12 31 06 10K
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
(Mark
One)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF
1934
For
the fiscal year ended December 31, 2006
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)
(State
of Incorporation)
|
|
(I.R.S.
Employer)
Identification
No.)
|
16
South Pennsylvania Avenue
Oklahoma
City, Oklahoma
|
|
73107
|
(Address
of Principal Executive Offices)
|
|
(Zip
Code)
|
Registrant's
Telephone Number, Including Area Code: (405) 235-4546
Securities
Registered Pursuant to Section 12(b) of the Act:
Title
of Each Class
|
|
Name
of Each Exchange
On
Which Registered
|
Common
Stock, Par Value $.10
|
|
American
Stock Exchange
|
Securities
Registered Pursuant to Section 12(g) of the Act: Preferred Share Purchase Rights
and $3.25 Convertible Exchangeable Class C Preferred Stock, Series
2
(Facing
Sheet Continued)
Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. [ ] Yes [X] No
Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. [ ] Yes [X] No
Indicate
by check mark whether the Registrant (1) has filed all reports required by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for the shorter period that the Registrant has had to file the
reports), and (2) has been subject to the filing requirements for the past
90
days. [X] Yes [ ] No
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this
Form 10-K. [ ]
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer
[X]
Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Act). [ ] Yes [X] No
The
aggregate market value of the Registrant’s voting common equity held by
non-affiliates of the Registrant, computed by reference to the price at which
the voting common stock was last sold as of June 30, 2006, was
approximately $69 million. For purposes of this computation, shares of the
Registrant’s common stock beneficially owned by each executive officer and
director of the Registrant and by Jayhawk Capital Management, L.L.C. and its
affiliates (together “Jayhawk”) are deemed to be owned by affiliates of the
Registrant. Such determination should not be deemed an admission that such
executive officers, directors and other beneficial owners of our common stock
are, in fact, affiliates of the Registrant. In addition, this computation does
not include the 719 shares of voting Convertible Non-Cumulative Preferred Stock
(the “Non-Cumulative Preferred”) held by non-affiliates of the Company. An
active trading market does not exist for the shares of Non-Cumulative Preferred.
As
of
March 19, 2007 the Registrant had 19,479,139 shares of common stock outstanding
(excluding 3,447,754 shares of common stock held as treasury
stock).
FORM
10-K
OF LSB INDUSTRIES, INC.
|
|
Page
|
|
|
|
|
PART
I
|
|
|
|
|
|
|
5
|
|
|
|
|
|
18
|
|
|
|
|
|
25
|
|
|
|
|
|
25
|
|
|
|
|
|
26
|
|
|
|
|
|
29
|
|
|
|
|
|
30
|
|
|
|
|
PART
II
|
|
|
|
|
|
|
32
|
|
|
|
|
|
36
|
|
|
|
|
|
38
|
|
|
|
|
|
67
|
|
|
|
|
|
69
|
|
|
|
|
|
69
|
|
|
|
|
|
69
|
|
|
|
|
|
70
|
|
|
|
|
PART
III
|
|
|
|
|
|
|
74
|
|
|
|
|
|
74
|
|
FORM
10-K OF LSB INDUSTRIES, INC.
TABLE
OF CONTENTS
|
|
|
|
|
|
|
Page
|
|
|
|
|
|
74
|
|
|
|
|
|
74
|
|
|
|
|
|
74
|
|
|
|
|
PART
IV
|
|
|
|
|
|
|
75
|
PART
I
General
LSB
Industries, Inc. (the "Company", “Registrant”, "We", "Us", or "Our") was formed
in 1968 as an Oklahoma corporation, and became a Delaware corporation in 1977.
We are a diversified holding company. Our wholly-owned subsidiary, ThermaClime,
Inc. (“ThermaClime”) through its subsidiaries, owns substantially all of our
core businesses consisting of the:
|
·
|
Climate
Control Business engaged in the manufacturing and selling of a broad
range
of heating, ventilation and air conditioning (“HVAC”) products for the
niche markets we serve. These products are used in commercial and
residential new building construction, renovation of existing buildings
and replacement of existing
systems.
|
|
·
|
Chemical
Business engaged in the manufacturing and selling of chemical products
produced from plants in Texas, Arkansas and Alabama for the industrial,
mining and agricultural markets.
|
Certain
statements contained in this Part I may be deemed to be forward-looking
statements. See "Special Note Regarding Forward-Looking
Statements."
We
believe our Climate Control Business has developed leadership positions in
niche
markets by offering extensive product lines, customized products and improved
technologies. Under this focused strategy, we have developed what we believe
to
be the most extensive line of water source heat pumps and hydronic fan coils
in
the United States. Further, we were a pioneer in the use of geothermal
technology in the climate control industry and have used it to create what
we
believe to be the most energy efficient climate control systems commercially
available today. We employ highly flexible production capabilities that allow
us
to custom design units for new construction markets and for the retrofit and
replacement markets, and our products are currently installed in some of the
most recognizable commercial developments in the country, including Prudential
Tower, Rockefeller Plaza, Trump Tower, and Time Warner Center, and are slated
to
be in a number of developments currently under construction. In addition, we
have a significant presence in the lodging industry with installations in
numerous Hyatt, Marriott, Four Seasons, Starwood, Ritz Carlton and Hilton
hotels. We also have a substantial share of resort destinations in Las Vegas
where we have units installed in over 47,000 rooms for a number of premier
properties, including the MGM Grand, Luxor, Venetian, Treasure Island, Bellagio,
Mandalay Bay, Caesar’s Palace, Monte Carlo, Mirage, Golden Nugget, Hard Rock and
Wynn resorts.
Our
Chemical Business has three chemical production facilities located in Baytown,
Texas (the “Baytown” facility), El Dorado, Arkansas (the “El Dorado” facility)
and Cherokee, Alabama (the “Cherokee” facility). Our Chemical Business is a
supplier to some of the world’s leading chemical and industrial companies. By
focusing on specific geographic areas, we have developed freight and
distribution advantages over many of our competitors and have established
leading regional market positions, a key element in the success of this
business. The primary raw
material
feedstocks (anhydrous ammonia and natural gas) of the Chemical Business are
commodities, subject to price fluctuations and are purchased at prices in effect
at time of purchase. Baytown consumes approximately 120,000 tons of purchased
anhydrous ammonia per year. The majority of Baytown’s production is sold
pursuant to a long-term contract that provides for a pass-through of certain
costs, including the anhydrous ammonia costs, plus a profit. El Dorado purchases
approximately 200,000 tons of anhydrous ammonia annually and produces and sells
approximately 500,000 tons of nitrogen-based products per year. The anhydrous
ammonia is purchased pursuant to a supply agreement whereby El Dorado secures
substantially all of its requirements of anhydrous ammonia from one supplier.
Although anhydrous ammonia is produced from natural gas, the price does not
necessarily follow the spot-price of natural gas in the U.S. because anhydrous
ammonia is an internationally traded commodity and the relative price is set
in
the world market while natural gas is primarily a nationally traded commodity.
The ammonia supply to El Dorado is transported from the Gulf of Mexico by
pipeline. Our cost of anhydrous ammonia is based upon formulas indexed to
published industry prices, primarily tied to import prices. Cherokee normally
consumes 4 to 6 million MMBtu’s of natural gas annually and produces
and sells approximately 300,000 tons of nitrogen-based products per year.
Natural
gas is a primary raw material for anhydrous ammonia. Natural gas costs continue
to exhibit volatility. In 2006, we saw daily spot prices per MMBtu, excluding
transportation, range from $3.54 to $9.90. Due to the uncertainty of the sales
prices of our products in relation to the cost of anhydrous ammonia and natural
gas, our Chemical Business has pursued a strategy of developing customers that
purchase substantial quantities of products pursuant to sales agreements and/or
formulas that provide for the pass through of these raw material costs. These
pricing arrangements help mitigate the commodity risk inherent in the raw
material feedstocks of natural gas and anhydrous ammonia. For 2006,
approximately 65% of the Chemical Business’ sales were made pursuant to
pass-through sales agreements. It is our goal to continue developing
pass-through agreements with our customers. The remaining sales are primarily
into agricultural markets at the price in effect at time of shipment. The sales
prices of our agricultural products have only a moderate correlation to the
anhydrous ammonia and natural gas feedstock costs and also reflect market
conditions for like and competing nitrogen sources. This can compromise our
ability to recover our full cost to produce the product in this market.
Additionally, the lack of sufficient non-seasonal sales volume to operate our
manufacturing facilities at optimum levels has kept the Chemical Business from
reaching full performance potential. Our primary efforts to improve the results
of our Chemical Business include securing increased non-seasonal sales volumes
with an emphasis on customers that will accept the commodity risk inherent
with
natural gas and anhydrous ammonia.
Segment
Information and Foreign and Domestic Operations and Export Sales
Schedules
of the amounts of net sales, gross profit, operating income (loss) and
identifiable assets attributable to each of our lines of business and of the
amount of our export sales in the aggregate and by major geographic area for
each of the last three years appear in Note 20 of the Notes to Consolidated
Financial Statements included elsewhere in this report.
Climate
Control Business
General
Our
Climate Control Business manufactures and sells a broad range of standard and
custom designed geothermal and water source heat pumps and hydronic fan coils
as
well as other products for the niche markets we serve. These products are for
use in commercial and residential HVAC systems including large custom air
handlers and modular chiller systems. The construction of commercial,
institutional and residential buildings including multi and single-family homes,
the renovation of existing buildings and the replacement of existing HVAC
systems drive the demand for our Climate Control products. Our Climate Control
commercial products are used in a wide variety of buildings, such as: hotels,
motels, office buildings, schools, universities, apartments, condominiums,
hospitals, nursing homes, extended care facilities, industrial and high tech
manufacturing facilities, food and chemical processing facilities, and
pharmaceutical manufacturing facilities. We target many of our products to
meet
increasingly stringent indoor air quality and energy efficiency standards.
The
following table summarizes net sales information relating to our products of
the
Climate Control Business:
Percentage
of net sales of the Climate Control Business:
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
|
61
|
%
|
|
54
|
%
|
|
52
|
%
|
Hydronic
fan coils
|
|
27
|
%
|
|
34
|
%
|
|
35
|
%
|
Other
HVAC products
|
|
12
|
%
|
|
12
|
%
|
|
13
|
%
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Percentage
of our consolidated net sales:
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
|
27
|
%
|
|
21
|
%
|
|
20
|
%
|
Hydronic
fan coils
|
|
12
|
%
|
|
13
|
%
|
|
14
|
%
|
Other
HVAC products
|
|
6
|
%
|
|
5
|
%
|
|
5
|
%
|
|
|
45
|
%
|
|
39
|
%
|
|
39
|
%
|
Geothermal
and Water Source Heat Pumps
We
believe we are a leading provider of geothermal and water source heat pumps
to
the commercial construction and renovation markets in the United States. Water
source heat pumps are highly efficient heating and cooling products which enable
individual room climate control through the transfer of heat through a water
pipe system which is connected to a centralized cooling tower or heat injector.
Water source heat pumps enjoy a broad range of commercial applications,
particularly in medium to large sized buildings with many small, individually
controlled spaces. We believe the market for commercial water source heat pumps
will continue to grow due to the relative efficiency and long life of such
systems as compared to other air conditioning and heating systems, as well
as to
the emergence of the replacement market for those systems.
Our
Climate Control Business has also developed the use of geothermal water source
heat pumps in residential and commercial applications. Geothermal systems,
which
circulate water and antifreeze through an underground heat exchanger, are among
the most energy efficient systems available. We believe the longer life, lower
cost to operate, and relatively short payback periods of geothermal systems,
as
compared with air-to-air systems, will continue to increase demand for our
geothermal products. We specifically target new residential construction of
moderate and high-end multi and single-family homes.
Hydronic
Fan Coils
We
believe that our Climate Control Business is a leading provider of hydronic
fan
coils. Our Climate Control Business targets the commercial and institutional
markets. Hydronic fan coils use heated or chilled water, provided by a
centralized chiller or boiler through a water pipe system, to condition the
air
and allow individual room control. Hydronic fan coil systems are quieter and
have longer lives and lower maintenance costs than other comparable systems
used
where individual room control is required. Important components of our strategy
for competing in the commercial and institutional renovation and replacement
markets include the breadth of our product line coupled with customization
capability provided by a flexible manufacturing process. The lodging and
hospitality industry is a significant user of hydronic fan coils. Subsequent
to
the September 11, 2001 tragedy, our hydronic fan coil operation experienced
a
decline of major lodging and hospitality construction projects in several key
geographic markets. During 2005 and 2006, this specific market continued to
improve.
Geothermal
and Water Source Heat Pump and Hydronic Fan Coil
Market
We
estimate the annual United States market for water source heat pumps and
hydronic fan coils to be approximately $480 million based on data supplied
by
the Air-Conditioning and Refrigeration Institute (“ARI”). Levels of repair,
replacement, and new construction activity generally drive demand in these
markets. In aggregate, the United States market for geothermal and water source
heat pump and fan coil products is returning to historical levels based on
data
supplied by the ARI. The previous decline in the total market in 2001 through
2003 was primarily a direct result of the slowdown in construction and
refurbishment related to the lodging and hospitality industry and has been
attributed to the events of September 11, 2001 and world unrest.
Production
and Backlog
Most
of
our Climate Control production occurs on a specific order basis. We manufacture
the units in many sizes and configurations, as required by the purchaser, to
fit
the space and capacity requirements of hotels, motels, schools, hospitals,
apartment buildings, office buildings and other commercial or residential
structures. As of December 31, 2006 and 2005, the backlog of confirmed orders
for our Climate Control Business was approximately $80.4 million and $56.2
million, respectively. The increase in our backlog relates primarily to the
increase in demand for our geothermal and water source heat pumps and hydronic
fan coils. Past experience indicates that customers generally do not cancel
orders after we receive them. We anticipate shipping substantially all of this
backlog within twelve months.
In
response to a record order intake level of our heat pump products, we have
increased unit capacity by almost 70% through additional shifts, overtime and
capital investment since the end of 2005. During 2006, we invested
approximately $4.9 million in fabrication equipment, plant-wide process control
systems and other upgrades relating to our Climate Control Business. For 2007,
we have committed to spend an additional $3.6 million for production equipment
and other upgrades. Our investment in the Climate Control Business will
continue if order intake levels continue to warrant. In addition to the
spending on equipment and systems, during 2006, we have invested approximately
$2.8 million in facilities, including a new 46,000 square foot building next
to
our existing heat pump manufacturing facility and the renovation of an existing
facility. These investments have and will increase our capacity to produce
and distribute our Climate Control products, primarily heat pump
products.
Marketing
and Distribution
Distribution
Our
Climate Control Business sells its products to mechanical contractors, original
equipment manufacturers and distributors. Our sales to mechanical contractors
primarily occur through independent manufacturers' representatives, who also
represent complementary product lines not manufactured by us. Original equipment
manufacturers generally consist of other air conditioning and heating equipment
manufacturers who resell under their own brand name the products purchased
from
our Climate Control Business in competition with us. The following table
summarizes net sales to original equipment manufacturers relating to our
products of the Climate Control Business:
Net
sales to original equipment manufacturers as a percentage
of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales of the Climate Control Business
|
|
17
|
%
|
|
22
|
%
|
|
21
|
%
|
Consolidated
net sales
|
|
8
|
%
|
|
9
|
%
|
|
8
|
%
|
Market
Our
Climate Control Business depends primarily on the commercial construction
industry, including new construction and the remodeling and renovation of older
buildings, and on the residential construction industry for both new and
replacement markets relating to their geothermal products.
Raw
Materials
Numerous
domestic and foreign sources exist for the materials used by our Climate Control
Business, which materials include compressors, steel, electric motors, valves
and copper. Periodically, our Climate Control Business enters into fixed-price
copper contracts. We do not anticipate any difficulties in obtaining necessary
materials for our Climate Control Business. In 2007, however, changes in market
supply and demand could result in increased costs, lost production and/or
delayed shipments. We believe the majority of cost increases, if any, will
be
passed to our customers in the form of higher prices as product price increases
are implemented and take effect and while we believe we will have sufficient
materials, a shortage of raw materials could impact production of our Climate
Control products.
Competition
Our
Climate Control Business competes primarily with seven companies, some of whom
are also our customers. Some of our competitors serve other markets and have
greater financial and other resources than we do. Our Climate Control Business
manufactures a broader line of geothermal and water source heat pump and fan
coil products than any other manufacturer in the United States, and we believe
that we are competitive as to price, service, warranty and product
performance.
Continue
to Introduce New Products
Our
Climate Control Business will continue to launch new products and product
upgrades in an effort to maintain and increase our current market position
and
to establish a presence in new markets.
Chemical
Business
General
Our
Chemical Business manufactures three principal product lines that are derived
from natural gas, anhydrous ammonia, and sulfur:
|
·
|
concentrated,
blended and regular nitric acid, mixed nitrating acids, metallurgical
grade anhydrous ammonia, sulfuric acid, and high purity ammonium
nitrate
for industrial applications,
|
|
·
|
anhydrous
ammonia, fertilizer grade ammonium nitrate, urea ammonium nitrate
(UAN),
and ammonium nitrate ammonia solution (ANA) for the agricultural
applications, and
|
|
·
|
industrial
grade ammonium nitrate and solutions for the mining
industry.
|
The
following table summarizes net sales information relating to our products of
the
Chemical Business:
Percentage
of net sales of the Chemical Business:
|
|
|
|
|
|
|
|
|
|
Industrial
acids and other chemical products
|
|
37
|
%
|
|
34
|
%
|
|
38
|
%
|
Agricultural
products
|
|
34
|
%
|
|
35
|
%
|
|
33
|
%
|
Mining
products
|
|
29
|
%
|
|
31
|
%
|
|
29
|
%
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
Percentage
of our consolidated net sales:
|
|
|
|
|
|
|
|
|
|
Industrial
acids and other chemical products
|
|
19
|
%
|
|
20
|
%
|
|
22
|
%
|
Agricultural
products
|
|
18
|
%
|
|
21
|
%
|
|
20
|
%
|
Mining
products
|
|
16
|
%
|
|
18
|
%
|
|
17
|
%
|
|
|
53
|
%
|
|
59
|
%
|
|
59
|
%
|
Industrial
Acids and Other Chemical Products
Our
Chemical Business manufactures and sells industrial acids and other chemical
products primarily to the polyurethane, paper, fibers and electronics
industries. We are a major supplier of concentrated nitric acid and mixed
nitrating acids, specialty products used in the manufacture of fibers, gaskets,
fuel additives, explosives, and other chemical products. In addition, we produce
and sell blended and regular nitric acid, metallurgical and commercial grade
ammonia and sulfuric acid. We compete based upon service, price, location of
production and distribution sites, product quality and performance. We believe
we are the largest domestic merchant marketer of concentrated and blended nitric
acids and provide inventory management as part of the value-added services
offered to certain customers.
Baytown
is one of the two largest nitric acid manufacturing units in the United States,
with demonstrated capacity exceeding 1,350 short tons per day. Subsidiaries
within our Chemical Business entered into a series of agreements with Bayer
Corporation ("Bayer") (collectively, the "Bayer Agreement"). Under the Bayer
Agreement, El Dorado Nitric Company ("EDNC"), a subsidiary within our Chemical
Business, operates Baytown at Bayer's Baytown, Texas operation. Bayer purchases
from EDNC all of its requirements for nitric acid at its Baytown operation
for a
term through at least May 2009. EDNC purchases from Bayer certain of its
requirements for materials, utilities and services for the manufacture of nitric
acid. Upon expiration of the initial ten-year term in 2009, 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.
Agricultural
Products
Our
Chemical Business produces ammonium nitrate at El Dorado and anhydrous ammonia,
UAN, and ammonium nitrate ammonia solution (“ANA”) at Cherokee; all of which are
nitrogen based fertilizers. Cherokee also has the ability to produce
agricultural grade ammonium nitrate. Although, to some extent, the various
forms
of nitrogen-based fertilizers are interchangeable, each has its own
characteristics which produce agronomic preferences among end users. Farmers
decide which type of nitrogen-based fertilizer to apply based on the crop
planted, soil and weather conditions, regional farming practices and relative
nitrogen fertilizer prices. We sell these agricultural products to farmers,
ranchers, fertilizer dealers and distributors located in the Central and
Southeastern United States.
