilities of $1.0 million. The increase in accounts receivable is primarily due to increased sales and increased days of sales outstanding in the Climate Control Business and seasonal sales of agricultural products in the Chemical Business, offset by decreased sales in the Industrial Products Business. The decrease in inventory was due primarily to a decrease at the Automotive Products Business due to liquidation of excessive inventories, including the sale of approximately $1.6 million of current inventory in connection with the sale of the business of a subsidiary, offset by increases in the Climate Control Business in anticipation of higher sales volume in the heat pump product lines and increases in the Chemical Business due to reduced sales of the Australian subsidiary. 28
Inventory in the Automotive and Industrial Products Businesses decreased from $29.0 million at December 31, 1998, to $23.4 million at June 30, 1999. Cash Flow From Investing And Financing Activities __________________________________________________ Cash used by investing activities for the six months ended June 30, 1999 included $4.2 million in capital expenditures. The capital expenditures were primarily for the benefit of the Chemical and Climate Control Businesses to enhance production and product delivery capabilities. Net cash provided by financing activities included (i) payments on long-term debt of $4.4 million, (ii) net increases in revolving debt of 10.3 million, (iii) the issuance of a $2.6 million term note by the Automotive Business, (iv) decreases in drafts payable of $.5 million, (v) dividends of $1.6 million, and (vi) treasury stock purchases of $.2 million. During the first six months of 1999, the Company declared and paid the following aggregate dividends: (i) $12.00 per share on each of the outstanding shares of its Series B 12% Cumulative Convertible Preferred Stock; (ii) $1.625 per share on each outstanding share of its $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2; and (iii) $10.00 per share on each outstanding share of its Convertible Noncumulative Preferred 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. As of June 30, 1999, the Company and certain of its subsidiaries, including ClimaChem and its subsidiaries were parties to a working capital line of credit evidenced by two separate loan agreements ("Revolving Credit Agreements") with an unrelated lender ("Lender") collateralized by receivables, inventory, and proprietary rights of the Company and the subsidiaries that are parties to the Revolving Credit Agreements and the stock of certain of the subsidiaries that are borrowers under the Revolving Credit Agreements. The Revolving Credit Agreements, as amended during the quarter ended June 30, 1999, provide for revolving credit facilities ("Revolver") for total direct borrowings up to $65.0 million, including the issuance of letters of credit. The Revolver provides for advances at varying percentages of eligible inventory and trade receivables. The Revolving Credit Agreements, as amended, provide for interest at the lender's prime rate plus .5% per annum or, at the Company's option, at the Lender's LIBOR rate plus 2.875% per annum. At June 30, 1999, the effective interest rate was 7.93%. The term of the Revolving Credit Agreements is through December 31, 2000, and is renewable thereafter for successive thirteen month terms. At June 30, 1999, the availability for additional borrowings, based on eligible collateral, approximated $16.4 million. Borrowings under the 29
Revolver outstanding at June 30, 1999, were $25.7 million. The Revolving Credit Agreements, as amended, requires the Company to maintain certain financial ratios and contain other financial covenants, including tangible net worth requirements and capital expenditure limitations; however, with the refinancing of the Automotive Products Business loan agreement as discussed below, the Company's financial covenants are eliminated, so long as the remaining borrowing group maintains a minimum aggregate availability under the Revolving Credit Facility of $15.0 million. Should the availability drop below $15 million for three consecutive business days, the Company would be required to maintain the financial ratios discussed above. The annual interest on the outstanding debt under the Revolver at June 30, 1999 at the rates then in effect would approximate $2.0 million. The Revolving Credit Agreements also require the payment of an annual facility fee of 0.5% of the unused revolver and restrict the flow of funds, except under certain conditions, to subsidiaries of the Company that are not parties to the Revolving Credit Agreements. Under the Revolving Credit Agreements discussed above, the Company and its subsidiaries, other than ClimaChem and its subsidiaries, have the right to borrow on a revolving basis up to $6 million, based on eligible collateral. At June 30, 1999, the Company and its subsidiaries, except ClimaChem and its subsidiaries, had borrowings under the Revolver approximately equal to then eligible collateral ($2.3 million). On May 7, 1999, the Company's Automotive Products Business entered into a Loan and Security Agreement (the "Automotive Loan Agreement") with an