Our
Chemical Business' agricultural markets have historically been in relatively
close proximity to El Dorado and Cherokee and include a high concentration
of
pastureland and row crops which favor our products. We develop our market
position in these areas by emphasizing high quality products, customer service
and technical advice. We have been expanding further into the Southeastern
and
NorthCentral United States. Using a proprietary prilling process, El Dorado
produces a high performance ammonium nitrate fertilizer that, because of its
uniform size, is easier to apply than many competing nitrogen-based fertilizer
products. We believe that our "E-2" brand ammonium nitrate fertilizer is
recognized as a premium product within our primary market. In addition, El
Dorado establishes long-term relationships with end-users through its network
of
wholesale and retail distribution centers and Cherokee sells directly to
agricultural customers.
Mining
Products
Our
Chemical Business manufactures industrial grade ammonium nitrate (“AN”) and 83%
AN solution for the mining industry. One of our subsidiaries, El Dorado Chemical
Company ("EDC"), is a party to a long-term cost-plus supply agreement which
was
amended during August 2006. Under this supply agreement, EDC supplies Orica
USA,
Inc. (“Orica”) with a significant volume of industrial grade ammonium nitrate
per year for a term through at least December 2010, with provisions for renewal
thereafter.
Major
Customers
The
following summarizes net sales to major customers relating to our products
of
the Chemical Business:
Net
sales to Orica as a percentage of:
|
|
|
|
|
|
|
|
|
|
Net
sales of the Chemical Business
|
|
20
|
%
|
|
19
|
%
|
|
17
|
%
|
Consolidated
net sales
|
|
10
|
%
|
|
11
|
%
|
|
10
|
%
|
Net
sales to Bayer as a percentage of:
|
|
|
|
|
|
|
|
|
|
Net
sales of the Chemical Business
|
|
14
|
%
|
|
15
|
%
|
|
18
|
%
|
Consolidated
net sales
|
|
7
|
%
|
|
9
|
%
|
|
11
|
%
|
Raw
Materials
Anhydrous
ammonia and natural gas represent the primary components in the production
of
most of the products of our Chemical Business. Spot natural gas and anhydrous
ammonia costs have fluctuated dramatically in recent years. The following table
shows, for the period indicated, the high and low daily spot price for natural
gas based
on
the price received on the Tennessee 500 Leg and for ammonia (excluding
transportation and other charges) based on the Green Markets low
Tampa.
Daily
Spot Natural Gas Prices Per MMBtu
|
Ammonia
Price Per Metric Ton
|
|
High
|
Low
|
High
|
Low
|
2004
|
$7.93
|
$4.16
|
$340
|
$182
|
2005
|
$15.25
|
$5.50
|
$399
|
$235
|
2006
|
$9.90
|
$3.54
|
$395
|
$270
|
As
of
March 10, 2007, the price of natural gas was approximately $---7.00 per MMBtu
and ammonia was $370 per metric ton. Natural gas is an integral raw material
in
the production of anhydrous ammonia. Prices of raw material feedstocks of
natural gas and anhydrous ammonia remain volatile, and we have pursued a
strategy of developing customers that purchase substantial quantities of
products pursuant to sales agreements and/or formulas that provide for the
pass-through of these raw material costs. These pricing arrangements provide
a
hedge against the commodity risk inherent in the raw material feedstocks of
natural gas and anhydrous ammonia. In addition, we economically hedge the
natural gas requirements in the financial markets for most forward sales
commitments made at fixed sales prices.
Interruptions
to the natural gas supply chain by the hurricanes of 2005 continued to
exacerbate natural gas prices into early 2006. Cherokee was forced to curtail
production in January and February of 2006 when major customers reduced
purchases due to the high natural gas raw material pass-through costs. The
natural gas supply chain continued to recover and by mid-2006, the Gulf of
Mexico supply was back to approximately 90% of pre-hurricane levels based on
a
report from the U.S. Department of the Interior.
Under
an
agreement, as amended, with its principal supplier of anhydrous ammonia, EDC
will purchase a majority of its anhydrous ammonia requirements using a market
price-based formula plus transportation to El Dorado through December 31, 2008.
We believe that we can obtain anhydrous ammonia from other sources in the event
of an interruption of service under the above-referenced contract. Our Chemical
Business natural gas feedstock requirements are generally purchased at spot
market price for delivery at Cherokee. Periodically, our Chemical Business
also
enters into fixed-price natural gas contracts for part of our requirements.
Seasonality
We
believe that the only seasonal products of our Chemical Business are fertilizer
and related chemical products sold to the agricultural industry. The selling
seasons for those products are primarily during the spring and fall planting
seasons, which typically extend from March through June and from September
through November in the geographical markets in which the majority of our
agricultural products are distributed. As a result, our Chemical Business
increases its inventory of ammonium nitrate and UAN prior to the beginning
of
each planting season. In addition, the amount and timing of sales to the
agricultural markets depend upon weather conditions and other circumstances
beyond our control.
Regulatory
Matters
Our
Chemical Business is subject to extensive federal, state and local environmental
laws, rules and regulations as discussed under “Environmental Matters" and
"Legal Proceedings" of Item 3.
Because
of growing concerns over ammonium nitrate, other nitrogen fertilizers and other
potentially hazardous materials, there have been new and proposed federal,
state
and industry requirements to place additional security controls over the
distribution, transportation and handling of these products.
We
fully
support these initiatives and believe they will not materially affect the
viability of ammonium nitrate as a valued product to the agricultural
industry.
Competition
Our
Chemical Business competes with several chemical companies in our markets,
of
whom CF Industries, Dyno Nobel North America and Terra Industries, have greater
financial and other resources than us. We believe that competition within the
markets served by our Chemical Business is primarily based upon service, price,
location of production and distribution sites, and product quality and
performance.
Employees
As
of
December 31, 2006, we employed 1,565 persons. As of that date, our Climate
Control Business employed 1,143 persons, none of whom was represented by a
union, and our Chemical Business employed 357 persons, with 117 represented
by
unions under agreements expiring in July through November of 2007.
Environmental
Matters
Our
operations are subject to numerous environmental laws (“Environmental Laws”) and
to other federal, state and local laws regarding health and safety matters
(“Health Laws”). In particular, the manufacture and distribution of chemical
products are activities which entail environmental risks and impose obligations
under the Environmental Laws and the Health Laws, many of which provide for
certain performance obligations, substantial fines and criminal sanctions for
violations. There can be no assurance that material costs or liabilities will
not be incurred by us in complying with such laws or in paying fines or
penalties for violation of such laws. The Environmental Laws and Health Laws
and
enforcement policies thereunder relating to our Chemical Business have in the
past resulted, and could in the future result, in compliance expenses, cleanup
costs, penalties or other liabilities relating to the handling, manufacture,
use, emission, discharge or disposal of pollutants or other substances at or
from our facilities or the use or disposal of certain of its chemical products.
Historically, significant expenditures have been incurred by subsidiaries within
our Chemical Business in order to comply with the Environmental Laws and Health
Laws and are reasonably expected to be incurred in the future.
The
Company has certain facilities in our Chemical Business that contain asbestos
insulation around certain piping and heated surfaces. The asbestos insulation
is
in adequate condition to prevent leakage and can remain in place as long as
the
facility is operated or remains assembled. The Company plans to maintain the
facilities in an adequate condition to prevent leakage through its standard
repair and maintenance activities.
1.
Discharge Water Matters
The
El
Dorado, Arkansas facility (“El Dorado”) within our Chemical Business generates
process wastewater. The process water discharge and storm-water run off are
governed by a state National Pollutant Discharge Elimination System (“NPDES”)
water discharge permit issued by the Arkansas Department of Environmental
Quality (“ADEQ”), which permit is to be renewed every five years. The ADEQ
issued to El Dorado a new revised NPDES water discharge permit in 2004, and
El
Dorado has until June 2007 to meet the compliance deadline for the more
restrictive limits under the 2004 NPDES permit. In order to meet El Dorado’s
June 2007 limits, El Dorado has reduced the effluent levels of its wastewater
and believes that the ADEQ will allow El Dorado to directly discharge its
wastewater into the creek that runs through its property.
In
order
to directly discharge its wastewater from El Dorado into the creek and to meet
the June 2007 permit limits, El Dorado has conducted a study of the adjacent
stream to determine whether a permit modification is appropriate. On September
22, 2006, the Arkansas Pollution Control and Ecology Commission (“Commission”)
approved the results of the study that showed that the proposed permit
modification is appropriate. A public hearing was held on the matter on
November
13, 2006 with minimal opposition. We believe that the ADEQ will issue to El
Dorado the permit modification during the third quarter of 2007. Accordingly,
direct discharge of wastewater into the creek appears at this time to be the
most likely wastewater discharge option, although there are no assurances that
this option will ultimately be made available to El Dorado.
If
El
Dorado is unable to directly discharge its wastewater, El Dorado is considering
the following other options to discharge its wastewater:
|
·
|
discharge
into the sewer discharge system of the city of El Dorado, Arkansas
(the
“City”), subject to El Dorado obtaining a sewer discharge permit from the
City; or
|
|
· |
utilization
of a joint pipeline to be constructed by the
City. |
El
Dorado
has submitted an application to the City which, if approved, would allow El
Dorado to tie-in to the City’s sewer discharge system and become an industrial
customer of the City. While we believe this to be a feasible option, this option
has been put in abeyance while El Dorado concentrates on reducing its effluent
levels to allow it to directly discharge its wastewater as discussed above.
Further,
for the past several years, El Dorado has anticipated utilizing a joint pipeline
to be built by the City to discharge its wastewater. The City has approved
the
construction of a joint pipeline, but the City’s construction of the pipeline is
subject to the City receiving a permit from the ADEQ. The ADEQ has not issued
the necessary permit to discharge wastewater into the pipeline and, as a result,
this has caused a delay of unknown duration in construction of the pipeline.
During March 2006, the ADEQ issued a draft permit to the City for the joint
pipeline, and a public hearing occurred in May 2006 to receive public comments.
The final permit was issued in March 2007. It is anticipated that both the
joint
pipeline group and opposing residents will appeal the final permit. The pipeline
will not be available by the June 1, 2007 deadline. The ADEQ has stated to
El
Dorado that since the direct discharge of wastewater appears promising, the
ADEQ
has declined to allow an extension of compliance deadlines that would coincide
with a delayed construction schedule for the City’s planned joint wastewater
pipeline.
Irrespective
of the option that El Dorado is required to utilize to dispose of its wastewater
El Dorado anticipates spending approximately $0.8 million to remove certain
contaminants from its wastewater as though it was permitted to directly
discharge into the creek. If El Dorado is required to utilize the City’s sewer
discharge system and obtains a sewer discharge permit from the City, El Dorado
will be required to obtain from the ADEQ an extension of the June 1, 2007
deadline and will spend an additional $0.5 million to connect to the City’s
sewer discharge system. If El Dorado is required to ultimately participate
in
the City’s joint pipeline to discharge its wastewater, it will be required to
obtain from the ADEQ an extension of the June 1, 2007 deadline, and anticipates
spending an additional $2 million for its pro-rata share of the City’s cost of
engineering and construction of the City’s pipeline.
In
addition, El Dorado has entered into a consent administrative order (“CAO”) that
recognizes the presence of nitrate contamination in the shallow groundwater
at
El Dorado. A new CAO to address the shallow groundwater contamination became
effective on November 16, 2006 and requires the evaluation of the current
conditions and remediation based upon a risk assessment. The final remedy for
shallow groundwater contamination, should any remediation be
required,
will be selected pursuant to the new CAO and based upon the risk assessment.
Based on area well surveys performed, there are no known users of this shallow
groundwater in the area, and preliminary risk assessments have not identified
any public health risk that would require remediation. As an interim measure,
El
Dorado has installed two recovery wells to recycle ground water and to recover
nitrates. The cost of any additional remediation that may be required will
be
determined based on the results of the investigation and risk assessment and
cannot currently be reasonably estimated. Therefore, no liability has been
established at December 31, 2006.
2.
Air Matters
To
resolve ammonia emissions from certain of our nitric acid plants, El Dorado
entered into a new air consent order which became effective December 19, 2006.
Under the terms of the consent order, El Dorado replaced the catalyst on the
units used for abatement of nitrogen oxide (a periodic maintenance requirement),
agreed to monitor ammonia slippage, and agreed to submit an air permit
modification to set an allowable limit for the ammonia emissions.
Under
the
terms of a consent administrative order relating to air matters (“AirCAO”),
which became effective in February 2004, resolving certain air regulatory
alleged violations associated with El Dorado’s sulfuric acid plant and certain
other alleged air emission violations, El Dorado is required to implement
additional air emission controls at El Dorado no later than six years from
the
effective date of the AirCAO. The ultimate cost of any technology changes
required cannot presently be determined but is believed to cost between $2.5
million to $4 million of capital expenditures, depending on the technology
changes as may be required. Our initial engineering evaluation began during
the
fourth quarter of 2006.
3.
Other Environmental Matters
In
April
2002, Slurry Explosive Corporation (“Slurry”), later renamed Chemex I Corp., a
subsidiary within our Chemical Business, entered into a Consent Administrative
Order (“Slurry Consent Order”) with the Kansas Department of Health and
Environment (“KDHE”), regarding Slurry’s Hallowell, Kansas manufacturing
facility (“Hallowell Facility”). The Slurry Consent Order addressed the release
of contaminants from the facility into the soils and groundwater and surface
water at the Hallowell Facility. There are no known users of the groundwater
in
the area. The adjacent strip pit is used for fishing. Under the terms of the
Slurry Consent Order, Slurry is required to, among other things, submit an
environmental assessment work plan to the KDHE for review and approval, and
agree with the KDHE as to any required corrective actions to be performed at
the
Hallowell Facility.
In
connection with the sale of substantially all of the operating assets of Slurry
and Universal Tech Corporation (“UTeC”) in December 2002, which was accounted
for as discontinued operations, both subsidiaries within our Chemical Business,
UTeC leased the Hallowell Facility to the buyer under a triple net long-term
lease agreement. However, Slurry retained the obligation to be responsible
for,
and perform the activities under, the Slurry Consent Order. In addition, certain
of our subsidiaries agreed to indemnify the buyer of such assets for these
environmental matters. The successor (“Chevron”) of the prior owner of the
Hallowell Facility has agreed, within certain limitations, to pay and has been
paying one-half of the costs of certain interim remediation measures at the
site
approved by the KDHE, subject to reallocation.
As
a
result of meetings with the KDHE, we recorded a provision of $0.6 million for
our share of these additional estimated costs for 2005. In addition, during
2006, additional costs were estimated due to requirements by the KDHE to further
investigate and delineate the site. As a result, for 2006, we recorded
provisions totaling $0.2 million for our share of these estimated additional
costs. The above provisions are classified as discontinued operations (in
accordance with SFAS 144) in the accompanying consolidated statements of income
(there are no income tax benefits related to this expense). At December 31,
2006, the total estimated liability (which is included in current and noncurrent
accrued and other liabilities) in connection with this remediation matter is
$1.4 million and Chevron’s share for one-half of these costs (which is included
in accounts receivable and other assets) is $0.7 million. These amounts are
not
discounted to their present value. It is reasonably possible that a change
in
estimate of our liability and receivable will occur in the near term. Should
soil remediation be required, it is expected to be completed during 2007
followed by up to five years of ground water monitoring.
Recently,
a site modeling was performed by a consulting firm for Slurry and Chevron which
indicates that the removal of the contaminated soil would have only limited
beneficial effect on the reduction of the contamination of the ground water
down
gradient of the site. The consultant’s modeling report was presented for review
to the KDHE in March 2007. As a result, Slurry and Chevron expect to attempt
to
pursue a course with the KDHE of long-term surface and ground water monitoring
to track the natural decline in contamination, instead of the soil excavation.
We estimate the costs relating to this course of action to be substantially
less
than the cost of the soil excavation but we are unable to determine if the
KDHE
will ultimately accept the proposal.
Risks
Related to Us and Our Business
Cost
and availability of raw materials could materially affect our profitability
and
liquidity.
Our
Chemical Business’ sales and profits are heavily affected by the costs and
availability of its primary raw materials. Anhydrous ammonia and natural gas,
which are purchased from unrelated third parties, represent the primary raw
material feedstocks in the production of most of the products of the Chemical
Business. The primary material utilized in anhydrous ammonia production is
natural gas, and fluctuations in the price of natural gas can have a significant
effect on the cost of anhydrous ammonia. Historically, there has been volatility
in the cost of anhydrous ammonia and natural gas, and in many instances, we
were
unable to increase our sales prices to cover all of the higher anhydrous ammonia
and natural gas costs incurred. Although our Chemical Business has a program
to
enter into contracts with certain customers that provide for the pass-through
of
raw material costs, we have a substantial amount of sales by the Chemical
Business that do not provide for these pass-throughs. Thus, in the future,
we
may not be able to pass along to all of our customers the full amount of any
increases in anhydrous ammonia and natural gas costs. We have suspended in
the
past, and could in the future, from time to time, suspend production at our
chemical facilities due to, among other things, the high cost or lack of
availability of such primary raw materials. Accordingly, our results of
operations and financial condition have in the past been, and may in the future
be, materially affected by the cost or unavailability of raw materials,
including anhydrous ammonia and natural gas.
In
addition, our Climate Control Business depends on raw materials such as copper
and steel, which have recently shown considerable price volatility. While we
periodically enter into fixed-price contracts on copper to hedge against price
increases, there can be no assurance that our Climate Control Business will
effectively manage against price fluctuations in copper and other raw materials
or that future price fluctuations in copper and other raw materials will not
have an adverse effect on our financial condition, liquidity and results of
operations. Our Climate Control Business depends on certain suppliers to deliver
the key components that are required in the production of its products. Any
disruption in such supply could result in lost production or delayed shipments,
which could materially affect our operations and cash flow.
In
recent years, our Chemical Business has been unable to generate significant
positive cash flows.
Due,
in
part, to lower than optimum sales levels, margin problems and extensive capital
expenditures, our Chemical Business has not generated significant positive
cash
flows in recent years. Continuing significant cash flow expenditures by this
business could have a material adverse effect on our financial condition and
liquidity.
Our
Climate Control Business and its customers are sensitive to economic
cycles.
Our
Climate Control Business is affected by cyclical factors, such as interest
rates, inflation and economic downturns. Our Climate Control Business depends
on
sales to customers in the commercial construction and renovation industries,
which are particularly sensitive to these
factors.
A decline in the economic activity in the United States has in the past, and
could in the future, have a material adverse effect on our customers in the
commercial construction and renovation industries in which our Climate Control
Business sells a substantial amount of its products. Such a decline could result
in a decrease in revenues and profits, and an increase in bad debts, in our
Climate Control Business.
Weather
conditions adversely affect our Chemical Business.
The
agricultural products produced and sold by our Chemical Business have in the
past, and could continue in the future, to be materially affected by adverse
weather conditions (such as excessive rains or drought) in the primary markets
for our fertilizer and related agricultural products. If any of these unusual
weather events occur during the primary seasons for sales of our agricultural
products (March-June and September-November), this could have a material adverse
effect on the agricultural sales of our Chemical Business and our financial
condition and results of operation.
Environmental
and regulatory matters entail significant risk for us.
As
discussed under “Environmental Matters” of Item 1, our Chemical Business is
subject to numerous environmental laws and regulations. The manufacture and
distribution of chemical products are activities which entail environmental
risks and impose obligations under environmental laws and regulations, many
of
which provide for substantial fines and potential criminal sanctions for
violations. Our Chemical Business has in the past, and may in the future, be
subject to fines, penalties and sanctions for violations of environmental laws
and substantial expenditures for cleanup costs and other liabilities relating
to
the handling, manufacture, use, emission, discharge or disposal of pollutants
or
other substances at or from the Chemical Business’ facilities. Further, a number
of our Chemical Business’ facilities are dependent on environmental permits to
operate, the loss of which could have a material adverse effect on its
operations and our financial condition.
We
may be required to expand our security procedures and install additional
security equipment for our Chemical Business in order to comply with the
Homeland Security Act of 2002 and possible future government
regulation.
The
chemical industry in general, and producers and distributors of ammonium nitrate
specifically, are scrutinized by the government, industry and public on security
issues. Under the Homeland Security Act of 2002, as well as current and
proposed regulations, we may be required to incur substantial additional costs
relating to security at our chemical facilities and distribution centers and
security for the transportation of our products. These costs could have a
material impact on our financial condition and results of
operation.
A
substantial portion of our sales is dependent upon a limited number of
customers.
During
2006, six customers of our Chemical Business accounted for 54% of its net sales
and 29% of our consolidated sales, and our Climate Control Business had one
customer that accounted for 16% of its net sales and 7% of our consolidated
sales. The loss of, or a material reduction in purchase levels by, one or more
of these customers could have a material adverse
effect
on
our business and our results of operations, financial condition and liquidity
if
we are unable to replace a customer on substantially similar terms.
Our
working capital requirements fluctuate because of the seasonal nature of our
Chemical Business’ agricultural products.
Because
of the seasonal nature of our Chemical Business’ agricultural products, our
working capital requirements are significantly higher at certain times of the
year due to increases in inventories of ammonium nitrate, UAN and other
agricultural products prior to the beginning of each planting season. If
additional working capital is required and not available under our revolving
credit facility, this could have a negative impact on our other operations,
including our Climate Control Business.
There
is intense competition in the Climate Control and Chemical
industries.
Substantially
all of the markets in which we participate are highly competitive with respect
to product quality, price, design innovations, distribution, service,
warranties, reliability and efficiency. We compete with a number of established
companies that have greater financial, marketing and other resources than we
have and are less highly leveraged than we are. Competitive factors could
require us to reduce prices or increase spending on product development,
marketing and sales that would have a material adverse effect on our business,
results of operation and financial condition.
We
are effectively controlled by the Golsen Group.
Jack
E.
Golsen, our Chairman of the Board and Chief Executive Officer (“CEO”), members
of his immediate family (spouse and children), including Barry H. Golsen, our
Vice Chairman and President, entities owned by them and trusts for which they
possess voting or dispositive power as trustee (collectively, the “Golsen
Group”) beneficially owned as of March 14, 2007, an aggregate of 3,542,375
shares of our common stock and 1,020,000 shares of our voting preferred stock
(1,000,000 of which shares have .875 votes per share, or 875,000 votes), which
together votes as a class and represented approximately 21.8% of the voting
power of our issued and outstanding voting securities as of that date. At such
date, the Golsen Group also beneficially owned options, rights and other
convertible preferred stock that allowed its members to acquire an additional
392,926 shares of our common stock within 60 days of March 14, 2007. Thus,
the
Golsen Group may be considered to effectively control us. As a result, the
ability of other stockholders to influence our management and policies could
be
limited.
Loss
of key personnel could negatively affect our business.
We
believe that our performance has been and will continue to be dependent upon
the
efforts of our principal executive officers. We cannot promise you that our
principal executive officers will continue to be available. Jack E. Golsen
has
an employment agreement with us. No other principal executive has an employment
agreement with us. The loss of some of our principal executive officers could
have a material adverse effect on us. We believe that our future success will
depend in large part on our continued ability to attract and retain highly
skilled and qualified personnel.
We
may have inadequate insurance.
While
we
maintain liability insurance, including certain coverage for environmental
contamination, it is subject to coverage limits and policies may exclude
coverage for some types of damages. Although there may currently be sources
from
which such coverage may be obtained, it may not continue to be available to
us
on commercially reasonable terms or the possible types of liabilities that
may
be incurred by us may not be covered by our insurance. In addition, our
insurance carriers may not be able to meet their obligations under the policies
or the dollar amount of the liabilities may exceed our policy limits. Even
a
partially uninsured claim, if successful and of significant magnitude, could
have a material adverse effect on our business, results of operations, financial
condition and liquidity.
Our
warranty claims are not generally covered by our
insurance.
The
development, manufacture, sale and use of products by our Climate Control
Business involve a risk of warranty and product liability claims. Warranty
claims are not generally covered by our product liability insurance and there
may be types of product liability claims that are not covered by our product
liability insurance. A successful warranty or product liability claim not
covered by our insurance could have a material adverse effect on our business,
results of operations, financial condition and liquidity.
Terrorist
attacks and other acts of violence or war, and natural disasters (such as
hurricanes, pandemic health crisis, etc.), have and could negatively impact
the
U.S. and foreign companies, the financial markets, the industries where we
operate, our operations and profitability.
Terrorist
attacks and natural disasters (such as hurricanes) have in the past, and can
in
the future, negatively affect our operations. We cannot predict further
terrorist attacks and natural disasters in the United States and elsewhere.
These attacks or natural disasters have contributed to economic instability
in
the United States and elsewhere, and further acts of terrorism, violence, war
or
natural disasters could further affect the industries where we operate, our
ability to purchase raw materials, our business, results of operations and
financial condition. In addition, terrorist attacks and natural disasters may
directly impact our physical facilities, especially our chemical facilities,
or
those of our suppliers or customers and could impact our sales, our production
capability and our ability to deliver products to our customers. In the past,
hurricanes affecting the Gulf Coast of the United States have resulted in
damages to, or shutdown of, the gas pipeline to Cherokee, resulting in that
facility being shutdown for several weeks. The consequences of any terrorist
attacks or hostilities or natural disasters are unpredictable, and we may not
be
able to foresee events that could have an adverse effect on our
operations.
Our
net loss carryovers are subject to various limitations and have not been
approved by the Internal Revenue Service.
Our
net
loss carryovers have resulted from certain losses, and we anticipate they may
be
used to reduce the federal income tax payments which we would otherwise be
required to make with respect to income, if any, generated in future years.
We
had available regular-tax net operating loss carryovers of approximately $49.3
million at December 31, 2006. The use of the net
operating
loss carryovers is, however, subject to certain limitations and will expire
to
the extent not utilized beginning in 2019. In addition, the amount of these
carryovers has not been audited or approved by the Internal Revenue Service,
and, accordingly, we cannot promise that such carryovers will not be reduced
as
a result of audits in the future.
Restatements
and amendments to our 2004 audited financial statements and certain matters
related to our disclosure controls and procedures may present a risk of future
restatements and could in turn lead to legal exposure.
In
response to comments from the SEC to our 2004 Form 10-K, and as a result of
changes we made internally, we restated and amended our 2004 audited financial
statements and on December 30, 2005, filed a Form 10-K/A (Amendment No. 1)
for
year ended December 31, 2004. As a result of the restatement and amendments
to
our 2004 audited financial statements and SEC comments, we also filed on
December 30, 2005, an amended Form 10-Q/A for each of the quarters ended March
31, 2005 and June 30, 2005.
As
a
result of this restatement to our 2004 financial statements, we also revised
our
2004 Form 10-K and first two quarters 2005 Form 10-Qs to provide that our
disclosure controls and procedures were not effective as of December 31, 2004,
March 31, 2005 and June 30, 2005, in our Form 10-K/A and Forms 10-Q/A, as a
result of assessing that the change from the LIFO method to the FIFO method
of
accounting was not material resulting in the decision at the time of the change
not to disclose and not to restate the prior years financial statements. We
believe that during December 2005, we corrected the weakness to our disclosure
controls and procedures by, among other things, establishing a Disclosure
Committee to maintain oversight activities and to examine and reevaluate our
policies, procedures and criteria to determine materiality of items relative
to
our financial statements taken as a whole. Restatements by others have, in
some
cases, resulted in the filing of class action lawsuits against such companies
and their management and further inquiries from the SEC. Any similar lawsuit
against us could result in substantial defense and/or liability costs and would
likely consume a material amount of management’s attention that might otherwise
be applied to our business. Under certain circumstances, these costs might
not
be covered by, or might exceed the limits of, our insurance
coverage.
In
addition, by letter received in August 2006 from the SEC, the SEC has made
an
informal inquiry of us relating to the change in inventory accounting from
LIFO
to FIFO resulting in the restatement of our financial statements, and, at this
time, we do not know if the informal inquiry:
|
·
|
will
rise to the level of an investigation or proceeding,
or
|
|
·
|
will
result in an enforcement action, if any, by the
SEC.
|
We
are a holding company and depend, in large part, on receiving funds from our
subsidiaries to fund our indebtedness.
Because
we are a holding company and operations are conducted through our subsidiaries,
principally ThermaClime and its subsidiaries, our ability to make scheduled
payments of principal and interest on our indebtedness depend on operating
performance and cash flows of our subsidiaries and the ability of our
subsidiaries to make distributions and pay dividends to us. Under its loan
agreements, ThermaClime and its subsidiaries may only make distributions and
pay
dividends to us under limited circumstances and in limited amounts. If
ThermaClime is unable to make distributions or pay dividends to us, or the
amounts of such distributions or dividends are not sufficient for us to service
our debts, we may not be able to pay the principal or interest, or both, due
on
our indebtedness.
We
are leveraged, which could affect our ability to pay our
indebtedness.
We
have a
substantial amount of debt. At December 31, 2006, our aggregate consolidated
debt was approximately $97.7 million resulting in total debt as a percentage
of
total capitalization of 70%.
The
degree to which we are leveraged could have important consequences to us,
including the following:
· our
ability to obtain additional financing in the future for refinancing
indebtedness, acquisitions, working capital, capital expenditures or other
purposes may be impaired;
· funds
available to us for our operations and general corporate purposes or for capital
expenditures will be reduced because a substantial portion of our consolidated
cash flow from operations could be dedicated to the payment of the principal
and
interest on our indebtedness;
· we
may be
more highly leveraged than some of our competitors, which may place us at a
competitive disadvantage;
· the
agreements governing our long-term indebtedness, including indebtedness under
the debentures, and those of our subsidiaries (including indebtedness under
the
debentures) and bank loans contain certain restrictive financial and operating
covenants;
· an
event
of default, which is not cured or waived, under financial and operating
covenants contained in these debt instruments could occur and have a material
adverse effect on us; and
· we
may be
more vulnerable to a downturn in general economic conditions.
Our
ability to make principal and interest payments, or to refinance indebtedness,
will depend on our future operating performance and cash flow, which are subject
to prevailing economic conditions and other factors affecting us, many of which
are beyond our control.
Future
issuance or potential issuance of our common stock could adversely affect the
price of our common stock, our ability to raise funds in new stock offerings
and
dilute your percentage interest in our common stock.
Future
sales of substantial amounts of our common stock or equity-related securities
in
the public market, or the perception that such sales could occur, could
adversely affect prevailing trading prices of our common stock and could impair
our ability to raise capital through future offerings of equity or
equity-related securities. No prediction can be made as to the effect, if any,
that future sales of shares of common stock or the availability of shares of
common stock for future sale, will have on the trading price of our common
stock. Such future sales could also significantly reduce the percentage
ownership of our existing common stockholders.
We
have not declared or paid dividends on our outstanding common stock in many
years and have a substantial amount of accrued and unpaid dividends on our
outstanding series of cumulative preferred stock.
We
have
not paid cash dividends on our outstanding common stock in many years, and
from
January 1, 1999, through December 31, 2005, we did not pay any accrued dividends
on our outstanding cumulative preferred stock. We intend to retain most of
our
future earnings, if any, to provide funds for our operations and/or expansion
of
our businesses. However, during each quarter in 2006, our board of directors
declared nominal dividends on certain outstanding series of our preferred stock,
as follows: $.10 per share on the then outstanding shares of our Series 2
Preferred, $.37 per share on our outstanding Series B 12% Cumulative Convertible
Preferred, and $.31 per share on our outstanding Non-Cumulative Preferred.
These
dividends are not for the full amount of the required quarterly dividends
pursuant to the terms of our outstanding series of preferred stock. As of March
19, 2007, there were approximately $6.8 million of accrued and unpaid dividends
on our outstanding cumulative preferred stock after the completion of our
recently completed exchange offer which is discussed under “Sale of Unregistered
Securities -Preferred Stock Exchanges and Completion of Exchange Offer” of Item
5.
We
do not
anticipate paying cash dividends on our outstanding common stock in the
foreseeable future, and until all accrued and unpaid dividends are paid on
our
outstanding cumulative preferred stock, no dividends may be paid on our common
stock. In the event of our liquidation, winding up or dissolution, there can
be
no distributions on our common stock until all of the liquidation preference
and
stated value amounts of our outstanding preferred stock and all accrued and
unpaid dividends due on our outstanding cumulative preferred stock are paid
in
full. Further, not paying all of the cumulative accrued dividends on our
outstanding preferred stock could adversely affect the marketability of our
common stock and our ability to raise additional equity capital.
We
are subject to a variety of factors that could discourage other parties from
attempting to acquire us.
Our
certificate of incorporation provides for a staggered board of directors and,
except in limited circumstances, a two-thirds vote of outstanding voting shares
to approve a merger, consolidation or sale of all, or substantially all, of
our
assets. In addition, we have entered into severance agreements with our
executive officers and some of the executive officers of our subsidiaries that
provide, among other things, that if, within a specified period of time after
the occurrence of a change in control of our company, these officers are
terminated, other than for cause, or the officer terminates his employment
for
good reason, we must pay such officer an amount equal to 2.9 times the officer’s
average annual gross salary for the last five years preceding the change in
control.
We
have
authorized and unissued (including shares held in treasury) 55,520,861 shares
of
common stock and 4,036,093 shares of preferred stock as of March 14, 2007.
These
unissued shares could be used by our management to make it more difficult,
and
thereby discourage an attempt to acquire control of us.
We
have
adopted a preferred share purchase plan, which is designed to ensure that all
of
our stockholders receive fair and equal treatment in the event of a proposed
takeover or abusive tender offer.
The
foregoing provisions and agreements are designed to discourage a third party
tender offer or proxy contest for control of us and could have the effect of
making it more difficult to remove incumbent management.
Delaware
has adopted an anti-takeover law which, among other things, will delay for
three
years business combinations with acquirers of 15% or more of the outstanding
voting stock of publicly-held companies (such as us), unless (a) the acquirer
owned at least 85% of the outstanding voting stock of such company prior to
commencement of the transaction, or (b) two-thirds of the stockholders, other
than the acquirer, vote to approve the business combination after approval
thereof by the board of directors, and (c) the stockholders decide to opt out
of
the statute.
Not
applicable.
Climate
Control Business
Our
Climate Control Business manufactures most of its heat pump products in a
270,000 square foot facility in Oklahoma City, Oklahoma. We lease this facility,
with an option to buy, through May 2016, with options to renew for three
additional five-year periods. For 2006, approximately 98% of the productive
capacity of this manufacturing facility was being utilized, based on two
ten-hour shifts per day and a four-day work week in one department and one
ten-hour shift per day and a four-day work week in all other departments.
During
mid-2006, we added three twelve-hour shifts per weekend. See discussion under
“Production and Backlog” of Item 1.
Our
Climate Control Business conducts its fan coil manufacturing operations in
a
facility located in Oklahoma City, Oklahoma, consisting of approximately
265,000
square feet. We own this facility subject to a mortgage. For 2006, our Climate
Control Business was using 87% of the productive capacity, based on one ten-hour
shift per day and a four-day work week and a limited second shift in selected
areas.
Our
Climate Control Business conducts its large air handler manufacturing operation
in a facility located in Oklahoma City, Oklahoma, consisting of approximately
110,000 square feet. We own this facility subject to a mortgage. For 2006,
approximately 53% of the productive capacity of this manufacturing facility
was
being utilized, based on one eight-hour shift on a five-day work week and
a
partial second shift in selected areas.
All
of
the properties utilized by our Climate Control Business are considered by our
management to be suitable to meet the current needs of that business. However,
we plan to
utilize additional space at some of our other facilities
for
distribution purposes as the result of the record order intake level of our
heat
pump products as discussed under “Production and Backlog” in Item
1.
Chemical
Business
Our
Chemical Business primarily conducts manufacturing operations (a) on 150 acres
of a 1,400 acre tract of land located at El Dorado, (b) on 160 acres of a 1,300
acre tract of land located at Cherokee and (c) on leased property within Bayer’s
complex in Baytown, Texas. The Company and/or its subsidiaries own all of its
manufacturing facilities except Baytown. Baytown is being leased pursuant to
a
long-term lease with an unrelated third party. Certain real property and
equipment located at El Dorado and Cherokee are being used to secure a $50
million term loan. For 2006, the following facilities were utilized based on
continuous operation:
|
El
Dorado (1)
|
91
|
%
|
|
|
Cherokee
(2)
|
83
|
%
|
|
|
Baytown
(3)
|
90
|
%
|
|
(1)
The
percentage of capacity for El Dorado relates to its nitric acid capacity. El
Dorado has capacity to produce other nitrogen products in excess of its nitric
acid capacity.
(2)
The
percentage of capacity for Cherokee relates to its ammonia production capacity
and was compromised by the curtailments in early 2006 as explained under
“Overview - Chemical Business” of Item 7. Cherokee has additional capacity for
nitric acid, ammonium nitrate and urea in excess of its ammonia capacity.
(3)
Production projects were completed at Baytown from 2004 through 2006 which
increased nameplate capacity by 7%. Further process fine tuning and capacity
increases are planned for 2007.
In
addition to El Dorado and Cherokee, our Chemical Business distributes its
agricultural products through 15 wholesale and retail distribution centers,
with
13 of the centers located in Texas (10 of which we own and 3 of which we lease);
1 center located in Tennessee (owned); and 1 center located in Missouri
(owned).
All
of
the properties utilized by our Chemical Business are considered by our
management to be suitable and adequate to meet the current needs of that
business.
1.
Environmental
See
“Business-Environmental Matters” for a discussion as to:
|
·
|
claims
by the KDHE regarding Slurry’s former facility in Hallowell, Kansas and
Chevron, the successor of the prior owner of the facility; and
|
|
·
|
discussion
as to a consent order between El Dorado and the ADEQ entered into
during
December 2006 to resolve certain ammonia
emissions.
|
2.
Chemical Business
Cherokee
Nitrogen Company (“CNC”), a subsidiary within our Chemical Business, has been
sued for an undisclosed amount of monies based on a claim that CNC breached
an
agreement by overcharging the plaintiff, Nelson Brothers, LLC, (“Nelson”) for
ammonium nitrate as a result of inflated prices for natural gas used to
manufacture the ammonium nitrate. CNC has filed a third-party complaint against
Dynegy and a subsidiary (“Dynegy”) asserting that Dynegy was the party
responsible for fraudulently causing artificial natural gas prices to exist
and
seeking an undisclosed amount from Dynegy, including any amounts which may
be
recovered by Nelson. The suit is Nelson
Brothers, LLC v. Cherokee Nitrogen v. Dynegy Marketing,
and is
pending in Alabama state court in Colbert County. Dynegy has filed a
counterclaim against CNC for $600,000 allegedly owed on account, which has
been
recorded by CNC. Although there is no assurance, counsel for CNC has advised
us
that, at this time, they believe that CNC will recover monies from Dynegy
and
the likelihood of Dynegy recovering from CNC is remote. Our counsel also
has
advised us that they believe that the likelihood of Nelson recovering monies
from CNC over and above any monies which may be recovered from Dynegy by
CNC is
remote.
CNC
has
filed suit against Meecorp Capital Markets, LLC (“Meecorp”) and Lending
Solutions, Inc. in Alabama State Court, in Etowah County, Alabama, for recovery
of actual damages of $140,000 plus punitive damages, relating to a loan
transaction. Meecorp counterclaimed for the balance of an alleged commitment
fee
of $100,000, an alleged equity kicker of $200,000 and $3,420,000 for loss
of
opportunity. CNC is vigorously pursuing this matter, and counsel for CNC
has
advised that they believe there is a good likelihood CNC will recover from
the
defendants and that the likelihood of Meecorp recovering from CNC is
remote.
3.