unrelated lender (the "Automotive Lender") secured by substantially all assets of the Automotive Products Business to refinance the Automotive Products Business' working capital requirements that were previously financed under the Revolver. The Company was required to provide the Automotive Lender a $1.0 million standby letter of credit to further secure the Automotive Loan Agreement. The Automotive Loan Agreement provides a Revolving Loan Facility (the "Automotive Revolver"), Letter of Credit Accommodations and a Term Loan (the "Automotive Term Loan"). The Automotive Revolver provides for total direct borrowings up to $16.0 million, including the issuance of letters of credit. The Automotive Revolver provides for advances at varying percentages of eligible inventory and trade receivables. The Automotive Revolver provides for interest at the rate from time to time publicly announced by First Union National Bank as its prime rate plus one percent (1%) per annum or, at the Company's option, on the Automotive Lender's LIBOR rate plus two and three-quarters percent (2.75%) per annum. The Automotive Revolver also requires the payment of a monthly servicing fee of $3,000 and a monthly unused line fee equal to 0.5% of the unused credit facility. At June 30, 1999, the effective interest rate was 8.75% excluding the effect of the source fee and unused line fee (9.4% considering such fees). The term of the Automotive Revolver is through May 7, 2001, and is renewable thereafter for successive twelve-month terms. At June 30, 1999, outstanding borrowings under the Automotive Revolver 30
were $9.2 million; in addition, the Automotive Products Business had $1.4 million, based on eligible collateral, available for additional borrowing under the Automotive Revolver. As a result of the terms and conditions of this facility, outstanding borrowings at June 30, 1999, have been classified as long-term debt due within one year. The Automotive Loan Agreement restricts the flow of funds, except under certain conditions, between the Automotive Products Business and the Company and its subsidiaries. The Automotive Term Loan is in the original principal amount of $2,550,000. The Automotive Term Loan is evidenced by a term promissory note (the "Term Promissory Note") and is secured by all the same collateral as the Automotive Revolver. The interest rate of the Automotive Term Loan is the same as the Automotive Revolver discussed above. The terms of the Term Promissory Note require sixty (60) consecutive monthly principal installments (or earlier as provided in the Term Promissory note) of which the first thirty- six (36) installments shall each be in the amount of $48,611, the next twenty-two (22) installments shall each be in the amount of $33,333.33, and the last installment shall be in the amount of the entire unpaid principal balance. Interest payments are also required monthly as calculated on the outstanding principal balance. On May 10, 1999, the Automotive Revolver funded approximately $9.3 million, and the Automotive Term Loan funded $2,550,000, the aggregate total of approximately $11.9 million was simultaneously transferred to the lender in payment of the Automotive Products Business' balance under the Revolver. The annual interest on the outstanding debt under the Automotive revolver and Automotive term loan at June 30, 1999, at the rates then in effect would approximate $1.1 million. In addition to the credit facilities discussed above, as of June 30, 1999, the Company's wholly owned subsidiary, DSN Corporation ("DSN"), is a party to several loan agreements with a financial company (the "Financing Company") for three projects. At June 30, 1999, DSN had outstanding borrowings of $9.6 million under these loans. The loans have repayment schedules of 84 consecutive monthly installments of principal and interest through maturity in 2002. The interest rate on each of the loans is fixed and range from 8.2% to 8.9%. Annual interest, for the three notes as a whole, at June 30, 1999, at the agreed to interest rates would approximate $.8 million. The loans are secured by the various DSN property and equipment. The loan agreements require the Company to maintain certain financial ratios, including tangible net worth requirements. In April 1999, DSN obtained a waiver of the covenants through June 2000. As previously discussed, the Company is a holding company and, accordingly, its ability to pay dividends on its outstanding Common Stock and Preferred Stocks is dependent in large part on its ability to obtain funds from its subsidiaries. The ability of the Company's wholly owned subsidiary, ClimaChem (which owns all of the stock of substantially all of the Company's subsidiaries comprising 31