Other
Zeller
Pension Plan
In
February 2000, the Company’s Board of Directors authorized management to proceed
with the sale of the automotive products business, since the automotive products
business was no longer a “core business” of the Company. In May 2000, the
Company sold substantially all of its assets in its automotive products
business. After the authorization by the board, but prior to the sale, the
automotive products business purchased the assets and assumed certain
liabilities of Zeller Corporation (“Zeller”). The liabilities of Zeller assumed
by the automotive products business included Zeller’s pension plan, which is not
a multi-employer pension plan. In June 2003, the principal owner (“Owner”) of
the buyer of the automotive products business was contacted by a representative
of the Pension Benefit Guaranty Corporation (“PBGC”) regarding the plan. The
Owner was informed by the PBGC of a possible under-funding of the plan and
a
possible takeover of the plan by the PBGC. The PBGC previously advised the
Company that the PBGC may consider the Company to be potentially liable for
the
under-funding of the Zeller Plan in the event that the plan is taken over by
the
PBGC and alleged that the under-funding is approximately $600,000. However,
the
Company’s ERISA counsel was verbally informed by a PBGC representative that he
would probably recommend no further action by the PBGC with respect to the
Company’s involvement with the Zeller plan. There are no assurances that such
recommendation, will be made or, if made, will be accepted by the
PBGC.
MEI
Drafts
On
July
18, 2006, Masinexportimport Foreign Trade Company (“MEI”) gave notice to the
Company and a subsidiary of the Company alleging that it was owed $1,533,000
in
connection with MEI’s attempted collection of ten non-negotiable bank
drafts payable to the order of MEI. The bank drafts were issued by Aerobit
Ltd.
(“Aerobit”), a non-U.S. company and at the time of issuance of the bank drafts
was a subsidiary of the Company. Each of the bank drafts has a face value of
$153,300, for an aggregate principal face value of $1,533,000. The bank drafts
were issued in September 1992, and had a maturity date of December 31, 2001.
Each bank draft was endorsed by LSB Corp., which, at the time of endorsement,
was a subsidiary of the Company.
On
October 22, 1990, a settlement agreement between the Company, its subsidiary
Summit Machine Tool Manufacturing Corp. (“Summit”), and MEI (the “Settlement
Agreement”), was entered into, and in connection with the Settlement Agreement,
Summit issued to MEI obligations totaling $1,533,000. On May 16, 1992, the
Settlement Agreement was rescinded by the Company, Summit, and MEI at the
request of MEI, and replaced with an agreement purportedly substantially similar
to the Settlement Agreement between MEI and Aerobit, pursuant to which MEI
agreed to replace the original $1,533,000 of Summit’s obligations with Aerobit
bank drafts totaling $1,533,000, endorsed by LSB Corp. Aerobit previously
advised us that MEI has not fulfilled the requirements under the bank drafts
for
payment thereof.
All
of
the Company’s ownership interest in LSB Corp. was sold to an unrelated third
party in September 2002. Further, all of the Company’s interest in Aerobit was
sold to a separate unrelated third party, in a transaction completed on or
before November 2002. Accordingly, neither Aerobit, which was the issuer of
the
bank drafts, nor LSB Corp., which was the endorser of the bank drafts, are
currently subsidiaries of the Company.
Neither
the Company nor any of its currently owned subsidiaries are makers or endorsers
of the bank drafts in question. The Company intends to vigorously defend itself
in connection with this matter. No liability has been established relating
to
these bank drafts as of December 31, 2006.
Securities
and Exchange Commission Inquiry
The
Securities and Exchange Commission (“SEC”) made an informal inquiry to the
Company by letter dated August 15, 2006. The inquiry relates to the restatement
of the Company’s consolidated financial statements for the year ending December
31, 2004 and accounting matters relating to the change in inventory accounting
from LIFO to FIFO. The Company has responded to the inquiry. At the present
time
the informal inquiry is not a pending proceeding nor does it rise to the level
of a government investigation. Until further communication and clarification
with the SEC, if any, the Company is unable to determine:
|
· |
if
the inquiry will ever rise to the level of an investigation or proceeding,
or |
|
·
|
the
materiality to the Company’s financial position with respect to
enforcement actions, if any, the SEC may have available to it.
|
We
are
also involved in various other claims and legal actions which in the opinion
of
management, after consultation with legal counsel, if determined adversely
to
us, would not have a material effect on our business, financial condition or
results of operations.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No
matters were submitted to a vote of our shareholders during the fourth quarter
of 2006.
ITEM
4A. EXECUTIVE OFFICERS OF THE
REGISTRANT
Our
officers serve one-year terms, renewable on an annual basis by the Board of
Directors. Information regarding the Company's executive officers is as follows:
Jack
E. Golsen (1)
|
|
Chairman
of the Board and Chief Executive Officer. Mr. Golsen, age 78, first
became
a director in 1969. His term will expire in 2007. Mr. Golsen, founder
of
the Company, is our Chairman of the Board of Directors and Chief
Executive
Officer and has served in that capacity since our inception in 1969.
Mr.
Golsen served as our President from 1969 until 2004. During 1996,
he was
inducted into the Oklahoma Commerce and Industry Hall of Honor as
one of
Oklahoma's leading industrialists. Mr. Golsen has a Bachelor of Science
degree from the University of New Mexico in biochemistry.
|
|
|
|
Barry
H. Golsen (1)
|
|
Vice
Chairman of the Board, President, and President of the Climate Control
Business. Mr. Golsen, age 56, first became a director in 1981. His
term
will expire in 2009. Mr. Golsen was elected President of the Company
in
2004. Mr. Golsen has served as our Vice Chairman of the Board of
Directors
since August 1994, and has been the President of our Climate Control
Business for more than five years. Mr. Golsen also serves as a director
of
the Oklahoma branch of the Federal Reserve Bank. Mr. Golsen has both
his
undergraduate and law degrees from the University of
Oklahoma.
|
|
|
|
David
R. Goss
|
|
Executive
Vice President of Operations and Director. Mr. Goss, age 66, first
became
a director in 1971. His term will expire in 2009. Mr. Goss, a certified
public accountant, is our Executive Vice President of Operations
and has
served in substantially the same capacity for more than five years.
Mr.
Goss is a graduate of Rutgers University.
|
|
|
|
Tony
M. Shelby
|
|
Executive
Vice President of Finance and Director. Mr. Shelby, age 65, first
became a
director in 1971. His term will expire in 2008. Mr. Shelby, a certified
public accountant, is our Executive Vice President of Finance and
Chief
Financial Officer, a position he has held for more than five years.
Prior
to becoming our Executive Vice President of Finance and Chief Financial
Officer, he served as Chief Financial Officer of a subsidiary of
the
Company and was with the accounting firm of Arthur Young & Co., a
predecessor to Ernst & Young LLP. Mr. Shelby is a graduate of Oklahoma
City University.
|
|
|
|
Jim
D. Jones
|
|
Senior
Vice President, Corporate Controller and Treasurer. Mr. Jones, age
64, has
been Senior Vice President, Controller and Treasurer since July 2003,
and
has served as an officer of the Company since April 1977. Mr. Jones
is a
certified public accountant and was with the accounting firm of Arthur
Young & Co., a predecessor to Ernst & Young LLP.
Mr.
Jones is a graduate of the University of Central
Oklahoma.
|
|
|
|
David
M. Shear (1)
|
|
Senior
Vice President and General Counsel. Mr. Shear, age 47, has been Senior
Vice President since July 2004 and General Counsel and Secretary
since
1990. Mr. Shear attended Brandeis University, graduating cum laude
in
1981. At Brandeis University, Mr. Shear was the founding Editor-In-Chief
of Chronos, the first journal of undergraduate scholarly articles.
Mr.
Shear attended the Boston University School of Law, where he was
a
contributing Editor of the Annual Review of Banking Law.
Mr.
Shear acted as a staff attorney at the Bureau of Competition with
the
Federal Trade Commission from 1985 to 1986. From 1986 through 1989,
Mr.
Shear was an associate in the Boston law firm of Weiss, Angoff, Coltin,
Koski and Wolf. Also see discussion under “Family Relationships” in Item
10.
|
(1)
Barry
H. Golsen is the son of Jack E. Golsen and David M. Shear is married to the
niece of Jack E. Golsen.
PART
II
ITEM
5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED
STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market
Information
Our
common stock is listed for trading on the American Stock Exchange under the
symbol “LXU”. The following table shows, for the periods indicated, the high and
low bid information for our common stock which reflects inter-dealer prices,
without retail markup, markdown or commission, and may not represent actual
transactions.
|
Quarter
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
First
|
|
$
|
7.48
|
|
$
|
5.87
|
|
$
|
7.93
|
|
$
|
5.95
|
|
Second
|
|
$
|
9.19
|
|
$
|
6.95
|
|
$
|
7.50
|
|
$
|
6.00
|
|
Third
|
|
$
|
10.25
|
|
$
|
8.25
|
|
$
|
7.35
|
|
$
|
6.05
|
|
Fourth
|
|
$
|
13.20
|
|
$
|
8.50
|
|
$
|
6.70
|
|
$
|
4.84
|
Stockholders
As
of
March 14, 2007, we had 740 record holders of our common stock. This number
does
not include investors whose ownership is recorded in the name of their brokerage
company.
Dividends
We
are a
holding company and, accordingly, our ability to pay cash dividends on our
preferred stock and our common stock depends in large part on our ability to
obtain funds from our subsidiaries. The ability of ThermaClime (which owns
substantially all of the companies comprising the Climate Control Business
and
Chemical Business) and its wholly-owned subsidiaries to pay dividends and to
make distributions to us is restricted by certain covenants contained in the
Working Capital Revolver Loan and Senior Secured Loan agreements to which they
are parties.
Under
the
terms of the Working Capital Revolver Loan and Senior Secured Loan agreements,
ThermaClime cannot transfer funds to us in the form of cash dividends or other
distributions or advances, except for:
|
·
|
the
amount of income taxes that ThermaClime would be required to pay
if they
were not consolidated with us;
|
|
·
|
an
amount not to exceed fifty percent (50%) of ThermaClime's consolidated
net
income during each fiscal year determined in accordance with generally
accepted accounting principles plus amounts paid to us within the
first
bullet above, provided that certain other conditions are
met;
|
|
·
|
the
amount of direct and indirect costs and expenses incurred by us on
behalf
of ThermaClime pursuant to a certain services
agreement;
|
|
·
|
amounts
under a certain management agreement between us and ThermaClime,
provided
certain conditions are met.
|
Holders
of our common stock are entitled to receive dividends only if and when declared
by our Board of Directors. No cash dividends may be paid on our common stock
until all required dividends are paid on the outstanding shares of our Series
2
Preferred, or declared and amounts set apart for the current period, and, if
cumulative, prior periods.
As
discussed below under “Sale of Unregistered Securities - Preferred Stock
Exchanges and Completion of Exchange Offer”, during 2006, we had transactions in
which Series 2 Preferred was exchanged for our common stock. Because the
exchanges were pursuant to terms other than the original terms, the transactions
were considered extinguishments of the preferred stock. In addition, the
transactions qualified as induced conversions under SFAS 84. Accordingly, we
recorded a charge (stock dividend) to accumulated deficit of approximately
$2.9
million which equaled the excess of the fair value of the common stock issued
over the fair value of the common stock issuable pursuant to the original
conversion terms. To measure fair value, we used the closing price of our common
stock on the day the parties entered into an exchange agreement.
As
of
March 14, 2007, we have issued and outstanding, 193,295 shares of the Series
2
Preferred, 1,000,000 shares of Series D Cumulative Convertible Class C Preferred
Stock ("Series D Preferred"), 612 shares of a series of the Non-Cumulative
Preferred and 20,000 shares of Series B 12% Convertible, Cumulative Preferred
Stock ("Series B Preferred"). Each share of preferred stock is entitled to
receive an annual dividend, if and when declared by our Board of Directors,
payable as follows:
|
·
|
Series
2 Preferred at the annual rate of $3.25 a share payable quarterly
in
arrears on March 15, June 15, September 15 and December 15, which
dividend
is cumulative;
|
|
·
|
Series
D Preferred at the rate of $.06 a share payable on October 9, which
dividend is cumulative but will be paid only after accrued and unpaid
dividends are paid on the Series 2 Preferred;
|
|
·
|
Non-Cumulative
Preferred at the rate of $10.00 a share payable April 1, which are
non-cumulative; and
|
|
·
|
Series
B Preferred at the rate of $12.00 a share payable January 1, which
dividend is cumulative.
|
We
have
not paid cash dividends on our outstanding common stock in many years, and
from
January 1, 1999, through December 31, 2005, we did not pay any accrued dividends
on our outstanding cumulative preferred stock. We intend to retain most of
our
future earnings, if any, to provide funds for our operations and/or expansion
of
our businesses. However, during each quarter in 2006, our board of directors
declared nominal dividends on certain outstanding series of our preferred stock,
as follows: $.10 per share on the then outstanding shares of our Series 2
Preferred, $.37 per share on our outstanding Series B Preferred, and $.31 per
share on our outstanding Non-Cumulative
Preferred.
These dividends are not for the full amount of the required quarterly dividends
pursuant to the terms of our outstanding series of preferred stock.
No
dividends or other distributions, other than dividends payable in common stock,
shall be declared or paid, by us in connection with any shares of common stock
until all cumulative and unpaid dividends on the Series 2 Preferred, Series
D
Preferred and Series B Preferred shall have been paid. As of March 19, 2007,
the
aggregate amount of unpaid dividends in arrears on our Series 2 Preferred,
Series D Preferred and Series B Preferred totaled approximately $4.8 million,
$0.3 million and $1.7 million, respectively.
Our
Board
of Directors did not, and does not plan, to declare a dividend on our preferred
stock during March 2007. There are no assurances that we will in the future
pay
any additional quarterly dividends on any of our outstanding shares of preferred
stock. We do not anticipate paying cash dividends on our outstanding common
stock in the foreseeable future, and until all accrued and unpaid dividends
are
paid on our outstanding cumulative preferred stock, no dividends may be paid
on
our common stock. See “Risk Factors”.
Sale
of Unregistered Securities
Completion
of Exchange Offer
On
November 10, 2006, the Company entered into an agreement (“Jayhawk Agreement”)
with Jayhawk Capital Management, L.L.C. and certain of its affiliates
(collectively, the “Jayhawk Group”). Under the Jayhawk Agreement, the Jayhawk
Group agreed, if the Company made an exchange offer for the Series 2 Preferred,
to tender (discussed below) 180,450 shares of the 346,662 shares of Series
2
Preferred owned by the Jayhawk Group. In addition, as a condition to the Jayhawk
Group’s obligation to tender such shares of Series 2 Preferred in an exchange
offer, the Jayhawk Agreement further provided that Jack E. Golsen (Chairman
of
the Board and CEO of the Company), his wife, children and certain entities
controlled by them (the “Golsen Group”) would exchange only 26,467 of the 49,550
shares of Series 2 Preferred beneficially owned by them. As a result, only
309,807 of the 499,102 shares of Series 2 Preferred outstanding would be
eligible to participate in an exchange offer, with the remaining 189,295 being
held by the Jayhawk Group and the Golsen Group.
On
January 26, 2007, our Board of Directors approved and on February 9, 2007,
we
began an exchange offer to exchange shares of our common stock for up to 309,807
of the 499,102 outstanding shares of the Series 2 Preferred. The exchange offer
expired on March 12, 2007. The terms of the exchange offer provided for the
issuance by the Company of 7.4 shares of common stock in exchange for each
share
of Series 2 Preferred tendered in the exchange offer and the waiver of all
rights to accrued and unpaid dividends on the Series 2 Preferred tendered.
As a
result of this exchange offer, we issued 2,262,965 shares of our common stock
for 305,807 shares of Series 2 Preferred that were tendered. In addition, an
aggregate of approximately $7.3 million in accrued and unpaid dividends were
waived as a result of this exchange offer. Pursuant
to the Jayhawk Agreement and the terms of the exchange offer, the Jayhawk Group
and the Golsen Group tendered 180,450 and 26,467 shares, respectively, of Series
2 Preferred for 1,335,330 and 195,855 shares, respectively, of our common stock
and waived a total of approximately $4.96 million in accrued and unpaid
dividends, with the Jayhawk Group waiving a total of $4.33 million and the
Golsen Group waiving a total of $0.63 million.
The
shares of common stock issued by us as a result of the tender offer were not
registered under the Securities Act of 1933, as amended (“Securities Act”)
pursuant to an exemption from registration under Section 3(a)(9) of the
Securities Act. No fractional shares were issued so cash was paid in lieu of
any
additional shares in an amount equal to the fraction of a share times the
closing price per share of our common stock on the last business day immediately
preceding the expiration date of the tender offer.
Purchases
of Equity Securities by the Issuer and Affiliated
Purchasers
During
the three months ended December 31, 2006, the Company and affiliated purchasers,
as defined, did not purchase any of its equity securities except that during
October 2006, we entered into various Exchange Agreements with certain holders
of our Series 2 Preferred to exchange an aggregate of 104,548 shares of Series
2
Preferred for an aggregate of 773,655 shares of common stock in transactions
exempted from registration pursuant to Section 3(a)(9) of the Securities Act.
These exchanges were subject to approval by AMEX to list the shares of common
stock to be issued in connection with the Exchange Agreements. In accordance
with the Exchange Agreements, the holders that exchanged Series 2 Preferred
for
our common stock waived any and all accrued and unpaid dividends on the Series
2
Preferred exchanged. On November 7, 2006, the AMEX approved the listing of
the
shares to be issued in the exchange. All such exchanges are shown in the
following table:
Period
|
(a)
Total number of shares of Series 2 Preferred
purchased
|
(b)
Average price paid per share of
Series
2 Preferred
|
(c)
Total number of shares of Series 2 Preferred purchased
as
part of publicly announced plans
or
programs
|
(d)
Maximum number (or approximate dollar value) of shares of Series 2
Preferred that may yet
be
purchased under
the
plans or programs
|
October
1, 2006 - October 31, 2006
|
104,548
|
|
$
|
66.43
|
-
|
-
|
|
|
|
|
|
|
|
November
1, 2006 - November 30, 2006
|
-
|
|
$
|
-
|
-
|
-
|
|
|
|
|
|
|
|
December
1, 2006 - December 31, 2006
|
-
|
|
$
|
-
|
-
|
-
|
Total
|
104,548
|
|
$
|
66.43
|
-
|
-
|
These
shares of Series 2 Preferred were cancelled. The average price paid per share
of
Series 2 Preferred is based on the closing market price of our common stock
on
the dates of the underlying Exchange Agreements.
ITEM
6. SELECTED FINANCIAL DATA
|
Years
ended December 31,
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
2002
|
|
(Dollars
in thousands, except per share
data)
|
Selected
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
$
|
491,952
|
|
|
$
|
397,115
|
|
|
$
|
363,984
|
|
|
$
|
317,026
|
|
|
$
|
283,553
|
|
Interest
expense (1)
|
$
|
11,915
|
|
|
$
|
11,407
|
|
|
$
|
7,393
|
|
|
$
|
6,097
|
|
|
$
|
8,218
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before cumulative effect of accounting
changes
(1) (2)
|
$
|
16,183
|
|
|
$
|
5,746
|
|
|
$
|
1,906
|
|
|
$
|
2,913
|
|
|
$
|
2,723
|
|
Cumulative
effect of accounting changes
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(536
|
)
|
|
$
|
-
|
|
|
$
|
860
|
|
Net
income
|
$
|
15,930
|
|
|
$
|
5,102
|
|
|
$
|
1,370
|
|
|
$
|
2,913
|
|
|
$
|
122
|
|
Net
income (loss) applicable to common stock
|
$
|
13,300
|
|
|
$
|
2,819
|
|
|
$
|
(952
|
)
|
|
$
|
586
|
|
|
$
|
(2,205
|
)
|
Income
(loss) per common share applicable to
common
stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before cumulative effect of accounting
changes
|
$
|
.95
|
|
|
$
|
.26
|
|
|
$
|
(.03
|
)
|
|
$
|
.05
|
|
|
$
|
.04
|
|
Net
loss from discontinued operations
|
$
|
(.02
|
)
|
|
$
|
(.05
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.29
|
)
|
Cumulative
effect of accounting changes
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
$
|
.07
|
|
Net
income (loss)
|
$
|
.93
|
|
|
$
|
.21
|
|
|
$
|
(.07
|
)
|
|
$
|
.05
|
|
|
$
|
(.18
|
)
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before cumulative effect of accounting
changes
|
$
|
.79
|
|
|
$
|
.23
|
|
|
$
|
(.03
|
)
|
|
$
|
.04
|
|
|
$
|
.03
|
|
Net
loss from discontinued operations
|
$
|
(.01
|
)
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.27
|
)
|
Cumulative
effect of accounting changes
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
$
|
.07
|
|
Net
income (loss)
|
$
|
.78
|
|
|
$
|
.19
|
|
|
$
|
(.07
|
)
|
|
$
|
.04
|
|
|
$
|
(.17
|
)
|
(1) In
May
2002, the repurchase of Senior Unsecured Notes using proceeds from a Financing
Agreement was accounted for as a voluntary debt restructuring. As a result,
subsequent interest payments associated with the Financing Agreement debt were
recognized against the unrecognized gain on the transaction. The Financing
Agreement debt was repaid in September 2004.