the Chemical Business and the Climate Control Business) and its subsidiaries to transfer funds to the Company is restricted by certain covenants contained in the Indenture to which they are parties. Under the terms of the Indenture, ClimaChem and its subsidiaries cannot transfer funds to the Company, except for (i) the amount of income taxes that they would be required to pay if they were not consolidated with the Company, (ii) an amount not to exceed fifty percent (50%) of ClimaChem's consolidated net income for the year in question, and (iii) the amount of direct and indirect costs and expenses incurred by the Company on behalf of ClimaChem and ClimaChem's subsidiaries pursuant to a certain services agreement and a certain management agreement to which the companies are parties. During 1998 and the first six months of 1999, ClimaChem reported a consolidated net loss of approximately $2.6 million and $8.6 million, respectively. Accordingly, ClimaChem and its subsidiaries were unable to transfer funds to the Company in 1998 and the first six months of 1999, except for reimbursement of costs and expenses incurred by the Company on their behalf or in connection with certain agreements. Due to ClimaChem's net losses for the year 1998 and the Company's (other than ClimaChem and its subsidiaries) limited borrowing ability under the Revolver, management recommended to the Board of Directors and such recommendation was approved, that the Company discontinue payment of cash dividends on its Common Stock for periods subsequent to January 1, 1999, until the Board of Directors determines otherwise. In addition, as of the date of this report, after consideration of the losses reported in the accompanying Condensed Consolidated Statements of Operations for the six months ended June 30, 1999, management has concluded that the Company does not have adequate liquidity to pay the next regular quarterly dividend of $.8125 per share on its outstanding $3.25 Convertible Exchangeable Class C Preferred Stock Series 2 and will recommend to the Board of Directors that such dividend not be declared at this time. Future cash requirements (other than cash dividends) include working capital requirements for anticipated sales increases in the Company's core Businesses and funding for future capital expenditures. Funding for the higher accounts receivable and higher inventory requirements 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 reductions in the Industrial Products and Automotive Products Businesses should generate cash to supplement those Businesses' availability under their respective revolving credit facilities. In addition, the Company is also considering the sale of certain assets which it does not believe are critical to its Chemical and Climate Control Businesses. In 1999, the Company has planned capital expenditures of approximately $10 million, primarily in the Chemical and Climate Control Businesses, a certain amount of which it anticipates will be financed by equipment finance contracts on a term basis and in a manner allowed under its various loan agreements. Such capital expenditures include approximately $1.5 million ($.6 million in the six months ended June 30, 1999), which the Chemical Business anticipates spending 32
related to environmental control facilities at its El Dorado Facility, as previously discussed in this report. The Company currently has no material commitments for capital expenditures. As previously noted, the Company and its subsidiaries, other than ClimaChem and subsidiaries of ClimaChem, are primarily dependent upon their availability under the Revolver, and funds available from ClimaChem, for their working capital. As described above, both sources of working capital are limited. As a result, management has discontinued the repurchase of the Company's stock until such time as the liquidity and capital resources improves and will recommend to the Board of Directors that the next regular quarterly dividend on its preferred stock not be declared. Management believes that with these actions, and the effect of certain cost reductions being undertaken, that the Company will have adequate cash flow to meet its presently anticipated working capital and debt service requirements. The last sentence of this paragraph is a forward-looking statement and is subject to the "Special Note Regarding Forward-Looking Statements." Subsequent to June 30, 1999, the Company announced it had decided to discontinue the spin-off of the Automotive Business to its shareholders. The decision was due primarily to the Automotive Business' inability to raise additional equity capital as a stand alone business. The Company has decided to aggressively pursue consideration of a number of alternative approaches to separate the Automotive Business from LSB. During 1998 and pursuant to the Company's previously announced repurchase plan, the Company purchased 909,300 shares of Common Stock, for an aggregate purchase price of $3,567,026. From January 1, 1999, through June 30, 1999, the Company has purchased under its repurchase plan a total of 87,267 shares of Common Stock for an aggregate amount of $230,233. Foreign Subsidiary __________________ As previously discussed in this report, on August 2, 1999, the Company substantially completed an agreement to sell substantially all of the assets of TES, effectively disposing of this portion of the Chemical Business. Under the terms of the Indenture to which ClimaChem is bound, the net cash proceeds from the sale of TES, are required (i) within 270 days from the date of the sale to be applied to the redemption of the notes issued under the Indenture or to the repurchase of such notes, or (ii) within 240 days from the date of such sale, the amount of the net cash proceeds be invested in a related business of ClimaChem or the Australian subsidiary or used to reduce indebtedness of ClimaChem. All of the proceeds received by the Company, through the date of this report (approximately US$3.5 million), have been applied to reduce the indebtedness of ClimaChem. The Company expects that the remaining net proceeds from the disposition of TES will be reinvested in related businesses of ClimaChem or used to retire additional indebtedness of ClimaChem. 33
Joint Ventures and Options to Purchase ______________________________________ Prior to 1997, the Company, through a subsidiary, loaned $2.8 million to a French manufacturer of HVAC equipment whose product line is compatible with that of the Company's Climate Control Business in the USA. Under the loan agreement, the Company has the option, which expires June 15, 2005, 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 1997 the Company advanced an additional $1 million to the French manufacturer bringing the total of the loan to $3.8 million. The $3.8 million loan, less a $1.5 million valuation reserve, is carried on the books as a note receivable in other assets. As of the date of this report, the decision has not been made to exercise its option to acquire the stock of the French manufacturer. 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 which it completed during 1996. 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 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. During 1995, the Company executed a stock option agreement to acquire eighty percent (80%) of the stock of a specialty sales organization ("Optioned Company"), which owns the remaining fifty percent (50%) equity interest in the Project discussed above, to enhance the marketing of the Company's air conditioning products. The Company has decided not to exercise the Option and has allowed the term of the Option to lapse. Through the date of this report the Company has made option payments aggregating $1.3 million ($1.0 million of which is refundable) and has loaned the Optioned Company approximately $1.4 million. The Company has recorded reserves of $1.5 million against the loans and option payments. The loans and option payments are secured by the stock and other collateral of the Optioned Company. Debt Guarantee ______________ At December 31, 1998, the Company and one of its subsidiaries had outstanding guarantees of approximately $2.6 million of indebtedness of a startup aviation company in exchange for an ownership interest in the aviation company of approximately 45%. 34
During the first quarter of 1999, the Company was called upon to perform on both guarantees. The Company paid approximately $500,000 to a lender and assumed an obligation for a $2.0 million note, which is due in equal monthly principal payments, plus interest, through August 2004, in satisfaction of the guarantees. In connection with the demand on the Company to perform under its guarantee, the Company and the other guarantors formed a new company ("KAC") which acquired the assets of the aviation company through foreclosure. The Company and the other shareholders of KAC are attempting to sell the assets acquired in foreclosure. Proceeds received by the Company, if any, from the sale of KAC assets will be recognized in the results of operations when and if realized. Availability of Company's Loss Carry-overs __________________________________________ The Company anticipates that its cash flow in future years will benefit from its ability to use net operating loss ("NOL") carry-overs 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. Such benefit, if any is dependent on the Company's ability to generate taxable income in future periods, for which there is no assurance. Such benefit if any, will be limited by the Company's reduced NOL for alternative minimum tax purposes which is approximately $35 million at June 30, 1999. As of December 31, 1998, the Company had available regular tax NOL carry-overs of approximately $63.8 million based on its federal income tax returns as filed with the Internal Revenue Service for taxable years through 1998. These NOL carry-overs will expire beginning in the year 1999. Due to its recent history of reporting net losses, the Company has established a valuation allowance on a portion of its NOLs and thus has not recognized the full benefit of its NOLs in the accompanying Condensed Consolidated Financial Statements. The amount of these carry-overs has not been audited or approved by the Internal Revenue Service and, accordingly, no assurance can be given that such carry-overs will not be reduced as a result of audits in the future. In addition, the ability of the Company to utilize these carry-overs 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. Year 2000 Issues ________________ The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may recognize a date using "00" as the Year 1900 rather than the Year 2000. This could result in a system failure or miscalculations causing disruptions 35