(2) Income
from continuing operations before cumulative effect of accounting changes
includes gains on extinguishment of debt of $4.4 million and $1.5 million for
2004 and 2002, respectively.
ITEM
6. SELECTED FINANCIAL DATA (CONTINUED)
|
(Dollars
in thousands, except per share
data)
|
Selected
Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
$
|
219,927
|
|
|
$
|
188,963
|
|
|
$
|
167,568
|
|
|
$
|
161,813
|
|
|
$
|
166,276
|
|
Redeemable
preferred stock
|
$
|
65
|
|
|
$
|
83
|
|
|
$
|
97
|
|
|
$
|
103
|
|
|
$
|
111
|
|
Long-term
debt, including current portion
|
$
|
97,692
|
|
|
$
|
112,124
|
|
|
$
|
106,507
|
|
|
$
|
103,275
|
|
|
$
|
113,361
|
|
Stockholders'
equity
|
$
|
42,644
|
|
|
$
|
13,456
|
|
|
$
|
8,398
|
|
|
$
|
6,184
|
|
|
$
|
1,204
|
|
Selected
other data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
dividends declared per common share
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The
following Management's Discussion and Analysis of Financial Condition and
Results of Operations (“MD&A”) should be read in conjunction with a review
of the other Items included in this Form 10-K and our December 31, 2006
Consolidated Financial Statements included elsewhere in this report. Certain
statements contained in this MD&A may be deemed to be forward-looking
statements. See "Special Note Regarding Forward-Looking
Statements."
Overview
General
We
are a
manufacturing, marketing and engineering company. Our wholly-owned subsidiary,
ThermaClime, through its subsidiaries, owns substantially all of our core
businesses consisting of the:
·
|
Climate
Control Business engaged in the manufacturing and selling of a broad
range
of air conditioning and heating products in the niche markets we
serve
consisting of geothermal and water source heat pumps, hydronic fan
coils,
large custom air handlers and other products used in commercial and
residential new building construction, renovation of existing buildings
and replacement of existing
systems.
|
·
|
Chemical
Business engaged in the manufacturing and selling of chemical products
produced from three plants located in Arkansas, Alabama and Texas
for the
industrial, mining and agricultural markets.
|
2006
Results
LSB’s
2006 sales were $492.0 million compared to $397.1 million in 2005, operating
income was $27.6 million compared to $15.0 million in 2005 and income from
continuing operations was $16.2 million compared to $5.7 million in 2005. Net
income was $15.9 million compared to $5.1 million for 2005.
The
Climate Control Business continued to report strong sales and operating results
due to record high backlogs and new order flow. Their sales were $221.2 million
compared to $156.9 million in 2005. Their operating income before allocation
of
corporate overhead was $25.4 million, an 80% increase over the $14.1 million
in
2005.
Our
Chemical Business reported improved results in 2006 with sales of $260.7 million
compared to $233.4 million in 2005. Operating income before allocation of
corporate overhead was $10.2 million, a 32% increase over the $7.7 million
in
2005.
Climate
Control Business
The
Climate Control Business has historically and consistently generated annual
profits and positive cash flows and continues to do so. Climate Control’s sales
for 2006 were $221 million, a 41% increase from the same period last year.
As
indicated above the Climate Control Business’
sales
and
operating income for 2006 were higher than in 2005. The increase in 2006 sales
and operating income as compared to 2005 is attributable to strong demand for
the geothermal and water source heat pumps that reported a 57% sales increase
and to the fan coil and other products that reported a 21% increase.
Management’s objectives for the Climate Control Business include the continued
emphasis on:
|
·
|
increasing
the sales and operating margins of all products,
|
|
·
|
developing
and introducing new and energy efficient products, and
|
|
·
|
increasing
production to meet customer demand.
|
Most
of
the products of the Climate Control Business are produced to customer orders
that are placed well in advance of required delivery dates. As a result, the
Climate Control Business maintains significant backlogs that eliminate the
necessity to carry substantial inventories other than for firm customer orders.
Due to the increase in the demand for Climate Control’s products, the backlog of
confirmed orders has also increased. The backlog of confirmed orders at December
31, 2006, was approximately $80 million as compared to $56 million at 2005
and
$28 million at 2004. We anticipate shipping substantially all of this backlog
within twelve months.
Management
is taking certain actions to increase the production level to reduce the product
delivery lead times and the current backlog. In response to record intake level
of customer orders, we recently increased our unit output through additional
shifts and overtime. Management
has also invested $4.9 million in fabrication equipment, plant-wide process
control systems and other upgrades during 2006 and has plans for additional
production equipment during 2007 including $3.6 million already
committed.
This investment is expected to increase capacity and reduce overtime. In
addition, during the fourth quarter of 2006, we acquired a 46,000 sq. ft.
building adjacent to our existing 270,000 sq. ft. geothermal and water source
heat pump production facility at an approximate cost of $2.5 million to increase
production and warehouse space. We
have
also committed approximately $1.2 million to renovate an existing building
as a
distribution center for our geothermal and water source heat pumps. At December
31, 2006, approximately $0.3 million of the $1.2 million commitment had been
expended. Both
of
these real property investments have been financed by mortgages.
In
October 2006, Trison Construction, Inc. (“Trison”), a subsidiary within our
Climate Control Business, was awarded reimbursement of defense costs of $1.2
million in connection with a binding arbitration filed with the American
Arbitration Association. The amount was paid in the fourth quarter and is
classified as other income which is included in operating income.
Our
Climate Control Business will continue to launch new products and product
upgrades in an effort to maintain our current market position and to establish
a
presence in new markets. In recent periods, the Climate Control Business's
profitability was affected by operating losses of certain new product lines
being developed over the past few years. Our emphasis has been to increase
the
sales levels of these operations above the breakeven point. During
2006, the results for these new products have not improved appreciably. We
believe that the prospects for these new product lines are improving and that
these products will contribute favorably in the future.
Chemical
Business
The
Chemical Business has production facilities in Baytown, Texas (the “Baytown”
facility), El Dorado, Arkansas (the “El Dorado” facility) and Cherokee, Alabama
(the “Cherokee” facility). Baytown and El Dorado produce nitrogen products from
anhydrous ammonia that is delivered by pipeline. Cherokee produces nitrogen
products from natural gas that is delivered by pipeline. As indicated above,
for
2006, the Chemical Business reported a sales increase of $27.2 million or 12%
and a $2.5 million or 32% increase in operating income before allocation of
corporate overhead.
Sales
in
all product lines were higher in 2006 in tons shipped, while our average price
per ton remained consistent with 2005. Industrial acids and other chemical
products increased $15.0 million or 18.7%; agricultural products increased
$9.1
million or 11.3%; and mining products increased $3.1 million or 4.3%.
Agricultural volumes increased in spite of a severe drought throughout the
mid-south and southeast United States. The increase in agricultural volume
is
attributable to our ability to reach outside our traditional geographic markets
and sell into markets previously served by competitors that have exited the
market.
The
increase in operating income is attributable to higher industrial acid and
agricultural sales, the improvement in production performance due to higher
throughput volumes, and an improvement in the natural gas supply and
corresponding average costs as the result of the hurricane disruptions of
2005.
Our
raw
materials, anhydrous ammonia and natural gas, are commodities subject to
significant price fluctuations, and generally purchased at prices in effect
at
time of purchase. Due to the uncertainty of the sales prices of our products
in
relation to the cost of anhydrous ammonia and natural gas, we have developed
some customers that purchase substantial quantities of products pursuant to
sales agreements and/or formulas that provide for the pass through of these
raw
material costs. These pricing arrangements help mitigate the commodity price
risk inherent in anhydrous ammonia and natural gas. Approximately 65% of the
Chemical Business’ sales in 2006 were subject to these pricing
arrangements.
Although
anhydrous ammonia is produced from natural gas, the price of anhydrous ammonia
does not necessarily follow the price of natural gas in the United States.
Much
of the anhydrous ammonia consumed in the U.S. is produced off shore and
delivered inland by pipeline, barge and rail with originations at or near the
Gulf of Mexico. Our raw material cost of anhydrous ammonia is based upon
formulas indexed to published industry ammonia prices tied to import
prices.
Most
of
the production from Baytown is sold pursuant to a long-term supply agreement
that provides for the pass through of certain production costs including
anhydrous ammonia. This facility continues to generate consistent operating
profits and reported higher sales and profits in 2006 than in 2005.
El
Dorado
produces approximately 500,000 tons of products per year from purchased
anhydrous ammonia. Approximately 59% of the volume sold in 2006 was sold
pursuant to pricing arrangements that allow for the pass through of the cost
of
anhydrous ammonia to the
customer.
The balance of these products sold during 2006 was primarily agricultural and
was sold at the spot market price in effect at the time of shipment. During
August 2006, a sales agreement for El Dorado to supply a significant amount
of
industrial grade ammonium nitrate each year pursuant to pricing arrangements
was
amended with mutual benefit to the parties for a term extending through 2010.
The amendment provides for, among other things, an increase of 10% of the
minimum annual tons beginning in 2007 and a price increase in the profit-per-ton
component.
Following
a trial in October 2006, a jury verdict awarded El Dorado approximately $9.8
million in damages due to the faulty repair of a hot gas expander in one of
EDC’s nitric acid plants. EDC will pay attorneys fees equal to 31.67% of any
recovery. The award is under appeal and will be recognized if and when
realized.
As
previously reported, Cherokee incurred losses in the third and fourth quarters
of 2005 and continuing into the first quarter 2006, related to disruptions
at
the plant caused by the record climb in natural gas costs due to the hurricanes
in the U.S. Gulf. Although Cherokee’s operating results were negative for 2006,
due to high natural gas costs in the first quarter and downtime in the third
and
fourth quarters, the 2006 operating loss was reduced from 2005.
Natural
gas prices continue to be unpredictable. Daily spot prices per MMBtu, excluding
transportation, during 2006 ranged from a high of $9.90 to a low of $3.54.
During 2006, approximately 71% of Cherokee’s sales were priced to include the
cost of natural gas.
Our
Chemical Business will continue to focus on growing our non-seasonal industrial
customer base with an emphasis on customers that accept the risk inherent with
raw material costs, while maintaining a strong presence in the seasonal
agricultural sector. The operations strategy is to maximize production of the
plants, thereby lowering the fixed cost of each ton of production.
Stock
Options
On
June
19, 2006, the Executive Compensation and Option Committee of our Board of
Directors granted 450,000 shares of non-qualified stock options to certain
employees which are subject to shareholders’ approval. The option price of these
options is $8.01 per share which is based on the market value of our common
stock at the date of authorization. These options will vest over a ten-year
period at a rate of 10% per year and expire on September 16, 2016 with certain
restrictions. Under SFAS 123(R), the fair value for these options will be
estimated, using an option pricing model, as of the date we receive
shareholders’ approval which is currently expected to be no later than our 2007
annual shareholders’ meeting. In general, a ratable portion of the total
estimated fair value relating to these options will be charged to selling,
general, and administrative expense (“SG&A”) at the date of shareholders’
approval and the remaining balance amortized to SG&A over the options’
remaining vesting period.
Preferred
Stock Exchanges and Completion of Exchange Offer
During
October 2006, we entered into Exchange Agreements with certain holders of our
Series 2 Preferred. Pursuant to the terms of the Exchange Agreements we issued
773,655 shares of our common stock in exchange for 104,548 shares of Series
2
Preferred. The holders that were parties to an Exchange Agreement waived their
rights to all unpaid dividends on the Series 2 Preferred exchanged which totaled
approximately $2.43 million.
As
discussed under “Sale of Unregistered Securities” of Item 5, during November
2006, the Company entered into the Jayhawk Agreement with the Jayhawk Group.
Under the Jayhawk Agreement, the Jayhawk Group agreed to tender in an exchange
offer (discussed below) 180,450 shares of Series 2 Preferred owned by the
Jayhawk Group. In addition, as a condition to the Jayhawk Group’s obligation to
tender such shares of Series 2 Preferred in an exchange offer, the Jayhawk
Agreement further provided that the Golsen Group would exchange 26,467 shares
of
Series 2 Preferred beneficially owned by them.
Our
Board
of Directors approved and on February 9, 2007, we began an exchange offer
to
exchange shares of our common stock for up to 309,807 shares of the Series
2
Preferred. The terms of the exchange offer provided for the issuance by the
Company of 7.4 shares of common stock in exchange for each share of Series
2
Preferred tendered in the exchange offer and the waiver of all rights to
accrued
and unpaid dividends on the Series 2 Preferred tendered. As a result of this
exchange offer, we issued 2,262,965 shares of our common stock for 305,807
shares of Series 2 Preferred that were tendered. In addition, an aggregate
of
approximately $7.3 million in accrued and unpaid dividends were waived as
a
result of this exchange offer. This exchange transaction qualified as an
induced
conversion under SFAS 84. As a result, in the first quarter of 2007, we will
record a charge (stock dividend) to accumulated deficit which will equal
the
excess of the fair value of the common stock issued over the fair value of
the
common stock issuable pursuant to the original conversion terms. In addition,
such stock dividend will decrease net income applicable to common stock,
thereby
negatively impacting earnings per common share for the first quarter of
2007.
Pursuant
to the Jayhawk Agreement and the terms of the exchange offer, the Jayhawk Group
and the Golsen Group tendered 180,450 and 26,467 shares, respectively, of Series
2 Preferred for 1,335,330 and 195,855 shares, respectively, of our common stock
and waived a total of approximately
$5.0
million in accrued and unpaid dividends.
Amendments
to the Series 2 Preferred
On
March
6, 2007, our stockholders approved two amendments to the Series 2 Preferred,
which amendments became effective on that date. The first amendment provides
that the right of the holders of the Series 2 Preferred to elect two directors
to our board of directors when at least six quarterly dividends on the Series
2
Preferred are in arrears and unpaid may be exercised only if and so long as
at
least 140,000 shares of Series 2 Preferred are issued and outstanding. The
second amendment permits us to purchase or otherwise acquire shares of our
common stock for a five-year period even though cumulative accrued and unpaid
dividends exist on the Series 2 Preferred. The five-year period commenced on
March 13, 2007, upon the completion of the exchange offer.
Business
Interruption and Property Insurance Claims
El
Dorado -
Beginning in October 2004 and continuing into June 2005, the Chemical Business’
results were adversely affected as a result of the loss of production due
to a
mechanical failure of one of the four nitric acid plants at the El Dorado,
Arkansas plant. The plant was restored
to normal production in June 2005. We filed a property damage insurance claim
for $3.8 million, net of a $1.0 million deductible. We also filed a business
interruption claim for $5.0 million, net of the forty-five day waiting period.
As of December 31, 2006, the insurers have paid claims totaling $5.5 million.
The insurers are contesting our remaining claims.
On
March
23, 2006, we filed a lawsuit in Federal Court in the Western District of
Arkansas, El Dorado Division, to collect amounts from our insurers to which
we
believe we are owed under the policy. The total amount claimed under the lawsuit
which includes business interruption and property claims, is approximately
$2.3
million, plus attorney fees. Additional recoveries, if any, will be recognized
when realized.
Cherokee
- As a
result of damage caused by Hurricane Katrina, the natural gas pipeline servicing
the Cherokee Facility suffered damage and the owner of the pipeline declared
an
event of Force Majeure. This event of Force Majeure caused curtailments and
interruption in the delivery of natural gas to the Cherokee Facility. Cherokee
Nitrogen Company’s (“CNC”) insurer was promptly put on notice of a claim, but
the quantification of the claim amount took time and involved the retention
of a
gas market expert and a business interruption consultant.
On
September 25, 2006, CNC filed a contingent business interruption claim. CNC
is
now in discussions with, and providing additional documentation to, the forensic
accountant hired by CNC’s insurers to examine the claim. The recovery of this
claim, if any, will be recognized when realized.
Liquidity
and Capital Resources
As
a
diversified holding company, cash requirements are primarily dependent upon
credit agreements and our ability to obtain funds from our ThermaClime and
non-ThermaClime subsidiaries.
On
March
14, 2006, we completed an $18.0 million private placement of the Company’s 7%
Convertible Senior Subordinated Debentures due 2011 (the “Debentures”). Interest
on the Debentures is payable semi-annually each year beginning September 1,
2006. We used substantially all of the net proceeds of $16.5 million from the
Debentures to purchase or redeem higher interest rate debt, including
ThermaClime’s 10 3/4% Senior Unsecured Notes due 2007 (“Senior Unsecured
Notes”). The remaining balance was used for general corporate
purposes.
Our
total
outstanding debt at December 31, 2006 was $97.7 million compared to $112.1
million at December 31, 2005.
During
the third and fourth quarters of 2006, $14.0 million of the Debentures were
converted into common stock at $7.08 per common share. At December 31, 2006,
there were $4.0 million
of
Debentures outstanding. In February 2007, there were additional conversions
of
$3.0 million leaving $1.0 million currently outstanding. The conversions from
debt to stockholders’ equity of $17.0 million improves the Company’s debt
leverage ratio. As a result of the $17.0 million conversions, annual interest
expense will be reduced by approximately $1.2 million.
Historically,
ThermaClime’s primary cash needs have been for working capital and capital
expenditures. ThermaClime and its subsidiaries depend upon their Working Capital
Revolver Loan, internally generated cash flows, and secured equipment financing
in order to fund operations and pay obligations.
The
Working Capital Revolver Loan and the Senior Secured Loan have financial
covenants that are discussed below under “Loan Agreements - Terms and
Conditions”.
ThermaClime’s
ability to maintain an adequate amount of borrowing availability under its
Working Capital Revolver Loan depends on its ability to comply with the terms
and conditions of its loan agreements and its ability to generate cash flow
from
operations. ThermaClime is restricted under its credit agreements as to the
funds it may transfer to the Company and its non-ThermaClime affiliates and
certain ThermaClime subsidiaries. This limitation does not prohibit payment
to
the Company of amounts due under a Services Agreement, Management Agreement
and
a Tax Sharing Agreement. ThermaClime’s Working Capital Revolver is a $50.0
million facility. As of December 31, 2006, ThermaClime had availability for
additional borrowing under its Working Capital Revolver Loan of $22.8 million.
Borrowing availability is based upon certain percentages of accounts receivable
and inventory.
The
Company is discussing with prospective lenders, the possibilities of refinancing
certain outstanding debt at more favorable terms, including, among other issues,
reduced interest rates. As of the date of this report, the Company has not
entered into definitive negotiations with any prospective lender to provide
such
refinancing. There are no assurances that the Company will be successful in
their efforts to refinance portions of its outstanding debt, or that if the
Company is successful in refinancing any of its outstanding debt that the terms
will be more favorable than the terms of the outstanding debt.
Capital
Expenditures
General
Capital
expenditures in 2006 were $14.7 million, including $7.7 million primarily for
additional capacity in the Climate Control Business and $7.0 million for the
Chemical Business, primarily for process and reliability improvements of
existing facilities. As discussed below, our current commitment for 2007
includes spending for production equipment, facilities upgrades and capacity
expansion in the Climate Control Business and spending for production equipment
and environmental compliance in the Chemical Business.
Other
capital expenditures for 2007 are believed to be discretionary and are dependent
upon an adequate amount of liquidity and/or obtaining acceptable funding. We
have carefully managed those expenditures to projects necessary to execute
our
business plans and those for environmental and safety compliance.