of operations, including, among other things, a temporary inability to process transactions, create invoices, or engage in similar normal business activities. Beginning in 1996, the Company undertook a project to enhance certain of its Information Technology ("IT") systems and install certain other technologically advanced communication systems to provide extended functionality for operational purposes. A major part of the Company's program was to implement a standardized IT system purchased from a national software distributor at all of the Company and subsidiary operations, and to install a Local Area Network ("LAN"). The IT system and the LAN necessitated the purchase of additional hardware, as well as software. The process implemented by the Company to advance its systems to be more "state-of-the-art" had an added benefit in that the software and hardware changes necessary to achieve the Company's goals are Year 2000 compliant. Starting in 1996 through June 30, 1999, the Company has capitalized approximately $1.2 million in costs to accomplish its enhancement program. The capitalized costs include $.4 million in external programming costs, with the remainder representing hardware and software purchases. The Company anticipates that the remaining cost to complete this IT systems enhancement project will be less than $50,000, and such costs will be capitalized. The Company's plan to identify and resolve the Year 2000 Issue involved the following phases: assessment, remediation, testing, and implementation. To date, the Company has fully completed its assessment of all systems that could be significantly affected by the Year 2000. Based on assessments, the Company determined that it was required to modify or replace certain portions of its software and hardware so that those systems will properly utilize dates beyond December 31, 1999. For its IT exposures which include financial, order management, and manufacturing scheduling systems, the Company is 100% complete on the assessment and remediation phases. As of the date of this report, the Company has completed its testing and has implemented its remediated systems for all of its businesses. The assessments also indicated that limited software and hardware (embedded chips) used in production and manufacturing systems ("operating equipment") also are at limited risk. The Company has completed its assessment and identified remedial action which will be completed in the third quarter 1999. In addition, the Company has completed its assessment of its product line and determined that the products it has sold and will continue to sell do not require remediation to be Year 2000 compliant. Accordingly, based on the Company's current assessment, the Company does not believe that the Year 2000 presents a material exposure as it relates to the Company's products. The Company has queried its significant suppliers, subcontractors, distributors and other third parties (external agents). The Company does not have any direct system interfaces with external agents. To date, the Company is not aware of any external agent with a Year 2000 Issue that would materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that 36
external agents will be Year 2000 ready. The inability of external agents to complete their Year 2000 resolution process in a timely fashion could materially impact the Company. The effect of non- compliance by external agents is not determinable at this time. Management of the Company believes it has an effective program in place to resolve the remaining aspects of the Year 2000 Issue applicable to its businesses in a timely manner. If the Company does not complete the remaining phases of its program, the Year 2000 Issue could have a negative impact on the operations of the Company; however, management does not believe that, under the most reasonably likely worst case scenario, such potential impact would be material. The Company is creating contingency plans for certain critical applications. These contingency plans will involve, among other actions, manual workarounds, increasing inventories, and adjusting staffing strategies. In addition, disruptions in the economy generally resulting from Year 2000 Issues could also materially adversely affect the Company. See "Special Note Regarding Forward- Looking Statements". Contingencies _____________ 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. See Note 5 of Notes to Condensed Consolidated Financial Statements. Quantitative and Qualitative Disclosures about Market Risk __________________________________________________________ General ______ The Company's results of operations and operating cash flows are impacted by changes in market interest rates and raw material prices for products used in its manufacturing processes. The Company also has a wholly owned subsidiary in Australia, for which the Company has foreign currency translation exposure. The derivative contracts used by the Company are entered into to hedge 37