Current
Commitments
As
of the
date of this report, we have committed capital expenditures of approximately
$8.4 million for production equipment, facilities upgrades and environmental
compliance in 2007. The expenditures include $4.8 million for the Chemical
Business and $3.6 million for the Climate Control Business. We plan to finance
approximately $3.6 million and the balance will be funded from working
capital.
In
addition, we plan to spend approximately $0.9 million in 2007 ($1.2 million
in
total) on an existing building to expand the distribution facilities of our
geothermal and water source heat pump business which has been funded by mortgage
debt.
In
addition, certain additional capital expenditures will be required to bring
the
sulfuric acid plant's air emissions to lower limits. There have been minimal
expenditures on this project since 2004. The ultimate cost is believed to be
between $2.5 million and $4.0 million, to be expended through February 2010.
Currently, there are no committed capital expenditures for the
project.
The
ADEQ
issued to El Dorado a new revised NPDES water discharge permit in 2004, and
El
Dorado has until June 2007 to meet the compliance deadline for the more
restrictive limits under the recently issued NPDES permit. In order to meet
El
Dorado’s June 2007 limits, El Dorado is considering three options to discharge
its wastewater.
The
estimated remaining capital expenditures to meet the requirements of the NPDES
permit ranges from $0.8 million to $2.8 million, depending on which option
El
Dorado utilizes or is required to utilize to meet the permit requirements.
Dividends
We
have
not paid cash dividends on our outstanding common stock in many years, and
from
1999 through 2005, we had not paid any dividends on our outstanding cumulative
preferred stock. During each of the quarters of 2006, our Board of Directors
declared and we paid partial dividends on certain outstanding series of our
preferred stock as follows: $.10 per share on our outstanding Series 2
Preferred, $.37 per share on our outstanding Series B Preferred, and $.31 per
share on our outstanding Non-Cumulative Preferred. These dividends were not
for
the full amount of the required quarterly dividends pursuant to the terms of
all
of our outstanding series of preferred stock. See discussion under “Dividends”
and “Sale of Unregistered Securities” of Item 5 concerning the issuance of
common stock in exchange for a portion of the Series 2 Preferred in October
2006
and March 2007. As of March 19, 2007, there were approximately $6.8 million
of
unpaid dividends on our outstanding cumulative preferred stock. We intend to
retain most of our future earnings, if any, to provide funds for our operations
and/or expansion of our business.
We
do not
anticipate paying cash dividends on our outstanding common stock in the
foreseeable future, and until all unpaid dividends are paid on our outstanding
cumulative preferred stock, no dividends may be paid on our common stock.
Compliance
with Long-Term Debt Covenants
As
discussed below under “Loan Agreements - Terms and Conditions”, the Senior
Secured Loan and Working Capital Revolver Loan, as amended, of ThermaClime
and
its subsidiaries require, among other things, that ThermaClime meet certain
financial covenants. ThermaClime's forecasts for 2007 indicate that ThermaClime
will be able to meet all required covenant tests.
Summary
Cash
flow
and liquidity will continue to be managed very carefully. We believe, with
the
$15.9 million net income for 2006 and the infusion of new capital as a result
of
the debenture offering and the subsequent conversion of the debentures to
stockholders’ equity, our capital base is improved. Based upon current
forecasts, we should have adequate cash from internal cash flows and financing
sources to enable us to satisfy our cash requirements for 2007. Due to the
volatility of the cost of major raw materials, we have historically experienced
revisions to financial forecasts on a frequent basis during the course of a
year. As a result, actual results may differ from our forecast, which could
have
a material impact on our liquidity and future operating results.
Loan
Agreements - Terms and Conditions
7%
Convertible Senior Subordinated Debentures - On
March
14, 2006, we completed a private placement to six qualified institutional
buyers, pursuant to which we sold $18.0 million aggregate principal amount
of
our 7% Convertible Senior Subordinated Debentures due 2011 (the “Debentures”).
Interest on the Debentures is payable semi-annually in arrears on March 1 and
September 1 of each year which began September 1, 2006.
The
Debentures are convertible by holders, in whole or in part, into shares of
the
Company’s common stock prior to their maturity on March 1, 2011. Holders
of Debentures electing to convert all or any portion of a Debenture will obtain
the following conversion rate per $1,000 principal amount of Debentures during
the dates indicated:
|
|
Shares
Per $1,000 Principal Amount
|
|
Conversion
Price
Per Share
|
|
March
1, 2007 - August 31, 2007
|
|
141.04
|
|
|
$
|
7.09
|
|
September
1, 2007 - February 29, 2008
|
|
137.27
|
|
|
$
|
7.28
|
|
March
1, 2008 - August 31, 2008
|
|
133.32
|
|
|
$
|
7.50
|
|
September
1, 2008 - February 28, 2009
|
|
129.23
|
|
|
$
|
7.74
|
|
March
1, 2009 - March 1, 2011
|
|
125.00
|
|
|
$
|
8.00
|
|
The
conversion rates will be adjusted to reflect dividends, stock splits, issuances
of rights to purchase shares of common stock and other events, as set forth
in
the Indenture.
We
have
used substantially all of the net proceeds for the purchase or redemption of
our
higher interest rate debt or debt of our subsidiaries, including ThermaClime’s
Senior Unsecured Notes. The remaining balance was used for general corporate
purposes.
Approximately
$13.6 million of the net proceeds have been used to purchase or redeem all
of
the Senior Unsecured Notes held by unrelated third parties and Jayhawk at
ThermaClime’s carrying value (which includes $1.0 million that was held by
Jayhawk) including accrued interest of $0.3 million. Approximately $6.95 million
of the Senior Unsecured Notes held by us remain outstanding.
During
2006, $14 million of the Debentures were converted into 1,977,499 shares of
our
common stock at the conversion price of $7.08 per share. Certain of the
conversions related to offers received from the holders and accepted by us
which
included additional consideration of $277,000 to be paid to the holders. Because
the offer met the criteria within SFAS 84-Induced Conversions of Convertible
Debt, the additional consideration was expensed. During February 2007, an
additional $3.0 million of the Debentures were converted into common stock
at
the conversion price of $7.08 per common share.
Working
Capital Revolver Loan
-
ThermaClime finances its working capital requirements through borrowings under
a
Working Capital Revolver Loan. Under the Working Capital Revolver Loan,
ThermaClime and its subsidiaries may borrow on a revolving basis up to $50.0
million based on specific percentages of eligible accounts receivable and
inventories. The Working Capital Revolver Loan matures in April 2009. As of
December 31, 2006, borrowings outstanding were $26.0 million and the net credit
available for additional borrowings was $22.8 million. The Working Capital
Revolver Loan requires that ThermaClime and its Climate Control Business meet
certain financial covenants measured quarterly. ThermaClime and its Climate
Control Business were in compliance with those covenants for the twelve-month
period ended December 31, 2006.
Senior
Secured Loan - In
September 2004, ThermaClime and certain of its subsidiaries (the “Borrowers”)
completed a $50.0 million term loan (“Senior Secured Loan”) with a certain
lender (the “Lender”). The Senior Secured Loan is to be repaid as
follows:
· quarterly
interest payments which began September 30, 2004;
· quarterly
principal payments of $312,500 beginning September 30, 2007;
· a
final
payment of the remaining outstanding principal of $47.5 million and accrued
interest on September 16, 2009.
The
Senior Secured Loan accrues interest at the applicable LIBOR rate, as defined,
plus an applicable LIBOR margin, as defined or, at the election of the
Borrowers, the alternative base rate, as defined, plus an applicable base rate
margin, as defined, with the annual interest rate not to exceed 11% or 11.5%
depending on the leverage ratio. At December 31, 2006, the annual interest
rate
was 11%.
The
Borrowers are subject to numerous affirmative and negative covenants under
the
Senior Secured Loan agreement including, but not limited to, limitation on
the
incurrence of certain additional indebtedness and liens, limitations on mergers,
acquisitions, dissolution and sale of assets, and limitations on declaration
of
dividends and distributions to us, all with certain exceptions. The Borrowers
are also subject to a minimum fixed charge coverage ratio, measured quarterly
on
a trailing twelve-month basis. The Borrowers were in compliance with the
required
minimum
ratio for the twelve-month period ended December 31, 2006 and the coverage
ratio
is considered to be achievable for 2007. The maturity date of the Senior Secured
Loan can be accelerated by the Lender upon the occurrence of a continuing event
of default, as defined.
Cross
- Default Provisions -
The
Working Capital Revolver Loan agreement and the Senior Secured Loan contain
cross-default provisions. If ThermaClime fails to meet the financial covenants
of the Senior Secured Loan, the lender may declare an event of default, making
the debt due on demand. If this should occur, there are no assurances that
we
would have funds available to pay such amount or that alternative borrowing
arrangements would be available. Accordingly, ThermaClime could be required
to
curtail operations and/or sell key assets. These actions could result in the
recognition of losses that may be material.
Seasonality
We
believe that our only seasonal products are fertilizer and related chemical
products sold by our Chemical Business to the agricultural industry. The selling
seasons for those products are primarily during the spring and fall planting
seasons, which typically extend from March through June and from September
through November in the geographical markets in which the majority of our
agricultural products are distributed. As a result, our Chemical Business
increases its inventory of agricultural products prior to the beginning of
each
planting season. In addition, the amount and timing of sales to the agricultural
markets depend upon weather conditions and other circumstances beyond our
control.
Related
Party Transactions
One
of
the manufacturing facilities within our Climate Control Business sustained
substantial water damage in its office area resulting from the improper
installation by an unrelated third-party vendor of certain plumbing to a
water
line. As a result of the water damage, it became necessary to replace all
of the
carpet in the office area of the facility. During 2006, we purchased replacement
carpet from a company (“Designer Rugs”) owned by Linda Golsen Rappaport, the
daughter of Jack E. Golsen, our Chairman and Chief Executive Officer, and
sister
of Barry H. Golsen, our President. We paid approximately $159,000 to Designer
Rugs for the new carpet, removal of the damaged carpeting and installation
of
the new carpet. During the second quarter of 2006, we were reimbursed under
our
insurance coverage for the cost of the carpet and installation except for
a
deductible amount of $25,000.
In
addition, another subsidiary within our Climate Control Business is in the
process of remodeling their offices including the replacement of carpet and
flooring throughout the office area. Payments totaling $69,000 were made
during
2006 towards a purchase totaling $75,000 from Designer Rugs. Substantially
all
of the carpet was delivered and installed in 2006. Final completion expected
early in 2007.
During
2006, Jayhawk purchased $1.0 million principal amount of the Debentures.
In
addition, we purchased $1.0 million principal amount of the Notes held by
Jayhawk. Jayhawk earned interest of $117,000 relating to these debt instruments
in 2006.
During
2006 we paid nominal cash dividends to holders of certain series of our
preferred stock. These dividend payments included $91,000 and $133,000 to
the
Golsen Group and the Jayhawk Group, respectively. Additionally, the dividend
payments included $23,000 collectively to the significant shareholders discussed
below.
As
discussed above under “Overview-Preferred Stock Exchanges and Completion of
Exchange Offer”, in October 2006, we issued 773,655 shares of our common stock
to certain holders of our Series 2 Preferred in exchange for 104,548 shares
of
Series 2 Preferred. The shares of common stock issued included 303,400 and
262,167 shares issued for exchange for 41,000 and 35,428 shares of Series
2
Preferred stock to Paul Denby and James Sight (“Significant Shareholders”),
respectively, or to entities controlled by the Significant
Shareholders.
As
discussed above under “Overview-Preferred Stock Exchanges and Completion of
Exchange Offer”, during November 2006, we entered into the Jayhawk Agreement
with the Jayhawk Group. Under the Jayhawk Agreement, the Jayhawk Group agreed,
if we made an exchange offer for the Series 2 Preferred, to tender 180,450
shares of the 346,662 shares of Series 2 Preferred owned by the Jayhawk Group.
In addition, as a condition to the Jayhawk Group’s obligation to tender the
shares of Series 2 Preferred in an exchange offer, the Jayhawk Agreement
further
provided that the Golsen Group would exchange 26,467 shares of Series 2
Preferred beneficially owned by them. Pursuant to the Jayhawk Agreement and
the
terms of the exchange offer, during March 2007, the Jayhawk Group and the
Golsen
Group tendered 180,450 and 26,467 shares, respectively, of Series 2 Preferred
for 1,335,330 and 195,855 shares, respectively, of our common stock and waived
a
total of approximately $5.0 million in accrued and unpaid
dividends.
Critical
Accounting Policies and Estimates
The
preparation of financial statements requires management to make estimates and
assumptions that affect the reported amount of assets, liabilities, revenues
and
expenses, and disclosures of contingencies. In addition, the more critical
areas
of financial reporting impacted by management's judgment, estimates and
assumptions include the following:
Receivables
and Credit Risk
- Our
sales to contractors and independent sales representatives are generally subject
to a mechanics lien in the Climate Control Business. Our other sales are
generally unsecured. Credit is extended to customers based on an evaluation
of
the customer's financial condition and other factors. Credit losses are provided
for in the financial statements based on historical experience and periodic
assessment of outstanding accounts receivable, particularly those accounts
which
are past due (determined based upon how recently payments have been received).
Our periodic assessment of accounts and credit loss provisions are based on
our
best estimate of amounts that are not recoverable. Concentrations of credit
risk
with respect to trade receivables are limited due to the large number of
customers comprising our customer bases and their dispersion across many
different industries and geographic areas, however, 10 customers account for
approximately 30% of our total net receivables
at December 31, 2006. We do not believe this concentration in these 10 customers
represents a significant credit risk due to the financial stability of these
customers. At December 31, 2006 and 2005, our allowance for doubtful accounts
of
$2.3 million and $2.7 million, respectively, were netted against our accounts
receivable.
Inventory
Valuations
-
Inventories are priced at the lower of cost or market, with cost being
determined using the first-in, first-out basis. Finished goods and
work-in-process inventories include material, labor and manufacturing overhead
costs. At December 31, 2006 and 2005, the carrying value of certain
nitrogen-based inventories produced by our Chemical Business was reduced to
market because cost exceeded the net realizable value by $0.4 million and $1.4
million, respectively. In addition, the carrying value of certain slow-moving
inventory items (primarily Climate Control products) was reduced to market
because cost exceeded the net realizable value by $0.8 million and $1.0 million
at December 31, 2006 and 2005, respectively.
Precious
Metals - Precious
metals are used as a catalyst in the Chemical Business manufacturing processes.
Precious metals are carried at cost, with cost being determined using the
first-in, first-out (“FIFO”) basis. As of December 31, 2006 and 2005, precious
metals were $6.4 million and $5.0 million, respectively, and are included in
supplies, prepaid items and other in the consolidated balance sheets. Because
some of the catalyst consumed in the production process cannot be readily
recovered and the amount and timing of recoveries are not predictable, we follow
the practice of expensing precious metals as they are consumed. For 2006, 2005
and 2004, the amounts expensed for precious metals were approximately $5.1
million, $3.5 million and $3.3 million, respectively, and are included in cost
of sales. Periodically, during major maintenance or capital projects we may
be
able to perform procedures to recover precious metals (previously expensed)
which have accumulated within the manufacturing equipment. For 2006, 2005 and
2004, we recognized recoveries of precious metals at historical FIFO costs
of
approximately $2.4 million, $2.1 million and $0.2 million, respectively, which
are reductions to cost of sales.
Impairment
of Long-Lived Assets and Goodwill
-
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amounts may not be recoverable and
goodwill is reviewed for impairment at least annually. If assets to be held
and
used are considered to be impaired, the impairment to be recognized is the
amount by which the carrying amounts of the assets exceed the fair values of
the
assets as measured by the present value of future net cash flows expected to
be
generated by the assets or their appraised value. Assets to be disposed of
are
reported at the lower of the carrying amounts of the assets or fair values
less
costs to sell. At December 31, 2006, we had no long-lived assets that met the
criteria presented in SFAS 144 to be classified as assets held for sale. We
have
considered impairment of our long-lived assets and goodwill. We obtained third
party appraisals of the fair values associated with Cherokee and made estimates
of fair values for others. The timing of impairments cannot be predicted with
reasonable certainty and are primarily dependent on market conditions outside
our control. Should sales prices permanently decline dramatically without a
similar decline in the raw material costs or should other matters, including
the
environmental requirements and/or operating requirements set by Federal and
State agencies change substantially from our current expectations, a provision
for impairment may be required based upon such event or events. See Item 1
"Business-Environmental Matters." Based on estimates obtained from external
sources and internal estimates based on inquiry and other techniques, we
recognized impairments relating to certain non-core equipment of $0.1 million
and $0.4 million relating to Corporate assets during 2005 and 2004,
respectively, (none in 2006) and $0.3 million, $0.1 million and $0.4 million
relating to certain capital spare parts and idle assets in our Chemical Business
during 2006, 2005 and 2004, respectively. These impairments are included in
other expense in the consolidated statements of income.
Accrued
Insurance Liabilities - We
are
self-insured up to certain limits for group health, workers’ compensation and
general liability insurance claims. Above these limits, we have insurance
coverage, which management considers to be adequate. Our accrued insurance
liabilities are based on estimates of the self-insured portions of the claims,
which include the incurred claims amounts plus estimates of future claims
development calculated by applying our historical claims development factors
to
our incurred claims amounts. We also consider the reserves established by our
insurance adjustors and/or estimates provided by attorneys handling the claims,
if any. In addition, our accrued insurance liabilities include estimates of
incurred, but not reported, claims and other insurance-related costs. At
December 31, 2006 and 2005, our claims liabilities were $1.6 million and $1.4
million, respectively, and are included in accrued and other liabilities. It
is
possible that the actual development of claims could exceed our
estimates.
Product
Warranty
- Our
Climate Control Business sells equipment for which we provide warranties
covering defects in materials and workmanship. Generally, the base warranty
coverage for most of the manufactured equipment is limited to 18 months from
the
date of shipment or 12 months from the date of start-up, whichever is shorter,
and to 90 days for spare parts. In some cases, the customer may purchase an
extended warranty. Our accounting policy and methodology for warranty
arrangements is to periodically measure and recognize the expense and liability
for such warranty obligations using a percentage of net sales, based on
historical warranty costs. It is possible that future warranty costs could
exceed our estimates. At December 31, 2006 and 2005, our accrued product
warranty obligations were $1.3 million and $0.9 million, respectively and are
included in current and noncurrent accrued and other liabilities in the
consolidated balance sheets.
Accrued
Plant Turnaround Costs
- We
accrue in advance the cost expected to be incurred in the next planned major
maintenance activities (“Turnarounds”) of our Chemical Business. Turnaround
costs are accrued on a straight-line basis over the scheduled period between
Turnarounds, which generally ranges from 12 to 24 months. At December 31, 2006
and 2005, current and noncurrent accrued and other liabilities include $1.0
million and $1.4 million, respectively, relating to Turnarounds.
In
September 2006, the Financial Accounting Standards Board (“FASB”) completed a
project to clarify guidance on the accounting for Turnarounds. The FASB issued
FASB Staff Position No. AUG AIR-1 (“FSP”) which eliminates the accrue-in-advance
method of accounting for Turnarounds. In addition, the adoption of the
provisions in the FSP is to be considered a change in accounting principle
with
retrospective application as described in SFAS 154-Accounting Changes and Error
Corrections, if practical. The
FSP
became effective for us on January 1, 2007. We currently are using the
accrue-in-advance method for Turnarounds that is eliminated under the FSP.
There
are three acceptable accounting methods for Turnarounds that we may adopt of
which we have elected to adopt the deferral method. We are currently assessing
the impact
the FSP may have on our financial statements which we believe could be
significant.
Executive
Benefit Agreements - We
have
entered into benefit agreements with certain key executives. Costs associated
with these individual benefit agreements are accrued when they become probable
over the estimated remaining service period. Total costs accrued equal the
present value of specified payments to be made after benefits become payable.
In
1992, we
entered
into individual benefit agreements with certain key executives (“1992
Agreements”) that provide for annual benefit payments for life (in addition to
salary). As of December 31, 2006 and 2005, the liability for these benefits
under the 1992 Agreements is $1.0 million and $0.9 million, respectively, which
is included in current and noncurrent accrued and other liabilities in the
accompanying consolidated balance sheets.
In
1981,
we entered into individual death benefit agreements with certain key executives.
In addition, as part of the 1992 Agreements, should the executive die prior
to
attaining the age of 65, we will pay the beneficiary named in the agreement
in
120 equal monthly installments aggregating to an amount specified in the
agreement. In 2005, we entered into a death benefit agreement with our CEO.
As
of December 31, 2006, the liability for death benefits is $1.4 million ($0.9
million at December 31, 2005) which is included in current and noncurrent
accrued and noncurrent liabilities.
Environmental
and Regulatory Compliance
- The
Chemical Business is subject to specific federal and state regulatory and
environmental compliance laws and guidelines. We have developed policies and
procedures related to environmental and regulatory compliance. We must
continually monitor whether we have maintained compliance with such laws and
regulations and the operating implications, if any, and amount of penalties,
fines and assessments that may result from noncompliance. At December 31, 2006,
liabilities totaling $1.4 million have been accrued relating to a consent
administrative order (“CAO”) covering El Dorado and a CAO covering our former
Hallowell facility. These liabilities are included in current and noncurrent
accrued and other liabilities and are based on current estimates that may be
revised in the near term based on results of our investigation, risk assessment
and remediation pursuant to the new CAO and Slurry Consent Order. In addition,
we will be required to make capital expenditures as it relates to the NPDES
permit and Air CAO.
Asset
Retirement Obligations
- We
have a legal obligation to monitor certain discharge water outlets at our
Chemical Business facilities should we discontinue the operations of a facility.
We do not believe that the annual costs of the required monitoring activities
would be significant and as we currently have no plans to discontinue the use
of
the facilities and the remaining life of either facility is indeterminable,
an
asset retirement liability has not been recognized. Currently, there is
insufficient information to estimate the fair value of the asset retirement
obligation. However, we will continue to review this obligation and record
a
liability when a reasonable estimate of the fair value can be made.
Deferred
Income Taxes -
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes, and the amounts used for income tax purposes. Valuation allowances
are
provided against deferred tax assets when it is more likely than not that some
portion or all of the deferred tax asset will not be realized. We are able
to
realize deferred tax assets up to an amount equal to the future reversals of
existing taxable temporary differences. The taxable temporary differences will
turn around in the loss carry forward period as the differences reverse. Other
differences will turn
around as the assets are realized or liabilities are paid in the normal course
of business. At December 31, 2006 and 2005, our deferred tax assets were net
of
a valuation allowance of $19.3 million and $26.1 million, respectively. The
decrease in the valuation allowance is due primarily to the utilization of
net
operating loss carry forwards in 2006.
Contingencies
- We
accrue for contingent losses when such losses are probable and reasonably
estimable. In addition, we recognize contingent gains when such gains are
realized. We are a party to various litigation and other contingencies, the
ultimate outcome of which is not presently known. Should the ultimate outcome
of
these contingencies be adverse, such outcome could create an event of default
under ThermaClime's Working Capital Revolver Loan and the Senior Secured Loan
and could adversely impact our liquidity and capital resources.
Revenue
Recognition
- We
recognize revenue for substantially all of our operations at the time title
to
the goods transfers to the buyer and there remains no significant future
performance obligations by us. Revenue relating to construction contracts is
recognized using the percentage-of-completion method based primarily on contract
costs incurred to date compared with total estimated contract costs. Changes
to
total estimated contract costs or losses, if any, are recognized in the period
in which they are determined. Sales of warranty contracts are recognized as
revenue ratably over the life of the contract. See discussion above under
“Product Warranty” for our accounting policy for recognizing warranty
expense.
Recognition
of Insurance Recoveries -
If an
insurance claim relates to a recovery of our losses, we recognize the recovery
when it is probable and reasonably estimable. If our insurance claim relates
to
a contingent gain, we recognize the recovery when it is realized.
Management's
judgment and estimates in these areas are based on information available from
internal and external resources at that time. Actual results could differ
materially from these estimates and judgments, as additional information becomes
known.
Results
of Operations
The
following Results of Operations should be read in conjunction with our
Consolidated Financial Statements for the years ended December 31, 2006, 2005
and 2004 and accompanying notes and the discussions above under “Overview” And
“Liquidity and Capital Resources.”
The
following table contains certain information about our continuing operations
in
different industry segments for each of the three years ended December
31:
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
221,161
|
|
|
$
|
156,859
|
|
|
$
|
141,014
|
|
Chemical
|
|
260,651
|
|
|
|
233,447
|
|
|
|
216,264
|
|
Other
|
|
10,140
|
|
|
|
6,809
|
|
|
|
6,706
|
|
|
$
|
491,952
|
|
|
$
|
397,115
|
|
|
$
|
363,984
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit:
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
65,496
|
|
|
$
|
48,122
|
|
|
$
|
42,721
|
|
Chemical
|
|
22,438
|
|
|
|
16,426
|
|
|
|
8,917
|
|
Other
|
|
3,343
|
|
|
|
2,330
|
|
|
|
2,145
|
|
|
$
|
91,277
|
|
|
$
|
66,878
|
|
|
$
|
53,783
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
25,428
|
|
|
$
|
14,097
|
|
|
$
|
11,707
|
|
Chemical
|
|
10,200
|
|
|
|
7,703
|
|
|
|
(877
|
)
|
General
corporate expense and other business operations, net
|
|
(8,074
|
)
|
|
|
(6,835
|
)
|
|
|
(7,586
|
)
|
|
|
27,554
|
|
|
|
14,965
|
|
|
|
3,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
(11,915
|
)
|
|
|
(11,407
|
)
|
|
|
(7,393
|
)
|
Gains
on extinguishment of debt
|
|
-
|
|
|
|
-
|
|
|
|
4,400
|
|
Provision
for loss on notes receivable-Climate Control
|
|
-
|
|
|
|
-
|
|
|
|
(1,447
|
)
|
Non-operating
income (expense), net:
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
Chemical
|
|
311
|
|
|
|
362
|
|
|
|
2,463
|
|
Corporate
and other business operations
|
|
312
|
|
|
|
1,199
|
|
|
|
(29
|
)
|
Provision
for income taxes
|
|
(901
|
)
|
|
|
(118
|
)
|
|
|
-
|
|
Equity
in earnings of affiliate - Climate Control
|
|
821
|
|
|
|
745
|
|
|
|
668
|
|
Income
from continuing operations before cumulative effect of accounting
chang
|
$
|
16,183
|
|
|
$
|
5,746
|
|
|
$
|
1,906
|
|
Year
Ended December 31, 2006 Compared to Year Ended December 31,
2005
Net
Sales
The
following table contains certain information about our net sales in different
industry segments for 2006 and 2005:
|
2006
|
|
2005
|
|
Change
|
|
Percentage
Change
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
$
|
134,210
|
|
|
$
|
85,268
|
|
|
$
|
48,942
|
|
|
57.4
|
%
|
Hydronic
fan coils
|
|
59,497
|
|
|
|
53,564
|
|
|
|
5,933
|
|
|
11.1
|
%
|
Other
HVAC products
|
|
27,454
|
|
|
|
18,027
|
|
|
|
9,427
|
|
|
52.3
|
%
|
Total
Climate Control
|
$
|
221,161
|
|
|
$
|
156,859
|
|
|
$
|
64,302
|
|
|
41.0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chemical:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Industrial
acids and other chemical products
|
$
|
95,208
|
|
|
$
|
80,228
|
|
|
$
|
14,980
|
|
|
18.7
|
%
|
Agricultural
products
|
|
89,735
|
|
|
|
80,638
|
|
|
|
9,097
|
|
|
11.3
|
%
|
Mining
products
|
|
75,708
|
|
|
|
72,581
|
|
|
|
3,127
|
|
|
4.3
|
%
|
Total
Chemical
|
$
|
260,651
|
|
|
$
|
233,447
|
|
|
$
|
27,204
|
|
|
11.7
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
$
|
10,140
|
|
|
$
|
6,809
|
|
|
$
|
3,331
|
|
|
48.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales
|
$
|
491,952
|
|
|
$
|
397,115
|
|
|
$
|
94,837
|
|
|
23.9
|
%
|
Climate
Control Business
· Net
sales
of our geothermal and water source heat pump products increased primarily as
a
result of a 52% increase in the number of units sold in the commercial and
residential markets due to customer demand representing an approximate 4% gain
in market share based on data supplied by the ARI;
· Net
sales
of our hydronic fan coils increased primarily due to a 10% increase in overall
average unit sales prices as the result of lowering discounting and higher
selling prices driven by raw material cost increases;
· Net
sales
of our other HVAC products increased as the result of an increase in the number
of larger custom air handlers sold primarily relating to three large
projects.
Chemical
Business
El
Dorado
and Cherokee produce all the chemical products described in the table above
and
Baytown produces only industrial acids products. Overall, volume of tons sold
for the Chemical Business increased 12% while sales prices remained consistent
with 2005.
· Volume
at
El Dorado increased 14% primarily related to agricultural products as the result
of the loss of production during the first half of 2005 as discussed below,
to
industrial acid and other chemical products due to spot sales opportunities,
and
to mining products relating to the growth of coal mining in the mining
industry;
·
|
Volume
at Baytown increased 24% as the result of a closing of a chemical
facility
within our market and other various spot sales
opportunities;
|
·
|
Volume
at Cherokee decreased 6% resulting from the suspension of production
during the first half of January 2006 as the result of a reduction
in
orders from several key customers due to the increased natural gas
costs
and further production curtailments throughout the first quarter
of
2006.
|
Other
- Net
sales
classified as “Other” consists of sales of industrial machinery and related
components. The increase in net sales relates primarily to increased customer
demand for our machine tool products.
Gross
Profit
Gross
profit by industry segment represents net sales less cost of sales. The
following table contains certain information about our gross profit in different
industry segments for 2006 and 2005:
|
2006
|
|
2005
|
|
Change
|
|
Percentage
Change
|
Gross
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
65,496
|
|
|
$
|
48,122
|
|
|
|
$
|
17,374
|
|
|
36.1
|
%
|
Chemical
|
|
22,438
|
|
|
|
16,426
|
|
|
|
|
6,012
|
|
|
36.6
|
%
|
Other
|
|
3,343
|
|
|
|
2,330
|
|
|
|
|
1,013
|
|
|
43.5
|
%
|
|
$
|
91,277
|
|
|
$
|
66,878
|
|
|
|
$
|
24,399
|
|
|
36.5
|
%
|
In
addition to the information presented in the above table, our Climate Control
Business’ gross profit percentage (as a percentage of net sales) was 29.6% for
2006 compared to 30.7% for 2005. The gross profit percentage of our Chemical
Business was 8.6% for 2006 compared to 7.0% for 2005. The gross profit
percentage relating to “Other” (see discussion above) was 33.0% for 2006
compared to 34.2% for 2005.
The
increase in gross profit in our Climate Control Business was a direct result
of
the increase in sales volume as discussed above. The decline in our gross profit
percentage was primarily due to raw material costs increases being incurred
ahead of customer price increases becoming effective.
The
net
increase in gross profit of our Chemical Business relates primarily
to:
|
·
|
Cherokee
as the result of not incurring the disruptions at the plant caused
by the
rise in natural gas costs due to the hurricanes in the U.S. Gulf
in 2005
and a decrease in electricity costs as a result of a negotiated reduction
in utility rates in 2006;
|
|
·
|
Baytown
due primarily to the increase in sales volume as discussed
above;
|
|
·
|
El
Dorado as the result of the increase in sales volume as discussed
above.
|
As
previously reported, beginning in October 2004 and continuing into June 2005,
the Chemical Business’ results were adversely affected as a result of the loss
of production due to a mechanical failure of one of the four nitric acid plants
at El Dorado. The plant was restored to normal production in June 2005. We
recognized insurance recoveries of $0.9 million and $1.9 million under our
business interruption insurance policy relating to this claim for 2006 and
2005,
respectively, which is recorded as a reduction to cost of sales. The negative
impact on gross profit resulting from the lost production was approximately
$4.1
million in 2005.
The
increase in gross profit classified as “Other” (see discussion above) is due
primarily to the increase in sales as discussed above.
Operating
Income
Our
chief
operating decision makers use operating income by industry segment for purposes
of making decisions which include resource allocations and performance
evaluations. Operating income by industry segment represents gross profit by
industry segment less selling, general and administrative expense (“SG&A”)
incurred by each industry segment plus other income and other expense
earned/incurred by each industry segment before general corporate expenses
and
other business operations, net. General corporate expenses and other business
operations, net consist of unallocated portions of gross profit, SG&A, other
income and other expense. The following table contains certain information
about
our operating income for 2006 and 2005:
Operating
income:
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
25,428
|
|
|
$
|
14,097
|
|
|
$
|
11,331
|
|
Chemical
|
|
10,200
|
|
|
|
7,703
|
|
|
|
2,497
|
|
General
corporate expense and other business operations, net
|
|
(8,074
|
)
|
|
|
(6,835
|
)
|
|
|
(1,239
|
)
|
|
$
|
27,554
|
|
|
$
|
14,965
|
|
|
$
|
12,589
|
|
Operating
Income - Climate Control: The
net
increase in operating income of our Climate Control Business resulted primarily
from the net increase of gross profit of $17.4 million as discussed above,
an
arbitration award of $1.2 million received in 2006 relating to the arbitration
case involving Trison as discussed under “Climate Control Business” of Item 3,
and a decrease in professional fees of $1.0 million primarily as the result
of
fees incurred during 2005 relating to this arbitration case. This increase
in
operating income was partially offset by increased shipping and handling costs
of $3.9 million due to increased sales volume and rising fuel costs, increased
commissions of $1.8 million due to increased sales volume and distribution
mix
and increased personnel cost of $1.6 million as the result of increased number
of personnel and higher incentives, and increased warranty costs of $0.7 million
due to the increased sales volume.
Operating
Income - Chemical: The
net
increase of our Chemical Business’ operating income primarily relates to the net
increase in gross profit of $6.0 million as discussed above. This increase
in
operating income was partially offset by an increase in handling costs of $0.8
million due primarily to increased sales volume and an increase in professional
fees of $0.4 million relating to legal costs associated with ammonium nitrate
anti-dumping tariffs. In addition, we recognized gains of $1.6 million from
certain property insurance claims in 2005.
General
Corporate Expense and Other Business Operations, Net: The
net
increase in our general corporate expense and other business operations, net
relates primarily to an increase of $0.6 million in personnel costs relating
to
increased group health care costs of $0.4 million and commissions of $0.3
million on the increased sales classified as “Other” as discussed above, an
increase in professional fees of $0.6 million due, in part, for assistance
in
our evaluation of our internal controls and procedures and related documentation
for Sarbanes-Oxley requirements, a litigation settlement of $0.3 million
relating to an asserted financing fee, and a decrease in gains of $0.7 million
from the sales of corporate assets. The increase was partially offset by the
increase in gross profit classified as “Other” of $1.0 million and a refund of
$0.4 million relating to insurance brokerage fees.
Interest
Expense
-
Interest expense was $11.9 million for 2006 compared to $11.4 million for 2005,
an increase of $0.5 million. This net increase in interest expense includes
$1.1
million relating to the Debentures sold in March 2006 and $0.3 million of
additional consideration paid in conjunction with the conversion of a portion
of
the Debentures during 2006 which was partially offset by a decrease of $0.8
million relating to the Notes which were purchased or redeemed during 2006.
Non-Operating
Other Income, net
- Our
non-operating other income, net was $0.6 million for 2006 compared to $1.6
million for 2005. In 2005, we recognized net proceeds from life insurance
policies of $1.2 million.
Provision
For Income Taxes
- Due to
net operating loss (“NOL”) carryforwards, provisions for income taxes consist of
federal alternative minimum taxes and state income taxes for 2006 and federal
alternative minimum taxes for 2005.
Net
Loss From Discontinued Operations
- Net
loss from discontinued operations includes provisions of $0.2 million and $0.6
million for 2006 and 2005, respectively, for our share of estimated
environmental remediation costs to investigate and delineate a site in
Hallowell, Kansas as a result of meetings with the KDHE. There are no income
tax
benefits related to these expenses.
Year
Ended December 31, 2005 Compared to Year Ended December 31,
2004
Net
Sales
The
following table contains certain information about our net sales in different
industry segments for 2005 and 2004:
|
2005
|
|
2004
|
|
Change
|
|
Percentage
Change
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
$
|
85,268
|
|
|
$
|
73,920
|
|
|
$
|
11,348
|
|
|
15.4
|
%
|
Hydronic
fan coils
|
|
53,564
|
|
|
|
48,760
|
|
|
|
4,804
|
|
|
9.9
|
%
|
Other
HVAC products
|
|
18,027
|
|
|
|
18,334
|
|
|
|
(307
|
)
|
|
(1.7
|
)
%
|
Total
Climate Control
|
$
|
156,859
|
|
|
$
|
141,014
|
|
|
$
|
15,845
|
|
|
11.2
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chemical:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
products
|
$
|
80,638
|
|
|
$
|
72,154
|
|
|
$
|
8,484
|
|
|
11.8
|
%
|
Industrial
acids and other chemical products
|
|
80,228
|
|
|
|
82,040
|
|
|
|
(1,812
|
)
|
|
(2.2
|
)
%
|
Mining
products
|
|
72,581
|
|
|
|
62,070
|
|
|
|
10,511
|
|
|
16.9
|
%
|
Total
Chemical
|
$
|
233,447
|
|
|
$
|
216,264
|
|
|
$
|
17,183
|
|
|
7.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
$
|
6,809
|
|
|
$
|
6,706
|
|
|
$
|
103
|
|
|
1.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales
|
$
|
397,115
|
|
|
$
|
363,984
|
|
|
$
|
33,131
|
|
|
9.1
|
%
|
Climate
Control Business
· Net
sales
of our geothermal and water source heat pump products increased primarily as
a
result of stronger customer demand, a 7% increase in overall average unit sales
prices due to the increase in our raw material costs as discussed below, and
change in product mix;
· Net
sales
of our hydronic fan coils increased primarily from a 6% increase in overall
average unit sales prices due to the increase in our raw material costs as
well
as an improvement in product mix;
· Net
sales
of our other HVAC products decreased $0.3 million. For 2004, net sales of other
HVAC products includes $3.8 million as a result of consolidating MultiClima’s
operating results in the second quarter of 2004 as required under FIN 46.
Effective July 1, 2004, we were no longer required to consolidate MultiClima’s
operating results. Excluding the effect of MultiClima, sales of other HVAC
products increased $3.5 million which includes an increase in sales of $1.1
million relating to our modular chiller systems, $0.9 million relating to our
large custom air handlers, $0.9 million as a result of an increase in
construction projects and $0.7 million relating to a new product line with
increasing demand.
Chemical
Business
As
discussed above, El Dorado and Cherokee produce all the chemical products
described in the table above and Baytown produces only industrial acids
products. Overall sales prices for the Chemical Business increased 13% but
overall volume of tons sold decreased 5%.
·
|
The
overall increase in sales prices reflects, in part, higher sales
prices
resulting from the increased cost of the raw material feedstocks
(anhydrous ammonia and natural gas) as discussed below;
|
·
|
The
volume at Baytown was down 14% due to lower demand for nitric acid
by
Bayer resulting from the shutdown of one of North America’s consuming
locations;
|
·
|
The
volume at Cherokee decreased 4% due primarily to the suspension of
production resulting from the hurricanes in the U.S. Gulf as discussed
above under “Overview-Chemical Business.”
|
Other
- Net
sales
classified as “Other” consists of sales of industrial machinery and related
components.