these risks and exposures and are not for trading purposes. All information is presented in U. S. dollars. See Note 9 of Notes to Consolidated Financial Statements for a discussion of the Australian subsidiary in 1999. Interest Rate Risk __________________ The Company's interest rate risk exposure results from its debt portfolio which is impacted by short-term rates, primarily prime rate-based borrowings from commercial banks, and long-term rates, primarily fixed-rate notes, some of which prohibit prepayment or require substantial prepayment penalties. Reference is made to the Company's Annual Report on Form 10-K for the year ended December 31, 1998, for an expanded analysis of expected maturities of long-term debt and its weighted average interest rates and discussion related to raw material price risk. As of June 30, 1999, the Company's variable rate and fixed rate debt which aggregated $181.8 million exceeded the debt's fair market value by approximately $5.3 million. The fair value of the Company's Senior Notes was determined based on a market quotation for such securities. Foreign Currency Risk _____________________ At June 30, 1999, the Company had a wholly owned subsidiary located in Australia, for which the functional currency is the local currency, the Australian dollar. Since the Australian subsidiary accounts are converted into U.S. dollars upon consolidation using the end of the period exchange rate, declines in value of the Australian dollar to the U.S. dollar result in translation loss to the Company. As a result of the commitment to sell the Australian subsidiary, which was closed on August 2, 1999, the cumulative foreign currency translation loss of approximately $1.1 million has been included in the loss on disposal of the Australian subsidiary at June 30, 1999. 38
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS Certain statements contained within this report may be deemed "Forward-Looking Statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements in this report other than statements of historical fact are Forward- Looking Statements that are subject to known and unknown risks, uncertainties and other factors which could cause actual results and performance of the Company to differ materially from such statements. The words "believe", "expect", "anticipate", "intend", "will", and similar expressions identify Forward-Looking Statements. Forward-Looking Statements contained herein relate to, among other things, (i) ability to improve operations and become profitable on an annualized basis, (ii) establishing a position as a market leader, (iii) payment of dividends on Preferred Stock, (iv) the amount of the loss provision for anhydrous ammonia required to be purchased, (v) declines in the price of anhydrous ammonia, (vi) availability of net operating loss carry-overs, (vii) amount to be spent in 1999 relating to compliance with federal, state and local Environmental laws at the El Dorado Facility, (viii) Year 2000 issues, (ix) improving liquidity and profits through liquidation of assets or realignment of assets, (x) the Company's ability to develop or adopt new and existing technologies in the conduct of its operations, (xi) anticipated financial performance, (xii) ability to comply with the Company's general working capital and debt service requirements, (xiii) ability to be able to continue to borrow under the Company's revolving line of credit, (xiv) sale of the Industrial Products Business, (xv) adequate cash flows to meet its presently anticipated capital requirements, and (xvi) ability of the EDNC Baytown Plant to generate $35 to $40 million in annual gross revenues once operational. While the Company believes the expectations reflected in such Forward-Looking Statements are reasonable, it can give no assurance such expectations will prove to have been correct. There are a variety of factors which could cause future outcomes to differ materially from those described in this report, including, but not limited to, (i) decline in general economic conditions, both domestic and foreign, (ii) material reduction in revenues, (iii) material increase in interest rates; (iv) inability to collect in a timely manner a material amount of receivables, (v) increased competitive pressures, (vi) inability to meet the "Year 2000" compliance of the computer system by the Company, its key suppliers, customers, creditors, and financial service organization, (vii) changes in federal, state and local laws and regulations, especially environmental regulations, or in interpretation of such, pending (viii) additional releases (particularly air emissions into the environment), (ix) material increases in equipment, maintenance, operating or labor costs not presently anticipated by the Company, (x) the requirement to use internally generated funds for purposes not presently anticipated, (xi) ability to become profitable, or if unable to become profitable, the inability to secure additional liquidity in the form of additional equity or debt, (xii) the effect of additional production capacity of anhydrous ammonia in the western hemisphere, (xiii) the cost for the purchase of anhydrous ammonia increasing or 39