Gross
Profit
Gross
profit by industry segment represents net sales less cost of sales. The
following table contains certain information about our gross profit in different
industry segments for 2005 and 2004:
|
2005
|
|
2004
|
|
Change
|
|
Percentage
Change
|
Gross
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
48,122
|
|
|
$
|
42,721
|
|
|
$
|
5,401
|
|
|
12.6
|
%
|
Chemical
|
|
16,426
|
|
|
|
8,917
|
|
|
|
7,509
|
|
|
84.2
|
%
|
Other
|
|
2,330
|
|
|
|
2,145
|
|
|
|
185
|
|
|
8.6
|
%
|
|
$
|
66,878
|
|
|
$
|
53,783
|
|
|
$
|
13,095
|
|
|
24.3
|
%
|
In
addition to the information presented in the above table, our Climate Control
Business’ gross profit percentage (as a percentage of net sales) was 30.7% for
2005 compared to 30.3% for 2004. The gross profit percentage of our Chemical
Business was 7.0% for 2005 compared to 4.1% for 2004. The gross profit
percentage relating to “Other” (see discussion above) was 34.2% for 2005
compared to 32.0% for 2004.
The
net
increase in gross profit of our Climate Control Business resulted primarily
by
the increase in sales of our geothermal and water source heat pumps and hydronic
fan coils as discussed above. This increase in gross profit was partially offset
by a change in product/customer mix and our inability to fully pass on to our
customers in the form of product price increases the increase in the raw
material cost of copper. The spot market increases through the twelve months
of
2005 for copper were approximately 40%. In addition, a decrease of $0.8 million
relates to MultiClima in the second quarter of 2004 as discussed
above.
The
net
increase in gross profit of our Chemical Business is due primarily to improved
margins on certain agricultural and industrial acid products and cost recoveries
during 2005 of $2.1 million of production catalyst (precious metals) used in
our
manufacturing processes compared to $0.2 million during 2004. The increase
in
gross profit was offset, in part, by our inability to fully pass on to our
customers the 25% increase in costs of anhydrous ammonia during the spring
and
fall planting seasons incurred by El Dorado, the 34% increase in costs of
natural gas sustained by Cherokee and the suspension of production at Cherokee
resulting from the hurricanes in the U.S. Gulf as discussed above under
“Overview-Chemical Business”. Cherokee also incurred an increase of $2.2 million
of electricity costs primarily as the result of increased rates charged by
their
utility company. In addition in 2004, net settlements of $1.5 million (which
increased gross profit) were reached with insurance carriers relating to a
vendor’s faulty repair work to a chemical plant boiler.
As
discussed above and previously reported, the Chemical Business’ results were
adversely affected as a result of the loss of production due to a mechanical
failure of one of the four nitric acid plants at El Dorado. We recognized
insurance recoveries of $1.9 million under our business interruption insurance
policy relating to this claim for 2005 which is recorded as a reduction to
cost
of sales. The negative impact on gross profit resulting from the lost production
was approximately $4.1 million in 2005 and approximately $1.0 million in
2004.
See
discussion above for products sold which are classified as “Other”.
Operating
Income (Loss)
See
discussion above concerning the definition and use of operating income (loss)
by
industry segment by our chief operating decision makers. The following table
contains certain information about our operating income (loss) for 2005 and
2004:
Operating
income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
14,097
|
|
|
$
|
11,707
|
|
|
$
|
2,390
|
|
Chemical
|
|
7,703
|
|
|
|
(877
|
)
|
|
|
8,580
|
|
General
corporate expense and other business operations, net
|
|
(6,835
|
)
|
|
|
(7,586
|
)
|
|
|
751
|
|
|
$
|
14,965
|
|
|
$
|
3,244
|
|
|
$
|
11,721
|
|
Operating
Income - Climate Control: The
net
increase in our Climate Control Business’ operating income resulted primarily by
selling, general and administrative expenses of $1.4 million relating to
MultiClima which were only incurred in the second quarter of 2004 and the net
increase in gross profit of $5.4 million as discussed above. This increase
in
operating income was partially offset by increased shipping and handling costs
of $1.0 million as a result of increased sales volume and rising fuel costs,
increased professional fees of $0.9 million primarily relating to litigation
and
related arbitrations between Trison and a customer (as discussed under “Climate
Control Business” of Item 3), increased commissions of $0.8 million due to
increased sales volume, increased personnel costs of $0.6 million due primarily
to increased group health insurance costs and increased provision for losses
on
accounts receivable of $0.5 million due primarily to lower than usual incidence
in 2004 and the increased sales volumes in 2005.
Operating
Income (Loss) - Chemical:
The net
increase in our Chemical Business’ operating income included the net increase in
gross profit of $7.5 million as discussed above and gains of $1.6 million from
replacement cost property insurance recoveries which includes $1.5 million
of
recoveries discussed above under “Business Interruption and Property Insurance
Claims” of Item 3 and a decrease in personnel costs of $0.3 million as a result
of a reduction in personnel at El Dorado. This increase was partially offset
by
an increase in handling costs of $1.0 million due primarily to higher railcar
lease and maintenance costs as the result of increasing the number of railcars
used to support our agricultural business.
General
Corporate Expense and Other Business Operations, Net: The
decrease in our general corporate expense and other business operations, net
relates primarily to an increase in gains of $0.7 million from the sales of
corporate assets, a decrease in professional fees of $0.3 million which includes
costs incurred during 2004 relating to a proposed unregistered offering of
Senior Secured Notes which was terminated, a decrease of $0.3 million of
provisions for impairments on corporate assets and a decrease of approximately
$0.6 million due to other individually immaterial items. This decrease was
partially offset by an increase in personnel costs of $1.1 million which
includes the recognition of death benefit obligations, an increase in group
health insurance costs and net premium costs associated with key individual
life
insurance policies including policies associated with a death benefit agreement
entered into with our CEO during the second quarter of 2005.
Interest
Expense
-
Interest expense was $11.4 million for 2005 compared to $7.4 million for 2004.
The increase of $4.0 million relates primarily to interest expense incurred
on
the $50.0 million term loan that was completed in September 2004 as discussed
under “Loan Agreements - Terms and Conditions.” A portion of the proceeds of the
Senior Secured Loan was used to repay the outstanding balance under a former
financing agreement (“Financing Agreement”). There was no interest expense
recognition on the Financing Agreement indebtedness from May 2002 through
September 2004 since that transaction was accounted for as a voluntary debt
restructuring in 2002. This increase was partially offset due to the repurchase
of $5.0 million of the Senior Unsecured Notes in September 2004.
Provision
for Loss on Notes Receivable
- Based
on our assessment of the liquidity and results of operations of MultiClima
and
its parent company, we concluded that the outstanding notes receivable were
not
recoverable. As a result, effective July 1, 2004, we forgave and cancelled
the
loan agreements in exchange for extending the Option’s expiration date from June
15, 2005 to June 15, 2008 with an estimated value of zero. We recognized a
provision for loss of $1.4 million for 2004.
Gain
on Extinguishment of Debt
- As a
result of the repayment in September 2004 of the Financing Agreement prior
to
the maturity date of June 30, 2005, we recognized the remaining unearned
interest of $4.4 million as a gain on extinguishment of debt.
Non-Operating
Other Income, net - Our
non-operating other income, net was $1.6 million for 2005 compared to $2.4
million for 2004, a decrease of $0.8 million. In 2005, we received net proceeds
from life insurance policies of $1.2 million. In addition, we recognized gains
of $0.2 million from the sales of certain current assets (primarily precious
metals) in 2005 compared to gains of $2.3 million in 2004.
Loss
from Discontinued Operations
- Net
loss from discontinued operations in 2005 consists of provisions of $0.6 million
for our share of estimated environmental remediation costs to investigate and
delineate a site in Hallowell, Kansas as a result of meetings held during 2005
with the KDHE. There are no income tax benefits related to these
expenses.
Cumulative
Effect of Accounting Change
-
Effective March 31, 2004, we included in our condensed consolidated balance
sheet the consolidated assets and liabilities of the parent company of
MultiClima as required under FIN 46.
As a
result, we recorded a cumulative effect of accounting change of $0.5 million
primarily relating to the elimination of embedded profit included in the cost
of
inventory which was purchased from MultiClima by certain of our subsidiaries.
Effective July 1, 2004, we no longer had a variable interest in this entity
and
were no longer required to consolidate this entity.
Cash
Flow From Operating Activities
Historically,
our primary cash needs have been for operating expenses, working capital and
capital expenditures. We have financed our cash requirements primarily through
internally generated cash flow, borrowings under our revolving credit
facilities, secured asset financing and the sale of assets. See additional
discussion concerning cash flows from our Climate Control and Chemical
Businesses in "Liquidity and Capital Resources."
For
2006,
net cash provided by continuing operating activities was $17.7 million,
including net income (which includes insurance recoveries of $0.9 million under
our business interruption insurance policy), plus depreciation and amortization
and other adjustments offset by cash used by changes in assets and liabilities.
Accounts
receivable increased $18.1 million relating primarily to the Climate Control
Business as the result of increased sales of our heat pump products, large
custom air handlers, and hydronic fan coils as discussed above under “Results of
Operations.”
Inventories
increased a net $7.3 million including:
· an
increase of $10.4 million relating to the Climate Control Business primarily
relating to the increased cost of certain raw materials and the increased
quantities of raw materials on hand due to increasing sales volume, partially
offset by
· a
decrease of $3.2 million relating to the Chemical Business as the results of
the
decline in the average cost of anhydrous ammonia and natural gas in December
2006 compared to December 2005 and reduced inventory on hand at Cherokee due
to
a Turnaround performed in December 2006.
Other
supplies and prepaid items increased $1.9 million primarily due to a net
increase of $1.4 million in precious metals as a result of the increased cost
of
precious metals and recoveries performed and additional precious metals
purchased net of the amount consumed in the manufacturing process in the
Chemical Business.
Accounts
payable increased $11.2 million primarily due to:
· an
increase of $5.4 million in our Climate Control Business resulting from
increased production of our heat pump products, large custom air handlers,
and
hydronic fan coils, increased cost of certain raw materials, and increased
levels of raw materials on hand and
· an
increase of $5.1 million in our Chemical Business resulting primarily from
Baytown’s property taxes and scheduled lease payments, costs incurred by
Cherokee relating to a Turnaround performed in December 2006, and increased
sales volume at Baytown in December 2006 compared to December 2005.
Customer
deposits increased $1.0 million primarily due to the increase in deposits
received on sales commitments by Cherokee and as down payments on two customer
orders of large air handlers in the Climate Control Business.
The
increase in other current and noncurrent liabilities of $3.5 million includes
primarily:
· an
increase of $1.2 million of accrued commissions primarily as the result of
increased sales volume in the Climate Control Business,
· an
increase of $1.0 million of deferred revenue on extended warranty contracts
as
the result of increased sales volume in the Climate Control Business,
· an
increase in accrued contractual manufacturing obligations of $1.0 million
pursuant to EDC’s supply agreement and EDNC’s Bayer Agreement in the Chemical
Business,
· an
increase of $0.7 million in accrued payroll and benefits due primarily to an
increase in the number of employees and to salary and wage incentives in the
Climate Control Business,
· an
increase of $0.6 million of accrued death benefits relating to our benefit
agreements with certain key executives partially offset by,
· a
decrease of $1.1 million of accrued property and franchise taxes primarily
due
to Baytown’s property taxes being processed and included in accounts payable at
December 31, 2006 as discussed above.
Cash
Flow from Investing Activities
Net
cash
used by continuing investing activities was $18.4 million for 2006 which
included $14.7 million for capital expenditures of which $7.7 million and
$7.0
million are for the benefit of our Climate Control Business and Chemical
Business, respectively. In addition, we made deposits of $3.5 million of
current
and noncurrent restricted cash which is to be used for capital expenditures
in
the Climate Control Business, working capital, and to fund an
unrealized loss on exchange-traded contracts.
Cash
Flow from Financing Activities
Net
cash
used by continuing financing activities was $1.4 million and primarily consisted
of:
· the
acquisition of $13.3 million of the Notes as discussed above under “Loan
Agreements - Terms and Conditions”,
· payments
of $6.9 million on other long-term debt, and
· payments
of $6.1 million on revolving debt facilities, net of proceeds, offset, in part,
by
· proceeds
of $16.5 million from the Debentures, net of fees of $1.5 million, as discussed
above under “Loan Agreements - Terms and Conditions” and
· net
proceeds of $8.2 million from other long-term debt.
Off-Balance
Sheet Arrangements
We
do not
have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of
Regulation S-K under the Securities Exchange Act of 1934, as amended, except
for
the following:
Cepolk
Holding, Inc. (“CHI”), a subsidiary of the Company, is a limited partner and has
a 50% equity interest in Cepolk Limited Partnership (“Partnership”) which is
accounted for on the equity method. The Partnership owns an energy savings
project located at the Ft. Polk Army base in Louisiana (“Project”). At December
31, 2006, our investment was $3.3 million. For 2006, distributions received
from
this Partnership were $0.9 million and our equity in earnings was $0.8 million.
As of December 31, 2006, the Partnership and general partner to the Partnership
is indebted to a term lender (“Lender”) of the Project, in the amount of
approximately $5.3 million, net of restricted cash for debt service of $0.9
million, with a term extending to December 2010 (“Loan”). CHI has pledged its
limited partnership interest in the Partnership to the Lender as part of
the
Lender’s collateral securing all obligations under the Loan. This guarantee and
pledge is limited to CHI’s limited partnership interest and does not expose CHI
or the Company to liability in excess of CHI’s limited partnership interest. No
liability has been established for this pledge since it was entered into
prior
to adoption of FIN 45. CHI has no recourse provisions or available collateral
that would enable CHI to recover its partnership interest should the Lender
be
required to perform under this pledge.
Aggregate
Contractual Obligations
Our
aggregate contractual obligations as of December 31, 2006 are summarized in
the
following table.
Payments
Due in the Year Ending December 31,
Contractual
Obligations
|
|
Total
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
Thereafter
|
|
(In
thousands)
Long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Working
Capital Revolver Loan (1)
|
|
$
|
26,048
|
|
|
$
|
5,492
|
|
|
$
|
-
|
|
|
$
|
20,556
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
Secured Loan due 2009
|
|
|
50,000
|
|
|
|
625
|
|
|
|
1,250
|
|
|
|
48,125
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7%
Convertible Senior Subordinated Notes
|
|
|
4,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4,000
|
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
leases
|
|
|
767
|
|
|
|
342
|
|
|
|
360
|
|
|
|
34
|
|
|
|
31
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
|
16,877
|
|
|
|
5,120
|
|
|
|
2,293
|
|
|
|
954
|
|
|
|
1,047
|
|
|
|
1,079
|
|
|
|
6,384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
long-term debt
|
|
|
97,692
|
|
|
|
11,579
|
|
|
|
3,903
|
|
|
|
69,669
|
|
|
|
1,078
|
|
|
|
5,079
|
|
|
|
6,384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
payments on long-term debt (2)
|
|
|
26,858
|
|
|
|
9,388
|
|
|
|
9,059
|
|
|
|
5,732
|
|
|
|
860
|
|
|
|
676
|
|
|
|
1,143
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
expenditures (3)
|
|
|
8,169
|
|
|
|
8,169
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
leases:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Baytown
lease
|
|
|
26,351
|
|
|
|
10,297
|
|
|
|
11,173
|
|
|
|
4,881
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
operating leases
|
|
|
12,052
|
|
|
|
3,120
|
|
|
|
2,244
|
|
|
|
1,794
|
|
|
|
1,226
|
|
|
|
819
|
|
|
|
2,849
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exchange-traded
futures contracts
|
|
|
3,208
|
|
|
|
3,208
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accrued
contractual manufacturing obligations
|
|
|
2,161
|
|
|
|
2,161
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchase
obligations
|
|
|
3,828
|
|
|
|
1,044
|
|
|
|
1,044
|
|
|
|
1,044
|
|
|
|
696
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual
obligations included in noncurrent accrued and other
liabilities
|
|
|
2,700
|
|
|
|
-
|
|
|
|
171
|
|
|
|
174
|
|
|
|
171
|
|
|
|
171
|
|
|
|
2,013
|
|
Total
|
|
$
|
183,019
|
|
|
$
|
48,966
|
|
|
$
|
27,594
|
|
|
$
|
83,294
|
|
|
$
|
4,031
|
|
|
$
|
6,745
|
|
|
$
|
12,389
|
|
(1
|
)
|
We
primarily utilize a cash management system with a series of separate
accounts consisting of several “zero-balance” disbursement accounts for
funding of payroll and accounts payable. As a result of our cash
management system, checks issued, but not presented to the banks
for
payment, may create negative book cash balances. These negative book
cash
balances are included in current portion of long-term debt since
these
accounts are primarily funded by our Working Capital Revolver
Loan.
|
(2
|
)
|
The
estimated interest payments relating to variable interest rate debt
are
based on the effective interest rates at December 31, 2006. In addition,
we used the balance of the Working Capital Revolver Loan at December
31,
2006 as the average outstanding balance of the Working Capital Revolver
Loan through maturity.
|
|
|
|
(3
|
)
|
Capital
expenditures include only non-discretionary amounts in our 2007 capital
expenditure budget. These amounts do not include, as discussed in
“Environmental Matters” under Item 1, an estimated range from $0.8 million
to $2.8 million as required under a NPDES permit effective June 2007
based
on current assumptions and an estimated $2.5 million to $4.0 million
over
the next four years relating to the Air
CAO.
|
Availability
of Company's Loss Carry-Overs
For
a
discussion on our net operating loss carry-overs, see Note 12 of Notes to
Consolidated Financial Statements.
ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
General
Our
results of operations and operating cash flows are impacted by changes in market
interest rates and changes in market prices of copper, steel, anhydrous ammonia
and natural gas.
Forward
Sales Commitments Risk
Periodically
our Climate Control and Chemical Businesses enter into forward sales commitments
of products for deliveries in future periods. As a result, we could be exposed
to embedded losses should our product costs exceed the firm sales prices. At
December 31, 2006, we had $0.3 million of embedded losses associated with sales
commitments with firm sales prices in our Chemical Business.
Interest
Rate Risk
Our
interest rate risk exposure results from our debt portfolio which is impacted
by
short-term rates, primarily variable rate-based borrowings from commercial
banks, and long-term rates, primarily fixed-rate notes, some of which prohibit
prepayment or require substantial prepayment penalties.
We
purchased two interest rate cap contracts for a cost of $590,000 in March 2005
to help minimize our interest rate risk exposure relating to the Working Capital
Revolver Loan. These contracts set a maximum three-month LIBOR base rate of
4.59% on $30 million. These contracts mature on March 29, 2009. These contracts
are free-standing derivatives and are accounted for on a mark-to-market basis
in
accordance with SFAS 133. At December 31, 2006, the market value of these
contracts was $385,000.
Commodity
Price Risk
Our
Climate Control Business buys substantial quantities of copper and steel for
use
in manufacturing processes and our Chemical Business buys substantial quantities
of anhydrous ammonia and natural gas as feedstocks generally at market prices.
Periodically, our Climate Control Business enters into exchange-traded futures
for copper and our Chemical Business enters into exchange-traded futures for
natural gas, which contracts are generally accounted for on a mark-to-market
basis in accordance with SFAS 133. At December 31, 2006, our purchase
commitments under these contracts were for 300,000 pounds of copper through
March 2007 at a weighted average cost of $3.10 per pound ($931,000) and a
weighted average market value of $2.86 per pound ($859,000). In addition, our
Chemical Business had purchase commitments under these contracts for 300,000
MMBtu of natural gas through June 2007 at a weighted average cost of $7.59
per
MMBtu ($2,278,000) and a weighted average market value of $6.47 per MMBtu
($1,942,000).
The
following table presents principal amounts and related weighted-average interest
rates by maturity date for our interest rate sensitive financial instruments
and
our purchase commitments under exchange-traded futures contracts and related
weighted-average contract costs by contract terms as of December 31,
2006.
|
Years
ending December 31,
|
|
|
(Dollars
in thousands,except for per pound and
MMBtu)
|
|
2007
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
Thereafter
|
|
Total
|
|
Expected
maturities of long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Variable
rate debt
|
$
|
7,032
|
|
|
$
|
1,610
|
|
|
$
|
68,916
|
|
|
$
|
258
|
|
|
$
|
283
|
|
|
$
|
466
|
|
|
$
|
78,565
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
average
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
interest
rate (1)
|
|
10.31
|
%
|
|
|
10.37
|
%
|
|
|
10.36
|
%
|
|
|
8.95
|
%
|
|
|
|