the Company's inability to purchase anhydrous ammonia on favorable terms when a current supply contract terminates, (xiv) changes in competition, (xv) the loss of any significant customer, (xvi) changes in operating strategy or development plans, (xvii) inability to fund the working capital and expansion of the Company's businesses, (xviii) adverse results in any of the Company's pending litigation, (xix) inability to obtain necessary raw materials, (xx) inability to recover the Company's investment in the aviation company, (xxi) Bayer's inability or refusal to purchase all of the Company's production at the new Baytown nitric acid plant; (xxii) continuing decreases in the selling price for the Chemical Business' nitrogen based end products, and (xxiii) other factors described in "Management's Discussion and Analysis of Financial Condition and Results of Operation" contained in this report. Given these uncertainties, all parties are cautioned not to place undue reliance on such Forward-Looking Statements. The Company disclaims any obligation to update any such factors or to publicly announce the result of any revisions to any of the Forward-Looking Statements contained herein to reflect future events or developments. 40
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 June 30, 1999, and the related condensed consolidated statements of operations for the six-month and three-month periods ended June 30, 1999 and 1998, and the condensed consolidated statements of cash flows for the six-month periods ended June 30, 1999 and 1998. 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, 1998, 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 February 19, 1999, except for paragraphs (A) and (C) of Note 5 and Note 14, as to which the date is April 14, 1999, 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, 1998, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. /s/ ERNST & YOUNG LLP ERNST & YOUNG LLP Oklahoma City, Oklahoma August 19, 1999 41
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, 1998, 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 ______ ___________________________________________________ <TABLE> <CAPTION> At the Company's 1999 Annual Meeting of Shareholders held on June 24, 1999, the following nominees to the Board of Directors were elected as directors of the Company: Number of Shares Number of "Against" and Abstentions Number of to "Withhold and Broker Name Shares "For" Authority" Non-Votes ____ ___________ ____________ _________ <S> <C> <C> <C> Raymond B. Ackerman 9,724,111 1,652,357 0 Gerald G. Gagner 9,895,048 1,481,420 0 Bernard G. Ille 9,724,425 1,652,043 0 Donald W. Munson 9,724,411 1,652,057 0 Tony M. Shelby 9,894,144 1,481,524 0 </TABLE> Messrs. Ackerman, Ille, Munson and Shelby had been serving on the Board of Directors at the time of the Annual Meeting and were reelected for a term of three (3) years. Mr. Gagner had been serving as a director of the Company at the time of the Annual Meeting and was elected for a term of one (1) year. The following are the directors whose terms of office continued after such Annual Meeting: Robert C. Brown, M.D., Charles H. Burtch, Horace G. Rhodes and Jerome D. Shaffer, M.D. 42
<TABLE> <CAPTION> At the Annual Meeting, Ernst & Young, LLP, Certified Public Accountants, was appointed as independent auditors of the Company for 1999, as follows: Number of Shares Number of "Against" and Abstentions Number of to "Withhold and Broker Shares "For" Authority" Non-Votes ____________ ____________ __________ <S> <C> <C> <C> 10,819,787 547,402 9,279 </TABLE> <TABLE> <CAPTION> At the Annual Meeting, the Company's 1998 Employee Stock Option and Incentive Plan was approved as follows: Number of Shares Number of "Against" and Abstentions Number of to "Withhold and Broker Shares "For" Authority" Non-Votes ___________ ____________ ___________ <S> <C> <C> <C> 6,209,998 1,916,119 3,250,351 </TABLE> <TABLE> <CAPTION> At the Annual Meeting, the Company's Outside Directors Stock Purchase Plan was approved, as follows: Number of Shares Number of "Against" and Abstentions Number of to "Withhold and Broker Shares "For" Authority" Non-Votes ___________ ____________ __________ <S> <C> <C> <C> 6,364,697 1,763,541 3,248,230 </TABLE> 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: 4.1 Sixth Amendment dated May 10, 1999, to Amended and Restated Loan and Security Agreement between BankAmerica Business Credit, Inc., and Climate Master, Inc., International Environmental Corporation, El Dorado Chemical Company and Slurry Explosive Corporation. 43
4.2 Second Amended and Restated Loan and Security Agreement dated May 10, 1999, by and between Bank of America National Trust and Savings Association and LSB Industries, Inc., Summit Machine Tool Manufacturing Corp., and Morey Machinery Manufacturing Corporation. 4.3 Loan and Security Agreement dated May 7, 1999, by and between Congress Financial Corporation and L&S Automotive Products Company. 10.1 LSB Industries, Inc. 1998 Stock Option and Incentive Plan which the Company hereby incorporates by reference from Exhibit "B" to the LSB Proxy Statement, dated May 24, 1999, for Annual Meeting of Stockholders. 10.2 LSB Industries, Inc. Outside Directors Stock Option Plan which the Company hereby incorporates by reference from Exhibit "C" to the LSB Proxy Statement, dated May 24, 1999, for Annual Meeting of Stockholders to be held June 24, 1999. 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 June 30, 1999. 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 23rd day of August 1999. 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) 44